Sunday, September 12, 2010

Inflation? Deflation? It's All About 'Meflation' - By Jason Zweig

Thanks to Will for passing this along.

Inflation or deflation?

Pick your poison, says Wall Street. Either Uncle Sam's borrowing binge will flood the system with money, leading to a replay of the 1970s as inflation eats away at your purchasing power. Or all that debt and the liquidation of distressed financial assets will paralyze the economy and send prices falling, like the deflation Japan has suffered for the past 20 years.

Market pundits everywhere are insisting that getting this "call" right is critical to investing success. The reason is obvious: If you design a portfolio meant to be a bulwark against inflation, and deflation stalks the land instead, your wealth will suffer. Likewise, a deflation-proof portfolio will get killed if inflation takes off.

No wonder online forums (and my mailbox) are full of questions from investors desperate to figure out whether they should protect against inflation or against deflation.

As obvious as it may sound, the belief that you ought to make a call and then overhaul your portfolio accordingly is wrong.

The problem is simple. No one knows how to predict, with any degree of reliability, whether the cost of living is going to go up or down. In 1979, as U.S. inflation was peaking, most experts predicted that it would stay high for years to come. Ten years later in Japan, the consensus was that stocks and real estate would continue to boom; no one foresaw that the nation was about to sink into a two-decade morass.

"What matters isn't whether somebody's forecast for inflation or deflation is more convincing to you," says Larry Swedroe, director of research at Buckingham Asset Management in St. Louis. "Instead, what matters is which of these risks would be most damaging to you."

So stop trying to guess the answer to the highly uncertain question of whether we will be hit with inflation or deflation. Start thinking about the much more knowable issue of what I call "meflation": the direct, personal impact of the changing cost of living on your investments, your budget and your labor income.

Depending on your circumstances, either a rise or a fall in the cost of living could be good for you.