By BRETT ARENDS
One of the standout features of the financial crisis has been that inflation has collapsed. Over the past few years, even as the Federal Reserve has pumped hundreds of billions of dollars into the economy to get it moving, prices and wages have barely moved, and the bond market has boomed.
In the past few weeks, as Fed chairman Ben Bernanke has announced his latest and potentially biggest program of money printing yet, inflation worries have suddenly and dramatically perked up in the bond market.
Bond yields have spiked, reflecting a jump in investors' concerns about the risks of rising prices down the road. The gap between the yield on regular 10-year Treasury bonds, and the yield on inflation-protected bonds, has widened to nearly its highest level since before Lehman.
Today the market is pricing in 2.6% inflation over the next 10 years -- compared with forecasts of barely 2% just two months ago.
That may not sound like much by historical standards -- back in the 1970s inflation touched double digits -- but it represents a big and potentially worrying move in a short period.
"The market is only just beginning to price in rising inflation," argues Josh Strauss of Pekin Singer Strauss Asset Management, a money management firm in Chicago. Investors have been "lulled into submission by the Fed," he added, but they were only willing to accept low bond yields "for so long."
The Fed recently announced a third round of so-called quantitative easing to boost the economy. The latest is essentially open-ended. The Fed will print money for as long as it takes to prevent the economy from sliding back into recession.
The Fed's activities distort the bond market. They are designed to drive down interest rates. Right now, argues Strauss, they are probably pushing down short-term rates more than longer-term ones.
Of course, when it comes to rising inflation fears, we have been here before. Inflation worries spiked, albeit briefly, along with commodity prices in early 2011. They quickly receded again as commodity prices fell.
Inflation is a critical issue for all of us as we save and plan for the future, but you will struggle to get a straight answer from economists on how high it is going to be, or why. Keynesian economists, who tend to be on the political left, argue that inflation will remain low so long as the economy struggles and unemployment remains high. But monetarists, Austrians, and other economists on the right have argued instead that inflation is the result of printing too much money. For them, Ben Bernanke's programs to inject further money into the economy -- coupled with the Uncle Sam's massive annual budget deficits -- are bound to produce inflation sooner or later.
For the past few years, the Keynesians have had the better of the data. Make of that what you will.
For investors, the more pressing issue is what this means for your money. The future course of inflation will determine whether that bond fund you buy, or that immediate annuity, will be a great investment or a disaster.
It's easy to question whether the latest surge in inflation will be yet another false alarm. After all, the latest reading of the consumer price index shows that it's eased in recent months to a relatively modest 1.7%. The jobless rate remains very high, and so long as that continues, wages won't rise very far either.
But there is a world of difference between expecting low inflation and betting your life savings on it. Millions of retirees have been forced by the crisis, and government policy, into making big gambles. Either they are buying longer-term bonds in a desperate hunt for yield, or they have been pressed into buying stocks instead.
As stock prices go higher, they become a worse and worse deal for new investors (that's a bit of math that most investors seem to forget). Today the dividend yield of the Standard & Poor's 500 index is about 2%, according to Wall Street Journal data. That means even your dividends are trailing forecast inflation.
Meanwhile, if you are holding a lot of cash, you are slowly but painfully losing ground to a small amount of inflation each month. It is easy to lose patience and begin to invest desperately, in stocks or bonds, for more yield.
But patience is an investor's greatest friend. We know that the Federal Reserve is distorting both stock and bond prices and making them higher than they would be otherwise. We know that because the Fed has said as much. Indeed, that is a matter of policy.
In these circumstances, it's hard to argue that this a moment to make a major capital commitment to stocks or bonds. Meanwhile, keep an eye on those inflation forecasts.