The following chart from McClellan Financial Publications is quite compelling, to say the least:

Many of us remember 1980. Home mortgage rates were in the double-digits and prime lending rates were near 20%. Now, 30 years later, we are completely on the other side of interest rates; mortgage rates are in the 3-4% range and 10 year treasuries are less than 3%. What's amazing is that there does appear to be almost a 300 year history of interest rates increasing for 30 years and then falling for thirty years.
 
This information is particularly important right now as our economy has brought us to the point where we are concerned about both inflation and deflation. Ugh. Let's review quickly the problems with each.
 
Deflation is the general decline in prices. While that might sound good initially, the real concern is a deflationary spiral. A simple example might be: prices fall, companies make less profit, they lay off workers, jobless workers don't spend money and eventually, the economy grinds to a halt. The scenario is further complicated by the baby boomer generation who need to increase their savings for retirement. Deflation is happening right now; the Consumer Price Index is actually slightly negative over the last two years. If unemployment continues at high levels and the housing market doesn't come back, it is very possible that deflation may continue and even increase. 
 
Inflation, on the other hand, is the measure of the purchasing power of a dollar. If your investment portfolio earns 6% and inflation is 3%, your "real" return is 3%. If your portfolio earns 6% and inflation is 1%, then your real return is 5%. A growing economy typically produces inflation; a stagnating economy typically produces deflation.
 
Government deficits and debt also impact inflation. U.S. Government bonds are the ultimate safe haven. When there are economic troubles here or abroad, investors scramble to purchase government bonds. However, because of the increase in federal deficits, expected to be $1.47 trillion this fiscal year, and increasing debt, the U.S. government has to keep borrowing more money. Once the economy starts to pick up investors will more than likely turn to other investments, which will drive up the interest rate on U.S. government bonds and other interest-bearing instruments. Higher interest rates will increase the cost of government borrowing and could lead to even larger deficits and the need for increased borrowing, further increasing interest rates and leading perhaps to a potential inflationary spiral.
 
No one can predict the future. However, it seems probable that continued deflation is more likely now than a spike in inflation. On the other hand, there will be a time that inflation will start heating up again, perhaps in the next two to five years. Accordingly, investment portfolios must be designed with the flexibility to perform in both deflationary and inflationary periods. In addition, they must be monitored and revised on a regular basis to take advantages of changing market conditions. Here at DWM, we focus on meeting those important criteria. 
 
If you would like to discuss how your portfolio can perform, in both low-interest rate and high-interest rate conditions, please give us a call.