It Is Pretty Obvious That Inflation Is Part Of The Government Plan (UUP, EWG, EWJ, DBA, XLE, EEM)

Martin Hutchinson: Forget about lost decades. Forecasts that we’ll be turning Japanese couldn’t be further from the truth. Here’s why.  It’s simple, really. Deflation is not in the interest of anybody in power, so it’s very unlikely to happen.

The U.S. Federal Reserve‘s policy move to target inflation last week just re-emphasizes this point.

That’s not to say deflation is a bad thing for everybody.

For savers and those living on fixed incomes, deflation would be a very good thing indeed.

Their income would gradually increase in real terms, and their savings would become steadily more valuable. Holders of Treasury bonds would also gain mightily from deflation.

However, the very people who would gain from deflation are not in power.

The People’s Bank of China can’t vote in the U.S. (yet!), Ron Paul is not president, and there is not an organized and powerful  savers’ political movement. After all, this is not Germany (NYSEArca:EWG) or Japan (NYSEArca:EWJ)!

Meanwhile, in the real world, the U.S. government is spending far more than it takes in, and its debt is rising to dangerous levels.  This has been happening on a bipartisan basis since at least 2001.

The Tea Party may have elected a Congress committed to reducing spending, but none of the battles of 2011 actually reduced spending  – they just slowed the rate of growth somewhat.

Since much of the debt is borrowed long-term at low interest rates, the best way to reduce its burden on future generations is to encourage inflation.

Savers may lose out on the deal, but to those in  Washington, the idea of inflating our way out of debt is irresistible.

Of course, sometimes we can depend on an independent central bank to resist this temptation. But at present, Fed Chairman Ben Bernanke is committed to near-zero interest rates in his fight against  deflation.

Now you don’t have to be a conspiracy theorist to  realize that, if the power structure is committed to at least moderate inflation, inflation is what you are going to get.

In fact, it is already brewing.

Keep Your Eye on The Money Supply

One of the more reliable signs of future inflation, at least in the medium term, is monetary growth.

In the last year, the St. Louis Fed’s Money of Zero Maturity, the nearest counterpart to the old broad-money M3, has risen by 9.5%, while the slightly narrower M2 has risen by 9.8%.

As for the monetary base, which monetary theory tells us is supposed to be the most accurate inflation indicator of them all, that’s up 29.9%. What’s more, there is  no sign of M2 and M3 slowing down.

If you don’t believe me, you can discover these  facts by clicking  here and seeing for yourself from the St Louis Fed’s weekly data.

This 9% to 10% increase in the money supply is  compared to a current rise in nominal gross domestic product (GDP) of about 5%.  (That’s including some acceleration in 2011’s fourth quarter over earlier in  the year.)

Since monetary “velocity” tends to increase  continually with modern payment systems, that is far more money growth than you need to currently run the economy.

So the real puzzle is not whether we will get inflation, but why we don’t have it now.

After all, interest rates have been near zero for more than three years now, and the money supply was rising faster than the economy for many years before that.

By all accounts, prices should be higher — but they  are not.

Inflation Pressures Begin to Build

Part of the answer is found overseas.

The main factor suppressing inflation since the middle 1990s has been the Internet and modern telecoms. These have made it much  easier to source products in low-wage countries.

So today we buy our clothes from China, whereas 20  years ago many of these same items were made in the U.S. The result has been about a 20% decline in apparel prices since their peak in 1993.

With this effect on consumer goods, and Moore’s Law making technology-based goods cheaper and better all the time, even the rise in  oil prices from about $10 per barrel in 1998 to about $100 today has been easily absorbed.

So the extra money that is sloshing around the world has pushed up commodity (NYSEArca:DBA) and energy prices (NYSEArca:XLE), but has had much less of an effect  on consumer prices.

However, there are signs that the price-suppressing effect of emerging markets (NYSEArca:EEM) manufacturing is coming to an end.

Chinese wages are rising rapidly, the currency has  risen against the dollar (NYSEArca:UUP), and China’s balance of trade surplus has almost disappeared.

In fact, consumer price inflation worldwide began trending up in 2011. Now that commodity prices are rising again – as you would  expect with expansionary money policy worldwide -2012 inflation pressures are  beginning to build.

And now even Ben Bernanke finally weighed in last  week as he tipped the scales even more decisively towards inflation.

By promising to keep interest rates at zero until the end of 2014, Bernanke has insured that interest rates almost certainly will remain below the inflation rate for the next three years.

That alone will cause inflation to rise, so we can expect the upward pressure on prices to continue.

So forget about deflation, since it will be vigorously resisted by the Obama Administration, Congress, and the Bernanke-led Fed. Inflation will keep heading higher from here.

In fact, by Election Day in November, inflation could be  at troubling levels.

As for turning Japanese? …. I don’t think so.

Written By Martin Hutchinson From Money Morning

Martin is a Contributing Editor to both the Money Map Report and  Money Morning. An investment banker with more than 25 years’ experience,  Hutchinson has worked on both Wall Street and Fleet Street and is a leading expert on the international financial markets. At CreditanstaltBankverein, Hutchinson was a Senior Vice President in  charge of the institution’s derivative operations, one of the most  challenging units to run. He also served as a director of Gestion Integral de Negocios, a Spanish private-equity firm, and as an advisor  to the Korean conglomerate, Sunkyong Corp. In February 2000, as part of  the Financial Services Volunteer Corps, Hutchinson became an advisor to  the Republic of Macedonia, working directly with Minister of Finance Nikola Gruevski (now that country’s Prime Minister). The nation had been staggered by the breakup of Yugoslavia – in which 800,000 Macedonians lost their life savings – and then the Kosovo War. Under Hutchinson’s  guidance, the country issued 12-year bonds, and created a market for the bonds to trade. The bottom line: Macedonians were able to sell their  bonds for cash, and many recouped more than three-quarters of what  they’d lost – to the tune of about $1 billion. Hutchinson earned his undergraduate degree in mathematics from Cambridge University, and an MBA from Harvard University. He lives near Washington, D.C.

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