The end of imported deflation plus peak oil plus a dovish Federal Reserve is an inflation formula.
Now add the debt bomb into the mix. The accumulated national debt is $12.8 trillion (about 90% of GDP) to which $4.1 billion is added every day. When debt surpasses GDP, early next year, the event will trigger headlines and a national discussion of what to do about it. Obama will renew his efforts to pass a value-added tax (which I don't think will pass this election year). But with Democrats holding much thinner majorities in Congress, or possibly none at all, the VAT-tax will go nowhere. Unlike Bill Clinton, Obama will dismiss any push for supply- side incentives in the hopes of growing the economy faster and along with it the tax revenue base. That will leave only one debt-busting option on the table. America will take door number three and inflate its way out of its debt. The Obama administration will make the political calculation to screw our creditors--older Americans and Chinese, basically. Older Americans don't like Obama anyway, and the Chinese don't vote.
So I think we will see 4% CPI inflation by year's end going toward high single digits (or more) by the decade's second half and possibly sooner. A 4% CPI means the real rate inflation will be much worse for many people, since CPI is an average of consumer prices for an average urban household. If you are not buying a flat-panel screen on Amazon or a hotel room on Priceline, but rather are just trying to survive by driving to work, putting food on the table, and paying your kids' medical and school bills, you are already suffering higher inflation than the CPI. My guess: It will get worse.
Some very smart forecasters, such as Gary Shilling and John Mauldin here, think a long-Japanese-like deflationary stagnation is a more likely scenario than a 1970s style stagflation. I would buy that ... if Americans were Japanese. But we aren't. We are a nation of borrowers, not savers, and therefore we will have no tolerance for a multi-decade deflationary recession that favors savers. We will pressure our politicians to "do something." Caught between the rock of debt and a hard place of slower growth--and unable to imagine transcendence in tax and budget cuts--our Washington geniuses will give us inflation.
Obama's economic team is making a bet that 2012 will be another year of cheap-money recovery before the bell rings and inflation becomes notably worse. If this bet pays off, Obama will win a second term. If higher inflation shows up sooner than 2012 or the economy falters, Obama is Jimmy Carter.
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