Recession Vs. Inflation: Must There Be a Winner?

Now I know how Ben Bernanke feels. I was asked to be on CNBC's Street Signs yesterday to talk about which was the bigger problem facing the economy: Rising inflation or the threat of recession. I had to pass because I couldn't come to a quick decision. My pals over at First Trust Advisers, Brian Wesbury and Bob Stein, are pretty sure they have the answer:

Inflation is the leading menace to the US economy.... The CPI is now up 5.6% versus last year, the most since 1991. Excluding the 1990-91 period—when oil prices soared in part due to Iraq's invasion of Kuwait—CPI inflation is the highest since 1982. Meanwhile, the "core" CPI is speeding up, increasing 0.3% in July and up at a 3.5% annual rate in the past three months. We expect further acceleration in the core CPI in the year ahead as the drop in oil prices gives consumers more money to spend on other goods and services.

An equally smart guy, Mark Perry, takes the opposite view of Stein and Wesbury at his Carpe Diem blog:

Although I usually agree [with] them, I don't see inflation as much of a menace right now. The core CPI inflation on an annual basis was 2.5% in July, barely above the 10-year average of 2.21%, below the levels close to 3% between mid-2006 to early 2007, and way below the 4.58% average since 1970.... In my opinion, unless and until the core CPI inflation starts to rise, inflation ain't a big problem. For example, inflation WAS a huge problem in the 1970s and early 1980s, but it was when CORE CPI INFLATION was rising by double-digits, not just oil, energy and food prices. By definition, inflation is a phenomena when ALL prices, in general and on average, are rising, NOT just food and energy. With core inflation so low and stable, I don't see how inflation can be a menace. And with oil prices plummeting and the dollar soaring, look for August inflation, both overall and core, to moderate.

I have a few additional thoughts on this:

1) Trade has been supporting growth big time, maybe adding 3.4 percentage points to GDP in the second quarter. But now the dollar is rising and international growth is slowing. So that makes me fret more about recession.

2) The credit markets are still ugly. Lending standards are tightening, and economist Mike Darda notes that one measure of mortgage spreads are at their highest levels since March. So that makes me fret more about recession.

3) Inflation expectations, as measured by the 10-year TIPS spread, have fallen by about a quarter of a point to a third of a point, depending on my statistical tweaks, during the past two months. That makes me worry a bit less about inflation.

4) Gold has fallen from just over $1,000 an ounce to around $800, a drop of 20 percent. That makes me worry a bit less about inflation.

5) The dollar is rising. That makes me worry a bit less about inflation.

6) Oil is falling, which is like a tax cut for Americans. That makes me worry a bit less about recession.

7) Antigrowth economic policies in 2009 may hurt the economy then and the financial markets today. That makes me worry a bit more about recession.

Add it all up, toss in the opinions of Wesbury, Stein, and Perry, and what do I get? Plenty of worry about both recession and inflation.