Last month, the price of a Bic Mac in China’s capital rose from 14 to 15 yuan – a 7% rise.

How many times have you heard people talk about the “debate” over inflation and deflation?

Ben Bernanke says he’s fighting deflation by printing more money. Something he likes to call “quantitative easing.” (So as the ordinary folks at home don’t start panicking about the value of their dollar savings.)

When the Fed “quantitatively eases” it simply credits America’s primary dealer banks (those that trade directly with the Fed) with freshly digitized dollars. In return, the Fed buys Treasury bonds from these banks.

You’ll probably recognize some of the names of these “primary dealers.” They include some of Wall Street’s finest: Goldman Sachs, Morgan Stanley, UBS, Deutsche Bank, JPMorgan Chase, Credit Suisse and Citigroup to name just a few.

(There’s an almost uncanny overlap with the worst offenders of the go-go subprime era. But that’s a story for another day.)

The problem with Bernanke’s plan is there is no deflation.

Here’s a chart going back to the 1950s of the official government measure of inflation in America: the Consumer Price Index (or CPI for short).

See that blip on the top right-hand corner of the chart? That tiny divot right around the time of the credit crunch? That’s the nasty deflation Ben Bernanke is worried about.

Turns out that as of October this year, the CPI was down just 0.7% from its all-time record high. But who are we to quibble with the wisdom of central bankers?

So Ben Bernanke continues to digitize new dollars into existence in his battle against deflation, leaving investors to worry about the consequences.

One indirect effect is inflation elsewhere. This may sound like a strange concept, but when the Fed prints money not all of it ends up in the U.S. Much of it travels abroad in search of profits and winds up in emerging market stocks and bonds, and in commodities markets.

This helps fuel inflation in “hot” emerging markets such as Brazil and China – both of which are now trying to deal with uncomfortably high inflation rates.

Want a real life example? Go buy a burger in Beijing.

Last month, the price of a Bic Mac in China’s capital rose from 14 to 15 yuan – a 7% rise.

That’s a big leap. And it’s pretty much in keeping with overall food inflation in China, which is up about 10% over the last 12 months.

This may seem like a far off problem. After all, you probably don’t live in Beijing or have to buy rice or flour on a Chinese factory worker’s wage.

But it’s a big deal for the markets – one that could have profound effects on investors moving into 2011.

China’s central bank, the People’s Bank of China, is widely rumored to be considering an interest rate hike this weekend to cool inflation. This is expected to have accelerated to 5.1% from a year earlier in November.

The problem is this may not have much of an effect of food prices, which do not respond well to interest rate increases.

Although people might be less likely to borrow money to buy a flat when rates are higher, people still need essentials such as food.

Besides, much of the reason for higher prices is linked to Ben Bernanke’s printing press. Traders are simply using the Fed’s cheap dollars to speculate on rising commodity prices – foodstuffs included.

One place a rate rise will have an effect is China’s overheating property market – which in some places is already reaching nosebleed levels.

To many, China’s property market is a bubble waiting for a pin. The property value-to-income ratio in Beijing is pushing 15. In Tokyo at the peak of Japan’s massive property bubble the ratio stood at nine times.

If the PBoC raises rates, this should help cool the property market.

What to Do?

Against a backdrop of lower property prices, one surprise winner may be the domestic stock market. If property prices come down significantly, Chinese investors would have few alternatives but to put their money in stocks.

Another winner could be gold. Beijing has recently approved a fund of funds that would allow Chinese citizens invest in gold exchange-traded funds (ETFs) outside of China.

This would be a natural move.

With the rate of inflation currently outstripping the interest rates on deposit accounts, gold makes the perfect alternative investment for inflation-conscious Chinese.

And if Chinese demand for gold takes off, expect to see a big pop in prices.

P.S. I recently recommended a low-cost way to own gold to Alpha Hunter members. Based on my analysis of Chinese demand, I believe gold could break through the $2,000/oz mark as early as next year. To find out more about Alpha Hunter and gain access to the full archive of emerging market recommendations, continue reading here.