(Caijing Magazine) The world is awash in Keynesian liquidity. Market consensus shifted in early March from depression mode to today's bull market. The case for a new bull run was built, first of all, on liquidity pumping up asset prices, followed by improvements in corporate and household balance sheets, and finally on rising demand.

This is a Greenspan dynamic that worked for the past 20 years. But it won't work this time. This flood of liquidity soon will lead to inflation, nipping the nascent asset bubble in the bud.

Liquidity works when a disinflationary force holds down inflation and channels liquidity into asset markets. Rising asset prices lead to debt demand. Higher leverage increases demand. This asset market-led growth model worked in the past because globalization and IT development kept inflation in check. As the upside from both has been absorbed, and no other source of production growth is in sight, liquidity will soon lead to inflation.

Most analysts argue against inflation on grounds that excess capacity due to slumping demand will keep inflation in check. Hence, they say, the liquidity boom won't be a problem until the global economy has fully recovered. I think this is faulty logic. Financial markets can channel liquidity directly into inflation through commodity speculation.

Despite declining oil demand, for example, prices have nearly doubled from their lows this past spring. This mainly reflects rising financial demand; a rising amount of liquidity has flowed into oil futures, which is being powered by expectations of inflation. As in the 1970s, these expectations alone are capable of turning liquidity into inflation.

Rising labor activism is another source of inflation. Most think labor unions are no longer an important force because their influence has waned over the past three decades. I think labor union power is driven by demand rather than supply. During an economic boom, few are interested in supporting labor unions. But in hard times, workers are more supportive of unions.

Globalization drove the boom during the past quarter-century. The bottom half of income earners in developed countries did not share this income growth; their wages stagnated through the boom. However, they benefited from rising property prices and easy credit conditions. They improved their living standards by borrowing -- running up credit card debt, paying minimum down payments for autos and property, and running up debt against rising property prices.

The pacification of globalization's losers is coming to an end. Creditors now know the risks and will no longer lend like before. When credit cards stop working, labor unions are likely to come back, demanding wage increases.

Excess capacity won't hold down inflation for two reasons. First, manufacturing value-added is much lower than it was before relative to raw material costs. Globalization has forced multinationals to shift production to low-cost countries such as China. In the process, manufacturing has decreased in importance. For example, steel prices are moving in tandem with iron ore prices, despite huge processing overcapacity. The reason is that iron ore accounts for more than half the cost of production. Coking coal is another quarter of the cost. Equipment depreciation, labor, and profits account for small shares of product price.