This week we had two more Federal Reserve members repeat what has become the theme for their chorus, but not one the market seems to be paying much attention to. It should be. The market believes the Fed will soon start to cut rates, perhaps as early as first quarter of next year. It is not altogether clear that this will be the case.

I must admit to being somewhat baffled as to the apparent disregard by the stock market for what I view as a tough environment in the medium term with either a slowdown or a mild recession being suggested by numerous factors. While there are a lot of positive features to the economy, to me the risk to the economy still seems to be to the downside. I take small comfort in the fact that this perspective is shared by Fed Vice Chairman Donald Kohn, a very solid economist and financial market observer.

On Tuesday night at New York University, Kohn stated that he is more concerned about inflation than slowing economic growth because a recession is unlikely. "In the current circumstances, the upside risks to inflation are of greater concern...I am surprised at how little market participants seem to share my sense that the uncertainties around these paths and their implications for the stance of policy are fairly sizable at this point."

It's been a random walk through the data fields this week. The headlines say that inflation rose a mere 0.1% in August. The markets liked that. But digging deeper, the data is not as sanguine. We had the depressing Philly Fed manufacturing index last week, but today we find that Chicago is doing more than fine. The Dow flirted with a new all-time high, but then took the train home early for the weekend, leaving those who care about such things feeling like a teenage boy at a Baptist youth camp, flush with excitement during the day but frustrated as you go back to your dorm. But there's always tomorrow. Or maybe not.

Copper is the metal with a Ph.D in Economics. But has the metal been too smart for its own good? Looking at some recent trends in copper usage, we can learn something about an economic concept called substitution and the cure for high prices. I comment on my "debate" on Kudlow and Company this week, and muse on growing older and the passage of time. Let's jump right in.

The market, my various mentors have all told me, is designed to cause the most pain to the largest number of people. And while I am not in pain, the recent move up in the various market indices is certainly not in keeping with my thoughts that the economy is going to slow down and thus should exert downward pressure on the equity markets. Has the world transitioned to a kinder, gentler Mr. Market? One who views investors with compassion and encouragement? Has he truly turned over a new leaf, and this time promises to be different? Should I simply smile and be patient, or throw in the towel and buy the Vanguard 500? And is the stock market really all that good at predicting the direction of the economy?

This week we look at a few random ideas, throw out a few thoughts on China, comment on oil, and analyze today's inflation data. The good news for long-suffering readers is that this letter should be briefer than usual, or that is my intent as we start out. Let's see how it ends.

"The opera ain't over 'til the fat lady sings." And speech after speech by members of the Federal Reserve over the past few weeks suggest that the fat lady is still waiting offstage, not sure of her cue. Today we look at a thoughtful speech given last night to a private gathering by Richard Fisher, President of the Federal Reserve Bank of Dallas. We then look at a few worrisome charts on global liquidity and inflation and some more data on housing.

But first, I want to welcome all the new readers. There has been a noticeable upsurge in new subscribers to the letter lately, possibly caused by the fact that more people are forwarding the letter to friends. If you do get this letter as a forward and you would like to join my 1,000,000 closest friends and get your own free copy each week, as well as my Outside the Box, where I feature the work of another writer, often with a different opinion than mine, you can go to www.frontlinethoughts.com and subscribe by simply entering your email address at the website. We don't ask for any other information or need a secret handshake. I like to keep it simple.

Daughter and business partner Tiffani spent a few days this week reviewing readers' comments from the past few months. She wrote them saying she loves that I enjoy researching and writing; and if they did, too, she asked them to refer the letter to their friends and colleagues.

The Fed elected to pause in its rate hiking assault on inflation this week. With the backward looking data pointing to higher inflation that must mean they expect the economy to slow down and thus tame what incipient inflation is lurking around the corner. But wait, the data this week suggests the economy may not be slowing down. The market thinks that means the Fed will have to pick up the rate hike cudgel and once again do battle with inflation, which means higher short term interest rates. But the Bond King himself, Bill Gross, declares we are at a turning point and another bull market in bonds is about to appear! Ed Hyman of ISI (no slouch of a prognosticator) says the economy is going to slow down and therefore we are getting ready to have a new bull market in stocks - starting now! (Huh? Did I miss something?) Dennis Gartman thinks the next move the Fed will make is to cut rates, which means the economy will be visibly slowing.

And on and on. It is like watching a tennis match, as each new "data point" suggests seemingly conflicting information. It is enough to give a soul economic whiplash. But if we look at the data, it may not be all that inconsistent. The problem may be that it is not telling us what we want to hear, that both inflation and a slowing economy are a concern. Today we sort through a mound of data and see if we can make some sense of it, all the while pondering what Bernanke must be thinking late at night.

This week I write from Grand Lake Stream in Maine. It has been a long time since I have taken a week off from writing, but I think this is the week to do it. But that means, gentle reader, that you get an upgrade in quality, as my friends (thanks, Louis!) at GaveKal have graciously permitted me to use one of their most recent newsletters, where they talk about the recent inflation numbers, survey the markets in Japan and discuss Chinese growth and taxes. It is an interesting letter, and I trust you will enjoy it. I will return next week. You can find out more about GaveKal at www.gavekal.com.

Authors: Louis-Vincent Gave, Arthur Kroeber,
Anatole Kaletsky, Pierre Gave

Which is the greater risk: inflation or recession? The markets may be struggling for an answer, but Ben Bernanke has made up his mind: he isn't worried about either!

Can you have too much of a good thing? And specifically, can targeting low inflation and stable prices create problems that are even larger than the ones a stable price policy is trying to avoid? Today we look at a very interesting set of ideas proposed by one William R. White of the Monetary and Economic Department of the Bank of International Settlements (BIS). The BIS can be understood to be a kind of a central banker's central bank. So when they talk about appropriate central bank policy, those of us much lower on the food chain should pay attention.

Let's look at one paragraph in particular, which I am sure will show up in bearish commentary all over the world:

"Should any or all of these series revert to their historical means, the sustainability of future global growth would also be open to question, perhaps leading to a deflationary rather than an inflationary outturn. To combine the two possibilities, the worst case scenario would be inflationary pressures, leading to a sharp tightening of policy, which in turn could precipitate a process of mean reversion in a number of markets simultaneously."

Exactly how do you measure inflation? Last week's letter showed how the Bureau of Labor Statistics uses "owners' equivalent rent" to measure the rise in housing costs rather than the actual price. The conclusion is that it certainly smoothes out the volatility of housing prices, and keeps the CPI (Consumer Price Inflation) from violent swings from quarter to quarter, it also yields periods where the CPI both understates and overstates inflation. Today, given the rapid rise in home prices, it understates the actual costs of inflation, especially if you are buying a new home.

Today's letter will start off with some comments from me on the direction of Fed policy and inflation, and then will go to some comments and notes on inflation I got from several distinguished analysts, including Peter Bernstein, Hoisington Management, and Charles and Louis Gave. I offer their comments in full and unedited, and I think you will find them enlightening.

How can inflation be so low over the past few years if we see rising energy prices, ever-increasing medical costs and especially the cost of housing rising so dramatically? Today, for the first time we see inflation actually showing the results of rising energy costs, and the number is ugly. But it is not as ugly as it could be. This week we look at how the Consumer Price Index is calculated. Like the making of sausage and laws, it is not pretty. It will make for a fascinating read, I think.

But first, I am compelled to make a comment on the Refco situation. Dennis Gartman has what he calls the cockroach theory. There is never one cockroach. If you see one, there are a lot of them in the walls. Observers have been seeing cockroaches at Refco for a long time. When the whole story comes out, it is not going to look good. How you can hide almost a half a billion in losses when going through a public offering is mind-boggling. Refco has had a long history of problems. Most never make the light of day, but there is one that you might recall.

A battle plan, we are told, seldom survives contact with the enemy. Nonetheless, military leaders throughout the world wisely persist in making plans they know will be changed time and time again once the battle starts. Contingency plans are made for all sorts of events, whether likely or unlikely, on the off chance that when something goes wrong (and Murphy assures us it will) that there will be a plan to deal with the next crisis, even if it is to declare victory and go home. Armies train to fight in every form of terrain, in all types of severe climes, as who knows from whence the next source of conflict may arise?

What would we think of a military force that failed to plan or train? We might question the political wisdom of a particular course of military action, but we expect our various militaries to be professional - to have planned for many different scenarios in which they might be called to act.