Keystone's Inflation Deflation Gauge

The inflation versus deflation debate is one of the most passionate arguments on the Internet.  Which side is correct?  Many times traders will talk past each other cherry picking the arguments that fit their projections.  The inflationists point to rising food prices; the deflationists hightlight the continued stagnation of our home prices.

Keystone's handy gauge is a means of quantifying the inflation versus deflation debate.  The gauge is a ratio of the CRB commodities index divided by the 10-year price.  As of today, 3/18/11, the gauge yields 348.67/103.03=3.38.

Keystone's Inflation Deflation Gauge:
Over 4.0 Inflation
3.0 to 4.0 Neutral
2.9 to 3.0 Disinflation
Under 2.90 Deflation

The current 3.38 places us within the neutral territory with a slight bias towards deflation.   To get a better feel, let's look back over previous readings.  The deflation scare during 2004 was verified with a 2.6 reading.  For the commodities bubble that popped in July 2008, the gauge was rocking to the upside at 4.32.  Then deflation was front and center again with a 2.00 reading as the equity markets bottomed in March 2009.  In January 2010, the economy and markets were in a disinflationary funk at 2.94.

After the equities markets topped and rolled over in April-May 2010,  the gauge registerd 2.8 and started to collapse.  Last summer we languished in deflation at 2.5 until Chairman Bernanke saved the equity markets with his QE2 POMO pumping scheme.  This pumping boosted the guage back up and over 3.0 by Thanksgiving and led to a 3.5 topping event early 2011.  For the last month the gauge favors the 3.4 area.

Thus, those inflationists that point towards runaway food and oil prices as proof of inflation are mistaken.  If the recent inflationary environment was truly runaway inflation, the gauge would be over 4 right now like it was in the summer of 2008, it is not.  A possible reason for this is that the recent food and energy spikes are more due to Chairman Bernanke's hot easy money chasing commodities, as well as Mother Nature handing the world severe body blows such as the Russian and Aussie droughts, Asian monsoons, Aussie floods, etc..., and not fundamentally due to too much money chasing too few goods.

As Mother Nature settles down and provides rich harvests in 2011, and perhaps Chairman Bernanke will remove the punch bowl, the greater risk remains on the deflationary side.  With all the Fed's printing, a first year economic student realizes it will result in severe inflation, but, that time has not yet arrived, and the inflation everyone thinks is here now may not actually surface until a couple years or more down the road.

Keystone wil update this gauge as appropriate if any significant levels are hit.  Check back often for updates.