Deflation the Clear and Present Danger

Lawrence Jones: We're at the point right now in the market where there's a lot of voices clamoring about the fear on inflation down the road. There are others that are suggesting that deflation is still the real fear that we need to worry about.

Can you talk a little bit about where you're coming down in this debate?

Jeffrey Gundlach: Unquestionably, deflation is the clear and present danger that's happening real-time. Almost everyone, even if they're an ultimate inflationist, acknowledges that deflation is today's problem.

I think that it's wrong to be reorienting inflation policy today in a major way for inflation. I think if you're doing a diversified move and you're adding some inflation protection, that's not a bad thing. But I still think it's more important to be thinking about the deflation side.

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I use an analogy of a wildfire. If a wildfire is coming down the street, you need to get a fire extinguisher. A lot of people say, "Oh, yeah, there's a wildfire of deflation today, but down the road inflation is coming." Well, to me, that's like saying let's ignore the wildfire and worry about maybe once the vegetation is burned up in the fire we get a flood down the line, so I'm going to go out and buy sandbags.

You don't need sandbags, you need to fight the fire, and the fire remains deflation. Very much in the news. We see wage cuts, particularly at the public level. I think there's much more of that coming at state levels and municipal levels.

And when you cut wages, it's incredibly deflationary. The "Cash for Clunkers" program is essentially a sign of deflation. You can only sell cars if you give such a cash payment that it effectively equates to cutting the price 20%. If you can only sell cars by cutting the price 20%, you have deflation.

And I think deflation and default go together, and default remains very high in the mortgage markets. Still no improvement there. And default still remains problematically high in the corporate market.

So deflation is still the problem, and I think those that are working on inflation hedges should go slow.