The ongoing debate in the inflation/deflation scenario is raging hotter than ever with seemingly no one able to come to any agreement about whether inflation or deflation will be "king" over the next few years. Slowly, however, a number of analysts are starting to come around to the conclusion that what we'll likely experience is a combination of both at the same time (viz., inflation in hard assets and necessities while deflation rages in the financial sector). But after going over the cycles with a fine-tooth comb I'm not even sure that scenario will prove to be accurate. I'm more inclined to believe that the coming 5-6 year period will be (in varying degrees) a microcosm of what we've seen in the past 2-3 years, that is, a period of inflation followed by a period of deflation followed by a period of reflation. Call it the "Inflation, deflation, reflation" scenario if you like.

I find it quite interesting that while many analysts were warning of the growing dangers of deflation back in the late '90s through 2001-2002, the more mainstream economic experts were wringing their hands over inflation. Well now those roles have been reversed with the Fed and other mainstream observers preaching deflation while the independent (and I might add, the more accurate) analysts are talking about the renewed threat of monetary inflation.

After embracing the deflation scenario over the past few years, I now find myself strangely warming up to the inflationary point of view...at least for now. After all, for the past two years producers have had to engage in the game of offering "factory incentives," rebates, discounts and other sales gimmicks in order to coax consumers out of their spending shells. This has largely proven successful, but as we all learned in Econ. 101, "there is no free lunch. Everything that producers offer to consumers must eventually be paid for by the consumers. The time has now come to pay the piper, so to speak. Those so-called incentives will be paid for by consumers in the form of higher prices for the goods and services they got at a discount a few months ago. Steadily, across the board, you will notice that everyone is raising rates and charging higher prices for everything from telephone, cable, and Internet service, to retail goods and food items.

To take one example, when a well-known ISP advertises to its subscribers that for every friend they convince to sign up to their Internet service, they will pay you $50. But where do you think that money will come from? It will eventually come from your pocket and this accounts, in part, for inflation in certain areas of the economy. The telephone provider industry certainly isn't immune to this kind of gamesmanship, offering people lower rates to switch their phone service as an inducement. But if you pay attention to your phone bills, you'll notice a gradual increase in rates over time to make up for the inducements.

Those incentives chickens are starting to come home to roost. Inflation in basic services and retail prices is become more and more common and more than one non-mainstream (i.e., independent) economist is predicting hyperinflation in the cost of living in coming months and years. For example, economist Walter J. Williams has written a most interesting series of articles in Criminal Politics magazine (a service of the Patterson Strategy Organization) entitled "Hyperinflation in the Cost of Living will Accompany Deflation in Asset Values." He sees a real unemployment rate of 14% or higher and warns of an economic "double jeopardy" with inflation in some areas of the economy followed closely by deflation in other areas.

Williams contends that Social Security recipients have been cheated by 28% due to what he calls "gross manipulation" of the inflation data by Clinton and Bush. "Inflation remains a U.S. economic problem that is sensed and realized by most consumers," writes Williams, "yet inflation is not recognized fully by the government, which deliberately under-reports it. Understated inflation may have certain political advantages, but it also cheats people on a retirement fixed income...it distorts economic reporting...and it misleads the financial markets and the investing public."

He also wisely points out that warnings by Fed Chairman Alan Greenspan of possible deflation (or what the Fed calls "negative inflation") appears to be a ploy aimed at justifying accelerated monetization (purchasing) of the federal debt by the U.S. central bank. In Congressional testimony on May 21, Greenspan reassured the Joint Economic Committee that he could fight deflation by buying government bonds of longer maturities and spiking growth of the money supply. "We do have the capability of moving out on the yield curve...expanding the monetary base," he explained.

Speaking of Greenspan, in his most recent testimony the Fed Chairman made the much quoted statement, "...the FOMC stands ready to maintain a highly accommodative stance of policy for as long as it takes to achieve a return to satisfactory economic performance." That little piece of Orwellian double speak could be the subject of a running commentary in itself. But if you carefully parse the statement all Greenspan really said is that the Fed will do whatever it takes for as long as it takes to achieve overall stability. "Satisfactory economic performance" is a relative term and doesn't necessarily mean the Fed is aiming for the high growth. What it means, I think, is that the Fed is completely satisfied with having a "trading range economy."

In my previous G-E commentary we looked at the coming 10-year period from the perspective of the 120-year Master Cycle. The conclusion reached was that for the next 5-6 years, the potential exists for a trading range in the stock market. But how would this extend to the rest of the financial markets and even to the economy? Would it not be reasonable to expect a dollar trading range? Or an interest rate trading range (such as existed in the years leading up to the prior K-wave bottom in 1940-1950)? In other words, through careful manipulation of the equity, interest rate and currency markets, the Fed could indeed achieve a "satisfactory economic performance" (at least from their standpoint) and perhaps keep the economy on an overall even keel. Inflation, deflation, reflation.

Whatever the case, it's sure to be an interesting few years ahead with the Fed pulling out all the stops in the never-ceasing game of Keep the Economy Afloat.