Column Is America Fed up?

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pay any heed to inflation. Which will mean inflation will rise further until it is their primary concern. I would not be surprised to see a 6% handle on the US inflation rate before the year is out—the highest rate in three decades.

Optimists say that the global slowdown will put a lid on inflation, but they are being too optimistic. Inflation is being driven by an excess of demand over supply—monetarists will argue this in money terms. Global supply is running up against bottlenecks as evidenced by the rise in inflation in those previous sources of disinflation, China and commodity markets. Following a record five years of over 5% growth, the growth of global demand may be slowing, but it is still growing above a level that is inflationary. Even when levels of demand fall back in line with levels of supply, the US inflation rate will have an extra-kicker from the 50% devaluation of the dollar since 2002.

More inflation than currently anticipated is generally better news for equities than bonds, especially given that yields on US, 10-year government paper have now sunk below 4%. I reckon 10-year US yields will end up closer to 6.5% in 12 months’ time. The problem for all other markets, though, is that if you can earn 6.5% on risk-free 10-year US dollars, all other risky instruments—from US corporate bonds to Indian equities—will have to be devalued to compete in the global market for capital. Equities may outperform government bonds, especially where they represent an investment in real assets, but it is not a bullish equity background and, perhaps more importantly, equity markets have yet to discount stubborn inflation and the policy dilemmas this delivers. Once the markets do so, equities will be a steal.