The deflation / inflation debate is one that will not die until each phase has played out. In The Path to Hyperinflation Jordan Roy-Byrne breaks down the three stages we’ll experience:

In the first stage, the economy enters a recession after a large credit bubble. The recession and end of the credit bubble lead to deflation. As a result, the US Dollar and US Treasuries outperform. Think 2008.

Policy makers (a term for interventionist bureaucrats) then provide stimulus via monetary easing and deficit spending. Gold (NYSE: GLD) and gold stocks (NYSE: GDX) outperform with silver not far behind. Think late 2008 to early 2009.

The economy gets a bump from the stimulus and economically sensitive markets such as commodities and stocks outperform. Think 2009.

This brings us to where we are now. The market is starting to sense that Europe’s debt burden is too high as its economies struggle to recover under the weight of excessive debt. The market is beginning to sense a rising probability of default. Precious metals are soaring against the Euro, the Pound and the Swiss Franc.

Meanwhile, with money moving back into US Treasuries, the US will have the ability to attempt another stimulus and announce further quantitative easing.  Europe is currently ahead of the US on its track to currency depreciation, rising inflation expectations, and rising CPI/PPI. The US still has time before the market begins to worry about its debt burden.

The next stage is the transition from the initial outbreak of price inflation to severe inflation. Inflation accelerates due to a loss of confidence in governments and currencies. A failed economic recovery leads the market to realize that the debt burden is too large and will ultimately be defaulted upon or inflated away. At this juncture, all commodities begin to perform well again. It may take anywhere from six to 18 months for this stage to be evident.

Finally, inflation is exacerbated as supply shortages emerge. Tight credit restricts new production and consumers begin to hoard. During such a period, precious metals and commodities will continue to perform well but the agriculture sector will be the real leader.

Most market observers, at least those of us who don’t wear the rose glasses of recovery, understand that the twelve months of rising stock prices that followed the March 2009 lows are a result of not economic recovery or improving market fundamentals, but government intervention in the form of bailouts and stimulus. As the largest credit bubble in history exploded in 2008, prices in everything from real estate to agriculture collapsed – significantly. As a result, the governments of the world pumped trillions of dollars worth of paper money at the problem. Had they not done so, it is likely that prices around the globe would have continued to drop.

Thus, what we experienced in 2008 was a severe bout of deflationary forces across not just stock markets, but just about every asset class in the world. It can be argued that we are actually still in a period of deflation and if / when the US government relieves stimulus intervention policies, you can expect a repeat of 2008. Deflationary forces have not yet gone away, as there is still too much bad debt in the system that needs to be cleared out, and the few trillion pumped in from government here and there may not be enough to keep prices at current levels. So goes the argument for deflation, basically.

However, as Mr. Roy-Byrne suggests, there is a lot of money currently flowing into US Treasuries, which means that global investors seeking safety from the debt problems of Europe are shifting their money out of Euro denominated assets and buying US Dollars denominated debt. For the time being, this should work to protect wealth, especially as problems throughout Europe continue to accelerate. No, it’s not just a problem with Greece – it’s Europe-wide and it will play out in coming months as it becomes evident that Spain, Italy and Portugal are ever worse off than Greece because they contribute much more to the European economy than the Greeks do.

To get an idea of what may happen to the US dollar in the future, just give the Euro a look. In the last 3 months, it has been absolutely pounded as investors rushed to safety. The loss of Euro purchasing power is evident in the significant price increases of precious metals in the European Monetary Union’s currency.

Now, take a look at the United States. If you think Greece or Spain or Italy are serious, consider the debt problems we have with our own states. In 2007 and 2008 the problems we experienced resulted from high debt loads and mismanagement with private companies. The next stage will be much worse, as we are going to be talking about government defaults.

As Mr. Roy-Byrne points out, “the US still has time before the market begins to worry about its debt burden.” Our time will be up when US states start announcing their insolvency and inability to meet the most basic obligations to which they have agreed, like paying state employees, making pension payments and covering the cost of health care. The federal government, in order to prevent panic, will have to move to stabilize the crisis, and they will do this not by bailing out Wall Street, but the states themselves. If you thought that the recent round of bailouts were bad for the dollar, wait until the majority of the states in the union come asking for emergency funds. The US government will have to print so much money that AIG, Freddie and Fannie will be considered child’s play.

This is when the rest of the world will realize that the US dollar is no longer a bastion of safety. This is when global investors will begin to scramble to off load their US debt based holdings like Treasury bonds. And this is when, if hyperinflation is in the cards, that the US economy will see the worst of the destruction in this crisis.

There is still a bit of time before we hit this level, but just as the real estate bubble was bound to pop, so too will the US government.