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Inflation just looks like the biggest story of 2011 for investors.

It’s not.

The success or failure of government actions to fight inflation is the biggest story of 2011.

What’s the difference?

If inflation were the story, you all know what I’d be telling you to do. Buy gold, silver, and platinum (and the shares of the companies that mine those metals) and other inflation hedges that will rise in price as the real buying power of money falls. Buy the shares of commodity producers because what they dig or pump or wash or whatever out of the earth is itself a great inflation hedge and because the profits of these producers will rise as real value of money falls.

But that’s not such great advice if 2011 isn’t going to be the year of inflation—maybe in retrospect 2010 should get that crown—but the year of the inflation fight.

If the fight against inflation is the story for 2011, investors can expect wave after wave of worry to sweep the financial markets for the economies that are on the front line of that fight—China, India, Brazil, and other emerging economies. Fears that governments will raise interest rates, increase bank reserve requirements, slap on currency controls will send stocks down in specific markets and frequently—because these emerging economies are currently the drivers for global growth—around the globe. To see the likely result of these worries just look at China’s Shanghai Composite Index, which finished down 13.4% for 2010.

What’s a good strategy for a “fight against inflation” market? To explain that I’ll have to start by describing where we are in the fight against inflation and how that battle will develop during 2011.

On the evidence so far, the fight against inflation is going to be a real barnburner because inflation has gained such a strong foothold in the world’s emerging economies.

Inflation was running at an annual rate of 5.1% in China in November 2010. The rate fell to 4.6% in December, but that was still well ahead of the government’s target—even after the government raised that target to 4% in 2011 from 3% in 2010.

In India the benchmark wholesale price index accelerated to an annual 8.43% in December from 7.48% in November. The big driver is higher food costs. The price of onions, for example, soared 70% in the week that ended on January 1.

In Brazil not only is inflation heading higher but also expectations for future inflation are surging. Economists who had been predicting 5.34 inflation for 2011 last week have raised their forecast to 5.42%. Inflation ran at a 5.91% rate in 2010. The government put its target rate for inflation at 4.5% in 2010 and 201.

Inflation isn’t running wild everywhere in the world. It remains controlled in the world’s developed economies. The European Central Bank has indeed flashed a “danger” sign on inflation in recent days but inflation in the European Union climbed to all of an annual rate of 2.2% in December. (That was the first time in two years that inflation ran ahead of the bank’s target of close to but below 2%.) Headline inflation in the United States ran at a 1.5% annual rate in December; the Federal’s Reserve’s preferred core inflation number, which excludes food and energy prices, was up at just a 0.8% annual rate. And in Japan inflation was a barely measurable 0.2% annual rate in November.

As you’d expect from these numbers, the response to inflation is concentrated in the world’s emerging economies. China has raised its benchmark interest rate twice and it reserve requirements for banks 4 times in the last six months. The Reserve Bank of India has raised its benchmark repurchase rate six times in a year and its expected to raise it again in January to 6.5%. In Brazil new central bank president Alexandre Tombini raised the benchmark Selic rate by 0.5 percentage points to 11.25%.

These actions are all impressive enough to take a whack out of the stock markets in each of these countries. Shanghai, as I’ve noted, wound up down 13% for 2010. Brazil, as measured by the iShares MSCI Brazil Index ETF (EWZ) was up 7.6% in 2010, but that’s just half the return of the U.S. Standard & Poor’s 500 Stock Index even though the Brazilian economy grew by a projected 7.5% in 2010. India’s BSE Sensex 30 Index finished flat from October to December 2010.

But these actions haven’t impressed investors that they’ll be enough to win the inflation battle.

For example, in China yields on the 10-year bond are moving up while the yield on China’s to-year note falls. The spread between the two grew to 0.71 percentage points on January 18, up from a 0.8 percentage point spread on January 4. That kind of increase in the spread between shorter and longer-term bonds is exactly what happens when worries about future inflation are increasing.

In Brazil, the yield gap between inflation-linked and fixed rate bonds now projects that inflation will climb to 6.5%. And the futures market is projecting that the central bank will increase interest rates to 13.25% in 2011. Once upon a time economists were projecting that interest rate increases would stop at 11.75% or 12%.

Financial markets expect that central banks and emerging economy governments are going to have to take far more drastic steps than they’ve taken so far to get inflation under control. In Brazil, financial markets seem to be looking for cuts in government spending to demonstrate the resolve of the new government. In China it looks like it will take increases in benchmark interest rates of another 1.5 to 2 points.

Emerging market governments would prefer not to go as far as the markets are now suggesting. After stimulating their economies to escape the global Great Recession, governments from China to Brazil don’t want to give up hard-won growth in the fight against inflation. That’s why so many of the moves announced so far have been what I’d call gimmicks—currency controls, increases in bank reserve requirements, tougher mortgage standards—that look to win the fight against inflation on the cheap.

I doubt that those will work. They don’t go to the heart of the problem—run away lending and money supply growth that are the result of a mix of stimulative domestic policies and hot-money flows from the U.S. monetary easing still being conducted by the Federal Reserve.

And as long as these measures don’t work and don’t get inflation under control, emerging economy financial markets won’t be able to relax. Every announcement of strong economic growth will be treated as mixed news since higher growth raises the odds of higher inflation.

This scenario is why the consensus wisdom on Wall Street says that U.S. financial markets will outperform many emerging markets again this year. U.S. growth at 4% or so won’t be higher than growth in China or India or Brazil, but with the U.S. Federal Reserve on hold and inflation in the Unites States so restrained, the U.S. markets don’t need to worry about interest rate increases that might slow the economy.

And why the consensus call is to move out of the shares of commodity producers and other companies that depend on demand from China and other emerging markets.

If you believe in 2011 as the year of fighting inflation—and I do, just to be perfectly clear–you ought to go about trimming those commodity and emerging market positions now—and rebalancing your portfolio to emphasize U.S. stocks. And you ought to be doing it now. (I’ll have some advice on how to do that in my 10:30 post this morning.)

Like most other consensus calls with an ounce of wisdom in them, the current preference for U.S. stocks over emerging market equities will run to excess. U.S. stocks will become relatively more expensive and emerging market stocks relatively cheap. And investors will forget that we’re talking about a fight against inflation that isn’t going to wipe out growth in emerging markets or all increases in commodity demand.

China’s economy, for example, will growth at Just 8.7% in 2011, down from 10.3% in 2010, because of efforts to fight inflation, the World Bank projected on January 12. Thanks to those same inflation fighting efforts global copper demand growth will slow to 6% in 2011 from 10% in 2010, according to Macquarie Group.

That doesn’t sound like a recession to me in either China or commodities. But I wouldn‘t be surprised if by some time in 2011 investors emotions have swung so far toward pessimism that they’ve selling emerging market and commodity stocks as if it were. If and when that happens, I’d prefer to be buying rather than selling into that pessimism.

And in the meantime, if you need markets besides the U.S. that look sheltered from the worst of the fight against inflation, that show good growth prospects, and that look relatively cheap on those growth prospects might I suggest Mexico, Poland, and European markets such as Italy. I’ll have some suggestions on those markets in coming weeks.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any stock mentioned in this post as of the end of December. For a full list of the stocks in the fund as of the end of December see the fund’s portfolio at