The U.S. economy is unwinding from a massive increase in the nation’s GDP. The fourth quarter GDP of 2005 ended with an anemic 1.8 percent increase. The first quarter GDP of 2006 ended with a massive gain of 4.8 percent; a gain not expected to be repeated throughout the rest of this year.

Economists were optimistic throughout most of April that the new FOMC Chairman, Ben Bernanke, would let the economy coast for another few months without another interest rate hike. However, optimism began fading after inflation indicators started moving up. Prospects for inflation will increase as the dollar weakens.

The Chinese let it be known that they will allow the yuan to gain 5 percent annually over the next five to seven years. This means the dollar will lose between 25 and 35 percent during that time. The odds that this will occur are extremely high. What is not so certain is how the Federal Reserve will react to rising prices. Will the Fed bring the economy to a quick end, drag it out for as long as possible, or will it attempt a soft landing; drain as much liquidity from the economy as possible without pushing the economy into more than one quarter of negative GDP?

If there is one thing I know for certain, it is that the Fed does not want to throw the economy into a full-fledged recession. Three factors have led me to this conclusion. First, this is a year for political campaigning. Second is the war in Iraq. Third is the need to maintain competition with China. If I am correct, this correction will pass in time. Blue Chips will emerge as a market leader. Inflation hedges will regain their lost luster and exceed recent highs. In the meantime, attempt to trim your losses and wait out the correction.