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Bull or bubble?

Veteran Wall Street trader Victor Sperandeo had a chilling forecast for the audience at an investor gathering last month in Century City, Calif. Hyperinflation, he warned, had become a serious possibility for the U.S. given the unprecedented fiscal and monetary stimulus supporting the economy.

That could translate into the consumer price index eventually rising at a rate of 50 percent or more per month, said the man known as Trader Vic.

Not unexpectedly, Sperandeo also had a product pitch for the 100 or so investors who were there at the invitation of money management firm Rydex SGI. In a time of hyperinflation, Sperandeo said, Rydex's "managed futures funds" would be a way to ride what could be exponential increases in the prices of commodities such as wheat and gold.

We've reached a point where inflation has become Topic A in many discussions about what comes next for the U.S. economy and financial markets.

The government's report March 4 that the economy created a net 192,000 jobs in February, in line with analysts' estimates, lent more credence to the idea that the recovery was regaining momentum.

But that also raises fresh questions about inflation as a side effect of growth, particularly given the Federal Reserve's ultra-loose monetary policies.

For investors, getting the inflation outlook right could be critical. A steep jump could be deadly for fixed-income securities such as bonds and cash accounts, though it might help housing and other hard assets.

Steep increases in prices of food commodities in the past six months already had made inflation a burning issue in developing nations such as China and India. With the surge in crude oil prices since social revolt escalated in the Middle East and North Africa over the last month, U.S. inflation is registering in its most visible form: at the gas pump.

When Federal Reserve Chairman Ben S. Bernanke went to Capitol Hill to deliver his semiannual testimony on Fed policy, he was grilled about inflation risks.

"Once price stability has been lost, as you well know, it is difficult and very costly to regain," Sen. Richard C. Shelby, R-Ala., lectured Bernanke.

The Fed chief was unruffled. "The most likely outcome is that the recent rise in commodity prices will lead to, at most, a temporary and relatively modest increase in U.S. consumer price inflation," he said.

Not that you'd expect Bernanke to sound worried. Managing an economy is about managing confidence. The Fed needs consumers, investors and business executives to believe that inflation won't get out of control. Otherwise, their behavior might quickly change in ways that could make soaring prices inevitable.

Remember the toilet-paper hoarding of the early 1970s amid rumors of shortages and expectations that prices would rocket?

So far, the Fed continues to insist that there is no inflation problem, so it sees no reason to tighten credit. By its preferred gauge of price changes in the economy, the personal consumption expenditures deflator, inflation was up just 1.3 percent in January from a year earlier. Excluding food and energy, the increase was a mere 0.8 percent.

The Fed would like to see annualized inflation near 2 percent as a sign that the economy is functioning closer to normal.

Yet the Fed's harshest critics believe the central bank's easy-money policies, as commodity prices rise, have created a massive inflation time bomb.

"We're on our way to hyperinflation," said Michael Pento, chief economist at money manager Euro Pacific Capital in New York.

If that conjures images of Germany in the 1920s, and people pushing around wheelbarrows full of worthless currency, that's exactly Pento's point.

Like many in his camp, he believes the federal government and the Fed ultimately will destroy the dollar's value by flooding the world with the currency — the government via its record budget deficits, and the Fed by keeping short-term interest rates near zero while pumping huge sums into the financial system by buying Treasury bonds from investors.

To be sure, the hyperinflationists remain a fringe group. And as you might imagine, they typically would like to interest you in buying their favorite investments, especially hard assets such as gold, which last week hit a new high of $1,437 an ounce.

One path to hyperinflation would be a global rush out of dollars and into commodities. That is happening now to an extent. But while the dollar has weakened against many other currencies over the last six months, it's hardly collapsing. And as the Fed has hoped, the dollar's slide so far has helped fuel a U.S. export boom by making our goods cheaper overseas.

Among Fed critics, few are as eloquent as James Grant, who edits the newsletter Grant's Interest Rate Observer in New York.

Like the hyperinflationists, Grant believes the Fed is following a dangerous policy of dollar debasement.

"If the Fed can conjure $600 billion in a few short months, what is the value of that money?" Grant asks, referring to the central bank's current Treasury-bond-buying commitment.

"That's where a number of people, seeming hysterics, have latched onto an essential truth: The cost of producing a dollar is essentially nothing," he said.

Yet Grant isn't betting on hyperinflation, or on what usually goes hand in hand with it, which is economic collapse.

"It's one possibility," he said of hyperinflation. "Another is (the economy) simply gets by, with many, many disappointments. That is more likely."

It also sounds a lot like the past decade.

If hyperinflation remains a nonstarter, what kind of 'flation might we expect from this point?

One possibility is the kind of inexorably advancing inflation that occurred in the 1970s, when the consumer price index rose from 3.3 percent in 1971 to a peak of 13.3 percent in 1979.

But the inflation of that era was driven in part by a price/wage spiral, meaning that as prices of goods and services rose, many workers' wages also rose to keep up, in turn feeding more price increases.

That spiral was a function of unions' considerable power back then. As the ranks of organized labor have shrunk, however, so has most workers' ability to demand inflation-beating wage growth.

For businesses, then, that means that "broad-based pricing power is missing now," said Srinivas Thiruvadanthai, an economist and director of research at the Jerome Levy Forecasting Center in Mount Kisco, N.Y. Sharply rising prices could quickly run up against many consumers' ability to pay for things.

But people have to eat, and many also don't have much choice about driving. That raises the risk that food and energy prices could continue to rise worldwide, keeping overall inflation elevated, even as spending on other goods and services wanes, weighing down economic growth.

That would be stagflation, a term coined to describe parts of the 1970s.

Another possibility is the one that terrifies the Fed: deflation. That probably would require the U.S. economy falling back into recession.

If that's your bet, then government bonds and cash accounts are the places to stash money, although some overseas investments also might hold up.

What the Fed hopes we'll believe is that it can succeed with the Goldilocks scenario of not too hot and not too cold: The economy continues to recover, job growth accelerates, annual inflation stays around Bernanke's preferred rate of 2 percent, Congress begins to pare the budget deficit, and the Fed slowly tightens monetary policy, taking back much of the $1.6 trillion it has added to the financial system since 2007 before that money can fuel inflation and melt the dollar.

Interviewed on CBS in December, Bernanke said he had "100 percent" confidence in his ability to make the right moves at the right time.

When was the last time any of the rest of us felt 100 percent confident about anything?

Bull or bubble?