The Wall Street Journal today declares that we needn't worry about inflation with the headline, "Inflation Fears Seem to Be, Well, Inflated." I'm not buying it. Its author points to the fact that the market bet on inflation and is now backing down on that bet. Drawing a conclusion about future inflation merely based on recent investor behavior is like drawing conclusions about international culture by going to Ebcot's World Showcase. Some deeper analysis is warranted.

Here's an excerpt:

But a funny thing happened on the way to Zimbabwean hyperinflation: People started buying Treasurys again, raising prices and pushing yields, which move in the opposite direction, lower. The 10-year Treasury note ended trading Monday yielding 3.490%, the lowest since May 29 and well off its 2009 peak of 3.94%.

"The market got overdone," says Miller Tabak strategist Dan Greenhaus, who says investors overestimated the speed and strength of an economic recovery. "There was a leap right from economic stabilization to incredible inflation pressures and outsized economic growth."

I think it's pretty obvious that investors would panic about inflation. Overreaction is a way of life for investors, especially the bad ones, who unfortunately dominate the market. That's why we have bubbles and volatility. Do you really think American businesses change in value several percent per day very often? Fear and excitement drive markets. The hope is that those emotions don't get too carried away. At a time of great uncertainty like this, keeping emotions in check isn't easy.

With interest rates kept so low for so long and government spending breaking records, inflation is all but certain. But that doesn't meant panic was justified -- at least not yet. As the author quips, we will not likely have Zimbabwean inflation. But for the U.S. to feel some pain, we only need an inflation number of about 5% or more, when we're used to between 1% and 3%.

Why haven't we seen inflation yet? There are still deflationary pressures being exerted on the economy due to the recession. If those pressures were not present, the inflationary effects of low interest rates and government spending might have been noticed. So, in a sense, that means inflation right now is a good thing -- if you're worried about deflation.

Where the author goes wrong, however, is in implying that there's nothing to worry about going forward. There will be inflation. As mentioned, it's virtually economic certainty. Inflation also tends to have a pretty significant lag to the actions at its cause. As a result, I never expected bad inflation to really begin manifesting itself until 2010. It probably won't appear until we are clearly out of the recession -- when you don't need to squint your eyes to see green shoots.

Separately, the article also contains this interesting chart:


Two observations:

First, the government (blue) line is just ugly -- but not surprising. That it's been negative even during some periods of economic growth is completely unacceptable, though not a shock, given that everybody knows the national debt has been steadily increasing for some time. That blue line remaining below zero indefinitely is simply not sustainable.

Second, what happens when you average the two curves? I don't have the raw data, so I have to just eye it. In doing so, it looks like you could draw a relatively straight line a bit below 0 until the first intersection around 1997. It then slopes downwards, towards -4. That's not a good trend. That average remaining below zero indefinitely is also not sustainable. What can be done to get the U.S. to spend only as much as, or even less than, it earns?

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