Deflation is now accepted as the biggest threat to Western economies, especially hugely indebted nations, like the U.S. and Britain.

Inflation, which was recently the major enemy, has swiftly retreated, as widely predicted.

Many experts are belatedly waking up to the gravity of the situation. In the UK, former Chancellor of the Exchequer, Ken Clarke, has dismissed comparisons with the 1970s, ’80s and ’90s, likening current conditions explicitly with 1929/30.

Normally cautious Bank of England Governor, Mervyn King, forecasts a 2 percent contraction in the British economy next year, with interest rates falling rapidly to nought percent for the first time in history.

Deflation is now the enemy we must all factor in to our expectations in the near-to-medium terms, even in the dependably buoyant American economy. The Japanese “lost decade” of the 1990s may be set to play out across the world.

Why then is deflation necessarily worse than inflation?

In an era of massive indebtedness, both private and public, deflation increases the burden. As incomes decline, debts remain the same — at levels signed for in better times. It’s the exact opposite of the apparent wealth created during periods of rapidly rising house prices.

Professor Peter Spencer of York University says, “It is going to be absolute murder in Britain if inflation turns negative. The big difference with past episodes is that we are now much more heavily indebted. Few people owned their own houses in 1930s. Debts were miniscule.”

Another symptom of deflation is that consumers wait for lower prices before shopping, causing job-losses in Main Street and yet more bad economic news.

So what can be done either to pre-empt or cure the curse of falling prices across the board?

Curiously, Keynesianism which, in its misunderstood version is disastrous in normal times, does hold out some hope in depressive conditions. Expect central banks to start printing money soon and dropping it from helicopters, if they haven’t started already. Want to buy some rising stock? Buy helicopter shares. [This is not financial advice.]

If you’re one of those noble souls who saved assiduously during the asset bubbles, you will just have to stand by and watch the profligate oafs who caused the problem clean up, while your own responsible hoard of value drains away.

It’s just not fair, but it will probably have to happen “for the greater good”.

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If you were an investment banker, the chances are you’ve already lost your job. If you were something less than a Master of the Universe, yours may have disappeared without a splash on CNN.

Is there any consolation for losing a job or a career, even in an economy on the brink of a slump? Paul Graham makes a great case for it.

“Our bodies weren’t designed to eat the foods that people in rich countries eat, or to get so little exercise. There may be a similar problem with the way we work: a normal job may be as bad for us intellectually as white flour or sugar is for us physically.”

But don’t jobs and food actually go together?

“The root of the problem is that humans weren’t meant to work in such large groups. … Though they’re statistically abnormal, startup founders seem to be working in a way that’s more natural for humans.”

Paul Graham — who is a venture capitalist — is right. You can buck the system and you owe it to yourself to make the attempt.

Incidentally, a recession is a great time to go it alone. Venture capitalists have money burning a hole in their vaults, there’s a surfeit of experts going cheap, and opportunities for anyone with a great idea or a new approach.

Innovation is at a premium during a downturn. Many of the biggest names in corporate America began in a garage during a recession when there was little else to do.

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Each succeeding generation seems to have to make that choice, depending on the business cycle and the severity of booms and downturns.

In the present world recession the context is so severe that it’s become a crisis in both the financial markets and the real economy. Many governments are having to nationalize part or all of their banking systems. Financial services never seemed so brittle.

Is that really the case though? In a well-argued article, The world needs Up-To-A-Pointism, John Evans suggests that by staying within the boundaries where governments and free markets work best, the world would be a much more stable place to live and do business.

Although mostly mutually-exclusive, the interface between regulation and free markets could be made to operate more efficiently, to the benefit of both.

Update: The rescue package was finally passed by Congress and is currently being implemented, with some changes allowing equity in banks to be bought by the government.

Wall Street is back in panic mode again after politicians failed to secure a rescue package for the distressed banking sector last night.

The scenes in Washington were close to farcical as senior members of the administration had stand up rows in the White House. Treasury Secretary, Hank Paulson, reportedly went down on one knee and begged Democrat Nancy Pelosi to pass the bill.

Her response, “Ask the Republicans,” was met with a bewildered “I know, I know” from Paulson.

The $700 billion bank bailout bill is meeting determined opposition from many quarters, in particular a group of Republicans who say the public is 100 to one against the deal.

Negotiations start again today and may spill over into the weekend.