The great deflation myth ... has there been a bursting of a buuble?

First off, happy new 2009. 2008 was by all accord a financially disastrous year, but it was not such a bad year, after all. We all (re)learned the meaning of trust and confidence. As in not trusting our elected or unelected officials, or the crony financial engineers.

The talk these days is to prevent the great deflation from taking hold of our lives. The Fed and Treasury have (are) done (doing) everything to pump $$ into the system. The effective lending rate is zero, if not negative. Billions (i. e. the new millions) are being thrown into the markets, for all to have. Well, not just all of us, but some of us, that is the GMs, Cerberus (sorry, Chrysler), bulge banks, etc. Soon, it may be the home builders and then the defunct subprime lenders.

Flash back only six months ago, in the summer of 2008, all talk was about the inflation beast. Prices of things people us every day, were going up, as far as the eyes could see. The Fed was duly warning of the coming inflationary cycle. The very same people who were chasing us into the inflationary scare, are now chasing us into the deflationary scare. Who do you believe? Uhh, it is the same 2008 question again: who do you trust? But, these are the same people who cover both sides of this story.

If you believe for the moment that we are in a deflationary environment, then you are a believer. We do not enter into arguments with you here. When a balloon is pumped with air and then develops a leak, it deflates. You fix the leak and further pump air and its radius gets bigger. Another leak develops, and air gushes out. This, is also called deflation. But, when the balloon is so full of air- like most of us- that it fabric has become so sheer that it is in danger of bursting into many pieces, and suddenly a large hole appears and air gushes out, it can no longer be called deflation. The process of leaking is a regulatory attempt at self-correcting an out of equilibrium process, and driving it toward equilibrium. This is what is happening now, contrary to many believes that we have had a bursting of the bubble.

Put another way, we are going through a process in which super inflated assets are reverting to norm and self-correcting. Unless and until that we go below the mean values for a whole range of assets, we are not deflating. That is all.