-David Kuo, Director at the financial website The Motley Fool. The opinions expressed are his own.-

Go on. Admit it. You didn’t see it coming, did you? You never thought a member of the G20 nations would dare to break ranks and raise interest rates this soon.

But Australia has done just that. The Central Bank of Australia has increased the cost of borrowing by 0.25 percent to 3.25 percent. It is doing what it thinks is right for the country regardless of what the rest may think. Now, Asian countries, keen to avert another bubble, may follow Australia’s lead and ratchet up interest rates before long.

Of course, Australia’s economy is vastly different to the UK’s. It has huge deposits of iron, aluminium and nickel that are in demand by mineral-hungry China. That said, Australia did briefly flirt with a downturn, which it successfully corrected with 21 billion pounds of fiscal stimulus.

But the UK is not Australia. We do not have huge deposits of mineral, and we are not near fasting-growing Asian countries either. What we do have are consumers saddled with over a trillion pounds of debt following a decade of binge borrowing, and a national debt burden of similar magnitude.
Therefore, it is unlikely that we will experience demand-led inflation. In fact, consumers are saving more of their household income than they have done for eight years.

The most recent Office for National Statistics report shows that between March and June British households saved 5.60 pounds out of every 100 pounds of household income. That is very different from the first three months of 2008 when we not only failed to save any money, but we even borrowed 50 pence for every 100 pounds of household income.

That said, we are still some way off getting our overstretched household finances back on an even keel. So, the savings ratio could go higher. In fact, it is still some way short of the long-run savings-ratio average of 8 percent of household income.

And herein lies the problem for the Bank of England.

According to the paradox of thrift, high levels of savings in a recession can prolong the economic downturn. That is because two-thirds of economic growth comes from consumer spending. So the less we spend, the longer it will take the UK economy to recover from the slump.
So what is the Monetary Policy Committee to do?

It has already slashed interest rates to historic lows. But that has failed to stimulate consumer spending. It has pumped 158 billion pounds of fresh money into the coffers of lenders through quantitative easing. But the money has, as yet, failed to invigorate the ailing economy.

However, both those measures will, in time, achieve their goals. The risk is not whether they will work, but instead, whether they will work too well and stoke inflation. Just as no one expected Australia to hike rates this soon, our days of enjoying low interest rates may end just as abruptly, and without warning. So save and invest what you can now.

- Carl Mollins is a Toronto-based journalist who has worked at the Toronto Daily Telegram, Reuters (in London), The Canadian Press news service (in Toronto, London, Ottawa, Washington, DC) and Maclean's magazine (in Toronto and Washington, DC). The opinions expressed are his own. -

It was long ago, in 1761, when Pennsylvanian portrait artist Benjamin West moved east—across the Atlantic. Nine years later in England, he looked back west to produce a controversial but renowned portrayal of the death of British General James Wolfe during England’s seizure of Quebec from France 250 years ago, on September 13, 1759.

Attention to the picture persists nowadays, so long since the British soldiers set up what rapidly became complete English control of the Canadian colony. Perennial prints and publication of West’s art and comparable materials are reminders of what launched Canada as a country divided linguistically, in culture and politically, the situation that remains today.

West devised that picture as the hired “history artist” of King George III, who was already ensnarled in England’s imminent loss of its other North American colonies as the independent United States of America.

That heightened the popularity of West’s picture, despite some criticism of its then-modernistic appearance. Painting Wolfe and the cluster of soldiers around him in battle dress strides away from the traditional portrayal of military heroes draped in capes and god-like postures. West did four paintings, differing in size, and they were repeated in hundreds of prints in the 1870s, more and more ever since.

West’s picture, titled "The Death of General Wolfe", portrays the situation by guesswork and by adding veterans who paid for their inclusion. In the foreground is a half-naked, barefoot, head-feathered person, an apparent tribal warrior of First-Nation Canadians, although the record indicates none were involved.

Even more factually fanciful is a similar picture showing the death in the same battle of the French commander, Marquis Louis-Joseph de Montcalm de Saint-Veran. In fact, the record indicates that Montcalm dies the following morning. Not only does the Montcalm army include First-Nations soldiers, but a tropical palm tree rises above the distraught soldiers.

Reinforcing the West painting’s provision of Wolfe’s heroism are poetic and musical tributes composed over the centuries.

Barely six weeks after the Quebec clash, the early English publication "Busy Body" published in its issue of October 22, 1759, a poem of Oliver Goldsmith, including the lines:

“. . . . O Wolfe! to thee a streaming flood of woe,
Sighing we pay, and think e’en conquest dear;
Quebec in vain shall teach our breast to glow,
Whilst thy sad fate extorts the heart-wrung tear . . . .
Yet they shall know thou conquerest, though dead!”

More than a century later in Canada, the poetic and musical Toronto schoolmaster Alexander Muir (Principal of Leslie and later Gladstone schools), composed during the 1867 formation of the Canadian Confederation what became a virtual national anthem in many schools for most of the following 100 years.

The lyrics of his stirring song, "The Maple Leaf Forever", proclaim that, “from Britain’s shore Wolfe, the dauntless hero, came and planted firm Britannia’s flag on Canada’s fair domain.”

His nationalist chorus reaches beyond that divisive history. Muir altered a line in which original lyrics referring to Canada’s commitment to the British floral emblems—Scottish thistle, Irish shamrock, English rose—to add the French fleur de lis, or lily.

The song goes on in the chorus to applaud “the maple leaf our emblem dear, the maple leaf forever”—an outlook fulfilled a century after Confederation with Canada’s replacement of its red ensign of the Union Jack with adoption of the Maple Leaf flag in 1965.

Yet still, two and a half centuries after the English took over Canada from the French, the country’s national attitudes created 250 years ago divisibly, day-by-day persist.

- Terry Charman is Senior Historian at the Imperial  War Museum in London. He studied Modern History and Politics at the University of Reading and while there interviewed Adolf Hitler's architect Albert Speer. He specializes in the political, diplomatic, social and cultural aspects of the World Wars, and wrote "The German Home Front 1939-1945" and "Outbreak 1939: The World Goes To War". He is curator of the exhibition Outbreak 1939 at the museum. The opinions expressed are his own. -

In September 1939, in marked contrast to August 1914, Britain went to war in a sombre mood of resigned acceptance of the inevitable. There was no Union Jack waving “hurrah” patriotism as there had been twenty-five years before. After Adolf Hitler had torn up the Munich Agreement in March 1939 and invaded the Czech lands, the British people recognized that appeasement had failed and that the German leader’s aggressive plans would have  to be stopped, and if necessary by force of arms.

On September 3, 1939,  when Prime Minister Neville Chamberlain announced on the radio that Britain was at war with Germany, for many  the news came as a relief from the tension of the past few weeks and months. An anonymous diarist noted: “Even horrible certainty seems better to me than uncertainty.”

While in Bradford a young man of military age wrote in his diary: “I don’t think I’m sorry to die so that Hitler will be crushed, but I do want a final peace this time, without constant crises.” Chamberlain’s over-personal broadcast-“you can imagine what a bitter blow it is to me...”-was hardly a rousing call to arms, and it was followed almost immediately by the wailing of air raid sirens.

Many people thought that they were heralding a devastating air raid that had been dreaded for so long. That morning, writer George Beardmore experienced a sensation of utter panic. He, like so many others, had seen the film “Things to Come” and remembered all “the dire prophecies of scientists, journalists and even politicians of the devastation that would follow the first air raid.”

In the event, it was a false alarm and somehow wholly symptomatic the rest of 1939. These were the months which novelist Evelyn Waugh was to later describe as “that odd, dead period before the Churchillian renaissance”, but at the time was called the “Phoney War”. There were no great battles on the Western Front, and it was not until 9th December that the first British soldier, Corporal Thomas Priday, was killed in action, a victim of “friendly fire”.

After an abortive attack on German warships on 4th September, the Royal Air Force confined itself to dropping aerial propaganda leaflets on Germany.“Fighting with bloody pamphlets” was one sour comment recorded that autumn about the enterprise. Only the Royal Navy, under Churchill’s energetic and aggressive leadership as First Lord of the Admiralty, seemed to be taking the war seriously, tackling the combined threat from German U Boats, surface raiders and magnetic mines.

Heavy losses were sustained, but in mid-December came victory following the Battle of the River Plate, an action which as Churchill said: “...in a dark, cold winter warmed the cockles of the British heart.” Many Britons as they listened to the First Lord’s pugnacious and confident broadcasts that autumn would have agreed with one diarist who wrote: “Hear Winston’s speech. Very good. Think he ought to be prime minister.”

Among Churchill’s colleagues there was a great deal of unwarranted optimism during the war’s first months. The Government laid plans to fight a three years war, but there were high hopes that the Nazi economy would collapse long before then, or that the “moderate” Goering would replace Hitler and conclude peace or that dissident German generals would topple the Nazi regime.

That false optimism was even reflected in the songs of the time: “We’re Gonna Hang Out The Washing On the Siegfried Line”, “We Won’t Be Long Out There” and “God Bless You, Mr Chamberlain.” And yet, as 1939 closed, when polled by Mass Observation, only 12 percent of British people confessed to being optimistic about 1940.

And at a New Year’s Eve party, an American correspondent saw how: “when Mr Churchill sang out the old year, he seemed deeply moved, as though he had a premonition that a few months later he would be asked to guide the British Empire through the most critical days it had ever faced.”

– James Saft is a Reuters columnist. The opinions expressed are his own –

The explosion in company pension fund shortfalls in Britain nicely illustrates issues which will dominate economics and investment in coming years: the re-pricing of risk, a disillusionment with equity markets, and the boom in savings these shortfalls will help to drive.

Under current accounting rules, the pension funds of companies in Britain’s FTSE 100 index are together 96 billion pounds ($170 billion) underfunded, more than double the deficit of a year ago and an all-time record, according to a report from pension fund consultants Lane, Clark & Peacock.

This is partly for the very positive reason that people are living longer but principally because of the dire performance of financial markets, especially equities, over the past year.

To make matters worse, the surge in corporate bond spreads, which are used to calculate the current value of pension plans’ future liabilities to retirees, has actually minimised how underfunded British pension plans look when accounting measures are applied. Minimised how underfunded they look, but not how underfunded they are.

One of the net results of all this is that companies are getting out of the pension providing business as fast as they can, pushing employees into plans where the saver takes all of the investment risk and the company is purely a contributor and a facilitator.

Individuals are less able to take the long view and hold riskier assets like equities during downturns, meaning they are more likely to hold more in cash and bonds than are company pension plans.

Individuals are also going to be increasingly aware of the shortfalls of the pensions they have coming, which will push the savings rate still higher.

A growing awareness that we are going to live a very long while will also support this. It’s nice to live to 90, but it takes savings to fund that old age, even if you plan to work until you are 70.

Put simply financial markets have been fantastically volatile during the past two years, making it difficult to figure out how much to save and even tougher to figure out how much those savings might earn over the longer term.

Amazingly, more companies in the Lane, Clark survey raised their estimates of long-term returns from equities than cut them in the past year. But even after a huge rally in recent months, five and ten year returns in many of the world’s equity markets look pretty uninspiring, especially if you apply any kind of penalty for the very extreme level of volatility.

Assumptions about equity market returns will likely fall in coming years and more pension funds and individual retirement savers will ease up on the percentage of their portfolios they allot to shares.

SAVINGS UP, CONSUMPTION DOWN

One of the key false assumptions of the pre-credit crisis age was that we lived in a newly tame economic era. This conditioned people to save less and take on more risks, as borrowers, lenders or investors. This leveraged economy grew more quickly than a more conservative one, and we rationalised away the risk by saying that better macro-economic policies meant we were in a new era where rainy days were fewer and less severe.

That obviously has been proved wrong, and the results are written in the pension plans deficits. We live in a more volatile, riskier world than we believed. As that realisation spreads, and as many retirees find they have too little in savings, behaviour will change in important ways.

A growing awareness of the fragility of growth and the volatility of markets will not just change the behaviour of investors but also others.

Banks, as we’ve already seen, are going to want more security and a better margin. That will crimp growth. Companies will be more cautious in how they borrow, invest and expand. That too will crimp growth. This is not a bad thing, but it is bad if you have a business or personal plan that is predicated on very high growth.

All investors will be less comfortable with equity risk, and as individuals will bear more of those risks alone, they will accentuate a trend away from equity investment.

But more powerfully, the fact that there is no benevolent company or government which can fund our 25 year retirements will push all of us to save more, as well as to be more cautious with how we invest the money we do save.

This will have a big dampening effect on economic growth, especially in the ageing West, and isn’t likely to be very helpful to long term equity valuations either.

Monetary and fiscal policy can work against these forces, as we’ve seen, and can ease the transition, but they can’t do it by themselves forever.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. )

Michael Goldfarb serves as a GlobalPost correspondent in the United Kingdom, where this article first appeared.

In America, the health care debate is about to come to a boil. President Barack Obama has put pressure on both houses of Congress to pass versions of his flagship domestic legislative program prior to their August recess.

Good luck.

Opponents are filling the airwaves with the usual litany of lies, damned lies and statistics about socialized medicine and the twin nightmare of bureaucratically rationed health care and high taxes amongst allies like Britain, France and Germany. So here is a brief overview of health care in some of Europe’s biggest economies: Britain’s National Health Service is paid for out of a social security tax. Services are free at the point of provision. No co-pay, no reimbursement. The budget last year was 90 billion pounds (about $148 billion). That makes the average cost per person about 1,500 pounds ($2,463).

The NHS is big — huge, in fact. With 1.5 million employees it is one of the largest employers in the world. Only China’s People’s Liberation Army, India’s state railways and good old Wal-Mart employ more folks. Sixty percent of the NHS budget goes toward salaries.

The French system is run on a compulsory purchase of insurance through the workplace. The insurance cost is based on how much a worker earns. Low-income workers pay nothing. The average contribution per person is about $4,000. The government sets fees for services and negotiates the price of drugs with pharmaceutical companies. (See related GlobalPost story “Why French doctors still make house calls.”)

Service is not free at the point of provision. But reimbursement for costs is swift and in the case of catastrophic illness all fees are waived. People are free to purchase supplementary insurance from private companies.

With a compulsory insurance plan, as in France, German care is universal and equitable. Germans pay approximately 14.3 percent of their earnings to buy this insurance. As in France, people are free to buy supplementary private health insurance. Each system is unique (as are all the systems around Europe) but they have two things in common that make them different from the United States: Coverage is universal and the cost of care as a percentage of GDP is significantly less.

For Europeans — even those who would label themselves conservatives — American attitudes to setting up a universal health care system with strong state participation and management seem bizarre. The peace of mind that comes from knowing that in an emergency you will be taken care of and you won’t be financially ruined has no price. Why resist it?

Beccy Ashton, policy adviser at health care think tank The King’s Fund, worked for more than half a decade in the U.S. She explains the difference this way: “In Europe healthcare is regarded as a human right. In America, people think of it as a commodity that you buy.” If you look at how the Big Three’s health systems came into being you realize changing American attitudes may be difficult.

Britain and France created their systems out of the rubble of World War II. Pushed from below, the leaders of both nations sought to bring greater social equality to their societies. Social security systems were set up with equal access to health care given pride of place.

This wasn’t done without facing down doctors and insurance companies, but politicians are never so bold as when the public will for something is clear. In 1945 in both Britain and France, there was no going back to the status quo before the war started. Germany’s system has the weight of history behind it. Its origins can be traced back to the first era of German unification when Chancellor Otto von Bismarck created the First Reich. In the 1880s he set up a system of compulsory health insurance by workers and employers and other forms of social security. He did not invent the system out of nothing. There had been a tradition among the German guilds going back to the Middle Ages of members making compulsory contributions to help their brothers in old age or if a colleague had to stop working because of injury.

Clearly, America at this moment in time has not recently experienced an epoch-shattering historical event like a World War and despite Obama’s comparative popularity, he doesn’t have the clout of an Iron Chancellor to simply decree what he wants and know that Congress will rubber stamp it.
Beccy Ashton points out, “The President must be aware of the fine line he has to walk. If he goes forward with a radical agenda, he knows you’ve lost before you’ve started.”

So people in Europe continue to watch with bemusement as American legislators grapple with reforming a system that basically needs to be junked. Professionals like Ashton answer calls from reporters and try to refute right-wing misinformation that floats around the debate. Those damned lies and statistics.

The only statistics on health care systems that really matter are life expectancy and infant mortality. Both speak to accessibility and affordability. If you want to know how the U.S., the wealthiest nation on earth, stacks up, here you go:

In life expectancy, the U.S. ranks 38th or 45th depending on whether one uses the United Nation’s statistics or those compiled by the CIA. (In both cases, life expectancy in Cuba is higher!) According to the CIA World Factbook, the U.S. has many more infant deaths than its EU counterparts or northern socialist (to right-wing ideologues) neighbor, Canada. While the U.S. has 6.26 deaths per live births, Canada had 5.04. Britain, France and Germany? 4.85, 3.33 and 3.99, respectively.

Other health links from GlobalPost:

Winter in the time of swine flu

Coming home from school with strawberry condoms

(Pictured above: Healthcare reform supporters rally outside U.S. Senator Sam Brownback’s office in Overland Park, Kansas, July 9, 2009. REUTERS/Carey Gillam)

– Paul Taylor is a Reuters columnist. The opinions expressed are his own –

Higher taxes? Lower public spending? Devaluation? Inflation? Investment in green growth?

European governments are pointing in very different directions as they debate an exit strategy from the global financial crisis. Despite European Union efforts to coordinate economic policy, there are clear signs that the main European economies will charge off in disarray towards separate exits.

Germany is stressing an early return to fiscal discipline despite economists’ warnings against a premature withdrawal of fiscal stimulus. Berlin has just amended its constitution to anchor a timetable for a balanced budget, and is holding down labour costs to promote an export-led recovery.

“This means that the German constitution now forces a very harsh austerity stance on Germany for the coming years,” economist Sebastian Dullien wrote on the Eurozone Watch blog.

“For the rest of (the euro area) this means that after the crisis, Germany will consolidate its budget much earlier and much quicker than the rest of Europe,” he said, arguing it would weaken domestic demand and hurt growth.

German and EU officials say the amendment merely enshrines existing European budget rules and note that a get-out clause allows parliament by a simple majority to set aside the target.

By contrast, French President Nicolas Sarkozy outlined plans last week to raise a big public loan to finance investment in “tomorrow’s growth”, despite warnings from the European Central Bank and the Bank of France against any increase in debt.

France’s deficit is set to remain higher than Germany’s. But with an eye to re-election in 2012, Sarkozy explicitly ruled out austerity or tax increases to pay off mounting public debt, although he talked of cutting wasteful spending, controlling health costs and possibly raising the legal retirement age.

In Britain meanwhile, the opposition Conservatives, scenting victory in a general election due within a year, are preparing to roll back public spending to curb a runaway deficit incurred partly to rescue wayward banks and combat the recession.

Conservative finance spokesman George Osborne has been quoted as telling business leaders: “After three months in power we will be the most unpopular government since the war.”

The Europeans face a common challenge — adapting to lower trend growth while coping with mass unemployment, an aging population and overstretched public finances after the deepest recession since the 1930s.

Different national economic cultures, as well as election timetables, explain the wide diversity of policy responses.

Britain has let the pound slide on foreign exchanges to help restore competitiveness after its banks were hard hit by the credit crunch. The British are more sanguine about the prospect of higher inflation after the crisis to work down public debt.

Influential French officials, such as Sarkozy’s political adviser Henri Guaino, see higher inflation as inevitable, and not necessarily unwelcome, and worry about too strong a euro.

Germany is allergic to inflation out of bitter historical experience in the 1920s and wants a strong currency.

Its Bundesbank president, Axel Weber, has said the ECB will not be influenced by politics in withdrawing liquidity once recovery is under way.

ECB President Jean-Claude Trichet has made clear that his institution, which defines its mandate of maintaining price stability as keeping inflation below but close to 2 percent, will not allow prices to surge.

Despite these deep-seated differences, there is one key area on which the Europeans ought to be able to agree.

The EU has taken global leadership in the last decade in moving towards a low-carbon economy based on cuts in greenhouse gas emissions and promoting renewable energy. Under President Barack Obama, the United States is also pushing for the green economy as a source of growth and jobs.

If European leaders joined together in a continent-wide investment and tax incentive programme to promote clean energy, energy efficiency and low-carbon innovation, they could boost the growth potential on which sound public finances depend.

(editing by David Evans)

– James Saft is a Reuters columnist. The opinions expressed are his own –

Britain’s banks are fulfilling their Darwinian role, to survive, rather than their economic one, to lend, and there is no easy or painless way out.

A glance at the latest Bank of England Credit Conditions Survey makes grim reading, with yet another marked tightening of lending conditions to households and businesses. Loans are harder to get and more expensive where available, which is hardly surprising given rising defaults and a hardening view that the UK will suffer a long and deep recession.

Mortgage approvals are running at a record low and there are widespread, though anecdotal, complaints of otherwise healthy small and medium sized businesses being squeezed to the point of failure by lack of finance.

On the face of it, Britain’s injection of 37 billion pounds of capital into three major banks and its guarantee of a further 250 billion pounds of interbank lending are not having the desired effects.

Banks, understandably, are hunkering down and trying to survive the next liquidity squeeze and minimize exposure to future risk, rather than taking risks and reflating the economy. While this may help individual banks, if they are sure footed enough, it will ultimately make the recession worse, defaults more frequent and lead to more bank failures in aggregate.

Given this, it is very likely that Britain will again have to intervene, either by further recapitalizing or nationalizing its banks, by providing some sort of state guarantee to lending, by forming a “bad bank” vehicle to fund or buy up doubtful assets, or some combination of all.

British Prime Minister Gordon Brown said that a second bailout was not the preferred option but that the government was exploring “other means by which we will try to get liquidity and cash into the system.”
Looking at the U.S. and British experience, it is hard to see what combination will restore lending and confidence and even harder to see that happening without an enormous cost and many unintended negative side effects.

For one thing, the very possibility of further government action means that private capital doesn’t know where it stands and may be reluctant to commit money to the financial sector.

Because there hasn’t been, and perhaps can’t be, a fully enunciated policy on who will be bailed out and under what circumstances, investors fear being wiped out if they commit capital to banks.

Investors may also be unwilling to buy up bad assets, like mortgage securities, from banks, because state intervention may be keeping unhealthy institutions alive and their dubious assets off the market. If these later fail they may disgorge and drive prices down further.

This isn’t an argument against state intervention — there really isn’t much choice — but we should be aware of its limitations and pitfalls.

CHOOSE YOUR POISON

There is a sense however that governments, in Britain and elsewhere, have been playing for time, trying to keep banks and banking ticking over. Some major U.S. banks were arguably insolvent during the aftermath of the Latin America debt crisis, but time and a steep yield curve allowed them to fight their way back. We probably don’t have that much time now, much less the yield curve.

Governments can follow two main paths in recapitalizing and unlocking the banking system:

They firstly can act in the actual market for assets that are gumming up the system, guaranteeing the assets itself, such as the United States is doing explicitly with bank bonds and effectively with Fannie and Freddie issues, and can also wade in and buy up those assets with its own money, attempting to provide a floor for valuations and encouraging people to get in now rather than wait for cheaper prices later.

It can also directly inject capital into banks, as has been done in the UK and United States, shutting down or forcing mergers among those that don’t seem likely to survive. This is far from a comfortable position for a government to be in and tends to make lots of different people angry for lots of different reasons, hence perhaps a rather timid approach by both Britain and the United States.

University of Chicago professors Raghuram Rajan and Douglas Diamond point to a third possibility, a mix of the two, buying up illiquid assets while focusing on doubtful institutions that are likely to become distressed. In other words, taking a harder line with failing banks, biting the bullet and shutting them down and wiping out shareholders.

“Unless those entities fail or are forcibly taken over, those illiquid assets are not going to make their way on to the balance sheets of well-capitalized banks, allowing the overhang of illiquid assets to persist, and forcing lending to be subdued until the distressed entities actually fail, ” Rajan and Diamond write in a paper prepared for delivery at an American Economic Association conference on Monday.

It will make a lot of people angry for a lot of different reasons, but just might speed up the recovery.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click here.  –

– James Saft is a Reuters columnist. The opinions expressed are his own –

With the U.S., Japan and Britain — nearly 40 percent of the global economy — facing the threat of deflation, it’s going to be just too easy for one, two or all three of them to get the policy response horribly wrong.

The global economy is so connected, and our experience with similar situations so limited that the scope for error is huge.

Think of it as having three pilots flying a jet plane, one each operating a wing and the third managing the tail.

Oh yeah, and they all work for different airlines.

Though there will be much talk of international coordination in the next year, and though the central banks and governments of the world will likely be rowing in the same direction, their ability to gauge the effects of monetary policy and government spending on their own economies will be pretty limited, and even more so on the whole.

Failure when fighting a global recession, a global balance sheet adjustment, a global banking recapitalization, debt deflation and very possibly actual deflation can take many forms.

“It’s very hard to calibrate and it’s awfully easy to overshoot or undershoot, both of which would be disastrous,” said Lena Komileva, London-based strategist at Tullett Prebon.

Under clubbing the response to falling prices means you could slip into a self-reinforcing deflation, making your debts, be they consumer, housing or government, heavier and setting up a cycle where businesses and consumers defer consumption and investment.

Over-reacting risks fomenting a new bout of inflation and potentially causing a new bubble. (Who knows what that would be — dirt, water, baseball cards?)

And remember too, when deflation was last an issue on this scale globally during the 1930s, the global economy was nowhere as near as integrated.

As for now, the signs are clear: deflation is a growing threat in much of the world’s economy, though still to be sure not the central forecast.

U.S. producer prices dropped by 2.8 percent in October, the largest decline on record. Core intermediate goods and core crude goods prices, which show inflation at earlier stages in the production cycle, fell by a big 1.7 and a staggering 17 percent, respectively.

Consumer prices, which are usually sticky on the way down, fell at a record rate in October, down one percent and even falling by 0.1 percent in the month when plunging food and energy prices are excluded. That will kill corporate profits and shows a business community racing with consumers to see who can capitulate fastest.

HERE, THERE AND EVERYWHERE

Inflation is falling rapidly in Britain too, with overall consumer price inflation down 0.2 percent in October, the first monthly fall since the annual January sales and the first in October since 2001, just after 9/11.

Japan meanwhile has slipped back into recession, domestic demand is weakening, wages are falling and deflation may develop some time next year, a scenario Barclays Capital rates as a 40 percent chance.

Even China, where inflation has tumbled to 4.0 percent in October from a 12-year peak of 8.7 percent in February, has moved its focus to averting deflation.

Be in no doubt, central banks have the tools to fight deflation; while interest rates can only be cut so much, officials can step up the quantitative easing now happening, they can commit to hold rates at zero for an extended period of time, they can drive down their own currency by purchasing foreign bonds or finally, simply print money and drop it from the famous helicopters.

The issue is not the tools, but the speed of the printing presses or size of the bond purchases needed to get the right result, especially when it is interacting with what will be huge tax cuts and deficit spending.

A mix of monetary and fiscal policy will work, but it’s got to be the right mix and it has to be reasonably well coordinated internationally.

None of this is without risk. Remember the last deflation scare in the U.S. in the early part of this decade, which in retrospect caused the monetary bubble which was nursemaid to the housing bubble.

Print money or borrow excessively and you could lose the confidence of the currency market and experience a run, which certainly will help to fight deflation but is no-one’s idea of good policy.

In theory the amount the state will need to borrow will be in part offset by the amount individuals save, or more to the point pay down in debt and decline to invest privately. That theory will be put to the test by the number of governments who are going to be selling a very large number of bonds, which will after all have to be paid back.

Next year is looking as if it will be as unconventional as it is scary.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund –

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