Five reasons to fear inflation

While the debate rages over whether the years ahead will be dominated by in-flation, de-flation, or some combination of the two, a quick look at the reasons why so many people are so terrified of inflation is in order.

This is not meant to be an all-inclusive discussion, simply an overview.

1. They've been printing so much money, it's got to go somewhere

Yes, I know, the newly created trillions of dollars that monetary authorities around the world have sent out to failing banks, auto companies, insurance companies, and others - much of that money is currently just sitting there as bank reserves, not entering the economy in the form of new bank loans that would have this sum leveraged up to who knows how many tens of trillions of dollars.

Of course, that's today's story.

Tomorrow's story (probably sometime next year) will be one of economies that have hit bottom, at which time, banks will be more willing to lend and consumers more willing to borrow. That's when all the newly printed money starts to create inflation.

The doubling of oil prices seen earlier this year is just a teaser for what's to come since central banks quickly lose control over where the money goes once it starts to move again. Of course, if there is no economic recovery, that money will just sit there and there will be little or no inflation. But, if we do manage to pull ourselves up out of this mess, we'll see the highest inflation in generations as policymakers will be loathe to repeat the mistakes that led to the 1937 recession, following the Great Depression.

2. The government's inflation numbers are bogus

When inflation does come roaring back, you probably won't see too much of it showing up in the government's Consumer Price Index (CPI) data since this measure has been systematically neutered over the last thirty years to make rising prices seem as though they're not all that bad compared to what we saw back in the 1970s.

You hear a lot about how economic policies have "defeated" inflation over the last few decades when, in fact, much of the lower inflation numbers have to do with cheap oil from the Middle East, cheap imported goods from Asia, and, most importantly, changes in the way the Bureau of Labor Statistics calculates the inflation statistics.

Since home prices were stripped out of the index in 1983, it's hard to imagine how we could ever see inflation over ten percent again since housing rental costs now account for more than 30 percent of the index. With the glut in housing due to the recently popped bubble (a bubble that would not have been possible if home prices had not been stripped from the inflation data), we'll have downward pressure on rents for years to come.

The bad news is that domestic services and energy will keep on rising and this will feel like 20 percent inflation even when the government says it's only six.

3. Peak oil is real and it is near

The ongoing recession/depression has been a boon to those who have long scoffed at the whole notion of Peak Oil - that cheap energy, fossil fuel that comes gushing up from out of the ground with little or no effort and has served as the very foundation of the world economy over the last 80 years or so, will soon be a thing of the past.

Of course, the fact that economic growth is now declining for the first time since the Great Depression puts a whole new spin on things, albeit, just a temporary one.

That is, unless what we've seen over the last nine months is what we'll be seeing for years and years and years.

Since changes in global energy consumption are inextricably tied to changes in economic growth, the only way that peak oil is not going to be a problem in the years ahead is if the global economy grows at a much slower pace. Slow growth means less jobs which mean lots of people have lots of idle time on their hands and governments don't generally like that.

Look for item #1 above to solve many of the world's economic problems in the near-term while creating even bigger inflation problems in the long-term as a return to world-wide economic growth once again stresses the relatively limited energy production capacity as it did last year.

4. Rich, smart people are buying gold

I don't know about you, but when I hear about people like John Paulson of Paulson and Company buying billions of dollars in gold bullion for his hedge fund and when stories begin to circulate about very wealthy individuals buying bullion by the truck load, apparently OK with the whole idea that it neither earns interest or pays a dividend - then I start to worry a little bit.

Most of the rich people in the world are rich for one very good reason - because they're smart.

And even though most of the investment world still doesn't have much of a clue about the nature of money and how, after almost four decades, a very long experiment with a world overflowing with fiat money is now going horribly wrong, a lot of smart people with a lot of money have figured it out.

In private clubs, board meeting rooms, and social gatherings all around the world, the likes of which neither you nor I will ever experience, they are swapping stories about how to buy and store gold because rich, smart people know the long history of paper money.

Paper money, issued by government fiat and backed by nothing other than confidence in the issuing government to act responsibly, has never endured. Governments always abuse this power and to think that it will be different this time is not only not very smart, it is naive.

5. The central bank does not fear inflation

The single most important reason to fear inflation is that the Federal Reserve and its minions of economists, accountants, and ne'er do wells do not fear it.

Never before have there been so many signs of impending financial calamity that have been missed by so many central bankers, economists, and policy makers around the world that there is absolutely no reason to think that they will be any better able to spot early signs of rip-roaring inflation than they were able to spot signs of a stock market bubble, a credit bubble, or a housing bubble.

In fact, even if there are indications of monstrous price increases on the horizon, the Federal Reserve and others will likely embrace the arrival of rising prices since what they really fear is de-flation. On this side of the Atlantic, they are determined to avoid a repeat of the 1930s when a sound money system had a completely different set of dynamics and they are loathe to do anything substantive to combat inflation until they are sure that they have vanquished their nemesis - de-flation.

Sure, they'll keep talking about "exit strategies" and how to "remove the accommodation" that has been provided over the last year or so in the form of trillions of newly created dollars, but they don't really mean it.

In the next few years we'll be creating a whole new chapter of economic history, one where inflation will play a central role. When the historians look back at 2009 they'll wonder, "Why wasn't anyone worried about inflation back then? When they could have done something about?"