Why Inflation is Coming to America

Inflation is coming to America because the Federal Reserve keeps printing money and has left interest rates at 0.25 percent since December 2008.

Because of this ultra-loose monetary policy, value of the dollar has declined against alternative currencies like gold and silver and raw materials like oil and copper since at least 2009.

Americans have been paying more and more money for food and gasoline since that time. Meanwhile, the price of crude goods for American producers has soared 16.4 percent year-over-year in March 2011. (In March 2010, it surged 32.9 percent from March 2009).

This is only going to get worse, at least in the short-term.

The value of major currencies like the Australian dollar and Canadian dollar are expected to continue to appreciate against the US dollar because of interest rate differentials.

Meanwhile, several major emerging market countries indicated that they will appreciate their currencies against the dollar in order to combat domestic consumer inflation.

When the US dollar declines against other currencies, it will be harder for American buyers to compete with foreigners with stronger currencies to acquire internationally traded commodities like oil. Moreover, imports of services and manufactured goods will become more expensive.

China – the biggest exporter to the US – is also seeing rising wages because it’s running out of cheap labor, which will further push up the cost of Chinese imports to America.

The devaluation of the US dollar and all the related consequences could actually be a part of the US government’s plan, however.

As inflation from global sources set in, Americans will consume fewer international goods because they’ve become too expensive. Moreover, American exports will grow because they’ll be cheaper to foreigners.

This all fits neatly with President Barack Obama’s plan to double US exports in the next few years and the US objective of “balancing the global economy” by reducing its trade deficit.

This is a dangerous game, however, and the key problem is having a dulled perception of risk and then losing control of inflation.

In Weimar Germany, the devaluation of the Mark did at first increase exports, according to hyperinflation expert Adam Fergusson. Moreover, it lowered the unemployment rate Blinded by these improvements, the Weimar government kept on printing money.

However, it eventually lost control and caused hyperfinlation.

Currently, Federal Reserve chairman Bernanke stubbornly and dangerously refuses to acknowledge the existence of inflation, chalking it up to a “transitory” spike in commodities prices.

He has been lulled into a false sense of security by the low levels of the CPI index, which is kept in check by the high unemployment rate and the slack in the economy, as most economists will tell you.

What many of them ignore, however, is just how fast inflation came suddenly seize the financial system once the unemployment rate is lowered and the slack in the economy disappears. The Weimar Republic’s hyperfinlation, for example, happened in just two short years. The period during which the Reichsbank lost control over inflation expectations was less than six months.

Moreover, economists shouldn’t be comforted by the low inflation in the mid 1990s and early 2000s period – and use them as comparables to today’s environment – because it was driven by globalization. In 2011 and beyond, US trade partners are actually likely to be a source of upward pressure on inflation.

US consumer inflation can easily spike in a matter of a few months once economic growth accelerates and the unemployment rate drops. It probably won’t be hyperinflation (assuming the Fed stops at QE2), but inflation of 5 percent or more is quite possible.

Alternatively, stagflation can occurred if the US dollar’s pace of depreciation rapidly accelerates before the unemployment rate is meaningfully lowered.

Whatever the case, the Fed’s loose monetary policy will cause inflation in America in one form or another.

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