The latest dispatches from the front lines give an edge to inflation. Yesterday, the Dow rose 133 points, putting it more than 500 points above its January low.

Commodities backed off, with the CRB down slightly and gold off more than $15.

This was very good news to Ben Bernanke and his merry band of market manipulators. Mr. Bernanke famously remarked four years ago that the world was a better place because of “improved monetary policy.”

Monetary policymakers “will not forget the lessons of the 1970s,” he assured investors.
We wondered what lesson he was talking about. As near as we can remember, the lesson of the ‘70s was that monetary inflation doesn’t always work. At some point, adding more money and credit becomes counterproductive. Or, to describe it in the language of classical economics, the marginal utility of greater and greater inputs of cash and credit falls into negative territory. Then, instead of producing the desired growth and prosperity, more inflation produces stagflation – rising prices without growth.

When that happens, the only way to deal with it is to bring in someone like “Tall Paul” Volcker, who stops waiting for the Humpty Dumpty economy to fall; he gives it a good shove, with interest rates over 15%.

Faced with what appeared to be a ‘70s style slump, Bernanke rushed off in the opposite direction – offering lower interest rates and more cash. He hopes to avoid a recession and - who knows - this morning’s news suggests that he may have done the trick.

A regional Fed governor is in the news, saying he believes there will be no recession in 2008. And the papers are reporting a resurgence of inflation in consumer prices.

“Global inflation climbs to historic levels,” says a headline in the International Herald Tribune . Here in London, officially, inflation is running at a 7-month high. On the opposite side of the world, in Japan, inflation levels are higher than they’ve been in 27 years. And all over the world, prices are rising.

No wonder. The Fed’s key rate is only 3.5%. Whatever the real rate of consumer price inflation is, it is surely higher than 3.5%. Maybe 4.5%, maybe much higher.

And the US federal government’s Open Checkbook policy helps too. Business Week reports:

“The federal budget deficit is running at a pace that is more than double last year's imbalance through the first four months of the budget year. In its monthly review of the government's finances, the Treasury Department said Tuesday that the budget was in surplus in January, but totals $87.7 billion so far this budget year, double the $42.2 billion imbalance recorded during the same period in 2007. The new budget year started last Oct. 1.

“The Bush administration sent its final budget request to Congress last week, projecting that the deficit for all of 2008 will total $410 billion, very close to the all-time high in dollar terms of $413 billion in 2004.

“So far this year, federal spending is 8.3 percent ahead of last year's pace, at $949.1 billion. That is far ahead of the 3.2 percent increase in revenues, which have totaled $861.4 billion in the current budget year.

“It is hoped the stimulus plan will keep the economy out of a recession or at least make the downturn milder and shorter than it otherwise would have been. The rebate checks are expected to start being mailed out in May with most Americans getting checks of $600 for individuals and $1,200 for couples filing their tax returns jointly. In addition, families with children will get an extra $300 per child.”

Do you see how wonderfully sophisticated this new “improved monetary [and fiscal] policy” is, dear reader? You jack up the whole economy with cheap money and credit...and then, when the thing starts to wobble, you put on another, bigger jack.

We don’t know what lesson Ben Bernanke drew from the ‘70s, but the lesson we recall is that you can’t keep jacking an economy up forever. Eventually, you have to let it down, or it will fall on your head.

But central banking is not a science. At best it is one part bad theory, one part low art and one part pure flimflam.

*** Sentiment in the housing market doesn’t turn on a dime. House prices made their biggest advance in history, between ’97 and ’06. It takes time for the momentum to exhaust itself.

Putting the question to homeowners, pollsters found that the 77% of them believed their houses had either stayed even or gained value in 2007. This result is completely at odds with the research results of the Case/Shiller Index, which puts the average house down about 10% for the year.

In Sacramento, the average house went down nearly 19% in the 12 months to the end of November ’07. In Las Vegas, the average loss was 17%.

*** Son Jules, at school in California, sends this little item:

“Exxon Mobil pays as much in taxes ($27 billion) as the entire bottom 50% of individual taxpayers, which is 65,000,000 people. The tax rate for the bottom 50% is only 3% of adjusted gross income; the tax rate for Exxon was 41%.”

Conservatives will be quick to spot the corruption. The people who pay little in taxes discover that they can vote themselves someone else’s money. Social Security, Medicare, education, protection – they want it all – as long as they don’t have to pay for it themselves.

But while the poor are trying to steal from the rich, the rich are doing their share of larceny too. Publicly-funded universities educate the sons and daughters of the well-to-do, not the poor. Retirement programs benefit those who live longest – again, the well-to-do, not the poor. Farmers want price supports...factory owners want tariffs...lobbyists want tax breaks hidden in the pleats of worthy legislation... And people with financial assets want protection from losses. In step the feds with money and credit – holding off crashes, avoiding bankruptcies and disguising losses with inflation...thus, shifting the burden of mistakes from investors to consumers.

As a democracy matures, the web of connivance and corruption becomes so tangled that people don’t know whether they come out ahead or behind. Then, the weight of it causes the whole society to sag.

*** Colleague Chris Mayer reports:

“China added more to global economic growth in 2007 than the United States. That’s the first time a country other than the U.S. pulled the bulk of the global economic sled since at least the ’30s.”

Buffett says it is not smart to sell the United States short. But selling the United States short has been a very good investment for the last eight years. Our guess is that it will continue to be a good investment, generally, over the next eight years too.

The United States is the General Motors economy – it is losing money on an annual basis, with high legacy costs, high debt, worn-out equipment, and a declining market share. Could it turn itself around? Yes. But not without a major upheaval – war...revolution...or bankruptcy.

Chris passes along another friend’s advice: “Get out of the dollar, teach your children Chinese, and buy commodities,” says Jim Rogers.

Bill Bonner is the President of Agora Publishing. For more on Bill Bonner, visit The Daily Reckoning.