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 has 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 would 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 prompted last 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?
Inflation Absolutely Here
Absolutely, yes, and it's already at 15% or higher.
Utilities: Our combined gas and electric is up 20% this year.
Cable and Internet: Up 3% – 6%.
Homeowners Insurance: Up almost 10%
Liquor Store: A $22 bottle of Jose Cuervo is now $26, so I've switched to a $20 per bottle brand. Wine that used to be $12 is now $14.99.
Health Insurance: Not yet known; I usually get renewal rates for our individual policy from our provider in September. I called them last week and they still had not mailed the renewals. I was told they were waiting because of the new health care concerns. Translate: Waiting to see what happened with elections. I'm expecting a 12% to 17% increase.
The Denver Post: I paid $165 for a one-year renewal last year. This year it was $220, and the paper is smaller, has more ads and less news. The business section is practically worthless. I seriously considered dropping it.
– Russ H.
Inflation Wiping Out U.S. Middle Class
Am I seeing inflation? Yes, but like the stuff that hits the fan, price increases are not evenly distributed. Food is up, gasoline is up, health-care costs are up, especially my insurance premiums, up 53% come Jan. 1, and college tuition and related costs are up. Things that are not increasing include wages and home prices, nor do I see any prospect that these items will soon feel any pressure to the upside, no matter how much money the Fed prints.
The Fed would desperately like to see inflation in home prices/values, as this would reduce the toxicity of the debt that is hurting banks and such, but I don't see it happening. That bubble has popped, and attempts to reinflate the previous bubble just serve to inflate new ones, which will pop in turn. Thus I, along with the rest of middle America, see my assets, including my earning ability, declining in value, while the things I have to buy to live are inflating rapidly. It appears that the American middle class is an endangered species, and our political masters either can't or won't help.
And speaking of help, honest numbers regarding inflation and employment would be a great place to start. The current numbers appear to be massaged to produce whatever result will justify the course of action that our political masters have already determined to pursue. As I once heard said, "I can prove anything if you just let me pick the data." And they don't just pick the data, they pick it out of thin air, whatever it takes to get the fore-ordained result. To the extent that we trust politicians and government agencies to do what is right, we are screwed. Look to your own defense.
– Gordon F.
Food Prices Up, Portions Down
Downsizing products is the name of the game in supermarkets.
How about Wheat Chex going from 22 ounces to 14 ounces? You can check out the downsizing of Cheerios and all General Mills Inc. (NYSE: GIS) cereals, or Breyers and most ice cream manufacturers going from half gallons (64 ounces) to 56 ounces and now to 48 ounces. I've got some older Dawn dishwashing liquid. One is 14.7 ounces, one is 12.5 ounces and now they are 10.5 ounces.
You see this everywhere. I guess the government ignores all this downsizing when they calculate inflation. My estimate is current inflation is about 6.0% – 8.0%. I expect it to go to around 15.0% by next year. That means the government will report about 5.0%.
Still, how is the Fed going to keep short-term rates near zero with reported 5.0% inflation?
– Jon J.
Yes – prices going up and quantity going down! They are inflating our packages with more air than product!
– Kirby B.
Every time I go to the grocery store, I overhear comments and complaints by folks noticing cost of food rising.
– Paul N.
I do know that an orange at the local grocery costs $1.10. I do recollect paying (but when, I'm not sure) 59 cents per pound, which equates to less than a quarter per orange. Is price inflation due to changes in resource demand or money (cash / credit) supply?
[Editor's Note: Thanks to all who responded to last week's "Question of the Week" feature regarding inflation. Be sure to answer next week's question: Are you a follow-the-leader investor? Have you profited by copying the market moves of famed investors, or do you prefer to turn elsewhere for stock guidance? Do you see any drawbacks to the required 13F filings or do you think the transparency is a beneficial regulation?
Send your answers to firstname.lastname@example.org.!
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Question of the Week Feature