A Lone Wolf Cries, 'Inflation!'

A contrarian thinks stimulus will push prices higher

Economist David Rosenberg likes to go against the grain. In 2005, when the housing market was booming, he was one of the first to say the bubble would burst. In 2006, when consumer prices were rising, he told investors to expect disinflation. In 2007, when the U.S. economy was still growing, he warned that a nasty recession was on the way.

So when Rosenberg, chief economist and strategist for Gluskin Sheff & Associates in Toronto and former chief economist for North America at Merrill Lynch, declares inflation is returning, peers take note. They may not follow, but they listen to a man who’s proven to be a shrewd prognosticator for the past decade. Rosenberg’s focus on inflation since last year marks a 180-degree turn for him—his earlier call on the threat of disinflation represents the view now prevalent among economists. “This deflation, disinflation, benign inflation story which seems to be everybody’s mindset is really yesterday’s story,” Rosenberg says. The Federal Reserve “is carrying out the mother of all reflationary policies. My bet is that eventually the Fed will get what it wants, and then some.”

Janet Yellen, the new Fed chairman, has said inflation is running below policymakers’ 2 percent target and is unlikely to flare up soon. Yet Rosenberg predicts wages and rents in the U.S. will head higher as the job and housing markets rebound and record stimulus by the Fed stokes prices. He says bonds are no longer safe with inflation on its way. So far the bond market has not borne out his pessimism: January was one of its best months ever.

Rosenberg says investors are being complacent, just as they were in 2003, when few economists or policymakers foresaw the inflation that prompted the Fed to begin raising rates in June 2004. “You have to expect that as the economy does better, inflationary pressures follow suit,” he says. “At some point the Fed will have to start raising rates.”

Some support for Rosenberg’s view comes from former Federal Reserve Bank of Cleveland President W. Lee Hoskins, who says Fed policymakers tend to tolerate higher inflation and act slowly to quell it.

Rosenberg addressed the possibility that the Fed won’t rush to put a lid on inflation in a Dec. 16 note, arguing that once commodity prices find a bottom and resume their upward rise, costs will increase for businesses and households. “The next decade is going to look more like the ’70s than many think,” he wrote. Triggered by the Arab oil embargo, inflation surged almost 12 percent in 1974. Fed Chairman Arthur Burns was slow to respond, and forecasters and investors were caught off guard. Paul Volcker, who took over at the Fed in 1979, had to raise the federal funds rate as high as 20 percent.

Rosenberg says the U.S. may avoid double-digit price hikes because the nation is older and consumption is more subdued. Still, inflation may match the high reached in the last cycle, of almost 5 percent for the consumer price index in 2005. Wages, rents, and the velocity of money—how quickly it changes hands—are “going to be rising significantly over the course of the next several quarters,” Rosenberg says. He adds that his stance will then seem less “ludicrous” than it does now.

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