Monday, January 24, 2011

More Economic Headwinds - Rising Prices

The WSJ headline today, Global Price Fears Mount, signal more risk to the economic recovery. Steel prices are rising as the price of raw materials, coal and iron, rise. China and Brazil are noted for their increased consumption of commodities. Meanwhile, the recovery is barely underway in the United States, with factories still sitting with unused capacity. Global food prices are also rising. The impact in Europe is expected to be rising interest rates to keep inflation in check.

The tough question is how this will impact the United States. The Fed is currently committed to fiscal stimulus. But commodity price increases have a history of triggering broader inflation. My concern is that the Fed will "get behind the curve" in fighting inflation and let it get out of control. Even though we briefly dipped into deflation in 2009, during the 2000s we have seen more volatility in the inflation measures than the 90s. There is no reason to believe we won't have swing to relatively high rates of inflation quickly as the economy recovers and commodity prices rise. Don't be fooled by the graph below, the dark line is actually at the 2% inflation line.
Image courtesy of WSJ.

For all of the talk about deflation from the likes of Krugman, we haven't actually seen deflation for any prolonged period. Maybe its just my bad experience growing up in the 70s, but I worry much more about an inflation that will require high interest rates that will crush out recovery.

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