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The Short Answer

As Prices Soar, How Can Investors Cope?

Here's how you can deal with the looming inflation threat.

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When the tech bubble burst in 2000, the Federal Reserve responded by slashing interest rates. That move helped keep the economy afloat, but it helped fuel another bubble in housing. After the housing bust triggered a broad credit crisis, the Fed answered again with steep rate cuts. That measure may have been necessary to prevent a financial meltdown, but it also could make higher inflation a greater possibility. The Fed's attempts to prop up asset prices by flooding the economy with cash could result in too much money chasing too few goods--the classic recipe for inflation.

Of course, if you've filled your gas tank or bought a carton of eggs lately, you probably don't need me to tell you that rising prices are already a problem. You're paying more for both food and energy thanks to surging commodity prices. And there are signs those higher prices are working their way through the broader economy: In February, the U.S. government announced that wholesale prices were 7% higher in January 2008 versus the year before. Consumer prices didn't rise quite as quickly, but its 4.3% annual pace was higher than recent historical norms.

Mention "high inflation" and many folks have flashbacks to the 1970s (if only bellbottoms and avocado-colored appliances were the lone unfortunate legacies of the decade). Thankfully, fashions have since gotten more sensible, and more importantly, corporate America has become much more efficient. The U.S. economy is a lot more global and less energy intensive than it was back then. (In the 1970s, the U.S. economy was much more industrial and used more energy, so it was hit harder by the decades' oil shocks.) And while the Fed may have flooded the market with cash, banks aren't exactly eager to lend it out, reducing the potential inflationary impact.

Christopher Davis does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.