Is Inflation Really Inevitable?

Type the word "inflation" into Google News search and you get over 20,000 hits. Type the word "deflation" and you get barely over 2,000, and many of them in relation to Japan.

Apparently the laws of cause and effect and the repercussions of that effect are confined strictly to one nation state. I'm not buying it.

It doesn’t end there, as it appears to me that there's a generalized consensus amongst the majority of commentators that inflation is inevitable, if not in the immediate future then certainly within the next two years, as the money currently residing as part of the monetary base, i.e., the Fed’s hockey stick, leaks out into the real world like a virus ripping large holes into our purchasing power.

It's usually at such extremes in sentiment that the opposite tends to occur.

I was in the inflation camp most of the last decade, parking my deflation fears in a quarantined section of my investment strategy. Quarantined in that I didn’t ignore them completely, in the spirit that saw banks take their responsibilities to a firing squad while lending billions of dollars to deadbeats.

To the contrary, I believed that Robert Prechter nailed it in his 2002 book Conquer the Crash, but that the inflation run had a few years left in it as part of a national orgy to get rich without lifting a finger.

2008 changed all that, however, when the first leg of deflation finally arrived with devastating force, following Prechter’s prescription to a tee. But that carnage is all but forgotten in certain circles as a result of the stock rally from the March 2009 lows, as many of those same inflation bulls are right back at it, some even calling for hyperinflation.

That we're merely in a countertrend move within the larger deflationary wave is ignored or not even understood. Anecdotal evidence of rising prices across various industries is spewed out as proof positive that inflation is back and is the larger threat. But these higher prices are totally in line with the rally in stocks over the past year and were arguably predictable, since the ocean of liquidity thrown at any and all assets by the recipients of free money have clearly pushed their prices up.

Demand in excess of supply pushing up prices is no more inflation than a liquor store owner raising his prices on payday to accommodate every Joe Six-pack in town headed his way. Wall Street is primarily dealers, and traders piggybacking, bidding up prices for trading profits hoping to repair their balance sheets before the next smash up isn't inflation, either.

A debt bubble dwarfing the monetary base popped in 2007-2008, and the credit contraction underway has years to run and will run its course despite the Fed’s futile efforts to stop it. We had decades worth of credit inflation with a few hiccups through 2007, and the mother of all credit bubbles in real estate. It's now deflation’s turn. History has shown that when credit bubbles pop, generalized deflation follows.

Gold has sniffed out this outcome and is refusing to launch. It hasn't gone up as stupidly as other assets, which means it should fall the least in the next down wave. This should bode well for gold stocks with strong balance sheets, for their profits will soar as input costs collapse. The timing of buys here will be key, for they too will head down initially along with everything else.

What of the Fed and it’s hockey-stick-shaped money supply? Hockey sticks can easily be smashed into kindling when enough force comes down upon them. Defaulting credit and debt that can swallow a few hockey sticks whole will certainly finish the job as the deflationary wave resumes over the next few months.