The battle rages!

Unstoppable inflation on the one side; immoveable deflation on the other. And what’s in between?

You are, dear reader; keep your head down.

At least you know where you are. Most people have no idea. Most middle class Americans are caught in this no man’s land. Inflation is shooting holes in their family budgets. While deflation blows up their assets.

The headline inflation number for 2007, in the United States, was announced yesterday – at 4.1. Still manageable, but it was the biggest annual increase in 17 years.

But yesterday, deflation was on the offensive. The Dow edged down, and when we look at the charts of almost any market – France, England, Japan, tech stocks, shipping stocks (keep reading), retail stocks – we see bear markets.

And yesterday, we thought we saw the first signs of a bear market in commodities too. Oil dripped below $90 and materials and energy stocks suffered, as investors bet that a slowdown would mean less demand for primary products.

France’s Le Monde chose this for its leading story today: “The Menace of Recession in the U.S. Grows Clearer.”

And now, even the candidates for the White House are taking a page from Bill Clinton’s playbook, entitled: “It’s the Economy, Stupid.” As Ed Hadas puts it: now the candidates are saying stupid things about the economy.

Mitt Romney won in Michigan, largely by telling an outrageously stupid lie. According to Le Monde , which is our source for American political insight, Romney pledged $20 billion of taxpayers’ money to revive America’s auto industry. We take this readily from Le Monde , because the French know how these tricks work; they have more experience with them. You take the money from the people who earn it, pass it out to the unions, insiders and party supporters; the auto industry goes wherever it is going anyway but the insiders travel in style.

The voters are ready to believe anything, especially if it sounds as though someone else’s money is headed their way. Besides, everyone feels entitled to a bailout, from the lowest assembly line worker to the richest Wall Street bank.

“The source of the problem is debt,” Lord Rees-Mogg explained at Wednesday’s lunch. “There’s too much of it . There’s so much that the financial authorities and Britain and America have no choice. They have to try to bail people out. They have to inflate the debt away.”

Too much debt is precisely what you’d expect to find at the end of any credit boom. When you give money away, you have to expect that people will take it. At least, as long as they believe they will be able to pay it back.

Presently, the yield on 10-year treasury notes is lower than the consumer price inflation figure. Which means, they’re giving money away. A shrewd investor would probably sell Treasuries and buy something with a higher return – say, gold .

Gold does not typically have any return at all. While its price was fixed to the dollar – it had a rate of return of zero. Which was a good reason not to own the stuff; you’d get a better yield from almost anything. But when the dollar was tied to gold, you didn’t need to own it.

Every dog has his day. And it looks to us that the mangy cur that sits at the number 79 slot on the periodic table is having his day at last. He is worthless at producing a profit, a dividend, or an interest coupon. Most of the time he just lies around, doing nothing...like a rich man’s pet. But there are times when he earns his keep, when he is worth every pound of meat you give him: he can be one mean junkyard pooch when he has to be.

If we are right, that stocks are in a bear market and that the nation is headed for a slump, the wise Daily Reckoning reader will stop worrying about making money and begin to fret about keeping it. He will wish he had befriended gold when the price was around $300, or $500. He will think twice about taking it in at $900. He will think even a third time on the day after gold goes down $20, as it did yesterday. (Yes, deflation hit gold too.) Still, our guess is that this gold bull market has a lot further to go .

How many of your friends own gold? Probably not many. How often do you see articles in the mainstream press about buying gold coins or gold stocks? Almost never.

The last time a major credit contraction and bear market came around, circumstances were different. A top in stock prices was reached in 1968. From there, stock prices fell while loose monetary policy goosed up consumer prices. In nominal terms, stocks held up fairly well. But in real terms, the losses were staggering – about 70% to 80%, from the top in ’68 to the bottom 14 years later. Meanwhile, gold soared, up to a high of $850. Gold and the Dow actually came within a few cents of each other in 1980 – when a single ounce of gold could have bought nearly the entire Dow.

Adjusting the gold peak to today’s dollar, it would be about $2,500. Adjusting the Dow to its ’82 low, it too would be about 2,500. Is that where the Dow is headed? Is that where the price of gold is going?

We don’t know. We don’t know the destination, but we suspect that’s the right direction.

Bill Bonner is the President of Agora Publishing. For more on Bill Bonner, visit The Daily Reckoning.