There has been some debate in the blogosphere about whether we can expect inflation or deflation in 2010. Figures released this morning show that inflation rose 0.2%, when economists were only predicting 0.1%. But with the credit crisis and the bursting real estate bubble, and the Fed’s reaction to those economic catastrophes by essentially opening a 24/7 printing press, investors and analysts are speculating about what all of this means.

First, let’s define these terms. From dictionary.com:

Inflation – a persistent, substantial rise in the general level of prices related to an increase in the volume of money and resulting in the loss of value of currency.

Deflation – a fall in the general price level or a contraction of credit and available money.

It’s obvious why inflation would be a concern for the average American. They could have to pay 15, 25, or 100 % more for a gallon of milk than they did the year before if the rate of inflation increased rapidly. But deflation means I could get more for my money, right? So why would it be a bad thing?

Because it can result in a deflationary spiral, which means just what it sounds like, that the entire economy will circle around a toilet bowl.

Deflation is bad if you are in debt because money in general becomes more expensive. You could have $80,000 outstanding on your mortgage, with a 0% interest loan. Yet the economy could be experiencing 10% deflation, meaning money is worth 10% more every year. So now your 0% interest rate is really a 10% interest rate.

According to Wikipedia, a deflationary spiral occurs “where decreases in price lead to lower production, which in turn leads to lower wages and demand, which leads to further decreases in price. The Great Depression was regarded by some as a deflationary spiral.”

So, what would happen in the US if we experience deflation or inflation in 2010?

If significant deflation occurs, banks could fail in big numbers.

If significant inflation occurs, the dollar could collapse.

We don’t have a crystal ball. The number of intersecting factors that would result in these kinds of large scale macroeconomic effects can be impossible to predict. But there is one asset class that will perform well in both states of high inflation and high deflation. Gold is the best insurance in hyperinflation and the best insurance in a deflationary spiral.

In an economic crash caused by deflation, gold can be one of the only assets left while others are destroyed by default. In a crash caused by inflation, gold benefits from devaluation because it can survive the elimination of currency-based assets.

Let the bloggers and economists argue about what the future holds, and protect your portfolio by hedging with gold.