Image: Inflation © Nick Koudis, Getty Images

Related topics: China, Federal Reserve, economy, investing strategy, Anthony Mirhaydari

A few months ago, I suggested that what we needed to cure our ailing economy was a dose of inflation. Not too strong a dose, but one strong enough to give the economy a swift kick in the rear.

While calling for inflation seemed like a terrible idea to many, there were a number of solid reasons to root for it: Higher prices would get companies spending on new equipment and employees, would push the stock market higher as cash flowed out of bonds and would encourage banks to start lending again. And for the most part, all of this has happened.

I wasn't alone, either. Federal Reserve Chairman Ben Bernanke was warning about the risks of falling prices and the creation of a Japan-style debt deflation death spiral during this period. He wanted to print more money to prevent it. This was the subject of a column I wrote back in August. Obviously, inflation staves off deflation.

But by the time the Fed got around to announcing its $600 billion "quantitative easing" money-printing operation back in November, the risks of deflation had passed and inflationary pressures were starting to build. The extra jolt of monetary stimulus sent prices skyward. It was too much. This was also discussed in one of my previous columns.

Image: Anthony Mirhaydari

Anthony Mirhaydari

Now, with food and fuel prices soaring -- crude oil is creeping toward $100 a barrel, while the United Nations' Food Price Index recently moved to an all-time high -- the risks have flipped to the other end of the spectrum. Now, excessive inflation is the bigger threat.

In fact, I've gone from rooting for inflation to being scared of it. It's going too far.

Here in America, prices are rising at rates not seen since early 2009. China's inflation rate hit a 28-month high of 5.1% in November. European prices jumped at a 2.2% annual rate in December, above the European Central Bank's 2% target. And in the United Kingdom, prices increased at a 3.7% rate in December after increasing a record 1% on a month-over-month basis.

As a result, and with investor sentiment at levels not seen since 2007, the stage is set for a period of weakness in the financial markets over the coming weeks as investors react to this concern. While I still believe we're in just the middle innings of a long-term bull market, the next few months could be very rough. Let's look at the reasons why.

Rises and riots

Inflation is spreading across the globe like a cancer.

In Africa and the Middle East, political turmoil driven by rising food prices has resulted in the ouster of Tunisia's president and protests in Algeria and Mozambique. The threat of food inflation has also sent leaders in Libya, Jordan, Morocco and elsewhere scrambling to keep prices down and their citizens off the streets. New demonstrations against economic hardships have appeared in Egypt and Mauritania.

In emerging markets, India's government is struggling to find a solution to a tripling of onion prices, Mexico has hedged against a rise in tortilla prices, Indonesia is grappling with a huge rise in chili-pepper prices, and China is contending with more-expensive cooking oil. Tension is in the air. India's shop owners, accused of speculative hoarding, have gone on strike in disgust. China has released cooking oil from its strategic national reserves in Xinjiang and Shandong. Indonesia's president has proposed that people start growing their own chilies in flowerpots.

These price pressures are extremely dangerous for a global economy still on the mend. With governments around the world tightening their budgets, the only source of new stimulus was from monetary authorities. Inflation takes that source of support away -- and could even set it in reverse.

Indeed, European Central Bank President Jean-Claude Trichet said he wouldn't hesitate to raise rates if inflationary pressures continue, despite the fact that troubled eurozone countries, including Ireland and Portugal, continue to depend on the central bank for support. In a recent news conference, Trichet made frequent references to his decision to raise rates in July 2008 in the midst of recession out of concern for rising commodity prices.

While in hindsight most think this was a mistake, Trichet brandishes the move as a sign of his commitment to fighting inflation above all else.

There's more. China last week increased the amount of reserve banks are forced to hold. It's the seventh such move since the beginning of 2009, and it comes in the wake of a surprise interest-rate hike in December. Thailand, South Korea, Serbia, Hungary, India and Australia also have raised interest rates recently, and more countries are expected to join in.

We've been protected . . . so far

Americans have largely been insulated from the global inflationary pressures that have accumulated over the last six months. But the problem is beginning to bite here. Gas prices have returned to levels that haven't been seen since 2008. And consumer confidence has taken a hit -- which will weigh on spending going forward. Yet the indirect risks are the greatest concerns.