Inflation vs. Deflation: Which Way Will This Tug-of-War Go?

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“U.S. loses jobs at the fastest rate in five years,” says a headline in the weekend’s Financial Times.

Economists had been expecting a drop of about 50,000 jobs last month. Instead, the non-farm total came to about 80,000 – the highest total since March 2003.

As the FT points out, this number will keep the pressure on the Bernanke team to cut rates. It didn’t mention that it will also keep pressure on the dollar – as speculators will expect the dollar to fall as a result. That’s the trouble with this battle between inflation and deflation – many of the soldiers don’t seem to know what side they’re on! When speculators unload dollars, it doesn’t have the effect on U.S. lending rates that Bernanke intends. In fact, it has the opposite effect. Pushing down on the short end of the yield curve (the Fed sets the rate at which member banks borrow from it, short-term), Bernanke hopes to drag longer-term rates along. Easier said than done. If speculators fear inflation, they sell the dollar, lower prices on U.S. credits and raise yields. All else remaining the same, prices on T- bonds go down, while yields go up.

But in this post-1971 world of ours – nothing stands still. You can no longer save a farthing a week…watching your little pile grow up…and looking forward to the day you can use it as you wish. Now, when that day comes, you’ll find your farthings aren’t worth what you thought. The ground has shifted under your feet…and your loyal soldiers have gone over to the other side.

The Bernanke team had a good week. By the middle of the week, everything seemed to be slipping and sliding his way. That is, stock prices were up and gold was falling. But by week’s end, whoever is on the other side in this tug-of-war had dug in its heels, refusing to budge. Gold was back up over $900…the Dow was off…and Bernanke was back in the news, saying that a “recession is possible”.

There is a big question that we’ve been unable to answer: Which way will this tug-of-war go? But we realize that this is the wrong question. Of course, it will go both ways. We will neither have our cake nor eat it. Instead, we will have both inflation and deflation…losses from consumer price increases, and losses from defaults. Between the two, the value of both our credits and our debts will go down.

In addition to the bad unemployment news, the weekend brought word that bankruptcies had risen 30% in market. Strip malls’ vacancy rates are the highest in 12 years (there is far too much retail space in the United States…it will take years to work it off). Gasoline hit a new record in Texas. Even the American Mortgage Bankers Association can’t pay its rent. And when pollsters put the question to them, 81% of Americans thought the country was going to Hell in a handcart. Yet, in spite of all this disturbing news, stock markets seem to want to go up – or at least not go down. The short sellers are in trouble; there are far too many of them and every small increase forces them to cover their positions, buying back in and sending prices higher.

Still, we do not want to hold U.S. stocks – other than the special situations we find from time to time. If our analysis is correct, the inflation that is holding up stock prices will be felt even more in other places – namely, in commodities, gold and consumer prices. When one bubble pops, the next one always appears somewhere else. So don’t even think about buying back into the finance sector. That trend is over. George Soros says it’s the end of the road for cheap and easy borrowing. That is to say, it’s the end of a trend that has been going for the last 28 years. We may not see another boom in the financial industry during our lifetimes.

We remind readers, too, that while stocks are no lower today than they were 10 years ago, stock market investors have lost about a quarter to a third of their money to inflation. The next ten years could bring another, similar loss, even without a crash or bear market on Wall Street.

Meanwhile, in what could be the NEW bubble area – gold was back over $910 on Friday, corn hit $6 a bushel…rice is disappearing from the market…and the developing world, according to the Washington Post, is in a panic.

Bill Bonner
The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
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