We begin a new week pondering the question that bedevils the conscientious market observer every day.Inflation? Deflation? Or as Agora founder Bill Bonner is wont to suggest, both?

“Inflation – rising prices, or a drop in the purchasing power of the dollar – will soon rise to the very top of economic concerns,” writes Chris Mayer. “I can’t understand why there are pundits who insist we can’t have inflation while the economy is weak. There are plenty of examples of weak economies with high inflation. After all, I don’t think they are hitting on all cylinders in Zimbabwe, where inflation is thousands of percent.”

Look at food prices, Chris says. “Soybean prices hit a nine-month high of $12.50 a bushel. The Department of Agriculture said that inventories would drop to only 110 million bushels – the lowest level since 1976-77, when inventories hit 103 million bushels. There were about 2 billion fewer mouths on the planet then. At today’s 32-year low, we can eat through that stockpile in about two weeks. Not a lot room for error; hence, the nine-month high in prices.

“We have a similar tight market in corn. In corn, we’re down to about a four-week supply, the lowest in six years. Corn has rallied also. In fact, the prices of a variety of grains are now at levels not seen since the last food crisis:”

“During the last food crisis, rice traded for $1,000 a ton and there were riots in different parts of the world. The financial crisis took the headlines away from the unfolding food crisis, but now we are looking at act II.”

To capitalize, Chris has some little-known agriculture plays in Mayer’s Special Situations – still available for a one-month trial for $1.

Neither are gasoline prices waiting for the deflation trend to go away. They’ve jumped an average 17 cents a gallon over the last two weeks. The Lundberg Survey puts the national average for self-serve regular at $2.66. San Franciscans are paying the most – $2.99 – while folks in Tucson, Ariz., shell out a comparatively paltry $2.41.

According to conventional wisdom, the numbers will be up because of rising energy prices, but “core” inflation for those of us who don’t consume food or energy will be mild. Forgive us for wondering if we’ve entered a time warp and it’s June 2008, instead of June 2009.

On the other hand… we’re looking still enjoying some deflationary crosscurrents. “Over the coming months,” says Dan Amoss, “as the Fed hints at restraint, we’re probably in for another bout of the ‘deflation trade,’ in which demand for Treasuries increases and most sectors of the stock market reverse their recent gains.”

The Fed, for the moment, is making hawkish noises, but it won’t last. “As the stock market falls and the economy weakens, we should expect the Fed to step on the accelerator again.”

“I find it useful to think about the Fed’s role in such terms; as fear of inflation grows, the Fed will tap the brakes on its monetary debasement, and as fear of deflation grows, it will push the accelerator to the floor, if need be. The endgame under this tragic scenario is the eventual destruction of confidence in paper money, rapidly rising import prices for U.S. consumers and lower standards of living.”

As far as markets are concerned today, it’s deflation, indeed.

Gold is down to a three-week low of $933. In large part, that’s a function of the dollar strengthening today. And that’s a function of comments from Russia’s finance minister over the weekend. At a summit of G-8 finance ministers in Italy, he said there’s “no alternative” to the dollar as the world’s reserve currency, and that right now the dollar’s in “good shape.”

With that, the dollar index has shot up to nearly 1%, to 80.9. The euro is down nearly 1%, to $1.38; the pound and yen have taken lesser hits.

“It sounds like, looks like and smells like a coordinated effort by those that have the most to lose should the dollar continue on its downward path of the last three months to put a lid on their losses,” writes Chuck Butler, his five senses as keen as ever.

“Makes sense… But you have to wonder about what they are really thinking and doing… I’m talking about China, Russia and Japan, who have ALL stated in the past weeks that ‘The dollar is fine, and there’s no substitute reserve currency’… These statements all give dollar bulls a boost, and tell them that these countries are not going to back away from dollars and dollar-denominated assets.”

“Now… there’s a BRIC meeting coming up soon… Brazil, Russia, India and China… And while the finance ministers of these countries are at the meeting, I doubt seriously that they will hold the same amount of ‘love’ for the dollar… But that sentiment will be kept to themselves, as they don’t want to send the dollar spiraling downward.”

“These BRIC nations had it all going for them until July of last year. They were sent spiraling downward like most assets until March of this year. I would have to think that the finance ministers of these countries would be interested in knowing how they can avoid another downward spiral caused by dollar buying… And… this… would be the key, folks… I don’t know what it would be, but if they did something like a currency swap/foreign exchange line between each other for trade, that would be colossal! Which is bigger than HUGE!”

The dollar strength has sparked a wave of deflation in commodities, too. Commodity indexes are down 2% today. Even oil is down $1.55 a barrel, to $70.49, traders unfazed by what sure looks like a stolen election in OPEC stalwart Iran, with the prospect of a power struggle there that could last weeks or months.

The tumble in commodities has cascaded into stocks. The Dow opened down more than 200. Every one of the 30 Dow stocks is down as we write.

China’s economic planners hope to pluck another strategic acquisition from Byron King’s Energy & Scarcity Investor portfolio. The state oil company Sinopec is bidding for a Geneva-based oil producer with a prime holding in Iraq’s Kurdish region.

The news comes about six weeks after the Chinese bid for another Byron pick – an Australian-based producer of rare-earth elements used in everything from flat-screen TVs to hybrid car batteries.

Byron recommended the oil stock last November when it sat below $15. It opened this morning over $45. A triple in seven months.

And he still has his eye on a basket of small gold stocks with similar potential. Officially, we have 356 copies of his special report, Set for Life: Eight Keys to Getting “Miserable Rich” With Gold remaining. But that was as of a week ago Friday, and we’ve sent roughly 100 copies out the door since then. You can get your own here.

An emendation to Friday’s edition: Household debt in the first quarter fell to $13.8 trillion, according to the Fed’s Flow of Funds report. Our thanks to a sharp-eyed reader for bringing the discrepancy to our attention.

While we’re on the subject, we’ll note that bloggers who’ve dug deep into the Fed report have reached a disturbing conclusion: Household debt is contracting, but the value of household assets is contracting much faster.

Still, don’t dismiss those falling household debt numbers out of hand, advises The Richebacher Letter’s Rob Parenteau. “Looking at the unique aspects of this recession, we find the sharp reversal of household financial balances from a deep deficit position to a net saving position quite important,” he writes.

“Households are reducing debt loads, in part with higher saving out of income flows, and this has implications for prospective bank loan volumes and sales revenue growth at consumer discretionary firms. Larger fiscal deficits are supporting the ability of households to net save, yet the shortening of maturity of Treasury debt issued, as well as the reaction of investors to a heavy calendar of issuance this year and beyond, is complicating matters. In addition, the shift toward inflation hedges like oil is draining income from households to foreign producers.”

Thus, “We can think of two sectors that have led the U.S. equity market charge – banks and consumer discretionary stocks – that can be questioned if we are correct that household deleveraging matters.”

Our friend and blogger Barry Ritholtz has been running the numbers on the General Motors bailout. How likely is it the Treasury will earn back its “investment”?

“GM has received $50.7 billion in taxpayer money,” Barry writes. When Government Motors comes out of bankruptcy, Uncle Sam will own 60% of it.”

“At its all-time high, GM’s market cap was $56 billion, which slid down to ~$7.3 billion prior to Chapter 11.”

“For the taxpayer to just break even on their investment , the New GM would have to have to reach a market capitalization of $84 billion – almost 150% of its all-time peak. That will be tough, even with the new GM’s better capital structure, employee contracts and much less debt . . .”

Barry is among the new faces you can see at this year’s Agora Financial Investment Symposium in Vancouver, along with familiar ones like Bill Bonner, Doug Casey and Marc Faber. Opening day is just five weeks away and slots are filling fast. Secure your access here.

Sign of the times: Name the best-selling car in the United States. Nope, not the Toyota Camry, although that’s a good guess. No, in these recessionary times the crown goes to…

No bailout money was used in the production of this automobile.

Yes, it’s the Little Tikes Cozy Coupe, a venerable model introduced in 1979 – earning itself a permanent spot recently at the Crawford Auto-Aviation Museum in Cleveland.

With an MSRP of around $60, the pedal-powered single-seater sold more than 457,000 units last year – more than any model of the gasoline-powered variety. It’s American-made in Hudson, Ohio, and free of the taint of bailout money or White House-engineered bankruptcy proceedings that hosed secured creditors.

As long as we have inflation on the brain today, a reader writes, “It seems there is an idiot academic at Harvard (only one?) whom Bernanke and Geithner have apparently been studying under, who says inflation is good because it induces people to spend their money before it loses value, rather than save for the future, and that creates jobs and prosperity. Yeah, just like in Zimbabwe.”

The 5: You could be referring to Ken Rogoff, the former chief economist at the International Monetary Fund, and Greg Mankiw, an adviser to Bush 43. Both of them, indeed, teach at Harvard and both of them went on record recently saying a 6% CPI would be just dandy “for at least a couple of years,” in Rogoff’s words.

We’ll just leave our remarks at that, lest our blood pressure rise to unsafe levels.

Source: Food Inflation Returns, Watching the Fed, Dollar Bulls Rampage, Bestselling “Car” and More!

This chart shows the price movements since the beginning of the year of the Powershares DB Agriculture Fund (NYSE:DBA). It represents a basket of futures contracts for commodities such as wheat, corn, soybeans and sugar. As Justice says, “Commodity after commodity has roared back to life, thanks to a combination of renewed inflation expectations, a crashing U.S. dollar, and newly bullish fundamentals.”

Last Thursday, we discussed at length the effects that inflationary expectations are having on the market. We said that Treasuries were a bad place to be and that energy-related commodities such as uranium and lithium were likely winners in an inflationary scenario. Justice points out that corn, soybeans and sugar are worth considering.

Corn prices surged to a six-month high,” Bloomberg reported earlier this week, “after the U.S. government said domestic demand will exceed production for the third time in four years, slashing reserves by 28%.”

Corn inventories are expected to fall even as the various demand sources for corn – food, livestock and fuel – rise an estimated 3.5% next year.

Soybean prices, meanwhile, recently hit seven-month highs on the CBOT (Chicago Board of Trade) after U.S. stockpile forecasts dropped. Beans were also boosted by word that the Brazilian National Agriculture Confederation, a major farm lobbying group in Brazil, would press for limited soybean acreage in the coming planting season to help keep prices firm.

And finally Sugar, not to be outdone, recently hit 34-month highs – their highest level in nearly three years – on “poor crops and robust demand,” according to the Financial Times. A failure of India’s local sugar crop was seen as a big price booster. “Swings in Indian sugar output, which move the country back and forth from exporter to importer, are a critical factor in global prices,” the FT reports.

“The price of lumber is a fair indicator of where the market is headed,” says Tom Dyson in last Friday’s DailyWealth. Lumber is an “on-demand” market. That means prices are set by real commercial demand (not the pie-in-the-sky nonsense we’re seeing in US equities right now). This from Tom:

Take the 2008 credit crisis as an example. The lumber price was the first to signal a bear market was coming. It peaked in May 2004. The Bloomberg Homebuilders Index peaked in July 2005. The Case-Shiller U.S. home price index peaked in July 2006. The credit crunch started in February 2007, when New Century Financial collapsed. And finally, the S&P 500 peaked in October 2007.

Gary lives in one of Iowa’s most productive farming counties. He helps local farmers sell their harvest using the futures and options markets in Chicago. He also makes million-dollar speculations of his own.

Gary really knows the “ag” markets. He used to be the head stock buyer in a cattle yard, he’s traded ag commodities every day for the past 40 years, and he spends all day talking with farmers.

The last time I met Gary – in November 2006 – he told me this:

“Corn is going to $5 a bushel, up from its current price of $3.33. Soybeans are going to $9, from their current $6.45. And Iowa farmland is a bargain at $5,000 an acre.”

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Today, corn is $6 a bushel, soybeans are $13, and prime Iowa farmland is $10,000 an acre.

Back then, it was obvious grain prices had to rise. They were too cheap, and with the ethanol boom in full swing, it was plain to see corn and soybean prices would rise. Now it’s not so clear…

Gary says a bad crop could send corn to $10. But that’s not likely. The farmers are planting their fields right now, and Gary thinks there’s going to be a big crop this year. That could push grain prices down.

Gary wouldn’t predict a fall or a rise in the grain markets. He can’t know the future. But he did tell me he had sold all the grain production from his own farm, locking in corn prices at $5.80 and soybean prices at $12.80.

While it isn’t clear what’s going to happen to the grains… Gary said hog and cattle prices have to rise. Here’s why:

A knife is made out of steel. The knifemaker simply turns a raw material into a more expensive “value added” product. The hog and cattle farmer does the same thing. Corn is the raw material. Hogs and cows are a value-added corn product. Think of livestock as corn bins with four legs.

When steel prices rise, the knifemaker has to raise his knife prices or he’ll go out of business. Farmers haven’t been able to raise hog and cattle prices. Years of cheap corn have built up large inventories of meat.

Now the hog and cattle farmers are going out of business. Soon there’s going to be a shortage and prices will rise. “There’s going to be drastically higher meat prices when all this washes out,” Gary said.

To invest directly in hog and cattle prices, you have three choices: You could make friends with a farmer and ask him to buy livestock for you. You could open a futures trading account and buy live hog or feeder cattle futures. (Prices are volatile. Make sure you use plenty of margin and retain a broker who knows the agriculture markets well.)

Finally, you can buy a publicly traded meatpacker like Tyson, Hormel, or Smithfield. But be careful… other “corporate” variables may influence the prices of these stocks and ruin the trade, even if livestock prices rise.

Good investing,

Tom Dyson