CHICAGO -- The Morningstar Investment Conference got under way Thursday, and the initial talk among the panelists was about warmongering. But while Iraq and terrorism were mentioned, the real war the fund managers and economists are supporting is the one against deflation.Taking the lead charge, of course, is the Federal Reserve. "They won't say so in plain English, but the Fed wants a higher inflation rate," said Paul McCulley, managing director and portfolio manager at the bond powerhouse Pimco. "The Fed will not tighten monetary supply until we can observe a visible reinflation environment." But while the panelists agree that President Bush and the Federal Reserve will succeed in their pull-out-all-stops push to pump up the economy -- indeed, they counseled investors to plan for an environment with higher inflation -- some expressed concern about the economy's long-term health.
Fighting a New WarThe need for reinflation -- an assessment with which all panelists agreed -- comes from a mix of political and economic cycles. The 1960s and 1970s saw a bull market in government, with capitalism in retreat, McCulley said. Monetary policy was conducted with an eye toward the Oval Office, and the goals were to limit private investments with government deficits, and to have higher regulation of the private sector. The 1980s and 1990s, though, saw the reverse. Monetary policy kept its eye on the bond market, private investment with government surpluses was encouraged, and deregulation reigned. But the bull market in capitalism ended with the new millennium, and now we're in a period during which capitalism is in retreat and deflation risk dominates. The cure: a monetary policy of reinflation. Monetary policy has shifted from a hard-money orientation with an eye toward the wishes of the Oval Office in the 1960s and 1970s to a 20-year war -- "a war, not a battle," McCulley said -- against inflation. "The Fed has finally got it," McCulley said. "They declared victory belatedly, but now have embarked on a new war." The near-term result of this push for reinflation is a bubble in the Treasury bond market. "That's a paradox we're grappling with," McCulley says. "In order to see a reinflation of the economy, it's necessary that the bond market believe that the Fed can't accomplish that. But if the bond market believes the Fed will fail, a bubble in Treasuries will result, long-term rates will come down, and the Fed will be successful."