The Federal fund overnight target rate was lowered to 1% this week, bringing us back to the record low interest rate reached in 2003/4. How low can it go?

For those of you keeping score, since August 2007 when the current economic crises really got going in the public eye (they have been building up for decades before the media turned on its spotlight), the Fed cut the funds rate from 5.25% down to 1.5% and then Wednesday, another ½ point, to 1%. One penny on the dollar.

If the overnight rate keeps going down, and some say it must, it will reach zero. That is where Japan’s economy was during much of the 1990’s when their ‘asset price bubble’ (also charmingly known as ‘the bubble economy’), from 1986 through 1990, featuring hugely over-inflated real estate and stock prices, finally burst. Japan’s flat period, known as the “Lost Decade,” lasted a long time.

Real estate got so nuts in Tokyo that in 1989 a square foot of Ginza dirt, attached to the rest of the earth, of course, was worth some $139,000.00. When the bubble finally burst, Japan went into a deflationary spiral, where things lost value, as opposed to inflation, which we remember from and after the Carter years, when things increased in price dramatically and the prime rate was over 20% for a time.

The Japanese Central Bank set the interest rates at approximately absolute zero; zip, zilch, nada. Nobody wanted to invest in anything. Some bank officers actually went so far as to make deposits in competing banks in order to get some action, somewhere! The government began subsidizing so many banks and businesses, that otherwise would have crashed and burned, that they were known as “zombie businesses.” It was truly the Night of the Living Dead for Japan’s economy for a longer time than our short ‘sound bite’ attention spans would be comfortable handling.

The real problem we face here now is not interest rates. Our problem is that, despite some $700 billion lent by the Fed in this ‘bailout,’ or whatever you would like to call it (or cuss at it), nobody wants to lend anybody any money for fear that they will never be paid back. Sort of a corporate Simon Legree status on steroids. You would think that an infusion of $700 billion would jump-start some lending out there in credit markets, no? Not much yet.

The Great Depression of the 1930’s was about a deflationary spiral – first, people stop buying things – why buy now when the price will be less if you wait a while? The mini-spike in real estate sales now being reported is about that – people rushing in to buy suddenly cheap real estate, often foreclosures. Next, investment slows down and stops. Then, demand falls and people who produce things stop producing them. Next come the waves of layoffs – and they are coming shortly. Businesses cannot compete, no matter how cheaply they sell their products and they start to fail in droves. Negative inflation is deflation.

The US has survived three major deflationary periods: the recession of 1836, which saw our currency contract by 30%; right after our Civil War in the later 1860’s – called the Great Deflation, and finally; the Great Depression our parents and grandparents talked about, from about 1930-1933, when things deflated at 10% per year and unemployment reached 25%. We may be embarking on our fourth major deflationary period if all the magic tricks being floated by Bernanke, Paulson & Company do not bring our economic mojo back.

Meanwhile, if you have outstanding credit and you can find a bank willing to lend, this might be a fine time to consider refinancing. And, a bit of belt-tightening probably wouldn’t hurt either – skip a few of those dinners at the restaurants with the $40 entrees and servings the size of a walnut floating in a watermelon-sized plate, where you have to go home and eat dinner again because there was so little food first time. Remember, there are less than 60 shopping days left until Christmas, if your favorite retailers can hang on that long.