"Consumer spending slowing, but how much?" asks one headline. "House prices cooling, but not collapsing," states another.

When we parted from you yesterday, dear reader, we told you Ben Bernanke was fighting a war on two fronts. There is the war trumpeted in the headlines - against inflation. But there is another war, too, against deflation, which is much more threatening. But that is left to the footnotes.

Many people wonder why Bernanke bothers to battle inflation at all. Core inflation numbers are mostly unchanged...and still low. What isn't so low is the price of gasoline, which is now at $3.00 a gallon, according to yesterday's news. And here, the trail gets confusing. The rising price of gasoline is a sign of inflation, is it not? Yet, what it does is siphon money out of the consumer economy. Motorists from San Jose to St. Augustine take dollar bills out their pockets and pay it to the oil companies, who turn around and send it to Saudi Arabia or Russia. The foreigners add to their claims on U.S. assets, while the supply of spendable "money" in America falls.

This is the curious "flation" that the U.S. faces. American consumers are running out of money just as their most important consumer prices rise. And so, along with Ben Bernanke, we are caught in a labyrinth of conflicting and contradictory paths. What can we do but follow the trail like Theseus' winding thread and hope it leads us out of the Minotaur's deadly labyrinth.

The first corridor we take leads us to an interesting discovery. Why would the Fed raise rates when there is no real inflation? In the recent market pullback, for example, investors dumped gold and commodities as well as emerging-market shares. They would not have done so had inflation been a worry. No, the Fed raises rates not so much to fight inflation as to fight deflation. Increasing short-term rates helps convince investors that inflation will be no problem, thus are they willing to lend long-term at lower rates. Lower long-term mortgage rates help sustain the real estate boom on which the entire economy depends.

But now we take a corridor to the left. And as we follow along, we notice the way the landscape changes. Years of booming stock prices gave way to years of booming house prices. Now, prices for both housing and stocks seem to be stuck...or actually falling. This is not inflation. This is asset price deflation. And it must be what the Fed most fears. When prices for residential housing go down...so does the U.S. economy.

Ah. So, then we turn to the right. What most economists expect now, we read, is neither typical inflation nor typical deflation. According to yesterday's newspaper reports, they look for "stagflation" to play a leading role.

Do you know how stagflation works, dear reader? If not, we are happy to supply you with an explanation. Remember how the Fed "stimulates" the economy? It does it by inflating the money supply. More money makes people think they have more wealth, leading them to make more mistakes. They borrow, they buy, they build, they spend, they invest...and whee! Oh, what a beautiful boom!

But after a while, people begin to realize that all this crisp fresh money is a fraud. Prices rise, and the consumer finds he has no more spending power than before. The businessman has expanded capacity, but finds he has no more customers than before. The investor looks at his returns, adjusts for inflation, and discovers that he has no more money than before. Once the humbug is unmasked, it no longer works. The Fed continues to introduce more "money," prices rise, but there is no boom anymore. The party is over. That, dear reader, is stagflation.

Milton Friedman predicted it in the '60s. Friedman might have been wrong about a number of things, but on this he was right. In the '70s, stagflation came to America.

And thus we remind you, dear reader, of an Essentialist Economic
Principle: A slump is opposite and equal to the fraud that preceded it. The recession of the '70s was the worst one since the Great Depression.

But in the '70s, America still has a few things going for it. It was still a major creditor, one that was able to finance its own consumption. Back then, the rest of the world owed us money, not the other way around. American mortgages were relatively low and the typical family could still pay its bills without mortgaging the house. The U.S. government ran its last real surplus during the Nixon years. Back in the 70s, we still bought and sold from overseas at a net surplus.

But then, following our bright thread, we move on and find that since 2001, 73% of all new government borrowings have come from overseas. And the imbalance between what is sold to foreigners and what is bought from them is so great that empty containers are piling up in southern California. They come bearing goods from Asia. But America has nothing to send back. So, the empty containers pile up in storage lots - so high that the locals are complaining that they block the view. As for the rest - mortgages, debt, deficits and all - you have heard the story often enough already.

All of which suggests that Bernanke's next war will a tough one. But a war against what? Inflation? Deflation? Stagflation? Or will it be some new kind of "flation" that hasn't even been invented yet?

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