Nouriel Roubini, writing over at Roubini Global Economic Analysis, a fellow who allegedly saw all of this coming, has a great (and long!) assessment of the situation. Because of the debts that we created - debts across the government, business and personal spheres - deflation must be fought at all costs and right now. Here's why.
In all of its forms and manifestations debt deflation sharply increases the risk that borrowers will be forced to default on real obligations that they cannot service. Thus, debt deflation is associated with a sharp rise in corporate defaults and household defaults that creates a spiral of deflation, debt deflation and defaults.When you have deflation, existing dollars become worth more. That includes the existing debts you have. 5% deflation means your debts just increased by 5%. If you were on the hairy edge of insolvency before, deflation just pushed you over the cliff. That leads to a new round of bankruptcies and more deflation and more bankruptcies and on until only the very strong have survived.
The problem is even worse for banks who count on the values of the assets they hold as collateral (houses, cars, etc.) for loans. If those values drop, they no longer meet their asset to debt ratio requirements and they have to declare bankruptcy.
If Bernanke and Paulson are thrashing around, trying every wild scheme they can concoct, that's why. They're just trying to shove financial calamity down the road a bit. Instead of screaming and pointing fingers, maybe we ought to apologize to them. I doubt they dedicated themselves to becoming experts in their fields just so they could come and clean up after us after we turned the nation's finances into confetti.