Inflation or Deflation?

Online, you will see people putting forth their opinions on whether we are facing inflation or deflation. You very rarely see them back them up with much.

The central case for deflation is that consumers have overspent. They have borrowed up to the hilt and have no more money to spend. When these stores sit with their doors open and no one buying, they will have to drop their prices. As the prices drop, people will delay their purchases for longer and longer. The store will continue lowering prices, and people will continue to delay purchases. This will spiral down into a disaster for many, with business being very depressed. Debtors will be especially hard hit, as the true value of their debt will go up.

On the other hand, we could have inflation. Some things in favor of inflation are large amounts of dollars abroad, our current spending habits, and government preference.

First of all, our dollars abroad. As the value of the dollar drops, people will want to hold them less and less. This will result in foreign and domestic spending of dollars. The chinese will not want to hold on to a currency that is rapidly losing value, and neither will Americans. That puts us in a situation of of people moving up their purchases, with more dollars chasing the same amounts of goods. Hello inflation.

American consumers always talk about how they are going to pay off those bills and get out of debt, but they rarely do something about it. Someone from work was talking about having too much debt, but they eat out frequently, and just bought a $2000 entertainment system. That is fairly typical based on my experience. People will continue buy as long as they can, knowing that if enough people get in trouble, the government will bail them out.

Oh, the government.

Successful politicians don’t care about logic or the future. They care about the next election. If they didn’t, they likely wouldn’t be in office in the first place. There are notable exceptions (Ron Paul), but as a trend, people are just looking for the next vote. Take the free money handout that the government is doing under the guise of a tax rebate.  They have just injected more dollars chasing the same amount of goods.  Inflation also helps debtors.  If a dollar drops in value by 10% in one year, your loan effective drops by the same amount.  Four years of such inflation, you would knock 34% off the value of the loan.   The government could use that to knock a few trillion real dollars off of national debt.

I think that given the situation, inflation is more likely.  Don’t keep too much money in cash.  A bit for buying opportunities is important, but make sure you are ready to take advantage of opportunities.  You don’t want to knock off the true value of your bank account by 34%

Good luck


1 Response to “Inflation or Deflation?”

  1. 1 Hulia March 7, 2008 at 2:53 pm

    So what would be your suggestion to do with money that was in a nest egg–say about a 3-6 month supply–“just in case?”

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