First, let’s look at the headlines:

“Manufacturing data add to recession worries,” says the Financial Times. The Philadelphia Fed says its index of factory output sank to a 7-year low this month.

Stocks didn’t like the report – the Dow finished down more than 142 points. Oil didn’t like it either...it slid off its all time high. But gold seemed cheered by the news, hitting a new record high above $950. Commodities rejoiced too – with the CRB up to a new all time high of 544.

“Gold nears $1,000 as stagflation fears grow,” says another FT headline.

“The fight against inflation is being sacrificed in G7 countries to avert the risk of recession and investors are likely to seek gold as an inflation hedge,” said one trader at Nomura Securities, adding that she expects the price of gold to AVERAGE $1,000 this year.

There you have it, dear reader. The world’s leading central banks are more worried about recession than inflation. And investors are betting that they’ll cut rates further to fight it. Lower lending rates...and easier credit conditions, generally...will cause higher levels of inflation.

Until now, central banks could get away with soft money policies, because the Chinese offset increases to the supply of money with massive increases to the supply of labor. Millions of Chinese moved from the farms to the factories – lowering the price of labor worldwide...and with it, prices of consumer products.

But there are many things cheap labor can’t produce – oil, for example. And gold. And copper. And food. Copper is up 22% so far this year. Gold is up 11%. Wheat is off the charts. And oil broke through the $100 barrier just this week.

Inflation has become a worldwide phenomenon. High cost copper...expensive oil...and rich food prices are working their way into the whole global consumer price structure. Inflation in China itself is over 7%, with wages rising more than 10%. Yes, the trend toward lower consumer prices led by China and Wal-Mart seems to have bottomed out.

Now, we’re looking at higher labor costs in China...and higher prices for Chinese exports. Along with higher prices for just about everything else.

Everybody loved inflation when it pushed up their stocks and house prices. But they hate it when it boosts the cost of their bread and taxi fares. Only gold investors like consumer price inflation. Hence, the smart money is wagering that the price of gold will go up...and so is our money!

It almost makes you feel sorry for Ben Bernanke and the other central bankers. They are caught between Scylla and Charybdis, between the cannons of inflation to the right of them and the big guns of inflation to the left. They enter the valley of death without a prayer and without a clue.

Of course, if they hadn’t been such dumb clucks in the first place, they wouldn’t have gotten themselves into this jam. But, heck, that’s what markets are for...that’s what life is for...to reward virtue and punish error. These fellows challenged the gods – pretending that they could control the markets and the business cycle. Of course, they couldn’t. All they could do was to use the old familiar Keynesian flimflam: print a little extra money so as to trick people into thinking they were wealthier than they really were.

Then, they’ll spend more and invest more. It will look just like a real boom. Over and over again – from the crash of ’87, to the Asian crisis, through the LTCM meltdown, and then the big dotcom crash, followed by the mini-recession of 2001, now the collapse of subprime and the bear market in housing – the Fed reached up its sleeve and slipped out an ace.

The trick may work longer than you expect it to, but not forever. Now, Mr. Market has pulled out his pistol and placed it on the table. He’s watching carefully; if sees that old, tattered ace of spades, there’s gonna be bloodshed.

Consumer prices in the United States are rising at a 4.3% annual rate – almost exactly the same rate at which Richard Nixon declared a state of emergency and imposed price controls. Oil is over $100 and gold is nearing $1,000. If the history of the ’70s replays itself, consumer price increases will hit double-digit levels within a few years, and the price of gold will shoot up over $2,500.

We doubt that it will happen like that. Because the financial situation of the United States – the world’s leading economy – is much worse than it was in the ’70s. By almost any measure you can think of – household debt, government deficits and debt, stock market prices, competitive position, housing prices, trade balance, savings, net assets – the United States is fundamentally (and probably irreversibly) weaker than it was 35 years ago. That could have a surprising effect: pushing the U.S. economy deeper into the ‘stag’ part of the territory and upping the ante for the inflationists. Deflation could hit so forcefully that price gains never have a chance.

All we know is that, now, the gods are having their revenge. And while it may be painful to investors, homeowners, workers, and just about everyone else, it is nevertheless instructive. And for a mischievous economist – still fun to watch.

“Fed fights to avoid ills of the ’70s,” says a headline in the International Herald Tribune. You can guess the story. Inflation on the one hand. Deflation on the other. What’s the poor Fed going to do?

Just about everyone expects it to take the easy way out – to cut rates again in March, try to play the old trick again, and as far as inflation is concerned, well, devil take the hindmost!

But just about everyone also expects the economy to soften in the first half of the year, but somehow improve after mid-summer’s eve. As to the first expectation, we are at one with the majority. As to the second, we are on our own.

*** The United States is now a net importer of food, we read recently. If we understand that correctly, there is no longer enough food Made in the USA to feed Americans’ appetites. Colleague Dan Denning began a nervous discussion on the topic when he sent this article from the Financial Times, with its headline reading: “The next crisis will be over food”

From the article: “...what is really catching the attention of Goldman Sachs (NYSE:GS) now is the outlook for agricultural prices. Or as Jeff Currie, head of commodities research at the US bank, says with disarming cheer: ‘We think we could go into crisis mode in many commodities sectors in the next 12 to 18 months...and I would argue that agriculture is key here.”

“Mr. Currie argues...if the world today was a rational economic place, then regions such as the Gulf which are food-constrained ought to be investing heavily in agriculture. And since the US is the world’s biggest agricultural supplier, this implies that the Saudi Arabians, say, should be snapping up farms in Wisconsin – as America secures oil in the most efficient manner by sending teams of Texans to Riyadh.

“But in practice numerous investment controls prevent Saudi Arabians from buying Wisconsin farms and Americans owning Saudi oil wells. And these controls are not being dismantled now. On the contrary, mutual mistrust is now rising. Hence the fact that Gulf leaders are currently considering desalinating sea water to plant wheat in the desert – while the US and Europe are trying to turn corn into fuel.

“Such exercises might make sense in domestic political terms; but they are apt to be fiendishly expensive. Thus the upshot of this misallocation, Mr. Currie would argue, is even more inflation – even if the world does experience some form of growth slowdown.

“Now, for any investor who is long on commodities right now (and I would guess that club includes Goldman Sachs), such trends might seem to smack of good news. For anybody who is dirt poor in the developing world, however, the picture is disastrous.

“But leaving aside this very real human tragedy, what should also be crystal clear for investors is that this is not a picture that points to 21st-century capital markets progress; nor is it likely to breed stability in the medium term. Anyone who thinks this decade’s problems start and end with credit, in other words, may yet receive a rude shock; sadly, we live in a world where soybeans may yet pack as painful a punch as subprime.”

“The globalization of the food supply has been great,” Dan continues. “3,000 mile chicken Caesar salads, as Jim Kunstler puts it. But just in time, calorie delivery is running straight into more conventional realities...like droughts, floods, and plain old high prices.

“I always thought the French position on retaining the ability to produce your own food was never fully discussed as a strategic choice. It is one thing to outsource your textile industry or your industrial base or your supply of oversize sweat pants.

“But outsourcing your supply of food and water, depending on unfriendly or unreliable trading partners to keep sending fresh fruit and poultry, or thinking the global system of trade will forever expand and never again contract; these are all dangerous assumptions that could leave you with an empty national stomach at night.”

Our Daily Reckoning suggestion: plant a garden.

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