Forget What We Said About Inflation, Say Big Investors — It’s DEFLATION You Should Be Worried About

By Henry Blodget in TechTicker:

Over the past six months, the smart money has gone from trying to cash in on the coming hyper-inflation the US will suffer as the Fed desperately tries to re-inflate the economy and destroys the dollar in the process…to reversing course and trying to cash in on a coming deflation.

For example, here’s PIMCO guru Bill Gross in the Wall Street Journal:

“Deflation isn’t just a topic of intellectual curiosity, it’s happening,” says Mr. Gross, who runs the $239 billion mutual fund Pimco Total Return Fund, citing an annualized 0.1% decline over the past two years in the U.S. consumer-price index. “It’s an uncertain world that’s tipping toward deflation.”

And that’s fine. Except that a few months ago, Bill Gross was positioning his fund to cash in on inflation.  And the same can be said of several other big names who have switched course in recent months.

Aside from noting the obvious–that gurus don’t have much more of an ability to predict the future than anyone else does–what does the current move toward deflation mean? Now that everyone expects deflation, should we take the contrarian view and expect hyper-inflation?

Not necessarily.

The deflation view is based on the experience of Japan, which has spent two decades trying to recover from the massive bubble that peaked in 1989.  Japan’s interest rates have remained near zero for most of that period, and it’s debt load has soared.  And yet it has still taken 20 years and counting for the government to stimulate inflation and get the economy going again.  So deflation may be with us for a long, long time.

On the other hand, US central bankers are far more paranoid about deflation than Japan’s ever seem to have been, so it’s likely that the Fed will try to do almost anything to avoid prolonged deflation.  And in its effort to kill deflation, the Fed may well trigger the hyper-inflation that many big-name investors were so freaked out about only a few months ago.

In other words, the current almost-deflation could crash to real deflation and then last for years as the US economy continues to de-leverage (reduce debt levels) … or it could quickly reverse and become inflation as the Fed buys debt and prints dollars in an effort to avoid it.  Stay tuned…

See Also: Here’s A Presentation Showing Why The US Is Headed For Japan-Like Deflation