Reports of Inflation’s Death Were Exaggerated

*** Occasionally you come across a small insect - a moth or a mosquito - fossilized in a drop of amber. The insect landed on bit of sticky tree say, millions of years ago, and then was covered by the flowing sap, which later hardened into amber.

The prices you see in today's markets reflect all the latest ideas, information, prejudices and hallucinations of investors - the sap at that moment. The next moment, they are history, past tense...and the investor, like that poor bug - is stuck. The sap looks attractive...but once he lights down on it...he's finished. He gets whatever he has coming.

The sap always keeps flowing...and saps are always surprised by it. So where is tomorrow's surprise coming from? There are two possibilities we can see. Either the global slump turns out to be much more punishing than investors expect. That is, instead of a soft landing for the world economy, there will be a smash-up that sends equities, property, and bonds a lot lower than people expect - with trillions of dollars in capital losses, tens of millions of families bankrupt, and a recession that is surprisingly deep and dreadful.

Another surprise might be that the reports of inflation's death were exaggerated. Inflation may not be dead at all - but just taking a rest. Oil may be going down, but it's not likely to go back to where it was in 2002. And since oil is so essential to the modern economy, higher priced oil is likely to continue working its way into consumer prices all over the world. And maybe China, India and Russia don't fall into such a deep slump that they stop using so much oil and other raw materials. And maybe their labor costs continue to rise at 10% per year - which then pumps up their export prices at double digit rates.

And, perhaps most important, neither the people nor the theories in modern central banking have changed. They are committed to a system with the dollar as its foundation...a system that ALMOST guarantees inflation.

We don't know what will happen - every day is a new day, after all - but we know how these central bankers think. And the more a recessionary downturn grips the world, the more Bernanke & Co. will fight against it. And they fight dirty - with counterfeit money.

It's the "Endgame for Fannie and Freddie" says this week's Barron's. And the weekend news brought word that the "US Likely to Recapitalize Fannie and Freddie." We expected nothing less. The two lenders are said to be worth about a negative $50 billion each - for a grand total of $100 billion. Of course, the feds don't exactly have a spare $100 billion lying around. But so what...they've got plenty of funny money. As the endgame comes for more American businesses and households, you can expect to see a lot more funny money passing itself off as the real stuff.

So which surprise is it likely to be? A deeper deflationary slump? Or a wilder ride on the inflation roller-coaster?

Both is still our guess.

Bill Bonner
for The Daily Reckoning Australia

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