Inflation is a sexy worry.
We can photograph it. A photo of a billion-dollar bill next to a pile of apples from Zimbabwe's recent bout of runaway inflation stuns the imagination.
It's the stuff of national nightmares. The German electorate and German bankers are still traumatized by Weimar-era inflation.
And we know what to do about it: raise interest rates, rein in the money supply or, if worse comes to worst, send the economy into a recession.
Deflation isn't sexy.
It's hard to photograph money getting more valuable, and falling prices aren't terribly dramatic.
Japan has been sunk in deflation for years, if not decades, without violence in the streets or even noticeable anguish. The period doesn't even have a catchy name.
And we don't know what to do about it. Increasing spending, running big deficits and subsidizing spending all work in theory, but they don't seem to have done much to solve Japan's persistent deflation problem.
That is why the possibility of deflation worries so many investors and economists right now. And why investors need to guard against both of these possibilities, as well as a third alternative that mixes some of the worst of both.
What sliding house prices might portend
If you look, you can see what might be signs of deflation.Certain big categories of prices are falling or have fallen and look likely to keep on falling. I'm talking about housing. Prices for this big-ticket item are still falling in the housing-boom-to-bust economies of the United States, Spain, Ireland and the United Kingdom. Economists predict that prices in some of these economies could keep on falling for five years. In the United Kingdom, for example, PricewaterhouseCoopers recently predicted that there was a 70% chance that the real cost of a house in 2015 would be below the price in 2007.
And you can certainly make the point from recent data that U.S. consumers are following in the footsteps of their predecessors in Japan in putting off purchases. That's a hallmark of deflationary psychology: Money will be worth more tomorrow, because prices are falling, so the inclination is to postpone spending as long as possible in order to take advantage of that.
The Federal Reserve reported July 8 that consumer credit -- the amount that consumers owe on credit cards and loans -- decreased at an annual rate of 4.5% in May. Revolving credit -- credit card debt -- decreased at an annual rate of 10.5%. That contributed to a 1.2% drop in consumer spending in the second quarter of 2010.
I think you can make a case for a rising danger of deflation. Nobel Prize-winning economist Paul Krugman made just such a case in his New York Times column on July 12.
But I also think you can make a case for a rising danger of inflation. Some very large economies -- China's and the United States', to mention just two -- have vastly increased their money supplies in the past year. Neither has seriously begun to reverse those increases. True, the Fed has stopped buying some classes of assets, but it certainly hasn't begun to sell those assets back to the financial markets.
And then you've got the traditional inflationary trappings of massive government budget deficits, often an inducement to governments to inflate their way out from under some debt.
Continued: 2 keys to the debate
