The Dow resumed its downward slide yesterday. It lost 237 points as the deflation commandos continued their counterattack.

It's war. And war is hell, as General Sherman said, before burning Atlanta to the ground.

Oil was unchanged in yesterday's trading. Gold gained $5.

Most of yesterday's hard fighting took place in the financial sector.

"Fed Sees Turmoil Persisting Deep Into Next Year," saith the New York Times.

The New York press tells us that Steve & Barry's, a clothing retailer with 200 stores, has filed for Chapter 11. And Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) got walloped again. The two Mississippi Companies [a reference to the government-chartered company in 18th century France that dominated a huge bubble, went broke and practically bankrupted the nation] desperately need to raise money. But even though the two are backed by the U.S. government and clearly "too big to fail," investors are being a lot more grudging with their money these days. Fannie had to pay 74 basis points over the Treasury rate to get cash, much more than in the past. Freddie's stock dropped to $10. Fannie's hit $15. Both traded as high as $60, if we recall correctly.

IndyMac (NYSE:IMB) is in the news too. The big mortgage lender specialized in Alt-A loans - a step up from subprime, but apparently not a very big step. The shares traded at $50 in 2006. Yesterday, they were marked down to 44 cents.

Bloomberg tells us that Wall Street debt is being "downgraded by derivative traders." They know the stuff better than anyone, of course.

What is surprising - to us, anyway - is that they aren't downgrading government debt. We believe the credit cycle has turned. After a quarter century of falling yields, it looks to us as though yields have formed a major, triple-bottom. Which is to say, bond prices, (remember, they go up as yields go down) have hit three successive peaks, more or less at the same altitude, in 2003, 2005 and again in 2007.

But if we're on the downward slope, so far it's a gentle one. We looked yesterday and found the 10-year T-note yielding all of 3.88%.

We have to pause a minute and draw breath. What are bond buyers thinking? Of safety, surely. They see this latest assault of deflation - with falling stock prices all over the world…with Wall Street collapsing…the Fed nervously holding the key rate at 2%…oil slipping, possibly topping out - and they look for a hole to jump in. What better hole than U.S. Treasuries…dug deep by the full faith and credit of the U.S. government and denominated in the almighty dollar?

Well, ahem…that there is the problem. The hole may be deeper than they think.

Conventional wisdom holds that inflation will not be a lasting threat. The experience of the last quarter century is that short bursts of rising prices are soon replaced by another longish period of stable ones. But this was the period when the Chinese and Wal-Mart were lowering prices on manufactured goods…when labor rates were held down by the influx of millions of people into the modern economy…and before the cycle of commodity prices turned up. This was also the period in which interest rates were falling…and almost infinite amounts of money were available to increase consumer spending and production. That period is over.

Nevertheless, millions of investors expect it to continue. They believe that a cooling world economy will bring the forces of inflation back to their barracks and that they can go on collecting 3.88% coupons without feeling like chumps.

Who knows? Maybe they're right. Still, we think they are morons. Even if they turn out to be right, the margin of safety on U.S. Treasuries is so razor thin they're bound to cut a vein.

The real issue for us here at The Daily Reckoning is how the world ends. The world as we know it…Boomland…the world of constantly expanding credit and rising asset prices…is finished, we think. Does it end with a bang or a whimper? Does it end with the bang of inflation? Or the whimper of dying prices?

"Both" is still our best guess.

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