Published: November 10, 2010

If Paul Revere were around, maybe he'd get on his horse and start yelling, "Inflation is coming! Inflation is coming!"

I think it is coming. In fact, in many ways, it's already here, just not yet widely recognized. The deflationists still hold sway in the bond market, where investors happily accept puny yields.

The deflationists argue that the dollar will buy more tomorrow than it does today. It is inflation's opposite. When most people talk about inflation and deflation, this is what they mean. This definition would pain the old economists who were more careful in their use of language.

Be that as it may, deflation today is an argument facing death by a thousand cuts. Every day, evidence rolls showing that the dollar is buying less. Today's Wall Street Journal points to the whale in the aquarium. One headline reads, "From Cereal to Helicopters, Commodity Costs Exert Pressure."

The article goes on to point out what is painfully obvious to anyone who follows commodities and companies. The cost of nearly everything is going up.

General Mills (NYSE: GIS) will boost the price of a quarter of its cereals to reflect rising prices for grains. Kraft (NYSE: KFT) is raising prices. Domino's Pizza hasn't said it will yet, but it did say the price of cheese is up 29% from a year ago. Profit margins are suffering in the meantime.

There is a long list of companies battling rising costs of the commodities. As the Journal notes:

"Corn is up 44%, milk is up 6.5%, hot rolled coil steel is up 4%, copper is up 29% and oil is up 14% from a year ago... Across Corporate America, more companies are wrestling with when and how much to raise prices as raw materials costs climb."

Still, the Journal's article had no discernible effect on the optimistic bondholders. (Or I should I write "bag holders"? For soon, they will be left holding the bag.) The bond market seemed bored and yields inched up just a touch today, such that the 10-year note pays a whopping 2.506%.

By the time the bond market says inflation is here, it will be too late - too late for bondholders.

In the meantime, the prices of gold and silver are up too. All of these things point to the obvious: The dollar is buying less.

Why?

Let us the count the ways. There is the U.S. government bleeding red ink and heavily in debt. Both portend bad things ahead. How will they square the circle? The easiest - and the most politically expedient - way is to print more money.

There is the jawboning going between central banks of the world all trying to cheapen their currencies. The rationale is to stimulate exports, but don't be fooled. The real effect of a cheapened currency is that your dollar will buy less.

There are kinds of fancy names for what the Fed is doing - "quantitative easing" comes to mind. But at bottom, they all mean the Fed will create more money.

I was at Grant's Fall Conference in NYC this week. Jim Grant, the host and editor of the excellent newsletter Grant's Interest Rate Observer, said: "Don't you sometimes get the feeling that the economists are pulling our leg? A bartender would call it watering the whiskey."

That is a good way to think about it. More dollar printing simply dilutes the buying power of all dollars. And so we see today the beginnings, the mere sprouts, of a fully fledged inflation. It can and will get much worse.

Don't pay attention to that thing called the Consumer Price Index, or CPI. It is running at about 2%. It is an engineered figure and not to be trusted. Oskar Morgenstern, who along with John von Neumann contributed so much to game theory, once described it as a "mere index of doubtful validity," as Grant relayed.

Nonetheless, on the basis of this suspect fluff, the Fed tells us inflation is under control. In fact, it is complaining that the inflation rate may be too low. As Grant quipped, "That's like the New York Police Department complaining about the lack of crimes."

Bernanke would have us believe the Fed can calibrate inflation within tolerances of 100 basis points. But it way overestimates its powers. Once the inflation train gets going, it will be very hard to slow down. One day, the Fed will wish inflation were only 2%.

-- Chris Mayer
Editor
Whiskey and Gunpowder

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Note: This article originally appeared on Whiskey and Gunpowder