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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How can we create a better working relationship between Governments and the markets they regulate?

Generation after generation has to make the choice between them. Why?

The solutions arrived at seem to turn on the nature of the business cycle and the strengh of current 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.

It may sound strange but Harvard University bears a heavy responsibility for the credit crunch.

Last week a “flight to safety” of investors in America’s $3.5 trillion Treasury money market was only halted by Secretary Henry Paulson’s swift action in nationalising the banking sector’s bad debts.

Read The Great Harvard Sausage Scandal 2008 over at Syntagma.

Who, then, are the people that created this vastly complex set of financial instruments based on the always-temporary phenomenon of rapidly-rising asset prices? And who were their managers who let them do it?

It appears that a large number of them are alumni of the Harvard Business School, even those working in Britain and Europe. President Bush is one of them. British PM Gordon Brown has surrounded himself with such types for more than a decade.

Read the rest of the article.

Trading on the LSE’s electronic platform was shut down this morning on one of its busiest days of the year.

The timing of the shutdown is unfortunate for the LSE, which is facing increased competition from rival trading platforms such as Turquoise, a Europe-wide platform set up by a number of the world’s biggest investment banks.

Another rival, Chi-X, claims to have taken over 15 percent of trading in FTSE 100 stocks recently.

To counteract the challenge, the LSE slashed trading fees at the start of this month in response to a partial launch of Turquoise, which is not due to start trading proper until October.

Today’s debacle was thought by the BBC’s Business Editor Robert Peston, to have serious consequences for the exchange. A great deal of money was tied up in the system, money that could not be used in a rapidly rising market.