Will the economy 'double dip'?

There are signs the U.S. economy could soon emerge from recession. But there are also fears that a recovery could lead to inflation and another downturn in 2010.

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By Paul R. La Monica, CNNMoney.com editor at large

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The dollar bounced back against the euro earlier this year but it's been losing ground against it since March.
Oil prices are still well below last year's peak. But prices have started to climb once again as the dollar has weakened.

NEW YORK (CNNMoney.com) -- The recession entered its 17th month this week, and despite some encouraging signs, few expect a true recovery until the end of this year at the earliest.

Even so, some financial experts think all the stimulus that the government has doled out could lead to a sharper turnaround than currently expected. But that's not necessarily a good thing. That's because such a bounce could trigger a quick rise in inflation that leads to another downturn.

"If the United States experiences a too rapid recovery, there may be a risk of another recession in 2010," said Bart van Ark, vice president and chief economist of The Conference Board in a report Wednesday. "It may fuel expectations for a return to inflation, adding to the uncertainty concerning the pattern and path of economic recovery."

Inflation? Really? Isn't it a little early to start worrying about rising pricing pressures when many are still concerned about deflation?

Van Ark conceded that the likelihood of another recession on the back of this one, a so-called double-dip recession, is small. But they've happened before, most recently in the 1980s, when a short recession in 1980 was followed by a 16-month downturn spanning 1981 and 1982.

And inflation concerns aren't as far-fetched as you might think.

Consider that the U.S. dollar, after several of months of rallying, has recently started to weaken again. The greenback is down 5% versus the euro since the beginning of March.

As the dollar has weakened, commodity prices have begun to creep higher. Crude oil, which was trading at around $34 a barrel as recently as mid-February, is now at about $52. The price of corn and soybeans futures have surged about 10% in the past month.

John Derrick, director of research with U.S. Global Investors, a San Antonio-based money manager with $2.5 billion in assets, said that he's not overly worried about the weakening dollar and spike in commodity prices.

He said that this is simply a byproduct of investors showing that they are willing to take on more risk.

In particular, he said that investors appear to be investing more in emerging markets with economies that are still expected to grow this year, such as China. And that has helped lead to expectations of stronger demand for commodities, which show themselves in the form of both higher oil prices and a weaker dollar.

And John Brady, senior vice president for global interest rate products at MF Global, a futures and options brokerage in Chicago, points out that it's hard to have inflation without accompanying wage growth. That clearly isn't happening.

"Inflation is not a problem and it won't be for years. Look at job the market. Inflation pressures are nil," he said.

Fed in a bind?

Still, a prolonged period of low interest rates -- the Federal Reserve cut rates to near zero in December and has left them there since then -- could also spark more inflation. And according to futures contracts on the Chicago Board of Trade, investors aren't betting on a rate hike until later this year.

Finally, the Fed has launched several large-scale programs to try and spur more lending.

Critics of the Fed contend that it is printing money to pay for these programs, which also can spur inflation down the road. And some fear the Fed would be forced to then raise rates quickly to nip inflation in the bud, which could then cause another contraction.

"Great Inflation may be upon us as both fiscal and monetary policies are forceful, but ineffective," wrote Axel Merk, president of Merk Mutual Funds, a Palo Alto, Calif.-based money manager specializing in currency investments, in a note to clients Tuesday.

"The Fed has no exit strategy that is viable -- it seems impossible to us the Fed could tighten monetary policy if and when inflation breaks out without causing yet another collapse in economic spending," Merk added.

But Brady said these critics are wrong and that the Fed has made smart moves.

"This slowdown emanated with the financial crisis and the broader economy will not recover until the financial sector recovers. The Fed is doing the right thing," he said.

Fed chairman Ben Bernanke is expected to talk about this issue in a speech in Charlotte on Friday. In past speeches, he has sought to allay fears by saying that the central bank can start to raise interest rates and unwind some of its new programs.

But another member of the Fed pointed out in a speech this week that this might not be as easy as it sounds. Charles Plosser, the president of the Federal Reserve Bank of Philadelphia, warned that such unwinding "will not necessarily be easy" due to potential political pressures.

"Will there be pressure from various interest groups to retain certain assets? Will there be pressure to extend some of these programs by observers who feel terminating the programs might disrupt "fragile" markets or that the economy's "headwinds" are too strong?" Plosser asked.

"Such pressures could threaten the Fed's independence to control its balance sheet and monetary policy. We will need to have the fortitude to make some difficult decisions about when our policies must be reversed or unwound," he continued.

That's an alarming statement, a concession that the Fed may have to worry about how Congress or the White House will react if the Fed starts raising interest rates before it's clear that the recession is over.

With all that in mind, I don't think it would be wise for the Fed, or investors, to completely rule out the possibility of inflation making a dangerous return down the road.

But Derrick makes a strong case for why worrying about inflation too much now misses the point. The only way inflation is likely to become a problem in the first place is because the economy is healthy again.

"Some of the concerns about inflation are legitimate. But the bigger concern for the immediate term is to get the global economy back on track," he said. "Let's actually have a recovery first before we worry about a double dip." To top of page

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