NEW YORK (CNN/Money) - Historically, sharp declines in stocks have lured in temporary buyers. But in a plunge that has taken it down 1,540 points, the Dow has fallen 12 of the 16 trading days this month. Selling has only bred more selling.

"When you run down the list of who owns stocks, you see that each camp has a reason to sell," said Miller Tabak bond market strategist Tony Crescenzi. "And their reasons for selling grow as stocks go down."

To begin with there are the investors who have been yanking money out of stock mutual funds at a nearly unprecedented pace. There have been outflows eight of the last nine weeks, according to AMG Data Services. In the week ended July 17 investors pulled $10.7 billion from funds -- the second-worst week for mutual fund outflows on record. (The worst came in December 2000.)

Many mutual fund investors are likely deep in the red. More than half of the money that's flowed into mutual funds since 1982 (the beginning of the bull market in stocks) came beginning in 1997. With the benchmark S&P 500 at lows not seen since May 1997 that money is at best dead in the water and at worst deeply under it.

With their portfolios shrinking many investors are being forced into a more conservative stance. When you are flush, putting a little money on the wheel isn't particularly dangerous. When you're down to your last dollar, you're playing Russian roulette with your financial future.

"If there are people who are counting on some kind of rebound soon so they can have food on their table or pay tuition, perhaps we should talk," said Banc of America strategist Tom McManus. "Because that's not what stock investing is about."

Foreign investors in U.S. stocks face a different set of problems. Where they had once thought the standards of corporate governance in the United States were among the highest in the world, this year's litany of accounting scandal has put their faith to the test.

Through May foreign flows into U.S. equities slowed, according to the Treasury Department, and anecdotal evidence suggests they may have lately turned negative. (The Treasury won't release June data until later this month.) In Merrill Lynch's latest poll of global investors, 57 percent of the respondents said that if they could pick one area of the world to underweight, it would be the U.S.

But as foreign investors sell U.S. stocks, they are also selling the U.S. dollar. As a result, not just stocks, but the dollar slides -- and the foreign investor takes a double hit.

The twin decline puts some large foreign investors into a horrible position. European insurers, for instance, need to be able to meet possible payouts. Just like the U.S. mutual fund investor, as their portfolios decline, they need to take on less risk. So they shift away from risky assets and repatriate funds to limit currency risk.

"These things have a habit of self-feeding, especially if the foreign perception of rising currency risk attached to owning dollar assets grows," wrote Credit Suisse First Boston economist Paddy Jilek last week. "Sometimes a butterfly can flap its wings and cause a storm."

U.S. pension funds are in similar straits. Stocks' drop has sharply reduced their portfolios over the past two years, leaving many of them underfunded. They, too, Crescenzi said, are forced into limiting risk by allocating money away from stocks into bonds.

It gets worse. The sharp drop this month has begun to spawn the darker fears.

In a nightmare scenario, the decline in stocks provokes an aversion to risk across the board. Consumers, worried about their financial futures, pull back, while banks become increasingly unwilling to lend. The economy stalls and our low-inflation environment shifts into deflation, an overall decline in prices.

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At that point figuring out how to fix the economy gets dicey. Any economics student knows how to fix inflation, PIMCO economist Paul McCulley noted recently: You raise interest rates, the cost of capital rises with them, and so it ends. "No macroeconomics student knows, however, how to fix a self-feeding deflationary 'mistake,'" McCulley wrote.

Just the fear of deflation is damaging enough: As it increases so too does the possibility that investors pull back from risk so sharply that capital markets freeze up. Economists like McCulley and, now, Paul Krugman, are calling for the Fed to step in. Briefly on Tuesday there were rumors that the Fed was holding an emergency meeting to consider cutting rates. Each day the market slides improves the chances the rumors come true.

"You've gone into this period where you're trading into this vortex. You're trading on fear," said CreditSights strategist Louise Purtle. "If you see continued declines like this it will need some external shock to break the pattern."

It's a shock that only the Fed could deliver.