How to offset the current deflation while preparing for inflation in the future
The fallout that has irradiated highly leveraged Western economies has started a King Kong-versus-Godzilla battle. To avoid getting trampled, you will need to finesse your credit options and hedge against inflation.
The monster characterization comes courtesy of Niall Ferguson. The Harvard professor and author of "The Ascent of Money" (Penguin, $29.95) sees deflation in the short term, followed by inflation.
King Kong, in Ferguson's parlance, represents the kind of deflation going on now. Economies from Japan to the United Kingdom, in his estimation, will continue to shrink this year. The exceptions are China, India, and Brazil. Godzilla is the wave of liquidity "pouring like a jet hose from central banks."
Viewing the contracting countries as being mired in "slight depressions" for the time being, Ferguson says it's only a matter of time before large government-bond investors start demanding higher yields - rates that "could put the brakes on economic recovery."
I'd go further and say that so much government debt raining down on Western economies will not only trigger inflation, it signals the end of an epoch of excessive affluence. The age of McMansions with big-screen televisions in every room and two sport-utility vehicles in the driveway is over.
Ferguson says the Group of Seven countries will have to sell more than $4 trillion of debt to stimulate their economies and rescue financial-services companies.
"It's hard to believe we won't get back to inflation eventually," he says. "But it won't happen as quickly as pessimists fear."
I agree with Ferguson that housing prices will fall further. Congress and the Obama administration have been unable to curb the foreclosure rate.
"The peak of foreclosures has yet to come," Ferguson says.
Ferguson says US households are experiencing a massive deleveraging, one that may bring spending back down to levels last seen in 2000.
What to make of this dismal forecast? How do you offset the current deflation while preparing your portfolio for inflation?
Ferguson says he is leaning toward Asian stocks, US corporate debt, and commodities that will benefit from Asian growth: oil, copper, and iron ore.
To find growth abroad, tap into emerging markets through exchange-traded funds such as the Vanguard Emerging Markets ETF or the iShares MSCI Emerging Markets Index fund. Be counterintuitive and look beyond the rotten returns of stocks and commodities last year and the sour situation today. And don't try to time any cycles.
As far as deleveraging goes, the advice could never be more fundamental: Pay down your most expensive credit card debt and refinance your mortgage at today's low rates.
John F. Wasik is a Bloomberg News columnist. He can be reached at jwasik@bloomberg.net. 
