Might just. But somehow, we think it unlikely. Because the runaway inflation in debt running to 2007 – securitized, collateralized, leveraged, you name it (or hire a PhD to name it for you) – created not only a boom in complex financial contracts, ripe for the lawyers to pick over today. It also created a very weird situation, historically, in the cost of living.

“In real terms,” as Dr.Marc Faber explained on Australian TV in late Feb., “let’s say inflation-adjusted commodity prices in the world peaked out in 1974. Then they went down until 1999 to 2001.

“So [it was] more than a 20-year bear market in commodities,” explained the Swiss fund manager and editor of the Gloom, Boom & Doom Report, “at which time commodity prices inflation adjusted in real terms were at the lowest level in the history of capitalism, some 200 years.

“Unbelievably depressed,” these commodity prices then began pushing higher notes Faber, “and the first ones to move because of the incremental demand from China – and especially incremental demand that came from exports from China to the United States – were the industrial commodities.”

Along with crude oil and base metals came natural gas…and then grains as bio-fuel production ate into food production…followed by rice and soybeans, gaining almost one-third since the start of this year. The cost of pork in China – a major staple for protein-hungry consumers – has risen more than 60% after a serious of New Year snowstorms.

“Normally commodity cycles last 45 to 60 years from peak to peak,” says Faber. “We occasionally call them Kondratieff’s.” But you don’t need to study or believe obscure Russian economists to spot that a flood of cheap money – the runaway inflation which took US house prices skywards and pumped Wall Street full of toxic junk – helped set fire to commodity prices.

Cheap money kept the US consumer consuming during the recession of 2001. It kept British home-buyers buying – not least as “buy to let” investors – even as price-to-income ratios broke new all-time records. It kept Chinese factories stoked with new orders, hedge funds stocked with call options, and the oil-rich kingdoms of Arabia stoked with architects building desert islands in the sea and mile-high office blocks in the desert.

And now? No one wants to let this bubble deflate. Not Ben Bernanke, his colleagues in Europe, their clients in Frankfurt and the City, the Treasury, all three US presidential candidates, stockholders, the mortgage banks or the over-indebted consumers sat underneath the entire heap of credit – securitized, collateralized, leveraged, you name it – with no hope of repaying.

Hence the solution to the last decade’s debt bubble; beating deflation with yet more inflation. Which is hardly a challenge to the bull market in commodities.

See how gold prices leapt when the Fed first got busy cutting its rates back in August?

There’s no guarantee it will happen next time. But the same thing happened during the last “Deflation Crisis” in the US economy, back when Alan Greenspan and his No.2 – a young Ben Bernanke – slashed the cost of dollars down to 1%.

Cheap money’s worth what cheap costs, of course. And choosing to buy gold before the trouble really got started still looks a smart move, some 38% higher inside seven months.

The blow-off above $1,000 may never be seen again, it’s true. But with rates heading down – and inflation rising – we’ll look to hold gold just in case this “solvency slump” keeps throwing out losers.

• The UBS-Bloomberg commodity index remains 30% above its level of this time last year;
• Saudi Arabia this week slashed its import tariff on wheat by 25%;
• Vietnam is looking to trim food exports by more than 10% in 2008;
• Government agents in the Philippines raided store-houses suspected of hoarding rice, up by one-third in price;
• The Asian Development Bank warns that inflationary pressures will persist in India for the next two to three months;
• The World Bank said Tuesday that rising food and fuel prices pose a bigger threat to East Asian economies than the ongoing US banking crisis;
• Average inflation in Ukraine – a top 10 exporter of wheat – will hit 20-22% this year according to a new report from the International Monetary Fund;
• Industrial output prices in Europe rose at their fastest pace in 18 months in Feb., growing by 5.3% from Jan.’s upwardly revised rate of 5.0% in the 15-nation single currency zone.

Curious to note, but across the European Union as a whole, producer-price inflation hit the “new EU” nations of Romania, Bulgaria and Hungary hardest. Outside these former communist states, the biggest year-on-year price increases hit those economies with the heaviest consumer debt burdens – Belgium (+8.9%), the Netherlands (8.8%), the United Kingdom (8.3%) and Denmark (+13.5%).

Most likely just coincidence though, right? Why would inflation in debt ever lead to inflation in prices?

Adrian Ash
The Daily Reckoning Australia

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