The Single Most Important Financial Decision You Face Right Now

The price of “stuff” is going up.

Gold hit a new high this week of $1,474 an ounce. Brent crude oil is trading above $125 a barrel. And silver broke through $40 an ounce.

Consumer prices are on the rise too. As I wrote on Monday, wages in the U.S. aren’t keeping up with the rising cost of living.

Average private sector wages rose 1.7% in March. Meanwhile, inflation is running at about 2%, largely due to higher energy and food prices.

Ben Bernanke at the Fed reckons these price hikes are nothing to worry about. They’re “transitory,” he says, and pose no real threat to the U.S. economy.

Of course, Bernanke’s measure of inflation doesn’t include the things that are going up in price most: food and energy. For the last 11 years, the Fed has refused to measure inflation by the headline Consumer Price Index. Instead, it sticks to what it calls “core” inflation, which strips out food and energy costs.

Pretty handy, huh?

The cost of bread and milk and gasoline can rocket higher, and the policy wonks in the Fed can pretend nothing is happening.

As you can see, the system is rigged to favor inflation. That’s because inflation is good for banks. (When inflation is high, people borrow more, because inflation will erode the value of the loan repayments.) And what’s good for banks is good for everyone – at least it is in the eyes of the Fed.

But what if Bernanke is wrong? What if the build-up in inflation isn’t “transitory,” like he says?

One person who thinks Bernanke is underplaying the threat of inflation is bond fund manager Bill Gross.

Gross runs Pimco, the world’s biggest bond fund. So he knows a thing or two about economics – especially inflation and deflation, which bonds are so sensitive to.

Gross reckons Bernanke is overlooking a major emerging market shift that means inflation is a much bigger threat that Bernanke understands. Here’s what he said on CNBC earlier this week:

The emerging and developing world is different these days. They’re less wage-sensitive and they’re more commodity-sensitive. In other words, citizens are demanding more for their money and they’re reflecting that in the form of higher commodity prices. To expect that to revert over the next several years is a little pollyannaish.

Wages and standards of living sure are rising in the emerging economies. I witnessed this firsthand in Vietnam in January – where once there were streets full of bicycles, there are now streets full of scooters and cars.

As wages rise in places like Vietnam and China, two things happen:

1) Emerging market consumers start buying more “stuff” – brick houses, gasoline for their cars, more meat-based meals. This pushes up demand for commodities and therefore causes prices to rise.

2) Exports from these places become more expensive, as higher wage costs feed into the prices of finished goods. This means places like China are no longer exporting deflation (in the form of cheap manufactured goods), they start to export inflation (in the form of higher priced goods).

All of this means one thing: U.S. Treasury bonds are going to be a terrible investment over the coming years.

It’s no wonder Gross’s Pimco has gone ultra bearish on Treasurys, dumping all of its U.S.-related government debt holdings.

Let me repeat that: The smartest bond fund manager on the planet…a guy who oversees a $1.1-trillion investment portfolio…thinks U.S. Treasurys are a lousy investment.

In times of deflation, bond prices go up. But when inflation rises, bond prices drop. That’s because bond prices are sensitive to interest rates. Higher interest rates (which accompany inflationary cycles) force bond prices down.

Right now, the Fed is the biggest buyer of Treasurys. This has the effect of keeping bond prices artificially high.

But what happens when the Fed stops being a buyer? Unless other buyers step in, demand for Treasurys will drop and so will prices.

Moving out of Treasurys is probably the single most important financial decision you can make right now. I urge you to consider following Bill Gross’s lead…before it’s too late.

If you are looking for fixed-income investments to round out your portfolio, consider something like the WisdomTree Emerging Markets Local Debt Fund (NYSE:ELD).

This ETF invests in debt denominated in the currencies of emerging markets. And it has a distribution yield of 4%.

ELD is not only a great way to earn yield in your portfolio, it’s a great dollar diversifier too.