By Michael Pento

This Thursday we will get the latest reading on the Producer Price Index (PPI), followed on Friday by the release of the Consumer Price Index (CPI). Investors are looking for more evidence in the debate between inflation vs. deflation. Those who espouse the belief we are in the middle of a deflationary cycle are predicting yet more evidence that prices continue to fall. However, those who believe we are in an inflationary environment point to recent trends in consumer inflation and projections about their future to bolster their argument.

Deflationists point to the collapse in home prices and commodities to bolster their argument. Indeed, home prices (according to the S&P Case-Shiller Home Price Index) have retreated 26.6% from their June 2006 high and the CRB Index is down a whopping 55% from its July, 2008 high. Real estate values were in an epic, worldwide bubble and the prices of commodities reached historically high and unsustainable price levels, so there is no surprise that both asset classes are down significantly. But the argument for deflation stops there, especially when measuring what the consumer actually pays for everyday existence.

It's true that the PPI for finished goods was down .9% in the twelve months ended December 2008 and is down 9.2% from its peak reached in the summer of last year. This is reflective of the diminished input prices experienced by producers due to the fall in commodities. In contrast, the Consumer Price Index is actually up .1% from the December 2007 reading and is only down 2.1% from its July 2008 high. The trenchant difference between PPI and CPI exists because retail outlets have been very slow to respond to falling input prices. Their reticence is due to the belief that the ebb in inflation will be just temporary.

Part of the pessimism for the continuation of lower prices comes from predictions made about their direction. Economists predict this week's data will show an increase in PPI of .2% and  a slightly larger increase in CPI of .3%. Yet, according to the Financial Forecast Center, the CPI is projected to actually rise 1.5% in the period December 2008 thru August 2009.

The facts are that although commodity and real estate values continue to fall, the American consumer continues to pay higher retail prices on a Y-O-Y basis and predictions are that those trends will continue. In aggregate, (despite the plunge in oil prices) consumers have failed to experience much deflation outside of plunging home prices and some mild relief at the pump, and the latter may well be temporary.