The European Central Bank (ECB) and the Bank of England made bold interest rate cuts yesterday with the British cutting rates to their lowest levels since 1955. Despite aggressive interest rate cuts by global central banks over the last 60 days, markets remain on edge and unable to find any semblance of balance.

In the United States, a post-Obama-elect victory on Tuesday failed to carry through into Wednesday’s trading with the Dow dropping 486 points and again on Thrusday, dropping another 443.

Europe is rapidly sliding into deflation since August with wholesale and retail price pressures declining sharply accompanied by tumbling euro. It’s not a pretty picture in Europe. Worse, Eastern Europe is leveraged to the global growth cycle – literally – and borrowed money is now leaving these markets as investors unwind risk.

Central banks are quickly running out of bullets, namely the scope to cut interest rates. Once rates hit zero percent, there’s a chance they can even head into negative territory.

The Japanese now have rates at just 0.30% after cutting their base rate last week. It’s not impossible that other industrialized countries will also face a similar conundrum if they can’t arrest falling prices. Interest rates did turn negative in the United States in the 1930s as the demand for ultra-safe Treasury bills propelled rates into negative territory, meaning investors actually paid the government to hold paper and not vice versa.

Central banks have numerous policy-setting tools at their disposal to combat this credit crisis, including SWAP agreements, intervention in foreign exchange markets and an arsenal of market-based tools that most of us have never even heard of. Bernanke and his European counterpart, Trichet, will throw everything they’ve got at this crisis until markets stabilize. After more than 15 months, however, both central banks have failed to calm investors.

Deflation is now investor enemy number one. The violent transition from inflation since July to deflation starting in September has been awfully alarming. Asset values continue to plunge virtually everywhere, including real estate, stocks, bonds and non-dollar currencies. My generation and even my father’s generation have never seen such an accelerated decline in asset prices in such a short period of time.

I’m actually hoping inflation makes a big comeback over the next 24 months because in that environment investors can make money. Deflation, however, is a much harder market to work with and, historically, investors have been clobbered trying to navigate through its rough waters. Case in point; since August 2007 most investors have lost money.

The extremely high degree of global market correlation makes this crisis even more dangerous because everyone is now in the same boat. It doesn’t matter where you invest or in what currency; the odds are high you’re losing big money.

Deflation makes harboring debt highly expensive and destroys both individual and corporate balance sheets faster than any other monetary phenomenon.

For individuals, asset allocation is now a major priority because of the high degree of correlation between assets. Make sure you have the right balance of stocks, bonds, currencies, alternative investments and, especially in this environment, reverse-index funds to offset your equity portfolio losses.

Deflation is a living hell. Let’s hope inflation returns soon.

I’ll be in-transit on Monday. My next post is on Tuesday. Have a good weekend.