This column was originally published on RealMoney on Oct. 27 at 1:05 p.m. EDT. It's being republished as a bonus for TheStreet.com readers.

So what of this whole deflation possibility?

The biggest potential cause of a major deflationary cycle in this economy is the very thing that has driven the virtuous cycle of economic and productivity growth during the last couple of decades: the communications and technological revolution.

Earlier this week, I highlighted some of the many ways the revolution has helped companies and individuals become ever more efficient and productive in a number of everyday tasks. The flow of information and capital has become so quick and easy, and distribution and logistics management has become so inexpensive and cost-effective that playing field after playing field is being leveled. But some of the very same technological advancements that have thus far benefited those who have leveraged them have the potential to reverse into negatives.

In fact, Internet access itself, the great field-leveler, is among the services being commoditized and feeling the deflationary pinch in the communications revolution. As the proliferation of new modes of accessing the Internet continues, these networks will be differentiated only by speed. That commoditization leads to price collapse, and that's already happening in voice-transmission and Internet-access costs. These price drops will only continue.

The sector where this dynamic is most clear is in media content ownership, and within that sector, music has so far been the industry most impacted. I noted in Monday's column that this year, I have spent 100 times more on music than I did in 2002, simply because the shopping process today is so much simpler than it ever has been.

But that ease of distribution and the leveling of this playing field are having some negative impacts on the music industry, with piracy the most visible form. From its roots in Napster ( NAPS) to the modern-day BitTorrent and other P2P programs, the playing field for music distribution has been so evenly leveled that millions of consumers are willing to use their time and energy and risk a criminal record to provide free access to any song ever recorded. Anyone who can tap into the Internet can make any piece of music content available to anyone else on the Internet, and the costs to enter the business of content distribution are practically zero.

It's hard for the entrenched music industry companies like Warner Music Group ( WMG) to compete with "zero," as in, free.

To be sure, Apple ( AAPL) and its legal iTunes music downloading store, as well as the other legal music sites around the Internet (including, ironically, the "new" Napster store), are helping battle this runaway music-industry problem. Legal music stores attract customers by guaranteeing the quality of the music and listing it at extremely reasonable prices, providing a new revenue source for the music companies. But again, note the words "extremely reasonable prices." Even when purchased legally, the cost of buying a great song has gone from $15 when bundled on a physical CD to 99 cents on a legal site to free on a P2P network. Can you say deflation?

Now, consider all the industries and products onto which this analysis can be projected. Any recorded content that can be digitized, including movies, TV shows, business telephone listings, written content and software will feel the impact of these forces.

There are two ways to look at the Internet and ease of distribution it enables. On one hand, it will drive prices ever lower, and depending on how willing people are to steal content (and if the billions of songs freely looted every day on the P2P networks are any indication, they're very willing), the ability to control pricing of these goods will evaporate. It's arguable that it already has. On the other hand, the instant gratification and ease with which this content can now be purchased through an explosion of outlets, combined with the elasticity that will come from ever-lower prices, could enable content owners to grow earnings through all kinds of new revenue streams.

Either way, though, prices for all content are heading lower. And that's deflationary.

And, of course, price control over any service that can be transmitted digitally will be lost as commoditization kicks in. From stock trading and analysis (you used to need to be in a major city to be a serious stock trader and analyst), to accounting (how many times have you read about companies outsourcing simple accounting jobs to India and elsewhere?) to brand management -- the examples of services that the Internet commoditizes goes on and on.

Ironically, in this analysis, the only products that can avoid the loss of price control and commoditization through excessive competition are physical goods. From fashion to concerts to live sporting events, only the physical world retains pricing power. Service sectors, which make up the majority of U.S. jobs and GDP, end up with price battles and endless competition from all corners of the country and the world.

And that, my friends, is how deflation really could become a problem, and how the bears finally could have their depression, while earnings evaporate as content, information, capital and services all flow toward the lowest possible price and most cost-effective areas until all the value is squeezed out of "value-added."

But wait, don't panic. This isn't today's business. And there are lots of strategies and legal protections that will counter these trends, even in those areas already under siege. I'll look at that in a column next week. (In case you're wondering, a "coming column" tease is indeed a strategy for protecting against commoditization of content!)


Please note that due to factors including low market capitalization and/or insufficient public float, we consider Napster to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

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At time of publication, the firm in which Willard is a partner was net long Apple and net short Warner Music Group, although positions can change at any time and without notice.

Cody Willard is a partner in a buy-side firm and a contributor to TheStreet.com's RealMoney. He also produces a premium product for TheStreet.com called The Telecom Connection and is the founder of Teleconomics.com. The firm in which Willard is a partner may, from time to time, have long or short positions in, or buy or sell the securities, or derivatives thereof, of companies mentioned in his columns.None of the information in this column constitutes, or is intended to constitute, a recommendation by Willard of any particular security or trading strategy or a determination by Willard that any security or trading strategy is suitable for any specific person. Willard appreciates your feedback -- click here to send him an email.

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