Investing Watch:  While my long term view is that the United States economy is actually in a much better competitive position than people give it credit for, I appear to be on a roll with my doomsday predictions.  First Bear Stearns, then the "conservatorship" of Fannie Mae and Freddie Mac, I’ve referred several times to the eventual demise of Lehman Brothers, and I poked fun at the business model of Merrill Lynch.  As of now it looks like Lehman Brothers will be liquidated and Merrill Lynch is getting swept up into the arms of Bank of America.  The shrinking of capacity in the financial services industry continues and will continue, I’m sure.  I had no idea, for example, that the venerable AIG was in trouble.  We will also get to watch the drama of what happens to Washington Mutual.  Perhaps even Morgan Stanley will lose its independence someday.

Beyond the specifics of who blows up, the important question is what it means for us regular folk.  The process of deleveraging is called deflation.  You can have deflation fast, like the great financial panics of the 1800s and early 1930s.  You can have deflation slow, like Japan for the last 15 years.  Or you can have hyperinflation, like Germany in the 1920s, where the government prints away the debt.

Given that the Treasury and Fed have been pretty adept at handling the crisis by engaging in the lender-of-last-resort role, it is unlikely that we will have deflation fast.  And given the dollar’s key role in the financial system, the US government has too much to lose geopolitically to rapidly inflate away our debts.  Thus, we will likely have deflation slow.

The gears of credit creation will have a hard time catching as the system goes through deleveraging, restructuring, and changing regulations.  Overleveraged consumers and baby boomers facing dim retirement prospects will save more and work later in life.  Consumption as a share of GDP will have to decline.  The US may even start running persistent trade surpluses.

And so after the deluge, the mailaise.  We’ll probably spend years griding sideways, with financial market participants dying of boredom and many drifting off the work in other sectors of the economy.  The debt load of the American consumer will gradually abate.  And sometime next decade, the US economy will be ready for rebirth and prosperity will return.

Just don’t hold your breath.