Inflation or Deflation?

The argument for inflation is that that fed is pumping money into the system and that money has to go somewhere . . . thus it will run up prices. The Fed increased their balance sheet by 1 trillion as well as lowered interest rates to 0% so that banks can borrow to create more money on their own. An additional inflationary source is the government debt. Since US Treasuries are considered "riskless cash equivalents", when the US borrows an additional 2 trillion dollars, that acts as more money pumped into the system.

The risk for deflation on the other hand is even greater, but so far, at bay. The US government owes trillions of dollars and is guaranteeing trillions more on financial firms balance sheets. If interest rates rise, if the Chinese stop lending, or if bank losses increase, it is possible the US government will default on its debt. A default by the US government would turn its trillions of Treasury bonds from "riskless cash equivalents" into "junk" or worse. If this happens, tons of money immediately gets sucked from the system and we have severe deflation. This is why the dollar increased in value and all prices dropped when banks were failing and defaulting in 2008 and early 2009. When the government stepped in and turned all those problems in "cash" by guaranteeing it, the deflation stopped.

Since the government does not want to default and be forced to reform, they will try their best to inflate our way out of this mess. The Fed is supposed to defend the value of the dollar, but I wonder if it really came down to it if they would allow a government default.

So what to do? For now, it is OK to bet on stocks and commodities that benefit from a declining dollar, but we should pay close attention because if this inflationary party stops, it will stop quickly and end very badly. Keep one foot on the stock market gas, and one foot our the door ready to leave the party and pay off all debts if the whole ponzi scheme starts to collapse.