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Inflation vs. Deflation: 'Wait, you're both right,' says John Mauldin

·Editor in Chief

It's one of the great macroeconomic debates of our time: Is inflation already here or is the world getting sucked into a deflationary spiral?

The answer is a resounding "Yes," according to John Mauldin, chairman of Mauldin Economics and president of Millennium Wave Advisors.

The reason this is so contentious and confounding, he explains, is that "inflation" is ill defined and people end up comparing apples-to-oranges.

Followers of Keynesian economics look at the general level of prices, while followers of the Austrian school of economics look at inflation in terms of money supply, Mauldin says in the accompanying video. In other words, inflation is in the eye of the beholder.

In the Keynesian camp, which includes a lot of central bankers, "you're not finding very much" inflation these days, he says.

Asked why many Yahoo Finance users and U.S. consumers believe otherwise, Mauldin says (essentially) that individual results may vary, i.e. if you have kids in college, you're definitely experiencing inflation. Tuition and fees at private nonprofit colleges rose 3.7% this academic year while costs for in-state tuition at public colleges rose 2.9%, according to the College Board. Both measures exceed the Fed's preferred inflation measure -- core Personal Consumption Expenditures -- which is up just 1.4% on a year-over-year basis.

But someone with younger children is experiencing something different and the government (and the Fed) are really trying to view inflation in the broadest possible terms, Mauldin continues. To paraphrase Larry Summers: People are much more sensitive to prices of items that are rising vs. falling.

Consider, for example, Paul Singer of the $25 billion hedge fund Elliot Management, who made headlines recently by warning about inflation or even hyperinflation. His evidence: "London, Manhattan, Aspen and East Hampton real estate prices, as well as high-end art prices," which have all risen by astronomical levels. Just this week, Christie’s set a record for an art auction, grossing nearly $853 million at their sale of modern art in New York.

But high-end real estate and art remain farther out of reach for average consumers than ever. Indeed, Fed Chair Janet Yellen is very focused on wages, where average hourly earnings are up just 2% year-over-year even as the unemployment rate has fallen sharply. More importantly, wage growth has been nonexistent for average American workers for a generation.

(Singer also made headlines by suggesting "a lot of the data is cooked or misleading," but Mauldin disagrees: "I do not see this is a conspiracy to mislead investors or consumers, or to slow down the rise in Social Security payments," he writes. See also Floyd Norris' recent NYT column on the same topic.)

'They See Inflation'

The followers of the Austrian school, meanwhile, see what the Fed, the Bank of Japan and (slowly) the European Central Bank are doing and "they see inflation," Mauldin says. "And it's showing up in asset prices."

In the end, Mauldin appears to side with the Keynesians, warning of the risk of "global deflation in the near future" in the most recent edition of his Thoughts from the Frontline e-letter. "Commodity prices are falling all over the world and especially in dollar terms. This is a result of the high prices of the last decade, which resulted in excess supply in a world where demand growth is trending lower, especially the demand growth provided by China."

But he also agrees with the Austrians about the danger of asset price inflation -- particularly what happens when it starts to unwind.

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"It is very possible that we could see asset-price deflation in the near future and an accompanying bear market," he writes, citing a possibility "that the next recession will actually be led by a bear market as opposed to the bear market simply resulting from a recession" as is traditionally the case.

"The recent bubble-like levels of subprime corporate credit and junk bonds have set up the potential for a collapse in debt valuations. Shades of 2008," he warns.

If he's right, the doves will "win" the inflation debate as another financial crisis would almost certainly result in global recession and lower prices for assets and goods alike. A Pyrrhic victory, to be sure.

Aaron Task is Editor-in-Chief of Yahoo Finance. You can follow him on Twitter at @aarontask or email him at altask@yahoo.com.  

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