"1) Deflation slows the speed of money to crawl due to fears about the deteriorating economy. The public hoards cash, or, in the case of the US, short term treasuries."
Not likely IMO in western markets. Australian's are even worse savers than Americans, and hoarding cash isn't really a scenario I see playing out in either economy. One exception is the switching of individual investors in super funds to fixed interest or cash options which results in an institutional move away from equities into cash. The real danger to the velocity of money is banks hoarding cash and being reluctant to lend to each other. We've seen a minute to midnight scenario around that late last year and may well again. It's a big danger.
What interests me about the model given above though is its relevance to China - a country with massive personal savings and a government that is actively already tring to get private citizens to spend savings. I can see a hyperinflationary scenario playing out in China first (and the recent US comments about manipulation of the Yuan is an interesting thing read this way - my feeling is that the US in particular is scared of this too), and I think that's one place to monitor very carefully in the deflation/stagflation/inflation balancing act. If China sneezes, I reckon we're all in for a big dose of that flu. Fixing every debt interest rate you can at that point would be prudent.
