John Jagerson

Investing for Inflation vs. Deflation

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Whether there are higher risks for deflation or inflation in the U.S. economy is being hotly debated right now. This is a good discussion to have and there is a lot to learn about each condition and the risks and opportunities each presents. It is even more important to understand that planning for either economic condition is probably the best thing investors can do right now.

Currently, the U.S. economy is showing more signs of deflation than runaway inflation. However, the Federal Reserve is working very hard to create money supply through quantitative easing to fight those risks. Most economists are likely to agree that deflation is more dangerous than inflation and therefore the Fed's efforts seem to be prudent.

A problem arises if the efforts currently underway to prevent deflation actually results in an inflation panic. Increasing the supply of money as quickly as the Fed has in 2008 and 2009 could definitely lead to higher inflation rates in the near term. Inflation and low economic growth is problematic for investors for a number of reasons.

• Inflation motivates spending rather than investing as consumer's dollars lose purchasing power. That behavior drives down bond and stock prices and drives yields up.

• Inflation usually increases interest rates. No rational investor would lend for interest rates that do not compensate for risk AND inflation. The higher risk or inflation rises the higher the required interest rate will be.