Frequently, I am asked whether I worry about inflation.  The answer is:  Yes — all the time!  There is no doubt in my mind about serious inflation coming at us.  Theoretically, it doesn’t matter that the Fed has “printed” so much money, as they can simply withdraw the excess money supply when necessary.  As a practical matter, it is politically difficult for the Fed to do that.  It has been described as “removing the punch bowl when the party gets started.”  Because of that delay, serious inflation is out there . . . but it is WAY out there!

In this space, I’ve explained the Monetarist theories about the supply of money increasing faster than the supply of things to purchase, i.e., more money chasing fewer goods drives up the price of the goods.  Like most things, it is usually more complicated.  What happens if people don’t spend the newly-printed money?  What happens if people save? What happens if banks don’t lend?

The increased money supply created by this Fed is not being circulated or spent by Americans like normal.  Called the “velocity of money,” it has slowed approximately 67%.  Serious inflation would return quickly if our normal spending and lending habits returned quickly.

I’ve also explained that inflation cannot sneak up on us.  It will be easy to see before it gets here.  Here is an example.

We measure inflation in prices at (1) the consumer level, (2) the wholesale level, and (3) the production level.  As we know, inflation at the consumer level (CPI) has been benign.  In fact, the Fed wants inflation at 2% and was lucky to get 1.7% over the past twelve months.  At the wholesale level (PPI), inflation was only 1.3% in 2012.  CPI was flat, and PPI was negative during the fourth quarter, primarily because of energy costs which fall at an annualized rate of 19.6%.  However, if you look further down the pipeline, you’ll see that prices at the production level have been increasing.  Theoretically, the increased prices at the production level would pass to the wholesale level and then the consumer level.  Yet, the 2.3% increase in food costs at the wholesale level was compressed to 1.8% at the consumer level.  That shows me the consumer is fighting back, but that cannot be expected to last.  Wholesalers cannot keep absorbing the inflationary pressure.

All this suggests a modest build-up in inflationary pressure over the next twelve months.  But, there is no evidence of the serious inflation that I expect later.  When you see the Fed start raising interest rates, you should already be owning real estate and commodities.

Subject to the unemployment level, the Fed has stated they don’t expect to raise rate through 2014.  So, you have plenty of time.