The financial markets are beginning to heat up. After a long lull, the action is beginning to mount and commentators are expecting a major showdown:  Ben Bernanke vs. Inflation. They buy the dollar because they think they know the outcome: Bernanke will win.

This week, the Bank of Bernanke is expected to stuff a few more rounds into the ammunition chamber. Its key lending rate is supposed to rise from 5% to 5.25% - the 17th slug since the Fed began "reloading the gun."

Stockpiling this kind of ammunition is supposed to make the dollar a little safer. And a little stronger. And so, it is in the currency markets. You can buy a euro for less than $1.26. While the dollar "should" go down - heavy trade deficits and federal deficits are wrapped around its neck like millstones - it isn't going down yet. For the moment, speculators can earn more from U.S. dollar bonds than from its rivals. They're banking on Ben. And they're entitled to think that he can hold off inflation, with his trigger-ready arm.

But the plot needs clarification.

There are two kinds of inflation. There is the kind that everyone hates: when prices for cigarettes and beer go up. And there is the kind that everyone likes: when prices of their houses and stocks go up. The Fed has become an "inflation hawk," they say, because it is becoming vigilant about increases in consumer prices. Raising interest rates is supposed to mean it's girding its loins to fight them. But depending on how you measure it, cost of living is rising no more than it has been for years - each year, consumer dollars lose two to five percent of their purchasing power. And who complains? No one.

The risk from consumer price inflation is only more consumer price inflation. But we don't think that is the risk that the Fed really fears. We don't think that is why Ben Bernanke is loading the gun. And we don't think it's what he intends to shoot. No. Americans aren't upset about consumer price inflation. They desperately need it. Without it, they wouldn't be able to pay their bills. Without it, they would not be able to refinance massive debts. The whole economy needs the sweet bubbly of inflation to keep effervescing. Imagine if debtors had to make payments in money that was costlier and harder to get hold of.

It's the risk from the second type of inflation that is the real danger, because asset price inflation is usually chased by asset price deflation. After prices go up, they must go down. A bear market follows a bull market. Bubbles are popped. And all of a sudden, investors don't feel so wealthy. They cancel new investments. They cut off new projects.  They pull back, and the whole economy pulls back with them. This is what happened in Japan...and it is what Ben Bernanke has had his eye on for many years.

Only, today, asset price inflation threatens much more serious damage in America than it ever did in Japan. Japan's lower and middle classes were never lured into outrageous levels of debt as they have been in America. In the land of the free, the lumpen mistook the Fed's bonanza for real wealth. They thought they could "take out' money from their houses, even though they couldn't remember ever putting it in. They began to believe that this brand of inflation was the same as the other and that they could depend on regular, reliable increases in their house values. Why not just spend the money, they asked themselves.

And they borrowed. And now they have to pay interest on their debts. And now pistol-packin' Ben is making it much costlier for them to do so. 

And so, we watch the news for the denouement. We notice that mortgage rates are back up to their highest level in four years and consumer confidence is going wobbly. Headlines report rising default rates. Regional papers warn that housing inventories are increasing. And hearsay evidence pours in every day:

"Nothing seems to be selling," complains a friend from Maryland. "I don't know if there are actually more houses on the market. But you definitely see more 'For Sale' signs up.  They go up; they just don't seem to come down like they used to."

Ben Bernanke, once in charge of Princeton Economics Department and now in charge of Americans' economic future, is not only loading the pistol...he is pointing it at their heads.

*** While the dollar rises against euros, gold rises against the dollar. After dipping down below $550, the yellow money is gaining ground on the green stuff. August contracts were trading at $588 per ounce on Friday.

"I figure the metal 'should' be worth something like $1,000 an ounce now to be in a rough equilibrium with the value of other things the dollar can buy," says our old friend, Doug Casey. "That's an arbitrary guess; there's no exact method I know of to determine gold's real dollar value. But, assuming that the government were to make good on dollars held by foreigners - forget about Americans - how high a gold price might be needed?

"First we need to know how many dollars are outside the United States. Nobody knows exactly. They constitute the reserves of most foreign central banks and the de-facto currency of record in dozens of countries for ordinary citizens. The amounts are almost beyond belief; it's said that, in Moscow alone, there are more US$100 bills circulating than in the entire United States. Could $5 trillion be the number? If so, and if there are the reported 261 million ounces in the U.S. Treasury, the value of that gold comes to about $20,000 an ounce. Just to make good on the reported U.S. trade deficit of $800 billion for the last year, we're talking $3,000 gold. Forget about what the numbers would be if you added in the domestic money supply, M-3. Especially since they don't even publish it anymore.

"But the numbers, at this point, are academic. My basic view on gold is unchanged. And the fact it had a 37% gain this year, reaching a peak of $725 on May 12, or has given back 22% since then is meaningless in the big scheme of things...before this market is over, gold isn't just going through the roof; it's going to the moon. And the market is by no means over. It's just starting to wake up from a generation-long slumber.

"It's unwise to try picking tops and bottoms in the market. But, the way I see it, gold has made its bottom as you read this. The fundamentals haven't changed; there's only been a swing in traders' sentiments."

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