Deflationary Scare

It was not long ago when i was a proponent of the "stagflation" theory. The period was Jan 2008, when i was of the strong view that the world was moving towards a high inflation period on the back of high commodity prices. I had even bought Gold ETF's after selling all my stock holdings (currently equity exposure is ZERO ;-)). Things have changed a lot after that, the scenario of high inflation no longer exists, we are seriously looking at a scenario of deflation. Deflation is as bad as high inflation, but driven by expectations. One caused by bubbles and another caused in the aftermath of one. Deflation is certainly a rare event, the last the world had seen a strong bout of it was during the Great Depression on 1929. Japan's lost decade is another fitting example of what happens in a deflationary economy. Expectations of lower prices or price falls can feed themselves in the current environment. 

Cut backs by banks in giving credit and falling incomes --> cutbacks in spending --> cutbacks in private investment -->cutbacks in employment  and falling incomes.

The cycle can be broken by fiscal and monetary measures.But monetary measures need a strong financial and banking system working, which is in a mess currently and credit markets clearly non functional. The case for a strong fiscal measure is quite strong. Some countries have already started moving towards increased government spending in creating infrastructure and employment. China has launched a program to increase spending to improve infrastructure in the country. But one has to wait and see what would be the effect of it. US is following a piecemeal approach with adhoc measures to save industries. Not sure how useful these measures. A better means would be to directly put in measures to increase consumer spending. The US government seems to be acting after the event/industry falls rather than before it falls. 

But again just spending by government might not aid in getting out of the rut, Japan has spent a lot during its lost decade (fiscal deficit stands at 150% of GDP) but it still could not get out of the rut. The G20 meeting is currently being held, lets see what they do about it.