The consequences of adopting a weak dollar and inflationary monetary policy to bail out the economy have begun to manifest themselves, although the real effects of the government's $12.8 trillion dollar recovery plan have only just started to show up. Investors should not be surprised to learn that the commitments, guarantees, and prodigal spending of the past two Administrations have come with harrowing consequences. Surprising or not, these painful consequences are just beginning to appear and are rather insidious in nature.

But the regular readers of my commentaries had been warned that massive money printing and government incursions into the free market would spark higher inflation and a falling dollar. To illustrate the point, the price of oil has increased 53% this year while gasoline has increased 26% in price since May 1st. That move alone should start to ring the alarm bells for everyone. But commodity prices have risen across the board sending the CRB Index up 14% in May alone. In addition, copper is up over 60% this year while cotton is up 18% in 2009 and the US dollar has also lost about 10% of its value since early March. So much for the deflation argument!

The cause of steep rises in basic materials and energy is not so much a U.S. demand story. Asia seems to be faring better; (their economy expanded at a 6.1% annual rate in Q1, the slowest rate in 10 years) while our economy has shed over 6 million jobs since the recession began and GDP contracted at a 5.7% annual rate in the first quarter. But the real cause in the rise of commodities can be found in the weakness of the US dollar.

Even with all of this in mind, the biggest negative effect thus far from the Administration's profligacy has shown up in surging bond yields. After hitting a secular low of 2.5% on the 10 year note, yields jumped to 3.9%! Meanwhile, mortgage rates leapt from a low of 4.85% to 5.45% last week, following the move in Treasuries.

Therein lays the problem. The progenitor of this crisis was a collapse in real estate prices and it has shown only a few signs of stabilization in sales, but is still far from a marked recovery in prices. In fact, last month's report on existing home sales showed a drop of 15.4% Y.O.Y. Both mortgage delinquencies and foreclosures reached record levels in Q1 2009 while the months' supply of existing homes actually climbed to 10.2 from 9.6. So while mortgage rates are on the rise, housing fundamentals continue to exhibit weakness.

Those soaring bond yields and mortgage rates will wreak havoc on our debt-imbued economy. Already we saw a report by the Mortgage Bankers Association showing a drop of 16% in the Refinance and Purchase Index for the week ending May 29th. For an economy that has a total debt to GDP ratio of 370%, we can also expect dire repercussions in everything from credit card loans to municipal bonds.

This is why Mr. Bernanke's next move on quantitative easing is so critical. Wednesday's auction of $19 billion in 10 year notes and Thursday's auction of $11 billion in 30 year bonds will be viewed with great anticipation. If Banana Ben steps up his manipulation of bond prices, the current fall in the dollar along with the rise in commodity prices and interest rates will seem inconsequential by comparison in the not too distant future.

Our government risks morphing what would have been a severe deflationary recession into an inflationary recession/depression in the longer term. Their decision to choose the inflationary route is based on the fact that inflation bails out those in debt. Make no mistake, for a country with $11.4 trillion in debt and a 2009 deficit equal to 13% of GDP, inflation is perceived as the only way out. However, inflation can never bail out anything or anyone, it only helps the very rich maintain their purchasing power while robbing it from the rest of the country. It will also be at the great expense of those who have made the mistake of holding their savings in dollar denominated fixed income instruments and who have not protected themselves by owning hard assets.

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