I had a chance to speak on Bloomberg Radio last night about the release of the Fed minutes from the June meeting. After spending some time going through them, looking at the exact wording and thinking about what was likely to happen over the next couple of months, I came to a conclusion: there really wasn’t all that much there.

Let’s recap. First, the markets reacted strongly to Ben Bernanke’s post-June-meeting press conference, where he said that the Fed would start to reduce stimulus at some point, not soon, if the economy’s performance warranted it. The market apparently interpreted this to mean the Fed would be exiting the stimulus immediately and raising interest rates shortly thereafter, resulting in a rise in rates and a hit to the stock market.

The volatility continues, with another decline yesterday in stock markets worldwide. And yet, in the U.S. at least, after a large drop at the open, markets slowly recovered through most of the afternoon before slipping again at the close. For today, most markets are in the green, and U.S. market futures are up as I write this.

Yesterday, we talked about the big picture and why the longer-term outlook for the U.S. is actually quite bright. I mentioned in passing that there are some shorter-term risks between here and there, and I wanted to spend some time today catching up on those.

The big one in the papers today is China. As you know, I’ve been very concerned about China for a long time. Most recently, I wrote about the decline in wage competitiveness and about some of the risks to the financial system, discussing in both posts the increasingly tense regional security environment in Asia.

A popular talking point these days is that the deficit over the past several years has been the worst since World War II. That’s absolutely true, as you can see from the chart below, but the statement misses a key point.

As I’ve been talking about the housing recovery for some time, I thought it would be worth giving it a more detailed look. I don’t intend to get very quantitative here, but there are a number of charts that illustrate just how far we’ve come. First, let’s take a look at housing affordability.

One of the wonderful things about the digital age is the emergence of mash-ups, where people combine elements of existing art in new ways. The idea has been around for decades, of course, but the Internet and digital technology have made it even easier to create and distribute.

Looked at in financial terms, the Federal Reserve (Fed) has done its bit by expanding the monetary base. There is quite a bit of money ready to go, and when it gets put into the economy, we will see inflation. But first, we need consumers and business to borrow and spend that money. That hasn’t happened yet; when it does, then we’ll need to worry about inflation. So it gives us a list of things to watch for:

1. The unemployment rate decreases. As excess labor is absorbed, companies will be forced to raise wages, which in turn will increase spending power. This is a necessary condition for inflation to move significantly higher, barring a rise in input costs, such as an oil shock. This will also signal increased growth, which should lead businesses to start investing again.
2. Banks start lending/consumers start borrowing again. This will probably lag increased employment, as people won’t/can’t, borrow without jobs, but once employment recovers, borrowing will most likely be close behind.
3. Growth in gross domestic product (GDP) ticks up. This will be an inevitable consequence of 1 and 2, but it is still worth watching as a leading indicator. Growth absorbs labor, materials, and everything else, and by increasing demand, it will certainly stoke inflation.

Even when some or all of these occur, inflation will not necessarily be on the immediate horizon, as there is still quite a bit of slack to work through—but it will be getting close. At that point, we should also see bond yields start to increase, which brings us to the investment implications.

Because we know inflation will increase eventually, any investments intended for more than a year or so should bear that in mind. For fixed income, shorter durations both limit the price risk and provide the opportunity to reinvest sooner at potentially higher rates. For equities, buying stocks that may potentially respond favorably to inflation, such as real estate investment trusts or commodity stocks, might make sense. For people who own or plan to buy homes, it would make sense to lock in today’s low rates.

None of this is to say that inflation is imminent—it is not. At some point, though, growth will resume, and the excess capacity that we presently have will be used up. As I have said, I believe that the U.S. economy has started a sustainable recovery, and if it is not derailed by actions from Washington, DC, that recovery may well result in inflation sooner than anyone now thinks. If so, that will actually be a very positive outcome, as it will mean we are finally through the aftermath of the financial crisis and into a more normal world.

Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs, and international economic, political, and regulatory developments. Use of leveraged commodity-linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.

Real estate investments are subject to a high degree of risk because of general economic or local market conditions; changes in supply or demand; competing properties in an area; changes in interest rates; and changes in tax, real estate, environmental, or zoning laws and regulations. REIT units/shares fluctuate in value and may be redeemed for more or less than the original amount invested.

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Recently, my posts have focused on the U.S., as that’s where most of the news has been, but I wanted to take a look at the rest of the world. Although nothing particularly urgent is happening, many issues we have discussed before continue to cook.

Europe

I have been getting a number of questions recently about a number of e-mails and webpages that predict certain disaster. The scenarios include a collapse of the dollar, hyperinflation, confiscation of private retirement accounts, and many other similar things.