There are a few indisputable changes in our economy.

Credit is tightening. Generally this is good because lending standards, whether to individuals to buy homes, or to real estate developers or other businesses, were way too lax. Marginal businesses will have much tougher standards to meet to renew credit lines.

Income statements have deteriorated. Especially if you are in a commodity business like steel, lumber or fuel, you have experienced the opposite of gouging as you sell your goods for less than you paid while your unit sales have dropped and desperate competitors sell at any price they can get to keep the doors open another week. You have probably experienced several consecutive months of losses.

Banks have a further problem lending to businesses with consecutive months of losses. But here is where a real potential problem awaits. We have a record deficit in a peacetime that will likely lead to inflation. The only reason it has not yet is because unemployment, uncertainty, and credit tightening has reduced the velocity or the speed of money circulating. Said differently, everyone is sitting on their cash, even with low returns. Therefore this cash is not chasing and inflating the prices of the goods in the economy.

If the flood waters don’t recede the levee will eventually break. This vast horde of cash will eventually enter the economy and a likely recipient will be industrial commodities. Housing and real estate wounds are still too fresh and the banks will not quickly pour their funds into that hole, although banks are noted for very short memories.

Stocks have a very clear value mechanism. If earning are poor and money pours into the stock market then the price earnings multiple elevates to a level when it is clearly overvalued. After the dot.com bust and the housing bust, pedestrian investors are still gun shy of the stock market.

But commodities have no clear valuation ceiling. Is gold overvalued at $1000 even if that is double its value of a few years ago? Is scrap fairly valued at $300 a ton or $600 a ton? Who knows? Is the proper price of gas $2.19 a gallon or $6.00 a gallon? There is no PE ratio to quickly determine if commodity prices are overvalued.

Inflation gets us used to higher prices. And we must compete with global economies for these commodities.

When inflation reignites industrial commodity prices, as I think it will, those who inventory and sell those commodities will be caught in a cash squeeze. They will need cash to cover the higher cost of replenishing inventory at a time when credit is sharply reduced. Many of these companies have been able to survive the recession with crappy income statements because of the cash they generated from their balance sheets as inventory and receivable costs dropped.

When this reverses they will experience a liquidity squeeze that will threaten all but the strong. If you sell these people on credit start watching them like a hawk. When inflation rebounds it will focus in industrial commodities and many in that field will be in trouble.

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