Fed Chairman Ben Bernanke told CBS News in March that he saw "green shoots" of economic recovery beginning to sprout, including in mortgages and business lending.
Now it seems like those "green shoots" that were beginning to appear may have been rooted in inflation.
Thanks to a combination of influences, including increased jitters on the part of investors and the Fed's decision to print large quantities of money, there's more reason than there was a few months ago to worry about a spate of inflation.
The U.S. dollar has fallen 10 percent since reaching a three-year high in March. Gold is up, commodities are up, and crude oil prices have roughly doubled this year. And the possibility of a debt downgrade for Britain, one of the few nations with a triple-A credit rating -- has shown that no currency is invulnerable.
Bill Gross, co-chief investment officer of Pacific Investment Management Co. in Newport Beach, California, said on Thursday that the United States' own triple-A credit rating will "eventually" be lost as well. "The markets are beginning to anticipate the possibility of" a downgrade, Gross said, according to Bloomberg News.
If this sounds obscure, especially when most of the recent talk has been about deflation, you're not alone. But let's walk through some of the implications:
Higher mortgage costs: Treasury securities leaped this week to a fresh high, about 4.4 percent for 30-year Treasurys. If that trend continues, expect 30-year mortgage rates to increase as well (otherwise investors would simply buy safer Treasurys). Imagine what significantly higher mortgage costs would do to housing prices that have, in some areas of the country, already been decimated.
A dollar that's worth less: Exports become cheaper, while imports become more expensive. All else being equal, gasoline prices go up. So do other commodities -- meaning that we'd likely resume the upward pay-more-for-food and pay-more-at-the-pump trend that was evident about a year ago.
A stock market and bond market crash: If investors start to view inflation and a devalued dollar as inevitable, it could result in a broad sell-off of stocks and bonds, and a flight of capital to other assets and currencies. (Swiss francs might become more attractive.) Inflation expectations are important.
By way of background, the Federal Reserve said in March that it would print $1.2 trillion out of thin air, a more aggressive step than its counterparts in Europe or Japan have taken -- making the U.S. dollar relatively more vulnerable. Minutes of an April 28-29 meeting released this week indicate the Fed considered increasing this amount.
U.S. banks have an enormous amount of excess reserves, according to Federal Reserve data, that would rapidly expand the money supply once lent out. "The enormous increase in reserves is potentially inflationary," Stanford economics professor John Taylor told the U.S. Congress in February. "With the economy in a weak state and commodity and many other prices falling, inflation is not now a problem, but at some time the Federal Reserve will have to remove these reserves or we will have a large increase in inflation."
"The question is whether the Fed will be able to reduce the reserves in time and whether people will expect the Fed to do so," Taylor said (see CBSNews.com's review of his recent book on the crash). The Fed "will have to sell a huge amount of securities backed by consumer credit, mortgages, student loans, and auto loans. This will be difficult to do politically."
It's true that the Federal Reserve could, assuming excellent timing and sufficient independence, sell its newly-purchased assets, reduce system-wide liquidity, and avoid serious inflation. This is the best-case scenario. Then again, that assumes perfection on the part of central bankers and politicians in Washington, D.C.