- The Washington Times - Tuesday, September 22, 2009

Brushing aside statistics that show an annual inflation rate of less than zero, investors already are selling off dollars and driving up the price of gold in anticipation of a surge in prices as soon as the economy recovers from its deep recession.

Many economists think deflation is still a greater worry, but the fear of inflation has prompted a reprise of last year’s speculative interest in oil and other commodities, which this decade have proved to be good hedges against inflation. That, in turn, can be a self-fulfilling strategy, as pouring money into commodities drives up prices.

Energy prices rose sharply this spring and summer, driven by the revived speculative interest and expectations of a global recovery, but recently have leveled off to about $70 a barrel. The jump in gasoline and other energy prices caused the annualized rate of inflation in the past three months to surge to 4.4 percent, although prices overall remain down from year-ago levels.

Raymond J. Keating, chief economist for the Small Business & Entrepreneurship Council, cited the energy- related surge as reason to worry about inflation. “That’s pretty darn hot,” he said. “Even with an underperforming economic recovery, high inflation can in no way be ruled out.”

But Goldman Sachs investment strategist Abby Joseph Cohen says such worries are “spectacularly premature.”

Economists point out that outside the energy sector, most prices are still deflating, which is usual during a recession. As unemployment rises, consumers throttle back on spending and businesses seek to hold down prices in order to maintain sales and market share.

The price slashing in the past year was the most severe since World War II, reducing inflation from an annual rate of nearly 6 percent a year ago to minus 2.1 percent in the year ended in July — the lowest in 50 years. The big drop in prices mostly mirrored the plunge in oil and other commodity prices after a run-up to record levels last year.

“Core” inflation — excluding energy and food prices — has remained low and steady at about 1.5 percent — well within the Federal Reserve’s target range of 1 percent to 2 percent. Some economists say nonenergy inflation could drop below 1 percent in coming months as unemployment continues to rise.

Labor costs — the biggest expense for most businesses — are declining, leaving room for further price cuts.

“Given the depth of the recession, it will take years to get back to full employment, and deflation rather than inflation seems to be the greater threat,” said David Kelly, chief market strategist at JPMorgan Funds. Economists generally agree that a decline of core inflation below 1 percent would pose a threat of deflation.

John Makin, a Wall Street economist and resident scholar at the American Enterprise Institute for Public Policy Research, said the risk of deflation is still higher than inflation but that “recent steps by the Federal Reserve to preempt deflation have — ironically and unexpectedly — prompted a surge in inflation fears both inside the United States and abroad.”

He said investors’ preoccupation with inflation is understandable in light of the economic traumas and extreme market conditions of the past year.

“It’s crazy, but real,” Mr. Makin said. “Oscillations between fears of inflation and deflation in post-bubble periods are not unusual.”

The principal reason for inflation fears is that central banks in developed nations have accelerated the printing presses in their efforts to boost economic activity.

While the massive influx of dollars helped bring the United States to the point of recovery this summer, it may have sown the seeds for a raging bout of inflation in coming months, the price hawks say.

“Since inflation ultimately is about too much money chasing too few goods, and given the historic increase in the money supply over the past year, a bout of stagflation — that is, slow growth and relatively high inflation — remains a serious risk,” Mr. Keating said.

Federal Reserve officials have insisted that they will move quickly to raise interest rates if inflation emerges as a threat. But Fed Chairman Ben S. Bernanke also has signaled that the central bank would be unwilling to raise interest rates as long as unemployment remains high. It is expected to exceed 10 percent for much of next year.

In an acknowledgment that the economy appears to be entering a recovery, the Fed has started gradually withdrawing some of the trillions of dollars it extended to lending markets to counter the financial crisis in the past year. Other Fed lending programs are falling by the wayside as banks find they no longer need them.

“We want to make sure that we don’t overstimulate the economy into an inflation,” Mr. Bernanke said.

For inflation hawks, worries about the Fed’s easy-money policies are intertwined with worries about spiraling U.S. government debt. Starting with the George W. Bush administration and accelerating with the Obama administration, the government went on a debt splurge to revive the economy and the stricken banking system.

The increase in U.S. Treasury debt is on track to exceed $2 trillion this year as a result of Mr. Bush’s $700 billion bank bailout program, President Obama’s $787 billion stimulus program, a surge in social spending and a drop in revenues resulting from the recession.

On top of this unprecedented mountain of debt, Mr. Obama and the Democrat-controlled Congress are making plans for even more spending programs. In the most visible example, the House passed a health care reform bill that — rather than curb deficit spending driven by Medicare and Medicaid — would add more than $200 billion to federal health care spending in future years, according to the Congressional Budget Office.

Mr. Obama insists he will not sign a bill that increases deficits, but the White House also insists it is premature to be talking about rolling back spending increases or raising taxes as long as the economy is weak.

Worries about whether political leaders will summon the resolve to tackle deficits are fed by talk that the debt has grown so large that the country will have to maintain moderate rates of inflation in order to pay it down. Paying off debt is easier with inflated dollars; that is the way the government “paid off” much of the debt incurred during World War II, the last time the country ran up such massive deficits.

“I’m advocating 6 percent inflation for at least a couple of years,” Kenneth Rogoff, a Harvard University professor and former International Monetary Fund chief economist, has told Bloomberg News. “It would ameliorate the debt bomb and help us work through the deleveraging process.

“There’s trillions of dollars of debt, in mortgage debt, consumer debt, government debt …” Mr. Rogoff said. “It’s a question of how do you achieve the deleveraging. Do you go through a long period of slow growth, high savings and many legal problems, or do you accept higher inflation?”

Despite the occasional advocate for inflation, government officials and economists generally remain committed to keeping inflation low. But Mr. Makin said worries that the U.S. plans to pay off debt with inflated dollars “would be substantially reduced if the Obama administration showed some signs of concern about the rapid increase in U.S. budget deficits that, in turn, fuels concerns about the Fed’s need to accelerate money printing.”

Standard & Poor’s Chief Economist David Wyss said worry about burgeoning government deficits and loose money policies is misplaced as long as the economy is weak.

“People are looking at monetary indicators and the big increase in government debt, and saying it could presage inflation,” he said. “That’s not necessarily the case.”

He noted that the Bank of Japan printed money in the 1990s to cover mushrooming government debt. Despite that flood of liquidity, prices in Japan have trended lower for the past 15 years.

“These simplistic arguments that there’s necessarily going to be inflation because of government debt are simply not the case. If you look at the history, the link is not as clear as people might think,” he said.

Mr. Wyss predicted that inflation won’t be a major factor in the United States for five more years, the time he expects it will take the economy to fully rebound.

Some see an inflation worry stemming from plans by Mr. Obama and Democratic leaders in Congress to ratchet up regulation of nearly every sector in the economy, from banking and finance to the environment and health care.

The most significant potential regulation involves an economywide cap on carbon dioxide and other emissions said to cause climate change - a sweeping measure that could affect every business and consumer and drive up energy prices across the board.

“Cap and trade will do nothing to reduce pollution, yet it will drive up production costs throughout the economy,” said Peter Schiff, president of Euro Pacific Capital. “In addition to the huge cost of paying the tax, its enforcement involves the creation of an entire new bureaucracy, the costs of which will be borne by American consumers in the form of higher prices.”

He said proposals to increase government subsidies and regulation of the health care system also will worsen inflation in what has been the most consistently inflationary sector of the economy, because it already is heavily subsidized and regulated.

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