Bill Fleckenstein

Contrarian Chronicles5/12/2008 12:01 AM ET

Why all roads lead to inflation

A combination of global expansion and money printing to avoid today's economic pain has set us up for tomorrow's spiraling prices.

By Bill Fleckenstein

Inflation is a topic that does not receive enough attention. I'll try to address that deficiency in this week's column.

Regular readers know my motto (which is on the masthead of my Web site): "In a social democracy with a fiat currency, all roads lead to inflation." Over the past couple of decades, through all the occasional chatter about deflation, I have resolutely maintained that deflation would not be the outcome we would see because the Fed would do what the Fed has done.

One major force helped hold inflation at bay during the 1990s: globalization. As Jim Grant points out in a brilliant essay titled "The Close of the Era of Peace and Quiet" in the current Grant's Interest Rate Observer (subscription required): "Between the early 1980s and the late 1990s, an estimated 2 billion new pairs of hands had joined the global labor force. Employers never had it so good, especially so in countries like the United States, where relocation to low-cost meccas of the East was no idle threat, but an actionable business plan."

Cheap labor, when combined with the technological advances of the late 1990s -- which were powerful, though no more potent than those we'd seen in the 1920s and 1960s, for instance -- helped offset the Federal Reserve's money printing.

However, in the wake of the stock bubble, that money printing set off the U.S. housing boom and began to cause different consequences.

In addition, because so many countries see their currencies as linked to ours, the Fed's money printing has led to global money printing, which continues to this day. And, in the wake of the mortgage debacle, we have once again chosen to flood the system with easy credit. That has forced parts of the world in the late stages of an economic boom, with already-high inflation rates (such as the Middle East and some Asian countries), to follow our ill-advised and shortsighted policies.

The global boom's bite

Exacerbating those inflation trends is the synchronized economic boom that the world has enjoyed for the past couple of decades, which is a major focus of Marc Faber, the editor of the Gloom, Boom & Doom Report (subscription required).

Combining Grant's and Faber's views, we see that the first decade of the global economic boom and the attendant expansion in the labor force held inflation in check. Now those laborers all over the world want more money, and economic expansion in countries everywhere is creating a tremendous drain on the world's resources, leading to higher commodity prices (exacerbated by more money printing).

That, ladies and gentlemen, is a recipe for accelerating inflation. And that is not going away anytime soon.

Video on MSN Money

Price of oil  © Kevin Phillips/Digital Vision/AGE Fotostock
CNBC: Oil fuels the inflation crisis
A look at how surging oil prices are affecting various sectors in business, with Steve Liesman and Rick Santelli.

As Faber pointed out to me during our recent meeting: "Central bankers have become hostage to inflated asset markets. Tight money will be difficult to implement."

In fact, Faber says, tight-money policies will be impossible to put in place, given the socialization of central bankers.

Get used to higher prices

I believe inflation will be with us for quite some time. Only when money printing leads to a collapse in the dollar or in the U.S. Treasury market will there be any possibility of the asset-market declines we face actually turning into the deflation that so many people still seem to expect.

While on the subject of inflation, Faber pointed out something about the Consumer Price Index that I had not been aware of (even though I'd known the CPI was a cheat and had devoted a chunk of a chapter in my book to that topic): In addition to the errors in the CPI that I routinely talk about -- those being hedonics and substitution -- he says food and health care are underweighted in the CPI. In fact, the U.S. counts food as only 8% of the index. Whereas, it counts for about 10% in the United Kingdom, about 15% in the rest of Europe and more than 18% in Japan.

Continued: Inflation and a global bust

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