Phase 1. Growth in consumption is curtailed as the consumer credit expansion due to housing slows. Employment is under pressure, as are wages and salaries, due to competitive pressure from the vast labor pool in China, India and Pakistan. “Core” inflation remains subdued. Headline inflation is significantly higher, as food and energy (and industrial commodity) prices continue to increase.

Phase 2. Mortgage defaults begin to rise significantly. Housing prices in the bubble areas are now off 25-30% from their peaks, but volume is very light and inventories are huge. The Fed begins to reduce interest rates. Bernanke opens with a big 1-2% reduction. The dollar declines against commodities. The yuan is allowed to rise significantly, as is the yen. Consumer prices begin to rise at a 10-15% annual rate, but incomes barely budge. Unemployment rises. Stagflation.

Phase 3. The housing market goes into full panic mode and major lenders are in trouble as defaults are widespread. Bernanke adopts Zero Interest Rate Policy (ZIRP), as the Bank of Japan did. The dollar goes into freefall and consumer prices soar, although unemployment continues to rise. Real family income has fallen by 50% from 2001.

Phase 4. Deflation and depression.