A friend of mine has explained to me a couple of times now, why he believes the economic environment is deflationary. Since houses have lost so much value and people paid so much for them, many homes are going into foreclosure. They eventually are resold at much less than the amount of the mortgage. The homeowner loses his equity. The bank loses much of the money they loaned. My friend believes this money has "disappeared", like magic. Since so much money has disappeared, there is now less money, making it relatively more valuable and therefore capable of purchasing a greater amount. This is what my friend believes. He's a very smart guy but wrong about this.
The money that the house was once worth, is in the pocket of the last person that sold or refinanced it. Of course, it's not really in his pocket any more. Most of it was used to pay off high interest consumer debt. Irregardless, the money is alive and well and still very much around. The foreclosed upon home owner and the mortgage lender paid off the previous owner. What they have lost is perceived value in the property. A different thing, way different.
No money has been lost from the economy. In fact, much money has been added, to subsidize the loses on bad loans. Mostly it has been given to large financial institutions. The same ones who now surprisingly, are posting huge profits.
Another argument my friend likes to make, is that lower home prices will lower the cost of living. Not really. Most people couldn't afford the inflated prices housing had reached. Interest rates were and still are being kept artificially low and payments were arranged so that no part of the principle was being paid off. In many cases only a small part of the interest was paid, so that the principle increased each month. This is still going on, despite previous disastrous results.
I don't think we are going to be seeing deflation any time soon. Does it cost you less to live than last year? In order for America to even begin to pay off the huge debts in both the public and private sectors, we need wholesale inflation. Hopefully, it will only be high inflation, for a long time. The alternative is monster inflation for a short time, culminating in the destruction of our monetary system. No one wants that. Even our worst enemies. This will be the only reason it may not happen.