Deflation and What it Means -

Business television and newspapers have made deflation a hot topic this week and, since Monday, Google has tracked 13,000 mentions of it.

Deflation is a recurring cycle in which the prices of goods and services fall. Isolated to one industry or sector, falling prices is the natural result of competition.

For example, when DVD players were first introduced, they were tagged at $800.

Today, you can buy them for less than $20.

Across many industries, however, and happening at the same time, falling prices can shut down the economy. Rather than buy things on the cheap, people stop buying anything at all. And why would they? The same items will cost less tomorrow.

And this is the problem with deflation -- it halts consumer spending and consumer spending makes up two-thirds of the U.S. economy. When it stops, the economic result is dwindling corporate revenues which leads to:

1. Layoffs of the workforce, which leads to...
2. Less consumer spending, which leads to...
3. Dwindling corporate revenues, which leads to...

And the spiral continues.

Deflation can be much more insidious that its expansionary counterpart -- inflation. Inflation is when the prices generally rise over time and it's an economic condition through which governments can comfortably navigate. Deflation, on the other hand, is more rare and, therefore, fewer practical control measures exist.

Whether the U.S. economy will slip into deflation is a matter of debate.

The Fed has cut the Fed Funds Rate to promote economic growth and those changes can take up to 12 months to work their way through the economy. Deflationary pressures we're seeing today, in other words, may have already been addressed and corrected by Ben Bernanke's 10 rate cuts in the last 14 months.

Until the market figures it out, though, expect that each mention of deflation will hurt the stock market and help the bond market -- including the mortgage-backed variety. This should help lower mortgage rates and make homes more affordable.

(Image courtesy: The Wall Street Journal)

Who Knows What the Future Holds?

As the stock market dips then jumps then dips again, it's important to remember that markets are unpredictable and nobody knows what will happen tomorrow.

Unfortunately, that doesn't stop the analysts from trying.

An obvious example comes from May of this year. As the price of oil crossed $120 per barrel on its way to an all-time high of $147, a Goldman Sachs analyst was quoted as saying that $200 oil was "likely".

It seemed like a logical conclusion at the time.

Today, though, just five months after the prediction, the analyst's "likely" scenario looks downright laughable. Oil is off by more than 40 percent since that day. And there's hundreds of examples just like this, all around us.

Every day, economic experts and analysts are on television, telling us what's going to happen in the future:

• They tell us when housing prices will reach a bottom
• They tell us when stock markets will rebound for good
• They tell us what the economy will do over the next 12 months

But none of them operate with the proverbial crystal ball -- it's all on "gut".

Another example is from today's CNNMoney.com. In the wake of the government's banking response, a mortgage analyst predicts 7 percent interest rates over the next six months This would represent a 1.5 percent from the recent lows.

The rate prediction may be accurate, or it may not. We won't know for another six months. But what we know today, though, is that mortgage rates are all over the place -- just like the stock market. One day up, another day down. And nobody knows what they'll do tomorrow.

Predicting the future has always been an inexact science but that won't stop the experts from trying. And the experts are wrong as often as anybody else.