by Joe Del Casino

Created on: September 21, 2009   Last Updated: September 24, 2009

If you're not confused by this stock market, you're probably not paying attention. The Dow-Jones Index halved from an all time high of more than 14,000 in October 2007 to less than 6,600 in March 2009. From March until September 2009, the index increased 50% to 9,800. Many pundits now believe that a new bull market is emerging and just as many believe a correction is coming; some believe the pullback may retrace the March lows.

The optimists believe that the speculative bubble is now deflated, reflation is well under way and that a modest correction may be coming merely because the market rallied too far too fast. They see investor sentiment as too bullish and point to retail investors pouring money back in the market as an indicator of a temporarily overheated market. (In March, cash amounting to 46% of the total value of our equity markets was parked in money market accounts, but by September that ratio fell to 30%.)

Pessimists, however, believe that the current market recovery is temporary and point to significant economic problems yet to be addressed. They believe that the looming risk of deflation will cause the coming correction to be protracted and severe; they also believe continued problems in the financial sector could catalyze another major deflationary spiral.

The consensus among optimists and pessimists is that unprecedented global government spending and deficits will eventually lead to robust (if not hyper) inflation. The pessimists, however, also believe that all those reflation efforts will prove insufficient to keep the world economy from returning to the brink of collapse. They argue that all the spending and expansive monetary measures should continue until deflation is realistically off the table. The Great Depression was the last major deflation, so even today's experts are unfamiliar with the phenomenon and, as a result, are much more frightened by it than the more common inflation. Ample anecdotal evidence suggests that the risk of deflation should be seriously considered:

The goal of delivering the global economy to a debt-to-global-GDP ratio half its peak of 400% will require, for example, a 30% global debt reduction and a 30% increase in global GDP. That process will be difficult and will take liquidity out of the global economy. Current global government spending in the trillions may still not be enough stabilize the deflationary vacuum caused by eliminating all that debt;

Consumer prices continue to fall as debt-overextended consumers

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