THE BLOG
11/04/2014 09:10 am ET Updated Jan 04, 2015

Inflation-Deflation See-Saw

The world is teetering in the balance, like two children on a see-saw in the playground. On one side sits inflation -- with its rising prices, higher interest rates, and diminished buying power. On the other side sits deflation -- with falling asset values, stagnant demand, bankruptcies and business failures.

If the works goes to either extreme, it can expect social unrest -- a polite term for violence in the streets as the "losers" find they either cannot afford the cost of living or are unemployed and cannot afford to buy even the basics.

Right now the see-saw is bouncing precariously from side to side.

The Inflation Side

The Japanese are firmly on the inflation side. They have announced that they will print more money to create inflation -- anything to stop the 20-year deflationary period in which they have lived. Consumers there are wary of spending, hoarding every penny in government bonds. The Japanese central bank is going into the market to buy both government bonds and some stocks -- paying for their purchases with newly created. credit.

The hope is that by flooding the Japanese economy with more money, consumers will start shopping, pushing prices higher. But the immediate impact of the plan has been to push Japanese stock prices higher while it pushed the value of the Yen lower.

With all that money floating around, the yen becomes less valuable, the true definition of inflation. With a "cheap" currency, Japanese goods become more affordable to foreign buyers -- thus stimulating more production and growth. The goal is to reach 2 percent inflation.

Meanwhile, the European central bank has also decided to create more "liquidity" in the Eurozone. It has a more complex job because of the many countries involved. The European central bank creates more Euros by purchasing loans from European banks, and paying with newly created credit.

But not all if Europe is in agreement with this strategy. Germany, in particular, remembers what happened when too much money was created in the 1939s, so they are very wary of igniting inflation. But Portugal, Spain, Italy, and Greece need something to jumpstart their economic growth. More money might do that.

Even China seems to have joined the pro-inflation battle, trying to stimulate its economy so that consumers there will keep buying apartments, and other consumer goods - keeping factories producing so that workers are employed.

Suddenly, there's a lot of weight on the pro-inflation side of the see-saw.

The Deflation Side

But on the other side -- the deflation side -- there are some heavy weights to counterbalance all the money creation going on around the world. First, there is our Federal Reserve's decision to stop buying bonds and creating new liquidity. Over the past eight years the Fed has created $4 Trillion out of thin air, buying mortgages and securities and paying with newly created credit. What happens when that flow of new money stops?

The second deflationary influence is the sudden glut of oil that has helped drive energy prices down. The Saudis are determined to keep market share, and they're not cutting back as prices drop. In fact, they just cut a below-market deal to sell to the United States. Oil producers need the cash, and keep pumping despite falling demand. It's all part of the downward momentum of the global economy.

There is a glut of raw materials around the world. Bumper crops have pushed grain prices down. China has slowed its purchases of industrial commodities, also leading to lower prices. The combination of oversupply and falling demand are creating persistent and headline-making global deflation.

And so the world watches the see-saw of inflation/deflation, wondering where money is safe.

The United States is getting the world's vote on that issue. We have moderate growth and stable prices. So, like a giant magnet, the U S dollar is drawing money from around the world, wherever it is created. Most of that money going is flooding into the stock market, pushing our stock indexes to record highs.

How and where will it all end? Will global inflation or deflation win out? The future of the global economy hangs in the balance.

That's why I've been taking about "balance" in your investments for the past few years. If we have economic growth, or just inflation, stocks prices will move higher. If deflation wins, you'll want to hold onto your cash -- even if you're not earning any interest -- to purchase assets at bargain prices and to maintain your lifestyle in case you lose your job In the downturn.

The see-saw is volatile, like kids in the playground touching their feet to the ground to push their side of the board up when it threatens to land them on the ground. There's no rhythm to the process, only the unexpected swings and lurches. Once you understand this analogy, you'll be less anxious and less prone to jump to one side or the other in a reaction to the latest news.

Balance is your only safe place. And that's the Savage Truth!

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