There has been a raging debate for the last 1 year: Inflation or deflation?

Inflation means borrow dollars and buy assets like real estate, commodities companies etc. Deflation means hang on to your dollars. After all, assets will be cheaper tomorrow.

I listened to this clip on CNBC on August 7th. Former President Clinton's Labor secretary Robert Reich, now an Economics Professor at UC Berkley, seems to be making a point to anybody who listens that we are in a very ugly recession. The turnaround is nowhere in sight. His point is that businesses have laid off workers and without job growth, no economic turnaround is possible: Consumers are in a savings mood and are not spending and businesses cannot make more products unless there are consumers, and so on. He has a point.

Let's crunch some numbers. The unemployment rate is running around 10% nationally, with a total of approximately 15 million unemployed. Since this recession started sometime in 2008, 7 million jobs have been lost. According to the recent Sep. 5th report by chief economist of US Chamber of commerce, there are about about 1 million net new entrants in the job market every year. Therefore, 11 million new jobs are needed by 2012, just to keep unemployment rate even at the 2008 level.

Recap of Upturn: Let us compare the price of Treasury Inflated protected securities (TIP), Gold (GLD), Gold Index (^GOX), Dow Jones Industrial Average (^DJI) and the 30yr. Bond (^TYX) from the week of Nov. 22nd through today. Irrational optimism caused DJI to peak just above 14000 in Oct. 2007. Gold followed the rising DJI, convinced it is infationary, peaked near $1000 per oz in March 2008. TIP also peaked at about $111 in the same period as Gold peaked. Meantime the 30yr. bond yield peaked at 5.3 around July 2007.

Downturn has tested deflationary sentiment: During the "Total Liquidation" period of fall 2008, everything sold off. Domestic Stocks, Foreign stocks, Emerging markets, foreign currencies, Gold, you name it. They all parked their money in dollar and dollar denominated treasuries. Like it or hate it, the true colors of investors were revealed. They sold off everything and parked their money in dollars, when it counted, period. Such was a flight to safety that the 30yr. bond yielded only 2.56% in Dec. 2008. Imagine lending money to the US Treasury at 2.56% for 30 years. Interpreting this another way, investors were convinced that deflation was taking over. No need to hold on to anything but dollars. After all, anything produced today can be bought with less dollars tomorrow, so no need to buy anything else. The price of TIP meantime bottomed at around $92 around week of Nov. 17, 2008. So people also sold off TIPs when the sentiment was no threat of inflation.

Let us first do a quick two week high level recap. Gold closed on Friday at approximately $934, silver at $14.23 and platinum at $1215 per oz. Compared to the values on June 6th, the precious metals weakened. Dollar demand must have therefore strengthened. The long bond closed Friday at 4.52%, at a lower yield than June 6th, confirming the dollar's strength. So far, so good. The data makes sense.

But this is just a two week end to end data point. In between there was a whole bunch of news. A tug of war went on, where the market could not make up its mind: Is the economy on the mend (inflationary)? Or is recovery still quite a ways away (deflationary)? The bond prices and precious metals therefore see-sawed a little bit.

A traditional rule of thumb for a conservative investor, advised by money managers, is to put an percent equal to your age in bonds and 100 minus your age in stocks. Some can put more in bonds or less, depending upon their risk appetite to stocks. To keep things simple, let's assume for the moment that bonds are in the same broad category as CDs or cash, dollar or foreign currencies.

If substantial assets are tied in cash (i.e. dollar bonds), it becomes extremely important to understand the relationship of dollar vs precious metals such as gold or platinum. This is the most important relationship to grasp. Not oil vs. gold, not oil or gold vs. stocks such as the Dow Jones average. Also not important is gold vs. foreign currencies such as the Australian dollar, euro or Canadian dollar. The reason is that gold is priced in dollars, and the relationship is largely inverse: i.e. gold rises in price as dollar weakens and vice versa.