Inflation or Deflation?

07/03/2014 10:00 am EST

Focus: STRATEGIES

Mary Anne & Pamela Aden

Co-Editors, The Aden Forecast

The big debate over deflation and inflation still rages on, and both sides have fundamentals backing them up, explains Mary Anne and Pamela Aden, editors of The Aden Forecast.

On the one hand, the monetary base has literally soared in recent years. This unprecedented type of money creation would normally cause big inflation, but so far it hasn't. This has shocked many experts-but the main reason why is because the velocity of money has been collapsing.

That is, the money's not circulating, banks are still risk adverse, so they're not lending like they normally would. As a result, the economy has remained lackluster and inflation is low. Or is it?

We all see prices going up in certain sectors. For example, food, gas, home prices, and medical costs are up, and college tuitions have soared.

Wholesale prices have also just started perking up. And, if you calculate inflation the way it was done in the 1980s, current inflation is closer to 10%, and not below 2% as the Fed's numbers show.

At the same time, however, deflationary forces are intensifying. The pressures are becoming ever more obvious and the markets are clearly reflecting this. The world's economies are super sluggish and barely holding on.

Plus, interest rates have been plunging around the world. This, in turn, has been one of the primary factors driving stocks and bonds higher. And these markets are signaling much higher prices ahead.

Meanwhile, the Japanese, US, and now European central banks have taken extreme monetary measures to fight off these growing deflation pressures.

No one wants deflation. So, further actions by the world's major developed countries are taking place to keep deflation from getting worse. Hopefully, this will also fuel some inflation in order to offset the deflation that's already taken hold.

At least, that seems to be their main goal. It's really a vicious tug of war but so far, deflation still has the upper hand, despite all the efforts.

Debt is the monster. With bonds poised to head higher in the months, and probably year ahead, we suspect this support level may be broken.

And if you think it can't happen, look no further than the massive debt levels. They've put a drag on global economic growth that's unlikely to be shaken any time soon.

Meanwhile, bonds are still outperforming all of the other markets and they're poised to head much higher. That's why we recommend keeping the larger portion of your total portfolio in long-term US government bonds and/or bond ETFs.

Best of all, it looks like the bull market in bonds is just beginning. In other words, it has a long way to go, at least until year end and probably beyond.

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