There continues to be a tug-of-war between a mini inflationary boom and a recession and/ or depression. The stock market has been quite strong in the last couple of years after tanking in late 2008 and early 2009. With the Fed's aggressive monetary policy since that time and with massive government spending, it was bound to create more asset bubbles. It is always a question of which assets will boom the most.
Of course, if we are in a mini inflationary boom, it is mostly an illusion. Real growth is based on savings, capital investment, and technological innovations. While there might be a little of that, most of the boom is illusory, caused by a loose monetary policy and massive government spending.
The last few days have been bad for the stock market. The Dow has retreated well below 13,000. It will be interesting to see where it goes from here. The 10-year yield has dropped back below 2%, meaning that either the Fed is buying more government debt or investors are running to perceived safety. Of course, U.S. government bonds are only safe as long as people still perceive them as safe or as long as the Fed keeps buying and pushing down rates.
It really does seem to be a struggle between inflation and recession right now. This doesn't mean that we can't have both at the same time. The Keynesians were proven wrong in the 1970's when there was high price inflation and high unemployment at the same time. With that said, I think one or the other will be more dominant. In the last 6 months, I was leaning more towards a mini inflationary boom (artificial) before we saw another recession.
Americans understand right now that something is not right with the economy. In fact, the pessimism has helped keep prices in check as more people try to save more and spend a little less.
What Americans don't understand (or at least not many) is that there are going to be some hard times in the near future no matter what. Even if Ron Paul were elected president and the Congress turned libertarian overnight, there would still be some pain. A drastic cut in government spending and regulations would probably cause a recession, but that would be the best case scenario, as the recession would likely be over quickly.
On the current path, we are headed for much worse. While government spending, regulation, and debt are major problems, that is not the worst of it. It also isn't the massive unfunded liabilities. The major problem for the short-term economy is all of the past monetary inflation that was used by the Fed to prop things up. It has not allowed for the previous malinvestment to correct and it has made things far worse by misallocating resources on a grander scale.
We actually need a recession to correct all of the previous malinvestment. We need a realignment of resources that coincide with actual consumer demand. Until that happens, the economy will not be on a solid footing. We will have to continue to endure these roller coaster ups and downs.
Let's see where the stock market goes from here. If it continues to go down, we may be headed back into recession. Then we will have to fear more monetary inflation by the Fed. If the stock market bounces back up, then it is more likely that we will continue in an illusory boom period. Either way, we will eventually see a major bust.