WASHINGTON (MarketWatch) – “Five of the Federal Reserve’s 12 district banks reported that the downward trend in the economy is showing signs of moderating, according to the central bank’s latest Beige Book report on economic activity. Contacts for several Fed districts said their expectations had improved, but none saw growth returning this year.”

This headline tells us that there is no recovery on the horizon yet—incipient or otherwise, as the inflation hawks would have us believe. Once we do begin to see a resumption of economic growth—maybe this fall at the earliest—then inflation would need at least another year to pick up any steam. Retail inflation as measured by the Consumer Price Index has in fact been negative over the past 12 months, after peaking at 5.8 percent in 2008. See the enclosed graph.

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The main inflation worry has been about the enormous amount of government debt. But the U.S. ran twice that amount of debt as a percentage of GDP during World War II that got us out of the Great Depression. Japan’s debt load is even higher.

And we cannot have inflation without rising wages and salaries—which make up more than 80 percent of incomes. Not only have wages and salaries barely kept up with the inflation rate for more than 30 years, but the jobless rate of this recession will reduce incomes even more. The average work week has now dropped to 33 hours—when it was 40 + hours during boom years.

A recent Elliot Wave newsletter (usually hawkish on inflation) by writer Bill Rice also maintains that looming fears of inflation are unfounded:

“The Federal Reserve’s balance sheet has exploded, with total reserve bank assets now standing at $2.079 trillion. This same time last year, total assets stood at $1.181 trillion. Inflation? Yes, the balance sheet is significantly inflated — but is it inflationary? Not necessarily”, says Mr. Fox.

“Such a huge reserve certainly has the potential to catalyze inflation (indeed a hyperinflation), but only if the Fed Chairman Bernanke liquidates the assets that make up the reserve accounts. Simply put, there is no inflation if the Federal Reserve refuses to turn those assets into cash (i.e., buys them back) and dump that cash into the economy.”

Consumer-driven inflation is not there, in a word. Consumers have to have cash (or credit) in hand to create demand upon products, services and raw materials — and thus drive up their prices. When rising home prices and easy-to-get credit cards financed consumer purchases, demand was strong. But now the housing equity is gone, millions are out of work, average wages are stagnant and lending standards have returned to the world of reality. "Inflationary pressures" are not here.

Therefore, the talk of inflation is essentially a head fake, which means it is based on fears of repeating past history, rather than facts. It is another form of the irrational pessimism permeating markets during this recession. And it is contagious, just as the infectious greed of the Greenspan era spawned irrational exuberance.

Nobel laureate Paul Krugman’s recent New York Times column sums up where we are: “A few months ago the U.S. economy was in danger of falling into depression. Aggressive monetary policy and deficit spending have, for the time being, averted that danger. And suddenly critics are demanding that we call the whole thing off, and revert to business as usual,” said Krugman. “Those demands should be ignored. It’s much too soon to give up on policies that have, at most, pulled us a few inches back from the edge of the abyss.”

The one and only sure sign of an economic recovery is when the real estate markets begin to recover, period. And that will take time—even more time if the inflation alarmists have their way and cause interest rates to climb further.

Harlan Green © 2009