That is why the dollar can go up if deflation is at hand even though the central bank will be trying to fight it by doing everything they can to lower the cost of borrowing money and inject more credit into the system. But by the time deflation becomes front page news, almost by definition, any fiscal and monetary response will be too little and too late.

This is a long-term series of events that will take years to unfold, not a domino process, and we are just now entering the second round of policy actions. That makes it difficult to understand why markets may continue to go up for a while. 

Narratives are linear by design. Scenes are set, characters identified and defined, actions unfold over time in steps that lead toward a resolution. Unfortunately, while narrative is convenient in helping us understand things, it is useless in predicting how things unfold.  Why? Because history does not unfold in a linear manner. 

Man, in retrospect, it all seems so clear. Have you ever thought that? I have. But why? Why does everything seem so clear in retrospect? Because we are hardwired to recount events in linear narrative fashion... even events that do not unfold in a linear manner!

In other words, our need for linear narrative colors our perception of history. Linear narratives unfold in steps, the output proportionate to the inputl e.g. the Federal Reserve Chairman lowers interest rates, the first a surprise 50 basis point cut, the stock market rallies, credit becomes less expensive, so people borrow and put that money back into the stock market, or in houses. That's the 2000-2005 period, right? It certainly seems that way.

However in reality, in non-linear systems, the output is not directly proportional to the input. So it's not the case that, say, if  the Fed does X, a proportional outcome will follow, or if the Fed and politicans implement Y and Z, a series of proportionate outcomes will follow. 

On the one hand, this is why it is so very easy to sit back and laugh at the predictions of economists and market strategists. Hoho, the one prediction that is guaranteed to be correct? That their predictions will most likely be wrong.

But this is not about "predicting" deflation. It's about discussing the most probable outcome of central banks continuing policies of attempting to maintain continued credit expansion. As long as credit expansion and demand for credit continues at an accelerating pace, the appearance of prosperity can conrtinue as asset prices increase. The transition period, where we are now, sees asset prices pressured by slowing credit expansion. If the Fed cannot reverse this slowdown in credit expansion, then the deflationary unwind will kick into full gear.

Nevertheless, this credit expansion comes at a price, a cost that must one day be repaid. That day has apparently arrived, and Bernanke's Jackson Hole isn't deep enough to bury it.