The Debate Continues: Inflation or Deflation

The question is of utmost importance to investors; inflation or deflation. The future is untold as of now and the saavy investor would be wise not to get too emotionally convinced of either scenario, but instead keep a rational and flexible opinion.

The Argument For Inflation:

• Alphabet soup lending facilities

• Discounted bills from the Fed

• Paying interest on reserves

• Explosion of excess reserves on Fed balance sheet

• Shotgun marriages between banks & ibanks

• Monetization of government debt via quantitative easingby the Fedand banks

• TARP

• Obama stimulus plan

• China's continued path of destruction focused on exports, funded through treasuries

• 0% interest rates

• Capital injections and guarantees into banks(non-TARP)

• Proposed "Bad Bank" to saok up toxic assets of banks

• Bail outs to US automakers

• International socialism via bail-outs, interest rate easing and stimulus plans
  

*Any additional inflationary points are welcome

The Argument For Deflation:

• Trillions of dollars/pounds/Euros/etc. of toxic RMBS, CMBS, CDS, CDO, LBO, HELOC, credit cards, emerging market debt on the balance sheets and in SIV's of banks, both US & international

• Commercial and ibanks overleveraged in debt, especially ibanks

• State government insolvencies and budget crises, with massive cut backs in spending and employment yet to be realized, but recognition becoming widespread

• Trillions of market capitalization lost in stock and bond markets

• Housing prices continue to drop and inventories remain high

• Commercial property delinquencies are rising and vacancy rates are falling, adversely affecting property prices negatively

• Pension plan shortfalls after years of unrealisticaly high return assumptions and are now underfunded with considerable losses

• Real unemployment approximately 13% and rising FAST!

• Lows savings rates of consumers to fall back on, and now retirement savings have been cut in half in most cases

• Consumers are overleveraged with credit cards, mortgages, HELOC's, student loans, auto loans and have spent all their savings on "stuff" and are underwater on their mortgages in many cases
  

• Consumers are experiencing a secular shift in attitudes and are favoring saving vs spending

• Unemployment and move to thriftiness is global, especially in China

*Any additional deflationary points are welcome

Now the importance of which force will be greater comes to mind. The persistent goal of inflation so important to the Fed has two big advantages in its favor:

1. Dollar as global reserve currency
2. Relative currency debasement of other countries via interest rate slashes and deficit spending

This gives the Fed more room to print than other governments, but even that is limited to a certain extent.

Can the Fed, US government, global central banks and governments print enough money to keep deflation from correcting global imbalances?

The most important deflationary factors on that list as I see it is the change in attitude of consumers and rising unemployment. As long as their refusal to spend frivolously on "stuff" persists and their incomes and/or jobs continue to be in jeopardy, the shift to thrift will rightfully lead this economy towards a more healthy savings rate.

On the inflationary side, government stimulus packages can only offer so much relief in comparison to the size of messy assets outstanding and the mark to market losses they will incur. Also, any job stimulus will be slow to realize in the economy and will only affect so many workers, while jobs continue to be lost at the same time. This goverment stimulus will only slow the rate of decline at best.

I still lean towards the deflationary side, but as originally mentioned, this debate will rage on throughout 2009.

Any thoughts?