In recent testimony before Congress, Fed Chairman Ben Bernanke implicitly recognized that he’s in that most uncomfortableof spots: between a rock and a hard place. On the one hand, he noted, growth in the current quarter will slow sharply, perhaps to1.5 percent or less. That’s more like stagnation than growth. At the same time, inflation
remains a risk, as a look at a chart of oil, copper, or any other commodity makes plain.
For even more evidence of the inflationary threat, consider the sliding dollar.
There’s a strong relationship between rising commodities and a falling greenback. They spur each other on in a vicious circle that is now starting to gather speed.Under the influence of all these factors, inflation already has started to pick up, and it’s likely to continue to accelerate. While we hope the rise will be gradual, there are no
guarantees.
The one potential remedy would be the kind of medicine Paul Volcker applied so diligently in the late 1970s-early 1980s. That means deliberately engineering a recession. This time, though, the repercussions of a recession could be dire, bringing down the entire world economy. Keep in mind that right now only about $200 billion in bad debts lie behind the current threat to the $13 trillion U.S. economy. If the Fed applied the monetary brakes, that $200 billion would balloon exponentially. We continue to think the risks of stopping inflation far outweigh the risks of tolerating it, and we think the Fed will come to the same conclusion.
In the absence of a recession, the market will likely muddle along even as inflation accelerates. It might even make new highs. But it will continue to be led by real assets such as gold, energy.