There is perhaps no more contentious debate out there among market mavens than the inflation vs. deflation debate. In the inflation camp, you have those arguing that thanks to the government’s über-loose monetary policy and its willingness to print money pell-mell, the logical conclusion is inevitably inflation or even hyperinflation.

Then you have the deflation camp saying that because the government’s monetary policies will ultimately fail to pump up and sustain inflation, you will see a big collapse in asset prices and a contraction in credit.

But how do you know which camp is right?

One way to monitor which side of the debate is closer to the truth is to look at the value of the U.S. dollar vs. rival foreign currencies. When the dollar is falling in value, i.e., when it’s worth less, inflation is taking place. Conversely, when the dollar is rising, it can be interpreted as a sign of deflation.

In the chart here of the U.S. Dollar Index, an index that measures the value of the greenback against other major global currencies, we see that from December to June deflation essentially ruled the roost. Despite efforts by the Federal Reserve to keep pumping liquidity into the market, the dollar just kept rising. In June, however, the tables were turned on the dollar, and from early that month until mid-August the dollar came down hard.

I know all of the arguments for and against both inflation and deflation, and they are too numerous to detail here. But what I think is actually happening is that there is both inflation and deflation at work, depending on what part of the economic pyramid you reside. If you are at the bottom of the income pyramid, then prices are rising and wages are stagnant. If you are at the top of the pyramid, your asset values (real estate, securities, etc.) are falling.

For those who want to read more about this issue, I suggest that you check out a great blog site called Daneric’s Elliot Wave. Scroll down to the section heading “THE EFFECTS OF A COLLAPSING PONZI IN SLOW MOTION - DEFLATION AND INFLATION AT THE OPPOSITE ENDS OF THE PYRAMID” and you can read this fine analysis on the economic pyramid and the inflation-deflation spectrum. It’s a definite must-read for those interested in this issue.