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Stocks on rise, but so is inflation



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Updated: May 3, 2013 12:14PM

What are the markets telling you when stocks make new highs and gold soars $55 an ounce to $1,393?

On Thursday, the Dow Jones industrial average rose 219.71 points, 2 percent, to close at 11,434.84 -- a two-year high.

The markets are saying that the "smart money" is betting that inflation is on the way -- in spite of the Fed's worry about a slowing economy, and in spite of weak jobs numbers, and in spite of the continued housing slump.

Many people think that inflation is an economic force when it really is a monetary problem: too much money being created. And the Fed's announcement that it plans to create another 600 billion U.S. dollars, out of thin air, has unleashed the inflation fears.

The Federal Reserve calls it "quantitative easing," saying it is buying Treasuries. What might not be so apparent to the average citizen is that the Fed is paying for the bonds it buys with newly created credit -- literally writing a "check" that gets deposited in the account of the bond-sellers. That's how the Fed "prints" money these days.

Where will all that money go? Banks and corporations already have plenty of money sitting in their coffers. And they're unwilling to make loans to risky customers. So it's a good bet that a lot of that new money will flood the stock market, in spite of the bad business climate. That's why stocks have reached two-year highs.

And that's why gold is soaring. No one can create gold out of "thin air." They've been trying that since medieval alchemists and Rumplestiltskin! Gold retains its value throughout the centuries because governments can print paper money to try to stimulate prosperity, but they can't create gold.

Here's another irony. The Fed says it is buying government debt in order to help keep interest rates down. But if inflation fears really spread through the global economy, the smart money will demand higher rates to compensate for the loss of value in the dollar because of inflation.

When people fear inflation, they either demand higher interest rates or switch to "hard assets" -- gold, silver, commodities and other currencies.

Until now, the Fed has been worried about deflation --falling prices. But if inflation fears take hold, they'll find themselves fighting a much stronger monster. And that's The Savage Truth!

Terry Savage is a registered investment adviser.

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