By Michael K. Farr, CNBC Contributor
Over the past few weeks, there has been a revival of the debate about the possibility of a Japanese-style deflation in the U.S. The fears were most pronounced two weeks ago when the major stock indices shed 5+% in a week's time and investors poured money into the safety of US Treasuries (taking the yield on the 10-year Treasury below 3%). There have been several such "flights to quality" during the course of the past 2-3 years since the financial crisis began. During these short periods of panic, investors typically sell all risky assets and buy whatever is safest, which is US Treasuries. However, there has been one notable exception: gold. Gold, which is typically a preferred hedge against inflation, has soared and remains near its highs as many investors fear the inevitable result of such government largesse -- inflation. So are the gold bugs right, or should we worry about the possibility of a lost decade of deflation? Here is where I stand: The bond market may indeed be warning us of the possibility of deflation going forward, and I certainly would not rule it out. However, the more likely reasons for the recent sharp drop in Treasury bond yields (and also the strength in the dollar) are 1) the flight to quality resulting from the European debt crisis, and 2) the realization that the U.S. is not experiencing a strong, V-shaped recovery. In our view, this flight to quality to Treasuries (and other dollar-denominated securities) has been quite fortuitous for the U.S., as it has reduced our cost of money across the economy at a critical time. Lower interest rates have undoubtedly been very helpful in generating economic activity and supporting asset prices this year. But in any event, our point is that the sharp drop in rates from this flight to quality from Europe could just as easily reverse upon the first whiff of stabilization in the eurozone. We may already be seeing the first signs of this stabilization.