November 20, 2013
By Bob Brooks
In this week's Market Report, I want to address the very debatable question – are we headed towards inflation or deflation?
This is a hotly debated topic where both sides think they are right. Only time will tell who was right.
People who support the theory of inflation point to the massive amounts of Federal Reserve money printing that is occurring, and how that is going to create widespread inflation. They also point out that the dollar is also going to crash at some point, and be worthless. That is the basis of their argument.
Personally, I believe that we have a higher percentage chance of seeing deflation winning this battle than inflation, and here is why.
(1) Debt is deflationary
Massive amounts of debt are typically more deflationary than inflationary. At some point, that debt has to either be paid back or the loss has to occur. The good news is that deflation detoxes the debt out of the economy and brings things back to balance. The bad news is that there are massive losses as everything comes back to balance.
(2) The velocity of money is falling
I also can't get past this very disturbing chart that continues to show the velocity of money literally cratering. The velocity of money tells us how many times money is changing hands. A high velocity of money is inflationary, and a falling, or negative velocity, of money is deflationary.
(3) The dollar tends to be strong in deflationary times
The dollar is in demand because credit is hard to get, and debt needs to be paid back. The dollar can actually strengthen through times of deflation. Further, you always have to remember something about the dollar. Yes, it is a train wreck and our currency is full of problems. However, you have to compare it to the other currencies. We are still king of the hill. Yes, one day that probably changes. For now, I don't see the dollar crashing.
(4) All of that money printing is filling the void of loss
If the money that is being pumped into the system was circulating, then it would be inflationary. However, it is going to replace resources that normally would be there but have been lost due to the financial crisis. Think of it as filling up a bathtub with water. If the drain were open, it would go right down the drain. If the drain were closed, the tub would fill up creating a massive amount of water. There isn't a massive amount of money flooding the economy.
Plus, money printing in itself doesn't create inflation. The global system is way more complicated than that.
Either way, inflation or deflation, represents medicine that the stock market and the economy is going to have to take one day as these massive imbalances in the system continue to mount. This is why you never want to be complacent with your investments, and always be comfortable with the risk that you are taking.