Don't expect the year-long rally in risky assets to be undermined any time soon by the Federal Reserve becoming concerned about inflation.

The old metaphor — that the Fed's job is to take away the punchbowl just when the party starts getting good — just doesn't apply in the current circumstances. That's not to say inflation isn't a threat in the medium term — it is virtually a promise.

But punchbowl thinking dates from a time when firstly the Fed was presumed to have a degree of control over events we now know is not true and secondly to an era when asset prices were the caboose rather than the engine of the economic train.

Even with an economy that is now growing, the risk of a self-reinforcing deleveraging spiral is enough to ensure that the Fed will not pull the trigger on tightening any time soon.

"Asset prices are embedded not only in our psyche, but the actual growth rate of our economy. If they don't go up, economies don't do well, and when they go down, the economy can be horrid," Pimco bond chief Bill Gross writes in his most recent letter to investors: http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2009/Midnight+Candles+Gross+November.htm

Gross argues that leverage inflated the price of assets even as investment in the US real economy flagged. As this happened the US economy became ever more dependent on asset prices and on the sectors, such as finance, which intermediated the borrowing. When the debt and asset bubble is pinched, the whole edifice is threatened, leading to a response like the one we've seen: massive and overwhelming aid trained on markets irrespective of the costs.

Pimco data shows that the prices of assets in the United States over the past 50 years have gone up 1.3 percent a year more than would have been expected given nominal growth in the economy, leading to a putative 100 percent overvaluation if you reason that the assets which depend on the economy for income shouldn't outgrow it.

Unsurprisingly, the real outperformance of asset prices against economic growth has come in the past 30 years, since when debt growth has accelerated.

There are other explanations for why asset prices have outpaced economic growth. For one thing, off-shoring and outsourcing have both suppressed wages in the United States, leading to higher returns on capital, and increased the income that US assets receive from overseas.

It's obvious that the past 25 years have not been kind to labour, and as its share of GDP has declined the share going to asset owners has increased. In that sense increasing asset prices makes economic sense, though there seems to be every chance that workers start to recapture some of what they have lost.

Taxes on capital and profits have also fallen in the United States, and, like wages, this is a trend that could easily be reversed in coming years, especially given the huge amount of public debt that will have to be paid back.

This brings us to the other very strong reason the Fed may have for not pulling away the punchbowl — or water bowl as perhaps we had better see it — even when the party turns inflationary: public debt.

Since the US has taken a decision to not allow too much of the private debt to default, it has taken on a corresponding increase in public debt which will have to be repaid ultimately. US debt as a percentage of GDP will exceed 60 percent, a level not seen since World War II.

But unlike the post-war period, Europe doesn't need rebuilding and though Asia will grow hugely those profits won't flow to US coffers.

So, if growth doesn't allow the United States to repay debts, there are two options, neither pretty; default or inflation.

"No policymaker in the developed world — and, by now, few in the developing world — would want to countenance default as an option," writes economist Spyros Andreopoulos of Morgan Stanley in London in a note to clients.

"This leaves inflation."

To be sure, the Federal Reserve takes its mandate to control inflation and its independence seriously, but it is going to find itself in a very difficult squeeze, partly of its own making. The debt is high, growth will be poor and the time for private defaults is past. Threats to its independence will only grow.

Given that, and the dependence of the economy on asset prices, it's not hard to bet that the evil we will be left with is inflation. Whether it is engineered or just kind of happens is less interesting than the reasonably high likelihood that it will happen at all.

For a time at least, that would argue that risky assets, particularly real assets and emerging markets, do well.

Longer term, things get stickier and stickier.

James Saft is a Reuters columnist and the views expressed are his own. You can e-mail him at jamessaft@jamessaft.com