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Let’s talk about inflation.
Sure, there’s little to worry about now. The slow economy will keep a damper on demand through 2012, and ample supplies of resources... from workers to raw materials...mean little pressure on wages or prices for at least the next year or so.
But come 2013 or soon after: Watch out.
Annual inflation of 5%-6% or more is a good bet, even if economic growth remains pokey. If the pace picks up, inflation will climb even higher.
Worse, the trend may continue for years.
Here’s why: A toxic cocktail is in the works... a powerful brew that makes a strong upward cycle of prices nearly inevitable. The main ingredient:
The government’s crushing debt load... already equal to 67% of the U.S.’ annual GDP and headed higher with each year’s budget deficit.
Add Washington’s inability to control it. Hamstrung by politics, the two parties show no signs of making the painful compromises that are needed to pare annual deficits enough to rein in debt.
Throw in the faltering economy and the Federal Reserve’s reluctance to raise interest rates for fear of throwing the country into another recession...
And you have a recipe for inflation. Skeptics who say that inflation comes from too much money chasing too few goods...clearly not the case in today’s economy... are humming the wrong tune. An overheated economy isn’t the only route to inflation. If it were, Zimbabwe’s 1,000-plus% inflation rate would’ve meant white-hot growth.
It’s a bit of a self-fulfilling prophecy, magnified by the enormous quantities of debt involved...$5 trillion in maturing Treasuries must be rolled over each year.
Expectations of inflation push up interest rates on long-term Treasuries as investors demand higher returns to compensate for erosion in their holdings’ value.
Prices of other assets are bid up as some holders of Treasuries coming due seek alternatives...stocks, commodities and so on...that may appreciate in value.
And goods and services...and the labor to produce them...start to cost more. Fearing that products they want or need will only carry a higher price tag tomorrow, consumers opt to spend more and save less today. With greater demand, prices rise.
So borrowers will win and creditors will lose. Debtors, including Uncle Sam, will pay back loans in dollars that aren’t worth as much as when they borrowed them.
In nominal terms, assets, including homes, will be worth more...a help to homeowners with underwater mortgages. But in real terms...little or no gain.
Inflation may even be stimulative, prodding the economy into faster growth. But once unleashed in a slow economy, inflation is hard to vanquish.