Dr. Gary Shilling wrote his first book, called simply Deflation, in 1998 and followed it up recently with another great work, titled The Age of Deleveraging. He first went long bonds in 1982, which has been one of the great trades of the last 30 years. He lists a whole host of reasons for a deflationary period over the next few years.

The argument for deflation is rather straightforward. The boom in the US and much of the world from 1982 until 2008 was partially the result of financial innovations and massive leveraging. That process has come to its end, and the private sector is de-leveraging and will do so even further as the economy softens and we slip into the next recession.

Governments are coming to the end of their ability to borrow money at reasonable rates in Europe, and soon in Japan and eventually in the US (and that time is not as far off as we would like). I described the whole process in my book Endgame. Assuming the US government deals with its coming deficit crisis in a realistic manner, the results will be deflationary. I will comment later on the Fed response.

The next big deflationary force is the slowing of the velocity of money. I have written numerous e-letters and devoted a lot of space in the book to the velocity of money and won't go into it again here. It has been falling for five years, pretty much as I wrote it would, back in 2006.

I was writing about the velocity of money at least as far back as 2001, and probably earlier. It is a very important concept to grasp.

We are now close to the historical average velocity of money, but since velocity is mean-reverting it will go well below the historical average. This process takes years; it is not something that is going to end any time soon.

A slow-growth, Muddle-Through economy is deflationary. High and persistent unemployment is deflationary.

Absent some new piece of data that I can't see now, we are in for lower bond yields in the US.

Rates are going lower and are going to stay low for longer than any of us can imagine.

I think the Fed will respond to the government acting in a fiscally responsible manner, which is inherently deflationary, by fighting that deflation with the only tool it has left; and that is outright monetization of debt. They will call it something else, of course, but that will be the actual outcome.

And they will be able to monetize more than you think they can without causing a repeat of the 1970s. Eventually it will catch up to us, as there is no free lunch, but they are betting they will be able to reduce some of the threat of actual inflation by cutting back on the money supply and raising rates. But we are years off from that. So, yes, at some point inflation will be back.

Anybody who says they know the timing is a lot more confident in his/her crystal ball than I am. Mine is rather cloudy on this topic.

But I think I can see out a year or so, and it looks like continued low rates and deflation. By the way, just to appease the Gold bugs among my readers, given my deflationary call, I will note in passing that solid Gold stocks were up hugely during the deflationary Great Depression of the '30s.

Even with the USD on the Gold Standard. Just saying.

John Mauldin