Inflation versus Deflation - The Case for Deflation

Over the past year, the stock market has seen a strong bull rally off of its March 2009 low which has certainly been great for many people's investment accounts. Unfortunately, it has also led many in the mainstream financial industry (media taking heads, traditional brokers, large bank economists, politicians etc..) back to the same level of blind optimism and complacency that was seen prior to the 2008 crash. Investors who share this complacent view of the market are likely in for another shock because before the economy can return to real growth and prosperity much of the malinvestment that was built up over the years of low interest rates and easy money must be cleaned out of the system. The government and Federal Reserve Bank have been implementing significant measures to try and prevent this natural economic process from occurring, however, the economy is too large and complex to be controlled by a handful of individuals. Most of those who are proponents of free markets will likely agree that the large amount of malinvestment in the economy will inevitably lead to another crash, and one that is likely bigger than that experienced in 2008. However, there is currently an interesting debate between those who believe that the current state of the economy will lead us towards a period of strong inflation (possibly even hyperinflation) and those who believe the opposite will occur and we will instead see deflation. The occurrence of either significant inflation or deflation will have serious and drastic effects on all areas of the economy. Although that being said, a period of strong inflation will result in the financial markets performing in a much different manner then a period of strong deflation. Inflation will lead to a significant nominal rise in the price of real estate, commodities, stocks, and virtually all other asset classes other than the dollar, which will decline in value. While a period of deflation will see a decline in the price of almost all asset classes and a rise in the value of the dollar. As such an investor who can correctly anticipate which of the two scenarios will play out will put themselves in a position to profit handsomely.