Inflation Shifts Front and Center

Now that economy is showing signs of improvement, inflation fears have resurfaced. Case in point: Some 41% of the National Association for Business Economics’ 266 members surveyed in August said that the lagging effect of the Federal Reserve’s decision to increase the money supply would be inflation.

For over a year now, foreign investors have doubted that the U.S. would be able to pay down its growing debt burden, and this has caused many of them to abandon dollar-denominated Treasury securities. This is the first year that the U.S. has ever lost foreign capital, and as a result, the Fed has had to step in and print approximately $2 trillion dollars to replace it. The problem is that right now, there are too many dollars and not enough demand. This means that rising inflation is all but guaranteed.

There is no doubt that inflation remains a major concern for economists and investors alike, especially since gold just hit $1,000 an ounce. Gold prices typically rise in September because the start of the holiday season in the world’s biggest gold-consuming countries tends to drive up demand. In fact, gold has posted monthly gains for the past 16 out of 20 Septembers, which is better than any other month of the year.

But today’s price surge is an indication that investors are starting to recognize that the dollar’s weakness may be more than temporary. Investors buy gold–like they do most commodities that are valued in dollars–as a hedge against a drop in the value of the U.S. currency in order to preserve capital.

This reality that the dollar will remain weak for some time is fueling inflation fears, so much so that President Obama is expected to instruct Americans on Wednesday night in his joint session before Congress to “save.” If the U.S. savings rate doesn’t continue to increase, the federal government’s massive budget deficit may not be able to be financed from foreign investors, especially the BRIC (Brazil, Russia, India and China) countries and many Middle Eastern countries that are now shunning the U.S. dollar. These BRIC countries increasingly prefer to be paid in a basket of currencies, especially the IMF’s Special Drawing Rights–a basket of foreign currencies that is inherently safer than a decaying U.S. dollar, which has lost 15% to 30% against many major currencies since March.

The bottom line is if Americans don’t boost their savings to counteract fleeing foreign capital, stagflation will likely ensue.

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