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Historically, stagflation - severe inflation in a stagnant economy - occurs immediately following an intense period of deflation as the economy fails, people lose faith in its currency and flee for alternatives.

Cinco de Mayo was no celebration for commodities, though plenty of analysts have long been calling silver (see here), oil (see here) and other commodity prices in bubbles. Silver was by all means "rejected" at the $50/oz mark last week and continues to plummet, while oil showed resilience until selling began to intensify May 4th. DXY, the US Dollar Index future spot price, rallied hard the final two days of the week, equaling its number of up days in the previous six weeks.

Whether we are seeing bubbles burst or a temporary unwinding of extremely crowded trades, the first week of trading has definitely seen some big players "sell in May." Whether or not asset prices will pack their bags and head south for the summer remains to be seen. Much too is largely dependent on the Fed, whose current quantitative easing plan is set to expire in June.

There has ultimately been no improvement in wages or private sector employment in the United States thanks to hundreds of billions of dollars shoveled into government black holes and onto corporate balance sheets. 60,000 additional McBurgerFlippers, as depicted in the May 6th jobs report, does not change that. With commodity prices in the clouds, minimum wage labor is cheaper versus other interchangeable inputs. High paying jobs are not being created, thanks both to a lack of innovation and ant-competitive government meddling.

Major corporations are reporting extreme profit margins thanks largely to limitless access to cheap capital since early 2009 and slashed asset prices since late 2008, allowing earnings to increase despite stagnant revenues. The first quarter of calendar year 2011 will show that even $4/gallon gas cripples the American consumer. Manufacturers and distributors simultaneously have to raise prices to account for higher costs, then even more so to compensate for decreased demand. In the end, fiscal market propping always fails and this time is no different. Consumers and producers alike find themselves unable to operate efficiently in an inflationary environment and needing to de-leverage.

If easing measures are extended in June, the US dollar will regain its status in the investing world as fuel for the debt machine. Silver has already tickled $50/oz and oil $115/bbl, both prices could double by the end of 2011 without continuation of recently instilled faith in King Dollar. Governments are running out of cash, Americans are no longer net savers and an all-time-high percentage are employed in the public sector, making perceptions of an expanded money supply illusiory if support ceases from federal policy and the Fed.

We are at a crossroads, Ben Bernanke is in the driver's seat and Tim Geithner is his obedient copilot. Will the dashing duo choose deflation or hyperinflation?

Investors will be well served to prepare for either scenario. Gold and silver, easily accessible through ETFs GLD and SLV, will be the greatest beneficiaries of extended measures, while good ol' Uncle Buck, whose upward movements can be captured by owning UUP, will shine brightest if entitlement programs slow significantly or are halted. In this climactic situation, patience will prove a virtue once again. Nimble investors willing to commit as soon once the Fed's cards are face up may find this to be one of the most profitable trading periods of their lifetime.

Disclosure: I am long SLV.

Source: Sowing the Seeds of Stagflation: Eye on Precious Metals, Dollar