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U.S. Inflation Set to Soar as the Country's Chief Export Boomerangs Back Home

While prices for food and energy have been rising, inflation in the United States has remained relatively subdued.

One common explanation for that phenomenon is that U.S. inflation has been "exported" to China and elsewhere through the U.S. Federal Reserve's monetary policy. And given the perennial U.S. balance of payments deficit, it's good to know the country has found something it can successfully export!

However, the bad news here is that inflation does not stay exported – and in 2011 it may boomerang back to make life on Main Street miserable.

Thankfully, there are precautions we can take to combat higher prices and preserve our wealth.

U.S. monetary policy has involved excessive money creation since 1995, fueling asset bubble after asset bubble. However, it has not produced inflation in the United States because the dollar is a reserve currency, so excess dollars flow to countries whose economies are more vulnerable to inflationary pressures.

In the 1990s, the excess dollars flowed to Argentina, whose currency was pegged to the dollar. The imported inflation wrecked Argentina's sound policies of that decade and contributed to a debt-fueled collapse in 2001. Since 2008, the excess money has gone to China, India, Brazil and other fast-growing emerging markets. It also has fueled a massive growth in foreign exchange reserves among the world's central banks. Central bank holdings of forex reserve have grown more than 16% per annum since 1998.

China, India, and Brazil all currently have massive inflation problems. China, which has increased its inflation by holding down its currency against the dollar, has been very proactive in tackling inflation as of late. The People's Bank of China (PBOC) surprised the markets on Christmas Day by raising its one-year refinancing rate by 52 basis points to 3.85% and increasing the benchmark deposit rate by 25 basis points to 2.75%.

The PBOC has increased bank reserve requirements five times in the past year and raised interest rates twice – albeit by a scant 0.25% each time.

China's official inflation rate currently is 5.1%, up from 1.5% at the beginning of 2010, but its figures are suspect. The PBOC probably will have to raise its benchmark rate several more times from its current level of 5.81% before it's able to bring inflation under control.

India's inflation is about 7.5%, but is expected to rise further since food prices are surging at double-digit rates. Prices for onions, for instance, are up 33% from last year. The Reserve Bank of India (RBI) is again raising interest rates, now at 6.25%. But, as in China, sloppiness in official inflation statistics means Indian interest rates are negative in real terms and the RBI will have to continue raising rates if it wants to control inflation.

Brazilian inflation was 5.91% in December and is rising fast. Newly elected President Dilma Rousseff fired the central bank chief and is trying to bring interest rates down from their current level of 10.75%. Again, inflation seems likely to surge in the near term.

To complete the BRIC (Brazil, Russia, India, and China) picture, Russian inflation is currently running at 8.8%. That's down from a year ago, but still much higher than the Russian government would like it to be.

With inflation rising in all four BRIC countries and many other emerging markets, the U.S. holiday from inflation cannot last much longer. The Fed's second round of quantitative easing (QE2), which included purchases of $600 billion in Treasury bonds before July, and the December package of tax cuts are also fueling inflationary forces.

Money growth, which had been low in 2009 after the burst in late 2008, has once again risen to worrying levels. Over the last four months, the average growth rates of broad money on the Federal Reserve Bank of St. Louis' Money of Zero Maturity and M2 Money Stock measures were up 10% and 7%, respectively. That's comparable to their growth in the 1970s.

Furthermore, oil prices are approaching $100 per barrel, and other commodity prices are strong, as well. So however successful the Fed has been in exporting inflation since 2008, its success won't last for much longer. At some point in 2011, inflation will be re-imported – and probably with a roar rather than a whisper.

When that happens, the Fed will have to raise interest rates to fight rising prices. Of course, Federal Reserve Chairman Ben Bernanke will almost certainly resist this inevitability, fudging figures and producing spurious arguments to avoid making the right decision. When the Fed does eventually raise rates, it will do so grudgingly – as it did during the period from 2004 to 2007.

That means higher short-term interest rates probably won't arrive until 2012, and higher long-term rates could potentially be delayed by more quantitative easing. The result will be an unholy mess that takes the form of surging inflation in 2011 and a second recessionary "dip" in 2012.

Gold and other commodities will continue to offer protection against the surge in inflation in 2011, as they have in the last few years. At some point, though, the market will start to anticipate tighter Fed policy and gold and other commodities prices will collapse.

Still, in 1979-80, gold and commodities prices went on rising for more than three months following then-Federal Reserve Chairman Paul Volcker's famous 1979 "October surprise," in which he pushed up the Federal Funds rate by two full percentage points over a weekend.

If the gold and commodities markets didn't believe the obviously serious Volcker would stop inflation until several months after he took decisive action, they certainly won't have confidence in the actions taken by a reticent Ben Bernanke. So your gold and commodities investments will probably be pretty safe even if the Fed does eventually start raising rates. Certainly they are a good bet for now. More importantly, they will protect you against the pending surge in inflation.

Action to Take: Given the likelihood of soaring inflation and a "double-dip" recession, investors would be wise to stock up on gold, silver and other commodities.

When it comes to the two most popular precious metals – and proven stores of value -the articles below discuss multiple vehicles by which investors can get in on gold and silver.

For Gold
: Check out Money Morning's forecast for gold for 2011, published as part of our "Outlook 2011" economic forecast series: Gold Price Forecast: Four Reasons the "Yellow Metal" Will Hit $1,900 an Ounce in 2011. Also worth your time, especially if you're a newcomer to precious-metals investing is our gold investment primer: Money Morning Special Report: How to Buy Gold.

For Silver: For silver, take a careful look at the Money Morning "Outlook 2011" economic forecast series installment: Silver Price Forecast: Investment Strategies for the "Other" Precious Metal in 2011.If you're new to precious metal investing, and would like a primer, check out Special Report: How to Buy Silver.

[Editor's Note: If you like the market insights and investment analysis that stories such as this one provide -but you want to receive stock recommendations, too, take a close look at our monthly affiliate newsletter, The Money Map Report.

Each month, the gurus who write for Money Morning get together and identify the very best profit opportunities you'll find anywhere in the world today.

Our writers use proprietary money-flow indicators to identify and isolate the most timely profit opportunities you'll find anywhere. For more information about The Money Map Report, please click here.]

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Join the conversation. Click here to jump to comments…

  1. Allen Simpson | January 13, 2011

    This is a very informative article. It clarifies why inflation in the U.S. has not occurred despite QE1 and 2

  2. jj | January 13, 2011

    Why do I keep reading stories stating that inflation hasn't arrived?What do you call 40% increases in cereal prices?That's approximately what has happened to cereal prices as Kelloggs,General Mills and others have drastically downsized package sizes.The same has occurred,with less downsizing,in just about every product sold in supermarkets.Several years ago Consumer Reports mentioned one brand of paper towel that had been downsized 6 times.I call this inflation and it has been going on for a long time.With housing bottoming the only things deflating are tech items.That doesn't offset everything else increasing in price.With fuel prices over $4 in China and much higher in Europe,it doesn't take much imagination to envision gasoline over $4 in the U.S. this year.I've read stories about American importers getting 33% less product for the same Dollars when purchasing clothing.So we can expect inflation to go over 10% this year.That should give us up to 5% inflation using govt statistics.Even admitted 5% is not going to allow the Fed to keep interest rates near zero.With most other countries raising rates the Dollar will collapse if we keep ours this low.Bernanke deserves this.The people of America probably deserve it too for having so much faith in big govt.

  3. James | January 13, 2011

    Agree. This is an informative article. Our chief export is dollars going to other countries like China, India, Brazil and Russia. Our export dollars are what keeping inflation under control in our own country. We are in a global economy now and we must expand our minds to think and act globally. The old rules don't apply, for a while anyway.

    The old school thinking was inflation (higher prices) results when money supply is increased. It was a case of "too much money chasing too few goods". Not anymore, when money can be exported to other countries to keep our own money supply under control.

    However, like you said, this is a temporary fix. Inflation will come. Price inflation is on the horizon.


    It is the Federal Reserve current policy to fuel inflation. It will keep injecting more fiat money into the system mainly to save the big banks, what you call, "overkill', do more than what is necessary to make sure your goal is achieved.

    This is a dangerous game the Fed is undertaking.

    The Federal Reserve policy is fueling commodity prices. Sugar is 28 cents a pound! Oil is heading for $100 a barrel. When oil reaches $100 our economy is going to tank, since oil pervades every aspect of our lives. After that it will not matter what the Fed does. It will not be able to control the economy.

    And another impending disaster looming over the horizon is the collapse of the EURO. PIGS (Portugal, Italy, Greece and Spain) will bring down the EURO.

    I agree with you, Mr. Hutchinson. Invest in silver, gold and commodities.

  4. Helen | January 13, 2011

    JJ is absolutely correct. I've noticed the same phenomena in my local grocery stores, along with a reduction in scope of choice. Manufacturers brands are being squeezed out to allow for store brand merchandise that can keep razor-thin profits from disappearing entirely.
    The country is under economic seige, no doubt about it. Inflation is not just coming, it's here, no matter what statistics Washington manufactures.

  5. Craig Kick | January 15, 2011

    This article is only missing one point. Interest rates rising at this point will collapse the dollar. The United States economy is not in 1979 or 1980 shape anymore. Back then America was a big producer with billions in debt….not trillions. Now there are $202 trillion in unfunded liabilities…..even if you remove everything but the National debt…..America has to print another trillion every 7 months to fund its spending….and this is accelerating. Why do you think the stock market is going up and interest rates are at all-time lows in a disastrous ecomony? Inflation…NEEDED inflation from the standpoint of central planners. The market knows the FED will step in…they have to! Any inkling of raising rates would destroy the bond market entirely… one would be coming in…..and everyone would want out. This would cause a default by the US. This is what happens when you let the FED control interest rates instead of the free market…….there is bubble after bubble until there are no bubble big enough to blow. Then the currency is trashed. It's happened in every country in the world 100% of the time when the money is backed by "faith". Gold and silver will never come down against the dollar. The dollar will not exist in 12-24 months so gold and silver will be priced in something else…..and this new currency will be backed by it.

    Look, you have 2 choices when you have trillions in debt…..print until the currency is dead or immediately default. The debt is too large to service through austerity or "hard work". Either way the currency goes to zero. It's about tax revenue…'s plummeting. Higher rates would crush the economy….tax revenue would plummet. The only way gold and silver would EVER go down with rising rates would be if rates were raised to slow a growing and rapidly expanding economy.

  6. n | January 16, 2011

    One of the best gauges of inflation is fast food. A McDonalds quarter pounder meal was held under 5 dollars for the longest time. In just the last few years, that has gone to 7.50 and THAT'S 50%.

  7. pat reppin | January 16, 2011

    Everything herein could be positively fascinating to me if I understood half of what I read.

    I am looking to buy silver, and I would have to take your advice and that of the silver handler and purchase junk silver as it appears to be what's a good buy.

    I dislike showing my lack of knowledge so flagrantly but I must ask: what does QE2 stand for?

    I apologize, but what can I say. I don't know what it means and it is used frequently.


  8. max | January 16, 2011

    your information is certainly in line with my beliefs and investments, and i certainly will continue to read your articles,as a canadian i see things are much more stable in our country for the moment.

  9. cwaltz | January 18, 2011


    QE2 is quantitive easing (round 2). Quantitive easing is a practice where the Fed injects money into the economy.

    QE2 was 600 billion if I'm not mistaken.

  10. chan | January 23, 2011

    America will remain as a "country of hope" and nothing will transform in to reality.Americans are not fit to think as globally.

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