(Chart from FSU, figures up to late 2006. The Fed discontinued publishing M3 numbers in March 2006 since they were too embarassing._

Here's the real short sharp economic picture. For the last deacade or so the Fed has been flooding the world with liquidity. Roughly the money supply has been increasing at about double the rate of GDP growth. In the late nineties that money was shoved into stocks (where it doesn't show up inflation numbers). In the early 2000's it went into the housing market (where it doesn't show up inflation numbers either, at least mostly), in the mid 2000's it had been going into commodity speculation (where it shows up in non core inflation which the Fed pretends doesn't matter) and into the hands of rich oilarchies, which has been a major cause of the run up in oil prices.

This is a problem that Bernanke inherited from Greenspan, who from the 1998 Asian crisis on, seemed to respond to every crisis (including crises like "Bad economic times will hurt Republican election chances in 2002 and 2004") by putting the pedal to the metal and releasing more gushes of liquidity, and then by tightening far later and slower than he should have (and yes, I said that at the time.)

While the inflation has only begun to show up in so-called core inflation, it has shown up in non core inflation - energy and food. As Barry Ritholz notes, as long as you don't drive, eat or have to heat (or cool) your house, there's not that much inflation. And as Stirling has noted repeatedly since the US imports energy and sells goods, if core inflation is low and non-core inflation is high, well that means what the US is losing out. And indeed oil imports are increasing as a proportion of the trade deficit.

Since people keep buying more, and the price keeps going up for the same amount of goods (the very definition of inflation), there's still more work to be done in taming inflation - and getting all that excess money out of commodity speculation.

Unfortunately Cousin Ben keeps saying things that indicate that he isn't going to raise interest rates very fast. Probably he'll continue the quarter point raises we've been seeing. Now, you may be thinking "phew", because if he raised it, say half a percent every month, that'd crash the economy. But here's the deal, what he's doing is going to allow a full blown nasty inflationary episode. Then, after the election, one way or the other, Cousin Ben will raise rates high enough to actually tank the economy. That takes a bit of time to feed back into the system. So you're looking at a recession starting some time in early spring to summer. It could happen earlier, but given the way the yield curve has been flirting with inversion (indeed even briefly inverting) and Cousin Ben's lack of room to raise without causing an inversion, the latest we're looking at is almost certainly Summer of 07.

It'd be better if we could have our recession without an inflationary binge first, but that appears unlikely at this point.

Expect this recession to be a pretty nasty one. I'm expecting something on the order of the early eighties recession, at best.