Falling Prices Put Fed on Guard (washingtonpost.com)

In recent testimony before the Joint Economic Committee of Congress, Federal Reserve Chairman Alan Greenspan said that while the economy is not yet "close to a deflationary cliff," he and his central bank colleagues are watching it closely and taking it very seriously.

During bad deflation, consumers and businesses -- knowing that prices are likely to be lower tomorrow than they are today -- hoard cash and put off buying things, making the recession worse and driving prices and wages down further.

That was what happened in the early 1930s, triggering the Great Depression. Something similar has taken hold in Japan, where prices are falling about 1 percent a year.

Stephen S. Roach of Morgan Stanley argues that some of those dynamics are now at play in the U.S. economy after the worst stock market losses since 1929.

"The risk of deflation is higher than at any time in the past half century," Roach said.

Americans can already see a few early signs of bad deflation taking hold in a number of industries -- Wall Street, commercial real estate, much of the technology and telecommunications sectors. Perhaps no industry shows it more clearly than the airlines.

"The endgame of global deflation cannot be dismissed out of hand," Roach said.

Translation: The Fed is very worried about a 1929 repeat.