As you shop for the best interest rates on certificates of deposit, money market, or savings accounts, there is a long-term consideration overhanging your choice of short-term rates: inflation. Inflation is the financial equivalent of erosion--you might not notice it from day-to-day, but over time it can eat away at things until you are no longer standing on firm ground. So, it is worth looking at some arguments both pro and con as to whether inflation is going to come back to life in the near future.

You might ask: why worry about inflation now? After all, recent Consumer Price Index releases have shown deflation (i.e., declining prices) rather than an uptick in inflation. Often times though, the best time to confront an issue is before it becomes a problem. That is generally the best time to take constructive action.

While the case for inflation is mixed, there are enough warning signs out there that it certainly merits serious consideration.

The Case for Rising Inflation

The 12-month periods ending in March and April of 2009 both saw deflation, in the form of negative price changes for the Consumer Price Index. How rare is that? These were the first 12-month periods of deflation since 1955. Obviously, this is not an environment that should be viewed as normal, and there are other reasons to be concerned about a revival of inflation:

• Oil prices. Since bottoming out in late December, 2008, oil prices had roughly doubled by late May of 2009. Just as the huge drop in oil prices from their peak in July, 2008 was a major factor in the general deflation of the past year, rising oil prices will start to put some pressure back on inflation going forward.
• Weakness in the dollar. Concern over the size of the bailout and stimulus commitments the U.S. government has made is eroding confidence in the dollar. Both U.S. Treasury bonds and the dollar itself have been declining. In any event, as the dollar weakens, it makes goods generally more expensive to people who do their buying in dollars.

The Case Against Inflation

While inflation is a valid concern, here are two reasons to believe it won't get too far out of hand:

• With higher unemployment currently, there is certainly some slack in the labor market to be taken up before wage pressures become a factor.
• With capacity utilization at the lowest level in more than a decade, there should be no near-term issues with capacity constraints becoming an inflationary factor.

Conclusion

While there are reason to be optimistic that inflation won't get out of control, there is evidence that it may start to be a factor again over the next year or so. For deposit accounts, the good news is that this would mean higher interest rates, but the bad news is that the benefit of those higher rates would be reduced by higher inflation. Worst of all, though, would be to find yourself locked into low rates at a time of rising inflation. Therefore, this may be a good time to keep your money fairly liquid, in money market or savings accounts, or perhaps in very short term CDs, and look to lock interest rates in for longer periods only once they rise.

Sources:

• http://www.doe.gov http://tonto.eia.doe.gov/dnav/pet/hist/rwtcd.htm

• Christopher S. Rugaber • Meltdown 101: Will China global currency idea fly? • Mar 24, 2009 • http://www.foxnews.com • http://www.foxnews.com/wires/2009Mar24/0,4670,Meltdown101GlobalCurrency,00.html