As recently as 9 months ago, it was easy to find a quote by anyone (your author included) that inflation seemed to be running rampant. Crude oil was pushing new highs, grain prices were exploding, meats and soft markets were running up as well. The prevailing fear was, as the US entered what we thought to be a simply downturn, cuts by the Fed would lead to extreme levels of inflation. Gold would go to $5,000 an ounce, crude would trade over $200, the cash strapped, debt-laden consumer would be in greater trouble.

Flash forward to November. Crude has fallen over 60% from its’ peak prices. Grains have given back 30% or more of their gains. We are now in a new paradigm, deflation. On the surface, lower prices are good for a consumer that is more focused on making their mortgage payments than buying a new plasma TV. Lower gas prices and lower food prices would seem to benefit individuals, and it will over the short term. Typically, reductions in inflation that are lead by commodities markets are beneficial because it increases consumer’s real income. The problems pop up as you look towards the future, when prices fall too fast in too short of a period.

As I sat in front of the TV Wednesay listening to Hank Paulson speak about banks and their needs to start up lending to individuals again, I wonder if a society like the US, which is so debt driven, is going to need to fall back on direct lending from the government to individuals. If monetary velocity continues to slow and banks continue to hoard capital, does the government have any choice? Is the Fed Discount Window going to become the latest drive-up ATM for American consumers? Is this the only way to put a bottom into the housing slide?

All signs point to continued reduction of risk at the bank level and resistance to lending from banks to individuals. Granted, LIBOR and TED spreads have narrowed, but banks are still reluctant to lend to each other and even more resistant to lend to cash strapped investors. We are currently mired in a global recession, the likes of which is due to get worse before it gets better. I believe that you will see contraction through at least Q3 2009.