The U.S. Federal Reserve has made one thing very clear: It views deflation as public enemy No. 1, and it will do everything in its power to keep that ruinous downward spiral in prices from taking hold.
But is the U.S. central bank focused on the wrong threat? And if that's the case, are U.S. policymakers setting the stage for a consumer-crippling inflation spike?
While the Fed last week announced more quantitative easing to pump more money into the U.S. economy – hoping that would encourage lending and spending – a cadre of cash-strapped consumers is worried the stimulus measures will actually ignite long-term inflation.
There is a precedent: The current policy is similar to one taken in 2003 – 2004, when the Fed kept rates near a record low and inflation rose faster than initially predicted.
"The parallels are very close to 2003, when the Fed had a maximum degree of panic about deflation when inflation had already bottomed out and was about to pick up," Stephen Stanley, chief economist at Pierpont Securities LLC, told Bloomberg. "Their inflation forecasts are going to be too low, and as a result policy is going to be very easy."
Inflation has slowed, rising 1.2% in September from the year before, the smallest gain since September 2001. A Reuters poll of 70 economists predicted that U.S. gross domestic product (GDP) growth will accelerate to a 2.2% annual rate in 2011's first quarter and to 2.5% in the second quarter.
But signs of an inflationary resurgence are starting to appear. Oil prices have climbed 18% since May, and such food staples as corn and cattle are up more than 20% so far this year.
Money Morning Contributing Editor Martin Hutchinson thinks the government's additional stimulus measures could spark a round of hyperinflation – sort of an inflation on steroids that causes market prices to skyrocket and currencies to plunge.
"With the Fed pumping all that cash into the system, deficits of $1.3 trillion and additional QE of $1 trillion on the table, the odds are getting greater all the time that a bout of hyperinflation could be in the cards," said Hutchinson.
Investors are worried, too – as the record prices for gold and silver underscore.
While the Fed has the tools to combat inflation, past experience shows that once the inflationary conflagration really starts to burn, it can take months or even years to put out the flames. And investors skeptical of U.S. economic policies are worried that it may already be too late.
"If prices only go up, say 3% to 4% over a course of a year, the Fed can probably keep it in check with a gradual increase in interest rates," said Hutchinson. "But the problem with inflation is it tends to take off very quickly. If you get a 20% bubble in prices in a few short months, the Fed would have a hard time reacting quickly enough."
This brings us to next week's Money Morning "Question of the Week:" Are you seeing signs of inflation? What, specifically, are you seeing? Are these rising prices putting the squeeze on your household budget? Do you think the Fed has misjudged the inflationary risk? What steps are you taking as a consumer and investor to protect against inflation?
Send your thoughts, questions and concerns to firstname.lastname@example.org.
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