When people are taking on excessive debt to purchase assets, this will naturally force the price of assets up over and above what would occur through normal supply and demand. This has been the thing driving up real estate prices and to a lesser extent the stock markets (personally, I see more of a case for the stock market to have increased in value than real estate, but stocks are more liquid and so they have reflected what the market thinks of the situation more than real estate for the moment).
We are about to face a massive debt deflation. Here is why. The problems in the US started before the economy soured. This is because people over leveraged to extreme levels - so much so that we have had Bear Sterns Collapse, Lehman Brothers Fall, Indy Mac collapse, Countrywide dive, AIG in trouble, the list goes on. These are not normal circumstances and will lead to a.) Lenders not wanting to lend out (banks don't even trust each other - look at LIBOR rates); b.) People not wanting to borrow (why borrow to spend on a falling asset class); c.) People tightening their belt which in turn leads to; d.) Less employment leading right back to a.).
Really, we haven't even seen the economy sour and we have enormous problems in our systems of finance. Just think 6 months to a year down the track when unemployment is really bad and no one wants to loan money or take on new debts. All people need to do to understand what it is going to happen is think logically about what things will be like 12 months from now. The system isn't just going to turn around because governments come to the rescue - it is beyond that. This is what the market is screaming to people. If it was going to be otherwise there wouldn't have been a massive sell off after the bailout. The market is screaming deflation and what the market wants the market will get no matter what politician thinks they can do.
I know that is hard to accept. I have investments that I truly want to go onwards and upwards. I honestly believed the government would be able to stop the deflation through intervention hence I used to be very bullish on energy. I now understand why that thinking is wrong for the moment and every indicator is telling me deflation is about to hit us and it isn't going to be pretty. It is unfortunate, but I believe realistic.
