An Inflation Straitjacket

What would be the catalyst for a new round of inflation? I've seen opinions for inflation and opinion for deflation, but with unemployment at 10%, I've generally sided with the deflation commentators.

But there is a possibility of inflation in the mid- to long-term. It would happen like this: Higher state sales taxes or new a VAT would raise the transaction price of most goods. Consumers, sensing the impending rise in taxes, would rush to buy products beforehand. The increased demand for goods would cause increases in retail prices, because of shortages.

Shortages? I hear you ask. What from?

Two sources: First, U.S. producers would still be working with reduced workforces and capital, and face higher marginal costs all around from increased payroll and revenue taxes levied by state and federal governments. Non-U.S. producers, who by then would be receiving cheap U.S. dollars, would mark up the price of their goods when denominated in U.S. dollars in order to keep up their revenues as counted in their local currency. U.S. retailers, of course, would have no choice but to pass along high goods prices to consumers in the form of higher retail prices.

There is a third effect: As inflation kicks in, the increased uncertainty about interest and inflation rates would then tend to cause consumers to be more conservative. Although consumers would pay higher prices for those items they do buy, overall their consumption would continue to drop or remain stagnant.

There would be an extended "frozen disequilibrium" that could last several years. Despite high inflation, low levels of production would tend to force the Federal Reserve to keep rates low, which would keep the dollar down and exacerbate goods shortages. Low rates would then encourage over-investment in goods because credit is cheap while inflation is high. Low rates would also depress tax revenues from earned interest.

Higher inflation would also reduce the future buying power of the Federal Government's budget deficits. Even better, inflation would send house prices up, fixing the mortgage crisis we are still in now. Hence, Government has several incentives to cause inflation.

To summarize: The inflation straitjacket is comprised of excessive Government debt and foreign exchange rates. We are headed for a period of stagflation that could last several years. It might not start until 2011, but once it is started it would be hard to extinguish.

Investment advice: Once again it is a great time to buy real estate. It is also a good time to invest in hard goods or collectibles that don't eat or need paint. Stocks are likely to remain stagnant; bonds will do poorly.