What's next, inflation or deflation?

What's next? If deflation is coming, I'm staying in cash. If inflation is coming, I'm buying all the rental properties I can afford. There's an argument for both.

The government can't afford deflation. Deflation would reduce their tax income while the government debt remains the same. The debt as a percentage of GDP or as a multiple of tax revenues would become even more enormous than it is now. So I would expect the government to do everything they can to avoid deflation - even at the risk of creating rampant inflation.

Although we're all breathing a huge sigh of relief over falling oil prices, gas is still over $2 a gallon at my corner station. In 2003, gas was $1.68 a gallon, and, in 2001, it was closer to $1.35. Opec wants to keep gas prices high, and who can blame them? We all want to keep our incomes as high as we can. Consumers have shown their price elasticity for gas, and, the bottom line is, we'll pay $3 a gallon and complain about it but keep buying it. Now that oil producers know we'll pay that much, they would be bad business people for accepting less. That's inflationary, because oil goes into everything - we burn it for heat, we produce electricity with it, we make everything from plastic grocery bags to medical implants from it, and we use it to transport every product we make from source to sale. Gas prices have a huge influence on consumer prices, because everything has to be trucked, shipped, flown, railroaded, or some combination thereof.

The declining value of the dollar - thanks, in large part, to our government and consumer debt - is inflationary. Everything we import is costs more when paid in deflating dollars.

On the other hand, we could be facing deflation.

As Americans worry about the future, they save more and spend less. People with products and services to sell, have to lower their prices to induce consumers to spend. Every newspaper has ads with massive rebates, incentives, and discounts on American cars. If you've been on the fence about remodeling, try getting some fresh quotes. Contractors are on sale. Lowes' price tags all say "new low price." And the Going-Out-Of-Business sales start at least 20% off. That's deflationary.

Unemployed Americans now number over a million. New layoffs are counted in the hundreds of thousands. Unemployed people don't tend to spend a lot, and they don't earn a lot. That's deflationary. Retail - the old "well, if I don't find anything else, I can go work at the mall" backstop for the unemployed, is struggling. People scraping by on savings is a deflationary force.

The Visa/Mastercard/HELOC printing press has virtually shut down. People are afraid to borrow, and that's okay, because banks are afraid to lend. Given the exponential effect lending and borrowing have on money supply, a reduction in borrowing is extremely deflationary. But, don't worry, the government is still borrowing.

An anonymous Internet user commented several years ago that we were heading for inflation in necessities and deflation in luxuries. Maybe, but a latte still costs $4.