The Real Inflation Question

The question isn’t whether or not we are going to have inflation the question is which kind.
inflation is imminent. The only argument that can be made is whether it will be stagflation, higher
inflation or rampant inflation. All of these scenarios are still in play. Does the global economy
continue to contract potentially leading to stagflation? Does the global/U.S. economy begin to grow
a little quicker leading to higher than normal, single digit inflation, or do we experience a global,
high growth/high employment recovery that leads to rampant, double digit inflation?
I think this is the most probable outcome. Rising inflation will be slow at first and then turn up sharply.

Stagflation is still very possible in the U.S. The Federal Reserve continues to increase money supply
in an effort to avoid the most damaging economic scenario. As they continue their attempt to stave
off stagflation they could be creating a high single digit inflation problem or even worse a double
digit 1970’s disaster. It is my belief that the Fed would welcome mid-single digit inflation. An even
weaker U.S. dollar would help the current trend of re-sourcing that is taking hold in the U.S.
manufacturing sector. Companies have begun to bring back manufacturing to the U.S. as it has
become more expensive to produce products in overseas. Higher inflation would benefit homeowners
that are upside down in their mortgages, creating additional jobs and GDP growth. Mid-single digit
inflation would also be a welcome contributor to our ability to pay down some of the $16 trillion
debt load by using cheaper currency. What the Fed would like to avoid is rampant inflation.
The Federal Reserve has artificially kept interest rates low. This is similar to not allowing steam
out of a locomotive engine. The steam would build up and eventually the pressure would cause it to
explode. The U.S. economy is no different. By artificially keeping interest rates low through buy
side liquidity that will eventually fade away, the Federal Reserve is creating a bubble. As soon as
the Federal Reserve stops supplying liquidity on the buy side the fixed income markets have
nowhere to go but down, potentially reversing a 31 year bull market.
I don’t believe stagflation will be the end result of the Federal Reserve’s monetary policies.
Instead, I’m confident that higher inflation and quite possibly rampant, double digit inflation is
likely. I’m a firm believer that economic growth and full employment (4% or less
unemployment) is probable.