20090101 deflation 18
Hand sticks pin into balloon with $100 bill. - 


TESS VIGELAND: The Federal Reserve meets this coming week to once again ponder a change in interest rates. Its main focus is usually whether or not inflation is somewhere out there on the horizon. But the Fed is not alone in this particular obsession. Many of you tell us it's one of your main worries. Inflation, deflation, and how to allocate your investments to avoid one or the other. But Wall Street Journal columnist Jason Zweig says we're going about this the wrong way. He says our primary concern should be me-flation. He's here with us to explain. And first, Jason, let's give a quick econ 101 of inflation versus deflation.

JASON ZWEIG: The easiest way to understand inflation and deflation is just to think of prices as if they were balloons. When you inflate a balloon, it gets bigger, and when you deflate a balloon, it gets smaller. Inflation is simply a persistent state of a rise in the cost of living, and deflation is a decline in the cost of living. In their moderate form, neither one is terribly bad. What scares people is the thought of getting a lot of either one of them.

VIGELAND: Well let's talk about the two different scenarios and why each would have, really, its own set of consequences for different people. Let's start with inflation and how that can either benefit or be a detriment.

ZWEIG: If you're on a fixed income of some kind -- let's say you're retired -- then inflation is murder because the amount of money you're earning is not going up, but the amount of money you need to spend is.

VIGELAND: And deflation?

ZWEIG: Well, deflation is the photographic negative of inflation. If you're on some kind of fixed income, deflation may well be good for you, but you really don't want to borrow money if you expect deflation.

VIGELAND: All right, well I know even on this very show, the advice we give people is try to figure out what kind of environment we're going to be in and then build your portfolio based on that prediction, and of course, people write to us and say, "How am I supposed to know what it's going to be?" So talk to us about your notion of "me-flation."

ZWEIG: Me-flation is the flation that I think people really ought to worry about. Instead of worrying about trying to forecast an outcome that really is pretty unpredictable, you should ask yourself, "Well, of these two flations, which one am I really more vulnerable to?" People spend much too much time trying to pick the forecast and not nearly enough time thinking about what their own personal risk is in this equation.

VIGELAND: Well, let's take the example that you give earlier on when talking about inflation, which is someone on a fixed income -- probably someone in retirement. So if they are fearing inflation, then how do they go about protecting themselves?

ZWEIG: If inflation is your concern, then you would probably want to do something like favoring inflation-protected bonds or TIPS, which are treasury securities whose value adjusts upward as inflation rises.

VIGELAND: All right, what if you decide that deflation is. What would affect you more than anything else?

ZWEIG: Well, if deflation is your greatest concern, you probably would want to favor long-term bonds. That's become advice that sounds pretty dangerous.

VIGELAND: Right. There's all this talk about a bond bubble.

ZWEIG: Right. By no stretch of the imagination are long-term bonds cheap. However, if you are hedging against a permanent risk, then you should regard this as a permanent holding.

VIGELAND: Jason Zweig writes the Intelligent Investor column for The Wall Street Journal, a good friend of the program. Thanks so much for your time today.

ZWEIG: My pleasure, Tess. Thanks.

Follow Tess Vigeland at @tessvigeland