Investor Jim Rogers thinks gold will double to at least $2,000 (around Rs93,200) an ounce. Economist Nouriel Roubini says that’s utter nonsense. As these well-known market personalities duke it out, they’re doing us a favour by highlighting a critical debate: Which is the bigger threat—inflation or deflation?

Inflation, though not to the extent many fear.

Saying this opens me up to a rebuke from the National Inflation Association. It chided Roubini last week for arguing there’s no inflation to drive gold that high. The group said he doesn’t understand inflation and deflation.

Then again, who really does these days? If you’re looking at economics and markets through traditional lenses, very little makes sense. Many concepts that seemed like rock-hard truths two years ago are looking shaky.

Just ask John Reed, who helped engineer the merger that created Citigroup Inc. Reed last week apologized for his role in building a company that has taken $45 billion in direct US aid, and said banks that big should be split up. Turns out, the 1999 repeal the Depression-era Glass-Steagall Act separating consumer banking from those involved in capital markets was a terrible idea after all.

Up has become down, and down has become up. Amid such disorientation, the risk is that policymakers will apply old ideas and relationships to new and diverse challenges. One such error would be prematurely taking away the stimulus that’s only now stabilizing growth.

Inflation risks

Only a fool would dismiss inflation risks at a time when the US Federal Reserve, Bank of Japan and Bank of England are holding short-term rates near zero and the European Central Bank isn’t far behind. Central banks are starting to unwind emergency measures introduced to stave off disaster, and that’s appropriate.

The risk is that policymakers go overboard looking for exit strategies. That, in a nutshell, is Roubini’s shtick and it’s hard to refute the views of the New York University professor. Yes, inflation must be contained, but so must the forces of deflation in the short run.

To me, Roubini’s worries are more persuasive than Rogers’ bet on gold. That also goes for Roubini’s view that bubbles pervade rallies in emerging market stocks. They do.

$2,000 gold

As 2010 approaches, there are widespread expectations that gold will continue rising. India’s recent purchase of $6.7 billion worth of the precious metal focused attention on the trend.

Yet the global economy is turning Japanese more than those fixated on inflation may realize. In a world awash with liquidity traps, price pressures aren’t the usual threat.

That’s not to say inflation won’t perk up, particularly in emerging markets. The Fed’s ultra-low rates are likely to result in inflation in China, Indonesia and Thailand before they do in the US. Bank lending is locked in neutral, at best, even though monetary-base growth in the US has increased exponentially over the past year. Oddly, the main beneficiary of the Fed’s liquidity is emerging market stocks.

At the same time, highly indebted US households will be spending even less now that unemployment is above 10%. Weekend news reports about the jobless rate climbing to a 26-year high were a huge consumption killer.

Too big to fail

Couple that with Washington’s enthusiastic embrace of the too-big-to-fail doctrine. Fannie Mae, for example, is looking for yet another public bailout—$15 billion this time. Executives at Citigroup, American International Group Inc. and Goldman Sachs Group Inc. all know the government won’t let them go the way of Lehman Brother Holdings Inc.

That encourages reckless decisions and will slow the process of clearing imbalances in the commercial real estate market and other sectors. All this suggests that Japan’s experience these past 20 years is more relevant to the US than many admit. Japan is still grappling with deflation.

The key difference between Japan and the US is the concentration of financial distress. In Japan, bad debt was concentrated in the corporate sector; in the US it’s in households.

The US may be sowing the seeds of yet another bad-loan crisis by expanding homeownership anew. How encouraging those who may be better off renting to buy homes in a weak economy is good policy is beyond me. It’s all a bit too Japan-like for comfort.

Japan lesson

Another lesson Wall Street hasn’t learned from Japan is the power of I’m sorry. Reed’s utterance of those very words in an interview with Bloomberg reporter Bob Ivry was extraordinary because bankers have avoided taking blame.

When rationalizing the crisis, bankers point to everything from too little regulation to too much regulation to low-income Americans fudging mortgage applications. What they haven’t done is look in the mirror and acknowledge the role of their own greed. Nothing dramatizes that more than the fat bonuses bankers are again paying themselves.

They will regret that strategy if markets falter anew. The trick for policymakers is to take some of the froth out of asset prices without going too far, too quickly, and ushering in global deflation.

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