A lot of secondary criticism leveled at the Fed's policies have revolved around the massive tidal wave of inflation being built up and a fear that it's bound to launch an unforeseeable Weimar-republic style inflationary spiral that will end up putting us down for the count.
In the short term, the deflation bugs are out, especially with the recent release of consumer CPI numbers of various vintages.
However,
it's important to look at both sides of the equation and in this case supply and demand seems to be in balance (at least for now). As we have noted
before, supply has been a little slower to react to demand in both an absolute and historical sense. Given that supply tends to lag a bit, this isn't surprising with regards to the absolute sense and given that the full nature of our recession wasn't understood until much later, this accounts for the historical lag.
Along with the CPI numbers, US capacity utilization numbers were released and much like many other numbers recently, came in more bearish than the consensus (down from 70.3% to 69.3%, under consensus by half a percent). As seen below, the fall in production has been pretty dramatic and the gap between production and capacity is at its highest level in almost 50 years. Currently we are producing slightly less than we were in 2002 - a lost 7 years that is likely to bounce back with a vengeance once the economy recovers.
Of course, the real problem is going to be when the economy does recover. If production lags demand by a significant amount, we could indeed have a serious inflationary scare; especially if the recovery happens in the context of a less than perfect credit market, which is not an implausible scenario. On an emotional level, many manufacturers have been badly burned by inventory levels over the past year or so which is unlikely to help the situation very much - especially for low margin businesses, they are going to be much more gun shy to pick up production for the recovery.
The missing piece in all this of course, is international trade flows. As we have discussed before, US imports are unlikely to return to pre-crisis levels anytime soon and the overall trade flows are going to take a while to return to the levels that we know and love. External demand is unlikely to stimulate US production before domestic demand, which would have been a potential check against the inflation dragon. Overall, price levels in the US are going to continue to be primarily dictated by domestic forces, so the larger message and warning signs remain.
