As government rains money down on the economy, many astute AMG National Trust Bank clients are concerned that inflation could soon erode their financial futures.

While little reason exists to expect inflation to pick up speed soon, the risk is increasing. In coming months, intense price competition brought on by the recession and efforts to pare inventories will make it extremely difficult for businesses to make any price increase stick. That should keep inflation low in the near term. However, the Federal Reserve Bank also is likely to keep short-term interest rates near zero for an extended period. As a result, the money stock and excess bank reserves will grow considerably—which puts the economy at risk for future inflation.

Currently, households and businesses are content to sit on a mountain of cash because of their concerns about the severity of the recession and the lack of safety of other investments, financial or tangible, but this will not always be so. As the economy recovers and the gap between demand for goods and services and productive capacity diminishes, the Fed will have to shrink the excess of money and bank reserves, or we will have the classic cause for inflation—too much money chasing too few goods.

The Fed may not have an easy time shifting policy. Banks may not be eager to buy the non-Treasury private debt now held by the Fed, and the Fed may not have enough Treasury bonds to absorb the excess. Political pressures to maintain low interest rates, when they should be moving up, could also come into play. All indications are that Fed policy makers are attuned to the issue and determined to act—but success is far from guaranteed, and the time for investors to take protective measures is before inflation accelerates.