Hi Hrattle!

You are taking my comments out of context. I am limiting the discussion simply to the projection of whether we face inflation or deflation in the months ahead. Yes, I would agree that the financial crisis we are facing is real and it is severe. But that does not settle the issue of whether the world is descending into deflation. It is too easy to make comparisons to the Great Depression, but that ignores the fact that things are very different today than they were back in the 30s. Just because the economy is under stress does not guarantee that the stresses will create the same circumstances as the last time around.

When I refer to 'noise' it is a description of the conflicting signals the markets are sending us. Yes, we have seen a big meltdown in the value of stocks. Is that deflation? Well, we have seen many similar meltdowns in the markets during the last 60 years that did NOT trigger deflation. So why are so many people jumping the gun and declaring deflation in effect today? And real estate values are in steep decline. Is that deflation? Have people already forgot the real estate crash of the 80s? In percentage terms the property value decline was at least as severe as we have put up with now, and again there was no deflation. It seems many people are rushing to make a cause-and-effect link where no such relationship exists. And that also amounts to noise.

You suggest that I have categorized the financial crisis as short term anomaly. That is not accurate. I would say that the rise in the value of the US dollar is a short term anomaly, and I would also consider the declining bond yields as something that is more of a head-fake than a sustainable trend. These are not indications of pending deflation, but short term responses to fear and panic, and money flow.

We have a glut of home inventory, and a glut of unsold cars in North America. In any glut, prices moderate until the demand returns to draw down that inventory. The data has been on record for many quarters that new home construction is down, and we also saw this month that many car fabrication plants are shutting down for several weeks in the new year. Both will have the effect to correct the short term glut and correct the oversupply. Is this deflationary? Prices will come down for specific sectors, but I do not see a systemic threat to the pricing power of the entire economy.

The 600-pound gorrilla that you refuse to deal with is that the government is printing and injecting more money in the economy than at any other time in the history of civilization to try and deal with the problems. So while there may be inputs along the way that are going to trigger lower prices, consolidation, and corrections to work off the extremes and excesses of the boom years, the overall effect of this money is INFLATIONARY. People choose to focus on short term noise that is not sustainable, but ignore the bigger threat of where the hell all that money is going to go when the gluts are worked off and bad loans are written down.

I do not trivialize the discussion with simple conclusions to complex problems. There is so much short term uncertainty to consider that its too early to know how it will settle out. But as investors we should not ignore the fact that the easiest way to deal with record debt levels will be to inflate our way out of the problem, and the issuance of huge piles of paper currency is exactly what has been ongoing. Sort out the noise and the answer is right there in the data.

cheers!

mike