Montreal, Canada

While global markets remain drunk with gains over the last five months consumer prices across the world continue to turn negative. And nowhere is this dangerous trend more pronounced than in Europe, especially Eastern and Central Europe where GDP in many countries has shrunk by 10% or more.

Falling prices gripped the euro-zone for the third straight month in July with CPI declining by 0.6% year-over-year. The 16 nation euro-zone remains trapped by falling consumer prices for the first time since the euro was introduced in 1999; several members, including Ireland, are in the midst of outright deflation. Irish CPI is contracting the heaviest in Western Europe with consumer prices down 5.4% year-over-year through June. The housing bust in Ireland has been among the worst in Europe acting as a drag on deflation.

To be sure, consumer prices are down sharply over the last year because oil prices have tanked from $147 a barrel to $68 now; but other components of CPI everywhere show wages moderating or declining, home prices falling and the cost of goods and services generally declining. Only healthcare and social services show employment gains.

Basically, Europe and the United States are now in deflation with Central and Eastern Europe about to join this dubious list following a collapse of capital markets, local banks and domestic consumption. Japan has been stuck in deflation for almost 11 years and still can’t shake off falling prices.

Deflation is now widespread in the industrialized world. The last time CPI turned negative in the United States was back in the mid-1950s under President Eisenhower. Latest CPI stands at -1.4% through May.

Owning hard assets like real estate, farmland, housing and other tangibles is generally a bad idea amid falling prices, weak credit growth and rising unemployment; yet that’s exactly the opposite of what’s happening since March when CPI turned negative across the world’s major economies, including China. Asset values have since skyrocketed, including stocks.

If the market is truly discounting a return to inflation over the next six months then we all better get a good prayer book. It won’t happen.

The loss of bank credit securitization is probably the most significant hurdle for the United States and Europe following the Panic of 2008. Trillions of dollars have been wiped-out or are no longer available to consumers and investment banks that structured toxic assets for intermediation. Banks aren’t lending. If bank credit remains largely frozen then it’s difficult to make a strong case for inflation; no economic growth, no rising inflation. It’s a simple relationship.

The transition from a banking crisis/financial crisis whereby the destruction of credit and other asset values is a rare monetary phenomenon to one of rising inflation and strong credit demand is a lengthy process. Studies have concluded that recessions combined with financial crises always delay the process of recovery.

The U.S. government’s fiscal stimulus is now working its way through the economy – including overseas where most major governments have launched massive spending initiatives in 2009. But don’t be confused; we need to see year-over-year price trends in employment, housing and domestic consumption stabilizing before believing we’re truly through the worst of this historical recession.

Central banks can cut interest rates to zero. They can offer tax incentives to spend, including discounted mortgages and cash-for-clunkers. But you can’t force someone to buy a house or a car, and you can’t replace organic spending with government incentives and fiscal packages every 12 months. Yes, we’re on the road to economic socialization and where this ends is anybody’s guess.