Here’s my spin on the deflation vs. inflation debate. I suggest you read Rich (as in our mighty Piggington.com leader) and Roubini on this topic and its effect long and short term on commodities (very enlightening).
We have strong deflationary forces that will likely dominate short-term. Agreed.
However, the Fed has opened its lending window to investment firms, commercial banks and insurance giants. In some weeks this exceeded 100 billion.
That fiscal stimulus is clearly inflationary…but rate spread data proves those financial institutions are still NOT lending out that money to other financial institutions. In other words, the traditional process of the fed pumping money into the larger financial system via lending to front row firms isn’t really functioning, even though that lending is now going to a much broader range of front row financial institutions.
Plus we got consumers hoarding cash, dramatically reducing spending, pulling money out of financial markets, and even maxing out equity lines of credit (pulling money out of banks). Even corporations are maxing out their revolving credit lines with banks, hoarding cash. Also, no more money coming into consumer pockets from equity re-financing.
So one might conclude that short-term the deflationary pressures are DOMINANT; yet, there is tremendous latent (and excessive?) fiscal stimulus (fed lending) that is held in check by the locked up financial markets not lending to each other. Plus we got those multiple other inflationary pressures held TEMPORARILY in check by the global recession. Plus you can expect the fed will cut rates again, soon.
Finally, we have the BIG QUESTION: when will the world start dumping dollars and trading into something else (gold? Euros? RMB?), as the dollar is unseated as the world’s de-facto reserve currency. That effect will be extremely inflationary for the dollar (more dollars released and less parties holding them or using them in financial transactions)
So let’s integrate all these factors.
CONCLUSION: short-term during this nasty global recession (12 to 18 months) we may well see CPI figures drop to zero or even go slightly into deflation territory….but watch out, because the inflationary pressures are bottled up, and when they explode all hell’s gonna break loose against the dollar.
So either mid-recession, or as the recession ends, we could move into rapidly accelerating decline of the dollar, and that will likely continue for YEARS AND YEARS.
This is why I cut gold back to 25% of portfolio, awaiting some potential better pricing on gold as this recession gets really ugly and deflationary pressures heat up. At the bottom of the recession buy gold and buy oil and dump dollars. That’s a winning strategy.
