Deflation is looming as the greatest threat to Western economies, especially for heavily indebted nations, like the U.S. and Britain.

Many people are belatedly waking up to the gravity of the situation. In Britain, 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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The British housing market could take 20 years to recover says one of the City of London’s leading investment banks.

In a note to clients, Mark Hake, an analyst at Merrill Lynch said ” … it looks significantly worse [than the 1990 downturn], with house prices falling faster and further and very little recovery in real terms expected over 20 years. … House prices are expected to be below their August 2007 peak in a further 10 years’ time.”

The investment bank forecasts house prices to fall 17 per cent this year, while inflation is set to continue its upward march in coming months as the economy absorbs the effects of higher oil and food prices.

If that were not bad enough, David Kern, economic advisor to the British Chambers of Commerce, thinks unemployment will rise to nearly two million by the end of 2009. He commented, “The results of this survey signal a menacing deterioration in UK prospects We are now facing serious risks of recession. London appears pretty weak and it’s across the board. Businesses are in a lose-lose situation. Falling demand and the squeeze on consumer disposable incomes will limit how far prices can be increased.”

With Nicola Horlick warning us off shares for three years, there aren’t many places left to put our funds.

As RBS’s credit analyst said last week, cash is the only safe haven now.

After finally ridding the British economy of its endemic postwar inflation, the current UK government seems to be slipping back into its old ways.

The Chancellor of the Exchequer (Finance Minister) recently said, “Pay awards in both the public and private sectors have got to be consistent with our inflation target of two per cent.” His reasoning is that if pay rises were higher, prices would go up and consume the value of higher pay.

A former Conservative Health Minister, who knew a thing or two about economics had this to say on the same subject, “Of course when there is inflation, prices rise, including wages, which are the price of labour. That is what inflation means; the statement is a mere definition. But it is as absurd to say that inflation occurs because prices rise as to say that it rains because the ground gets wet. You cannot have rainfall without the ground becoming wet; the one is inseparable from the other; but we do not mistake the result for the cause.”

His alternative to Labour’s prices and incomes policy approach would be to take money out of circulation by the government spending less or the Bank raising interest rates, or a combination of both.

In Britain, growth is at present around 2pc, and is likely to fall to about 1.3pc in the coming year. Inflation, according to government approved figures is about 3.5 per cent. That gives a total of 4.8pc.

Compare that to a rise in money supply (M4) of 12pc and the cat is out of the bag.

Inflation is caused by having too much money chasing too few goods. And it’s the government that injects that money into circulation, partly by excessive borrowing.

Plus ca change …