Monday, June 08, 2009

Deflation or Inflation? Or Both?

The big debate right now with economists is whether the United States will experience Inflation or Deflation. The short term view seems to be that deflation is a possibility, though the long view is that inflation is more likely. However, there are bright economists on both sides of the debate - both however cannot be right.

The inflation view, which I favor basically argues that massive deficits will lead to inflation. While deficits in and of themselves don't lead to inflation, these deficits are deemed to be so large (on top of already massive spending programs) that instead of financing the deficits with existing money supply, the Federal Reserve will have to finance them by purchasing the debt the treasury issues - thus expanding the money supply greatly and diluting the value of the dollar.

The deflation view makes sense in the short term as unemployment rises and people have less to spend, the prices of goods fall.

I'm not sure its wise to make a bet either way, but to maintain flexibility to react to whichever comes our way. My bigger fear is inflation and the high interest rates that could come with it.

Scott Dauenhauer CFP, MSFP, AIF