Inflation vs. Deflation

Inflation

During and prior to the 1^st half of 2010 the media has frequently focused on the view that rampant inflation or “hyper-inflation” will inevitably result from  US massive deficit spending related to social programs, wars in the Middle East, and, most recently, trillions spent in bailing out financial institutions, AIG, and the auto & housing industries.

During the 1970’s so-called “conservative” investors cried after stashing their life savings in cash or Treasury Bonds only to find that their portfolios lost value or buying power as our government expanded the money supply to pay for the Vietnam War.

With the cost of our current war(s) and bail-outs dwarfing the spending of the 1970’s, financial advisors are less confident about recommending that conservative investors stay liquid this time around. In the ‘70’s those who bought grains and metals gained while those in stocks, bonds, and cash watched their savings dropped -often dramatically.

Those who believe that deflation is the more likely outcome of our financial crises expect that creditors will stop lending money, debtors will default, and a deflationary spiral will result. 

In this scenario, cash will be “king,” much as it was in 1929 when stocks, bonds, real estate, and even commodities fell in value as bankruptcies flourished and thousands of banks closed their doors.  The deflationists point to the 50 % decline in the Dow Jones, 50% drop in crude oil prices, and the continuing decline in home prices as evidence of their mindset.

U.S. Dollar

One critical market we monitor is the value of the U.S. dollar in the form of the U.S. Dollar Index. This index was created in 1973 to represent the value of the U.S. dollar against a basket of currencies which represented major trading partners of the U.S. at the time.  The Dollar Index provides us with a proxy for comparing the dollar with other major currencies (the basket is composed of the Eurocurrency, British Pound, Japanese Yen, Canadian Dollar, Swiss Franc, and the Swedish Krona) but does not necessarily depict the value of dollar compared to gold or other commodities. 

The dollar index may provide a barometer of U.S. inflation compared to that of other countries but it may not reflect the net core US inflation rate, per se.  It is possible, for example, that worldwide inflation may take place but the value of the dollar index may not show a major decline.

The View of Breitinger & Sons

While we believe hyper-inflation will most likely be the ultimate result of the government bail-outs and excessive deficit spending, we at Breitinger & Sons believe investors, hedgers, and speculators must remain vigilant to both the inflation and deflation arguments.

We predict that, instead of a simple one way trend, that our financial system and the politicians who attempt to control it will encounter wild swings in both directions much like a speeding driver who has lost control of an automobile.

We expect to see large bouts of both inflation and deflation as the government responds to unemployment, fiscal deficits, as well as surpluses and shortages of fuel, agricultural commodities and other natural resources.

We intend to closely monitor trends in currencies, federal debt, market sentiment, and basic commodity prices to help our clients avoid large losses and potentially profit from the volatility resulting from the government’s wrestling with a national debt which now exceeds $ 13 trillion.