Back in early 2008 before the financial system almost cratered, oil prices were heading to the Moon as the bull market in commodities went into over-drive. Fuelled by rising oil consumption, falling global crude production and a multi-year bear market in the dollar, investors and speculators alike piled into raw materials. And oil was leading the charge – the single largest constituent in every commodity benchmark index.

Though high oil prices didn't trigger the 2008-2009 recession, it certainly didn't help, either.

According to American economist James Hamilton's research, only one post-WW II recession was not triggered by a rising oil price. In other words, every recession since 1945, except one, was the direct result of soaring crude oil prices. Hamilton recently claimed that the current recession is the result of persistently high oil prices in the 2007-2008 period before the rally was killed-off by a snowballing credit panic starting in July 2008.

Since late January 2009, crude oil prices have more than doubled.

Typically, as we approach the nadir of an economic expansion, rising inflation forces central banks to counter rising price pressures with higher interest rates. This process eventually chokes off growth and causes a recession. Most post-WW II recessions were directly caused by tightening monetary policy; Hamilton's argument that oil prices are the primary factor leading to a contraction of output is not entirely accurate. Still, it does hold merit because high oil prices (and therefore refined petroleum by-products like gasoline) ultimately acts as a tax on domestic consumption.

With the United States still in the midst of a severe recession since late 2007, high oil prices this year haven't helped the consumer. Could it be that high oil is deflationary and not inflationary?

Bond prices would agree.

After hitting a high of 3.98%, the yield on the benchmark U.S. 10-Year T-bond has rallied to 3.34% this morning.

Since bottoming in June, government bonds worldwide (except Norway) have begun a recovery process. Bonds, which were smashed earlier this year following the end of the "financial Armageddon" scenario, have since sharply reversed this summer at the same time stock prices have soared. That's a curious relationship because since 1997 bonds have managed to produce a negative correlation to stock prices, especially amid global dislocation or market panics.

One of my favourite bears is Sociéte Générale's Albert Edwards.

In this morning's Financial Times (see page 21) Mr. Edwards makes the case for government bonds and the rising threat of prolonged deflation. Edwards believes that despite a second-half economic recovery now taking hold, bond markets have been sharply rallying – signalling deflation. And the threat of future government bond supply – especially from the United States and the United Kingdom – will be absorbed, says Edwards.

If you need proof about overzealous government bond issuance then look no further than Japan.

Even as the Bank of Japan exercised quantitative easing in the 1990s the economy continued to shrink while bank lending contracted. But despite Japan's massive issuance of government bonds in the 1990s (Japanese government borrowing is more than 180% of GDP) bond yields rallied all the way to the floor amid deflation, or falling prices. Supply was absorbed.

The same might happen in the West.