Inflation May Follow Recovery

Many people believe higher inflation is just around the corner, especially with the U.S. government flooding the market with new money. It’s worth keeping a keen eye on several factors that could ignite inflation.

More good news is finding space on the financial pages as the global economy continues a slow recovery.

World trade flows have been rebounding, and business inventories continue to decline. Even unemployment, a lagging indicator of economic upturn, appears to have peaked and is showing signs of improvement.


But the 12 regional banks of the U.S. Federal Reserve have supported the recovery by printing more and more money. Many economists believe this may lead to another round of inflation similar to what happened in the 1970s.

Inflation is a sustained increase in the general level of prices for goods and services. With the huge debt our government has created (in excess of $10 trillion!), many investors believe the value of the dollar is declining.

Forces Feed Beast

Nobel Prize Economist Milton Friedman (1912-2006) defined inflation as “too much money chasing too few goods.” For the last decade or so, however, inflation has been unusually low. And, until very recently, there has been too little money chasing too many goods.

Historically, inflation doesn’t suddenly appear as a beast out of thin air. There are three different forces that drive inflation.

The first requirement is a surge in demand in an overheating economy.

In an overheating economy, the government, corporations and households try to buy more goods and services than can be produced, trending prices higher. That’s not a problem right now since there’s plenty of slack in the global economy. The world’s factories are running well below capacity.

Inflation also requires a significant increase in consumer income. High employment has kept wage increases well below their long-term average. A big increase in wages will not likely occur until there is full employment.

The third requirement is an increase in the money supply and credit growth. The Federal Reserve’s historic money supply increase has certainly stoked inflationary fears.

But WMB believes it will take more than the Fed pumping money into the system to ignite inflation.

Banks must also open the floodgates of credit. To date, we still are not seeing an easing of bank credit. Banks haven’t increased lending levels to their pre-crash highs and many are still recovering from their last credit binge.

Looking Ahead Now

All three factors – demand, wage growth, and money and credit growth – must rise simultaneously for inflation to take hold, according to most financial experts.

That’s only likely to occur only after we’ve had a full recovery and a complete healing of the financial system.

WMB believes that although there has been recent growth in our economy, a full recovery is still far down the road. And, a full recovery of the banking system is likely even further away.

But the borrowing continues, and policy makers may be tempted to take the easy way out by printing new money, which could fuel inflation worries.

WMB believes that over the near term, a small increase in inflation wouldn’t be entirely unwelcome — it would be a sign the economy has finally recovered. Higher inflation may or may not hit us hard at some point in the future.

In the meantime, we should continue to keep all eyes focused on the 800-pound gorilla known as inflation. Feed it too much and suffer the consequences across the board, from industry to consumers.

This post is by TechMan, WMB co-author who blogs about trends, issues and ideas affecting industry, business, technology and consumers. If you like this post, please share it.