The media has been going on and on about deflation. Long-term bond prices have also been trending up and long term yields have been dropping, which means that the market thinks there will be long-term deflation. Even the Consumer Price Index numbers that came out claim that inflation is under 2% annually!

(Of course, if you’re one of the unlucky 533,000 people who lost their jobs last month, you really couldn’t care less about deflation).

Let’s first look at the Government reported numbers.

                      May   June  July  Aug.  Sep.  Oct.  Nov.   ended     ended                      
                             2008  2008  2008  2008  2008  2008  2008 Nov. 2008 Nov. 2008

All items..........    .7   1.2    .9   -.2   -.1  -1.2  -2.1     -12.9        .7

Food and beverages    .3    .8    .9    .6    .6    .3    .2       4.2       6.0
Housing...........    .5    .5    .7    .0   -.2    .0   -.1       -.8       3.1

Apparel...........   -.2    .0    .8   1.0    .0  -1.2    .2      -3.9        .2
Transportation....   2.1   4.0   1.8  -1.7   -.7  -6.0 -10.9     -52.1     -10.4

Medical care......    .1    .2    .1    .3    .3    .1    .2       2.7       2.7
Recreation........    .0    .2    .4    .5    .2    .0   -.1        .8       1.9

Education and
  communication..    .3    .5    .5    .2    .0    .2    .2       1.6       3.4

Other goods and
  services.......    .5    .6    .5    .2    .2    .3    .1       2.4       4.4

Special indexes:Energy............   4.5   6.8   4.0  -3.2  -1.7  -9.0 -17.8     -70.8     -14.3

Food..............    .3    .8    .9    .6    .6    .3    .2       4.1       6.2
All items less
food and energy    .2    .3    .3    .2    .1   -.1    .0        .1       2.0

Lets start with the largest expense for most people, housing.

Yes, house prices have decreased. However, if you’re already a home owner or a renter then you’re probably not seeing any benefit. The only people who’re benefiting are those people who can actually qualify for a home loan and have enough cash for a down-payment. The 100% financing loans have disappeared as a result of the tightening of the lending standards. As I mentioned in the last post, it’s not the cost of credit, buts the availability of credit that is important.

Energy prices actually have dropped down from $147/barrel to around $40/barrel in the past 5 months. However, I heard billionaire T Boone Pickins on the radio today say that OPEC is going to keep cutting production until oil is back up at $75/barrel. In the long run, I agree with him. While a global recession might reduce the demand for oil, there are 3 billion people in Asia who are getting a little richer every day and want air conditioning, cars, motorbikes and other luxuries that consume oil. Without alternate energy sources, oil prices have to rise. The current price drop is likely to be short-lived.

According to official numbers, education costs have only gone up 1.6%-3.4% in the past year. However, my MBA program has seen a much higher percentage increase in tuition than last year, and it might see another increase next year (according to a letter I received from the Dean of my Business School).

Likewise, medical costs have also gone up only 2.7%, but my health premiums and medical costs seem somehow higher than that.

And while food and beverage prices have only seen an official 4.2-6% inflation, prices of food items that I consider my staple diet like Tyson Chicken Wings and Sirloin Steak Burgers at Costco have gone up about nearly 50% in the past 2 years.

Meanwhile, the Federal Reserve is printing money like its going out of style. (And at this rate, it actually might). In theory, increasing the money is inflationary. That’s one reason why a house that cost $30,000 in the 70’s costs $300,000 today. More money in circulation means every existing dollar is now worth less. At least thats the theory. Increases in productivity and technology have managed to improve our standard of living despite this inflationary pressure, but there must be some point at which you start seeing inflation. Maybe we’re at that point now.

The government has committed to more money on financial bailouts than its ever spent in its history. According to an article in the SF Gate, the Financial Bailout may end up costing the taxpayer $8.5 trillion dollars.

According to an article on CNBC, that’s more than the cost of almost everything else the US government has spent on even adjusting for inflation!

Here are estimates for the major US government expenditures (all figures inflation-adjusted):

Hoover Dam: $782 million

Panama Canal: $7.9 billion

Gulf War: $98 billion

Marshall Plan: $115.3 billion

Louisiana Purchase: $217 billion

Race to the Moon: $237 billion

Savings & Loan Crisis: $256 billion

Korean War: $454 billion

New Deal: ~$500 billion

Iraq/Afghanistan/War on Terror: $597 billion

Vietnam War: $698 billion

NASA Budget since inception: $851.2 billion

World War II: $3.6 trillion

Total = $7.63 trillion

I thought this was the most interesting section of the SF Gate article:

The Fed’s activities to shore up the financial system do not show up directly on the federal budget, although they can have an impact. The Fed lends money from its own balance sheet or by essentially creating new money. It has been doing both this year.

The problem is, “if you print money all the time, the money becomes worth less,” Rogers says. This usually leads to higher inflation and higher interest rates. The value of the dollar also falls because foreign investors become less willing to invest in the United States.

Today, interest rates are relatively low and the dollar has been mostly strengthening this year because U.S. Treasury securities “are still for the moment a very safe thing to be investing in because the financial market is so unstable,” Rogers said [That’s Diane Lim Rogers, chief economist with the Concord Coalition, not Jim Rogers!]. “Once we stabilize the stock market, people will not be so enamored of clutching onto Treasurys.”

At that point, interest rates and inflation will rise. Increased borrowing by the Treasury will also put upward pressure on interest rates.

In the past 10 years gold is up 300%+. That’s about 300% better than the return on the S&P500 over the same time period! This is not an indication of deflation.

And what does veteran investor Jim Rogers think about this? In a recent Bloomberg interview he predicted that the dollar is “going to lose its status as the world’s reserve currency,” adding, “It will be devalued and it will go down a lot. These guys in Washington, they want to debase the currency.”

“They think that if you drive down the value of your money, it makes you more competitive, now that has never worked in history in the long term,” said Rogers.

Paul Watson of the Prison Planet states:

The head of the International Monetary Fund, Dominique Strauss-Kahn, warned that advanced nations will be hit by violent civil unrest if the elite continue to restructure the economy around their own interests while looting the taxpayer. Strauss-Kahn’s comments echo those of others who have cautioned that civil unrest could arise, specifically in the U.S., as a result of the wholesale looting of the taxpayer and the devaluation of the dollar.

How long will it be before Americans realize the looming specter of hyperinflation spells disaster for their life savings? How long will it be before we see rioting in the streets on a par with the scenes witnessed in Iceland over the weekend, where the Icelandic krona has lost half its value in a matter of weeks?

I’m not buying the deflation argument. In fact, I wouldn’t be surprized to see 10-12% inflation for the next several years. I’ve been buying gold coins since gold was $500/ounce and I’ve adding to my position on pullbacks. Maybe in a few years time, $850 gold and $12 silver may look like a bargain!