By Jon Nadler
Overnight markets confirmed that which many had already feared: this is to be the worst month for world stock markets, ever. Sensing more trouble, the Bank of Japan handed a symbolic rate cut to the markets, which then continued lower as if nothing happened. The Nikkei lost 452 point to end a very dark October.

This is looking like it is going to be one long, cold economic winter and the fear is that it could lead to trouble on the social front as the harsh stresses knock people in various countries down like bowling pins. Local currencies from Hungary to Poland, and from Romania to the Ukraine have plunged as eastern Europe bleeds foreign investment money faster than a B-movie gore-fest.

The dark and scary mood also persisted in the commodity markets as metal after grain, and sugar after fuel, all dropped by amounts that start with the superlative "largest" before the metric of the drop is described. To wit: gold is heading for its worst monthly drop since 1983, wheat for its largest monthly decline in 22 years, copper and aluminium for their largest drop in over twenty years, sugar for its biggest monthly fall in a decade. Need we go on? Sure we do. Capping the worst achievement category, crude oil. It will record its single largest monthly drop....ever.

The final session of Blacktober opened on the downside again fro gold bullion. Spot prices fell $11.00 to open at $725 as the week's rally which stalled out in the $770's started to look like the precursor to a more pronounced fall in the upcoming week. Today's consumer spending data will likely reveal a nightmare on Main Street in the making. No surprises. No treats, either. And, no, this is no trick. It is a real as it gets.

Silver lost 42 cents to start at $9.32, platinum dropped $36 to $790 and palladium fell $10 to $188.00 per ounce. The dollar continued to be scary strong, rising like Dracula from his coffin - all the way to 85.54 on the index. Oil sank back into the sand faster than a zombie, quoted at 63.89 per barrel. But, enough of that. Let's see what is at the root of all of these horror-show unfoldings.

We have a lot of graveyard ground to cover, so we better dig into the bloody matter. Bluntly stated, stag-deflation is knocking at the door tonight, and its spectre is glowing with an eerie shade of sickly green. Inflation is now harder to find than a poltergeist in full sunlight. We have found two exposes for you to read over this weekend, and ponder how what they portend will affect you. Because affect you, it will. We start the educational section of today's post with a crystal ball gazing session by Marketwatch's Mark Hulbert:

"Is the gold market sensing deflation?

It's important to ask this question, because something is most definitely bothering the gold market. Between Oct. 8 and Oct. 23 alone, for example, bullion dropped by some $225 per ounce. It dropped $15.50 per ounce on Thursday as well.

No doubt there are lots of factors that are conspiring to bid gold down. One that I mentioned in a column a couple of weeks ago is sentiment among gold timing newsletters.

I was prompted to consider deflation as another factor by recent developments in the Treasury market. That market is many orders of magnitude larger than the gold market, and its collective judgment cannot be dismissed lightly.

And right now, the Treasury market considers inflation to be a far lower threat than it was just a couple of months ago.

Consider the yields on regular nominal, Treasuries and those that prevail for the Treasury's Inflation Protected Securities, or TIPS. The primary difference between these two kinds of Treasuries is that TIPS' yields are protected against changes in the inflation rate. Theoretically, at least, this means that the difference in these yields will reflect the bond markets' expectation of future inflation.

As of Thursday night, the yield on 10-year regular Treasuries stood at 3.95%, according to the CBOE's 10-Year Treasury Yield Index. The yield on 10-year TIPS, in contrast, stood at 3.03%. The difference of 0.92 percentage points implies that the bond market is betting that the CPI will average less than 1 percent annually over the next decade.

Inflation over the next decade of less than 1%? That seems incredible.

To be sure, the flight to quality in recent weeks has undoubtedly skewed this number downwards. The market for regular Treasuries has received a disproportionate share of that flight to quality, artificially depressing the yields on 10-year Treasuries.

Economists at the Cleveland Fed have devised an econometric model that estimates the degree to which the spread between nominal Treasuries and TIPS is skewed downward by these liquidity considerations. That model recently calculated this bias to be around 0.5 percentage point, suggesting that the true message of the bond market right now is that inflation would average around 1.4% year over the next decade.

That's still incredibly low, given that the CPI over the past 12 months was up 4.9%. It's unlikely that the CPI can start at nearly 5% and nevertheless average 1.4% over the next decade without it actually turning negative along the way.

And that in effect means the bond market is betting on deflation.

This puts into perspective the federal government's efforts in recent months to pour huge amounts of money into the financial arena. That would otherwise be quite inflationary.

But not if the forces of deflation are as large as the bond market is evidently assuming them to be.
And judging by the recent performance of both the bond and gold markets, it would appear as though deflation still has the upper hand."

In case Mark was not convincing enough, let's consult Nouriel Roubini, weekly Forbes columnist and Professor at NY's Stern Business School. Today's lesson: Stag-Deflation.

"Back in January, I argued that four major forces would lead to a risk of deflation-- or "stag-deflation," where a recession would be associated with deflationary forces--rather than the inflation that mainstream analysts have worried about.

They were: (1) a slack in goods markets, (2) a re-coupling of the rest of the world with the U.S. recession, (3) a slack in labor markets, and (4) a sharp fall in commodity prices following such U.S. and global contraction, which would reduce inflationary forces and lead to deflationary forces in the global economy.

How has such argument fared over time? And will the U.S. and global economies soon face sharp deflationary pressures? The answer: Deflation and stag-deflation will, in six months, become the main concern of policy authorities.

First, the U.S. has entered a severe recession that is already leading to deflationary forces in sectors where supply vastly exceeds demand (housing, consumer durables, motor vehicles, etc.). Aggregate demand is falling sharply below aggregate supply. The unemployment rate is up sharply, while employment has been falling for 10 months in a row. And commodity prices are sharply down--about 30% from their July peak--in the last three months, and are likely to fall much more in the next few months as the advanced economies' recession goes global. So both in the U.S. and in other advanced economies we are clearly headed toward a collapse of headline and core inflation.

Is there any doubt about this ongoing inflation capitulation and the beginning of sharp deflationary forces? Take the current views of the economic research group at JPMorgan Chase. This group was, in 2007-08, the leading voice arguing about the risks of rising global inflation and the associated risks of a global growth reflation, and that policy rates would be sharply increased in 2008-09.

This week, however, the JPMorgan research group published its latest global economic outlook, arguing that we are headed toward a global recession, negative global inflation and sharply lower policy rates in the U.S. and advanced economies--a 180-degree turn from its previous position. What a difference a year makes!

Do you have any further doubt that we're headed toward a global deflation or--better--a global stag-deflation? Read on: Aggregate demand is now collapsing in the U.S. and advanced economies, and sharply decelerating in emerging markets. There is a huge excess capacity for the production of manufactured goods in the global economy, as the massive, and excessive, capital expenditure in China and Asia (Chinese real investment is now close to 50% of gross domestic product) has created an excess supply of goods that will remain unsold as global aggregate demand falls.  Continued...