I think deflation is dangled as an excuse to allow more irresponsible money creation to flood the system. Sure we are going through a short term phase where the prices of some things are in decline. That is always part of the story even during raging inflation. Look at the price of big screen TVs over the last 10 years or so. Most of this decade has been characterized by runnaway inflation, yet the some items are always declining. In the last year or so, because home prices have come down, people are talking deflation, and throwing the word around like we face a crisis. Well, all one needs to do is look back at home prices 10 years ago and then compare to today. Prices are still way up. I think it would be more accurate to label the situation as a corrective phase after house prices had gone up too fast, rather than cite it as evidence of inflation. There is a slowdown in the economy for sure, and some businesses built up inventory of product that needs to sell. The auto sector is a good example. So again, we will see short term price discounts to clear that oversupply. It is not an indicator of systemic deflation.

To me the story is inflation. The simple fact is that the US government cannot pay back all borrowed money if things remain as they are. They can default, or they can flood the system with money and pay it back in devalued dollars. A default would definately trigger real deflation. Where the money supply is impaired, the prices of all goods and services come down. Fewer dollars in circulation means the prices of goods come down to compete for those dollars. Then its not just confined to sectors of oversupply, but everything: clothes, entertainment, haircuts, etc.

A devaluation is the most likely outcome. We are probably in the early stages of that right now. More money is pumped into the system, making each dollar worth less (and eventually worthless). Debts remain fixed while money floods the system and therefore its easier and cheaper to pay down debt. And as money loses value, people rush to buy stuff that will preserve value.

Sort out the noise from short term anomalies and try to keep track of the main trend. There is localized deflation at work to resolve price imbalances, but overall the main driving force is money creation and hence inflation. Eventually real estate will come back to a sustainable level, and the glut of new cars will be burned off, but the money creation cycle will continue to affect the pricing of all goods and services for a long time to come.

cheers!

mike