Yesterday, the world had a chance to take a better look at the Fed's latest rate cut…

"Yecch," it said. And so "Hell Week" continued.

Despite the Fed's intervention, in both London and New York the cost of money for most borrowers actually went up.

"Fed cuts fail to lower 30-year mortgage rates," notes the Los Angeles Times. At the long end of the yield curve, rates are determined more by fear of inflation than by the Fed's price fixing. Thirty-year fixed-rate mortgages have gone up from 5.6% to 6.4%.

But even at the short end, where the Fed is pressing its fat thumb on the scale, "Money market rates rise as banks hoard cash," says a Bloomberg report.

The banks are holding onto their money because they figure they might need it. That's what everyone does in the opening stages of a credit contraction. They're afraid that if they lend it out…they will later discover that the borrower can't pay it back.

Yesterday brought news that two big borrowers had gotten whacked. Endeavor Capital lost 28% trading Japanese bonds. And poor John Merriwether! Almost exactly 10 years ago, the man's Long-Term Capital Management went broke. Now, the news tells us that his bond fund has just taken a 24% hit.

And Britain's biggest mortgage lender - HBOS - denied rumors that it is having liquidity problems.

The Fed giveth.

Mr. Market taketh away.

It's "the Great Unwind," says Citigroup. What is being unwound is the ball of debt, derivatives, speculation and outsized asset values all over the world.

The Dow fell yesterday - down 293 points. Commodities got whacked hard too. Oil lost nearly $4 a barrel. Gold dropped to $945. And copper - which tends to be an indicator for the whole economy - seems to have topped out.

In terms of our 'battle' between inflation and deflation, yesterday, deflation won.

*** In spite of all the bad news, Hell Week hasn't really been so bad. It's more like Purgatory or Limbo…or a halfway house after coming out of state prison.

The headlines speak of a worldwide financial crisis, but so far, the effects of this crisis are extremely limited. The OECD reports that unemployment around the globe is only 0.3% higher than it was a year ago, the same figure U.S. unemployment has risen during that period.

Aside from panicky capital markets, some areas don't seem to be suffering at all. Latin America, Asia, the Gulf, and Africa all seem to be growing, with no significant economic effects - at least, not yet.

The Financial Times summarizes the outlook for the world's major regions:

In the United States, people wonder how hard the landing will be.

In Europe and Japan they wonder whether the landing will be hard or soft.

In the rest of the world, they ask whether they will have a landing at all.

America's central bank is now lending money at about half the rate of consumer price inflation. A borrower can take the money and almost certainly make money. If nothing changes, he'll pay back money worth less than the money he borrowed…or, he can put it on deposit in Britain at twice the yield…or in Brazil, where he'll get 5 times the yield.

The lower rate is intended to encourage borrowing. Whether it also encourages consumer spending, hiring, and capital investment is another whole group of questions with very uncertain answers. If the answer is yes…you can reasonably expect further inflation in the commodities markets…rising stock prices…and a positive GDP growth. If the answer is no…you can expect higher unemployment, falling stock and housing prices…and probably falling commodity prices too.

While yesterday was clearly a 'no' kind of day…there is no guarantee that every day will be a 'no' day.

Another way to look at this is a way long time Daily Reckoning sufferers will recognize: it is our familiar battle scene…with the heavy cavalry of inflation charging the steadfast infantry of deflation.

While that picture has fairly well described the financial world for the last year or so…we think it is time to add a complicating feature. It is as if a third army has appeared on the field of battle…of unknown size…and unknown intentions. So let us review the battle lines.

On the one side, is the familiar force of a credit cycle downturn…believed, by us, to be the beginning of a major contraction in the credit market. These things are big. The last big force in the credit world was the expansion that began in 1980. Obviously, it lasted for 25 years, perhaps a bit more. That expansion seems to have come to an end. Yields are about as low now as they were when the last expansion began…and probably turning up.

That "probably" is an important word. Recently, yields have been going down, as investors sought safety from default over safety from inflation. Looking for protection in the treasury market seems to us a bit like looking for veracity in the U.S. Congress…and we suspect that when things settle down, investors will realize they've made a mistake.

"The credit crunch is rapidly morphing into a credit collapse," says Harvard's Kenneth Rogoff. "The same factors that propelled the housing bubble are now spinning in reverse. And there's no bottom in sight."

On the other side, of course, is the other familiar force - inflation. It's what you get when you favor the production of 'money' over the production of the things it is used to buy. Inflation is clearly driving up some prices. Oil is holding over $100. Gold has been on a tear for 8 years. Rice just hit a 32-year high. CNNMoney reports that inflation is Americans' number one concern.

Meanwhile, keeping our pict-o-rama of the world's financial scene before us, with inflation on the left, deflation on the right, down the center comes a huge, disorganized, polyglot collection of fighters - lean and hungry - emerging markets, oil producers, former Soviet republics…the bric-a-brac of humanity.

While deflation knocks down commodity prices - these emerging economies are buying them as fast as they can.

While inflation is pushing up automobile prices - they're making new cars for only $2,500.

While deflation cools the U.S. economy - these third world economies are still heating up.

While inflation squeezes aging, middle class families in the West - in the East, millions of young, new families are becoming middle class, bursting at the seams with new consumer demand.

What will happen when these three armies collide?

We don't know…but we're watching…

Bill Bonner is the President of Agora Publishing. For more on Bill Bonner, visit The Daily Reckoning.