When the U.S. Treasury made the decision to attack the nation's current economic meltdown with massive rate slashes and huge infusions of liquidity as it bailed out many of the country's largest financial institutions and major corporations, financial analysts began predicting that inflation would follow.

Although the U.S. economy is still in a deflationary recession, at some point, the winds will change and the U.S. will see an increase in inflation. When? That is the million dollar question - but few can argue against the inevitability of the final result.

While acknowledging that inflation has not yet emerged in the grand scheme of the economy, analysts at Blanchard and Company Inc. offer an explanation as to why that has been the case and explain why inflation is as much a concern for the economy today, and into the future, as it was when the Fed's printing presses went into overdrive last year. [See St. Louis Federal Reserve Bank graph below.]


Right now, normally it would be incomprehensible that the amount of new money being created has not led to inflation or even hyperinflation. However, the reason we have not seen inflation take off is due to the slowdown of the velocity of money. Because fear is still rampant, money is not changing hands in the way that was originally planned, says Donald Doyle, Chairman and CEO of Blanchard and Company. Over the last six months, the money supply has grown exponentially, but because the economy is in such bad shape, we remain in a deflationary recession because so few are lending money, borrowing money, or spending money.

Doyle says this cycle will continue until confidence in the economy returns, and banks, investors and consumers, begin to spend money, as the bailout plan is designed to encourage them to do.

Ultimately, Doyle sees Treasury money supply reaching a critical mass that will fan the fires of inflation, increasing it to a level that could potentially produce hyper-inflation. And he says, until the velocity of money returns to normal, the U.S. economy will not see the improvement the stimulus was created to generate. Doyle says he sees major companies continuing to have financial problems, unemployment continuing to rise, bankruptcies continuing to increase, and ongoing home foreclosures multiplying the existing problems.

So what can the Fed do?

Doyle sees the Fed having few choices other than printing even more money, adding to the likelihood of an inflationary meltdown in the dollar. That's why gold and other tangible assets remain investments with a big upside because of their appeal as safe-havens during times of economic uncertainty and as hedges against inflation.

It's not a question of ‘if,' but ‘when', says Doyle. Investors still have a window of opportunity to prepare for, or hedge against, the coming erosion of the value of paper assets by diversifying their portfolios with tangible ones, even with gold maintaining a price level above its 1980 high in spite of a bloated dollar.