Deflation or Inflation: Choose Your Poison

06/08/2009 12:01 am EST

Focus: MARKETS

Terry Savage

Author, The Savage Truth on Money

Commodity prices are rising, gold is rising, and currencies of commodity-exporting nations such as Canada and Australia have soared against the US dollar in the past few months.

That’s despite all the fears of deflationary collapse in the United States, all the evidence that housing prices are still on the decline and that commercial real estate values are following housing downward, and despite the fact that unemployment is still rising (though not as fast as previously) and that a record number of Americans—32.2 million—is using food stamps to help buy groceries…all signs of a deflationary collapse…

Yes, despite all this, there is a whiff of inflation in the air!

You can see it in gold prices, which at $960 an ounce [it closed below $955 Friday—Editor] are $82 higher than a year ago. You can see it in energy prices, especially oil. Less than a year ago, crude oil hit $147 a barrel, then subsequently collapsed to below $34 a barrel in winter. It has now jumped above $68 a barrel, and Goldman Sachs—remember them from the $200-a-barrel days?—is predicting $85 by the end of the year.

You can see the fear of inflation in the relationship between the US dollar and the Canadian dollar, which was trading under 80 cents two months ago, and now is 92 cents. Yes, here in Ontario, where I’m writing this, the economy has been hit hard by the auto manufacturing crisis (there are actually huge Canadian auto parts suppliers located not far from Detroit). But still the Canadian dollar increases in value against the US currency, because Canada is not only an oil exporter, but a rich source of agricultural commodities—and even water! (It’s entirely possible that water will one day be more valuable than gold, since you can’t drink gold!)

And speaking of agricultural commodities, you can see more than a whiff of inflation in soybean prices, not to mention the price of corn, which we impractically use to make ethanol—a political subsidy to compete with oil, even though the cost outweighs the benefits if you consider the impact on food prices and animal feed.

Yes, while everyone is watching the headline numbers for “green shoots”—bits of good news about the US economy and the end of the recession—they are missing the big winds of change.  How could the US economy not recover, given all the stimulus we’ve injected?

Well, yes, there’s still a possibility of another, second leg of the downturn, especially if mortgage foreclosures continue to rise—and they will, as the continuing high jobless numbers show that people must be depleting their savings to stave off losing their homes. 

And lenders, including foreign central banks, are becoming wary of leaving their assets in paper dollars, thus forcing the US Treasury to pay higher interest rates to fund our balooning deficit.  Higher rates—another result of inflation fears—could push the economy back into deeper recession.

But for now, look beyond the government reports and the political blame game. The markets speak loudest. And they’ve been warning of inflation. If you survived the past year’s financial devastation, start looking forward. What are you doing to protect yourself? Please join the conversation by making a comment here.

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