Blogs & Comment

Inflation fears misplaced?

The U.S. monetary base has doubled to $1.7 trillion (US) since September, a consequence of theFederal Reserveflooding financial markets with liquidity to head off a collapse of the financial system. This startling jump has many observers worried about inflation taking off. Some even think the magnitude of the financial crisis will require an expansion in the money supply that could lead to hyperinflation.
This reminds me of the time I was following the macroeconomic commentary of a bank economist during the 1990s. As the economy recovered from the recession earlier in the decade, he kept warning about inflation reappearing. His warnings went on for a couple years yet inflation remained well behaved. Then came news his reports were no longer available. He had been let go by the bank.
I wonder if the inflationists this time around will similarly discover that their fears were misplaced. In March, the U.S. consumer price index (CPI) fell 0.4% year-over-year, the first decline in half a century. The core CPI was up 1.8% — mostly due to an increase in cigarette prices.
But what really makes one question the inflationary thesis is the amount of slack in the economy. As the Financial Times of London reports, the Congressional Budget Office calculates the “output gap” willbe 7% in 2009 and 2010. They dont expect it to be closed before 2015. Prices dont normally start going up until the output gap is a lot smaller.
Many people, including several well-known investors, have been calling for a bursting of the bubble in U.S. government bonds. I have been lookingat going short with the ProShares Ultra-Short 7-10 Year Treasury ( PST) or ProShares Ultra-Short 20+ year Treasury ( TBT) exchange-traded funds. However, until there is a resurgence of inflationary pressures, the decline could be less dramatic that what mightinitially beexpected.