Five Stages of Inflation

[craigr]

From the Blog. Thought you'd enjoy. Did I miss any other stages? I'm thinking that Stages 2 & 3 are sometimes reversed and/or combined.



With talk of inflation in the air, I thought I’d mention what I call: The Five Stages of Inflation

Be on the lookout for the early symptoms and act accordingly. Not acting before Stage 5 is damaging to your wealth.

Stage 1

Denial – “Prices are stable and the currency is strong! We don’t know what’s causing inflation!”? – First sign of trouble is not admitting you have a problem.

Stage 2

Anger – Blame the Victims – “Greedy businesses are responsible!”? – May also involve idiotic government campaigns that indirectly blame consumers for causing the currency to fall in value instead of reckless government spending.

Stage 3

Bargaining – Price and Wage Controls – “We are doing this to protect the economy!”? – Welcomed at first by a naive public (until the product shortages kick in).

Stage 4

Depression - Pointing Fingers and Acting Hopeless - "It's the previous administration's fault! We don't know what to do any more."  – While making no serious effort themselves to remedy the situation even though they know what needs to be done.

Stage 5

Acceptance – Screw the Populace – “It is our fault. But it’s your patriotic duty to lose your life savings.”?- May also involve confiscation of hard assets, freezing of bank accounts, capital controls to prevent citizens from sending money offshore, etc. By this point much value in the currency has been destroyed.

The five things above have happened in one form or another in all countries that have had high inflation (even in the US).

How to protect yourself from The Five Stages of Inflation:

1) Hold some hard assets all the time. You won’t be able to react fast enough to a serious currency problem. You need to have protection in place before it happens. If you can put some money offshore beforehand it’s a good idea to do so.

2) Don’t believe government figures on inflation. Rely on the markets. The markets don’t care about political speeches and aren’t up for re-election. If the markets say inflation is higher than government numbers, then it is.

3) If price controls are being proposed, stock up on everything that they are thinking of controlling. Shortages will always follow price controls. If you are a speculative daredevil, invest some money in a way to take advantage of the price controls when they eventually fail and are forced to break.

4) Don’t listen to words. Only actions matter. If the discussions you hear in the news are not addressing the over-printing of money then it’s not a solution. The people in charge are just stalling.

5) Ignore pleas for patriotic duties to ruin your life savings and allow your assets to be confiscated. You didn’t cause the problem so you don’t have to pay for it while those in charge continue without penalty. Do what you need to do to protect yourself and don’t feel guilty about it.

[Lone Wolf]

Heh.  I am just a bit too young to remember the "Whip Inflation Now!" but the whole thing has always sounded like some kind of parody of a tin-eared government propaganda effort.

What were you thinking was an example of stage 5 in the United States?  The confiscation of gold during the Depression comes to mind, but I viewed that as more of an effort to cause lots of inflation and currency debasement rather than a result.

Anyhow, this is a good write-up.  None of this stuff is complicated but unfortunately I have no doubt that from time to time we'll see these really awful ideas (price controls, putting the blame on hard assets or "big business", etc.) will be with us time and again.

I have a further confession as well.  While I do subscribe to the HBPP's philosophy of remaining agnostic between the four different economic conditions and their likelihood, inflation has always struck me as far, far more likely than deflation.  I think that a sufficiently determined government, particularly a very desperate one that was willing to use both fiscal and monetary policy to achieve an inflationary goal, would succeed.  PRPFX's bias toward dealing with inflation therefore does strike me as a reasonable one.  I still go with the Harry Browne 4x25% allocation for my own investments but in the long run I do feel that inflation has by far the stronger long-term likelihood of success in a fiat currency world.

[MediumTex]

I would say that there are also five stages of deflation.

In some ways the deflation process is more interesting than the inflation process, since it has so much more economic cognitive dissonance to try to overcome.

The fact is that any financial crisis triggered by a debt overhang is deflationary for debt-based reserve currency economies and the deflationary fallout is a generational phenomenon. 

In other words, deflation will be with us until the early 2020s, and that is the best case scenario.

The Fed's impotence in creating sustained inflation/inflationary expectations will be painfully exposed as this process grinds forward.

That is the MediumTex prediction.  People will come to terms with it slowly and it will likely follow the five stages outlined in the OP.

[craigr]

I wrote that post after being inspired researching inflationary events around the world. I'm not predicting it is happening now. Just what to look out for if it really gets rolling.

Did #5 happen in the US? In a hybrid sense in the 1930's gold confiscation it did. They seized the assets first and then inflated the currency later for the citizen's own good of course. Currently I think the US is implementing a stealth currency control through red tape by making it very hard for US citizens here and abroad to open accounts in non-US banks. It is only getting worse and is happening behind the scenes as a result of recent legislation.

Re: Deflation

Tex you'll be happy to know that I posted about the possibility of deflation all the way back in Spring 2008 on the Diehards forum. This was when oil prices were reaching $200 a barrel and people thought inflation was coming:

http://www.bogleheads.org/forum/viewtop ... ary#185528

Also there are cases to be made that inflation could cool off rapidly. There is a lot of wealth being removed from the system right now in terms of home price declines, etc. and that is deflationary.

That's the kind of market call I should get engraved on a plaque and hung above my desk! Time to start that newsletter.

EDIT: I bumped that old thread. That statement was one for the record books.

[Lone Wolf]

Tex you'll be happy to know that I posted about the possibility of deflation all the way back in Spring 2008 on the Diehards forum. This was when oil prices were reaching $200 a barrel and people thought inflation was coming:

That was a good call.  You do lose some Prognostication Points for calling gold and silver "incredibly expensive" back in April 2008, but this is still good. 

The Fed's impotence in creating sustained inflation/inflationary expectations will be painfully exposed as this process grinds forward.

I might need to be walked through this one.

I believe that a government cannot control the price of an asset in real terms.  Thus, if the market concludes that an asset which once was priced at $1,000,000 is now only worth $500,000, the government cannot influence that price to go higher so long as a "dollar" retains the same value.  The government couldn't touch any prices in terms of ounces of gold since it does not control gold.

However, I also believe that a government's ability to initiate and sustain monetary debasement (aka inflation) is virtually unlimited, particularly if both monetary and fiscal tools are brought to bear.  A trivial example: if the government were to swell its budget to 300 trillion dollars, write everyone in America a 1 million dollar check, and have the Fed print enough money to pay for it all by purchasing every bond in sight, catastrophic monetary debasement and skyrocketing prices will result.  This means our target asset could go back to $1,000,000, and probably well beyond.

None of this would really increase the asset price in real terms (and is of course completely ruinous.)  But I do believe that a government can increase all prices in terms of dollars almost without limit, although I don't believe it can necessarily do so in a controlled fashion or without screwing everything up.

So in my view, there's a distinction between "asset deflation" and "monetary deflation" (such as what happened regularly with a gold standard but not AFAIK on a sustained basis under a fiat currency.)  This seems to explain why we could see asset crashes in Iceland accompanied by double-digit price inflation.  It also seems to be a piece of the puzzle as to why gold has done so well against deflationary headwinds.  There's a baked-in assumption that "inflation" and "deflation" are strict opposites and cannot both take place at the same time.  But is that true?

Of course, this is all merely just what I think.  If I knew, I wouldn't need a Permanent Portfolio, would I?  What do others think?  Am I making a false distinction?

[Storm]

A trivial example: if the government were to swell its budget to 300 trillion dollars, write everyone in America a 1 million dollar check, and have the Fed print enough money to pay for it all by purchasing every bond in sight, catastrophic monetary debasement and skyrocketing prices will result.

One important thing to note - if the government gives everyone $1,000,000, and everyone just uses the money to pay off their mortgages, credit cards, and puts the rest in savings, no inflation will occur, because you haven't increased the velocity of money.

The key point that the Fed has yet to learn is that just increasing the money supply, when everyone is in "hunker down and save" mode, does nothing to prevent deflation.  In order to get inflation going again, those dollars need to go out and spend themselves, over and over again (velocity).  We've increased the M0 money supply, but the velocity of money has actually decreased, which points to secular deflation, as MT wisely pointed out.

[Saluki]

Long term deflation may be impossible, but over the short term inflation-deflation expectations can shift violently, with corresponding effects on the value of your assets .  The pieces of the Permanent Portfolio act together to protect you from these value swings. 

As I write this, stocks are down 1.6%, gold is down 1.1%, but treasury bonds are up 2.5%.  Assuming cash's change is 0%, a Permanent Portfolio would be down only 0.05%, thanks to the bonds.  The same thing happens on a larger scale over longer terms. 

[MediumTex]

In a debt-based reserve currency financial crisis situation, money is destroyed through credit contraction faster than any government could ever hope to inject new money into the system.

Imagine a tidal wave coming at you on the beach, and then imagine having at your disposal the most bitchin' high pressure fire hose every made.  It wouldn't matter, your fire hose would be orders of magnitude less powerful than the power of the approaching tidal wave. 

The approaching tidal wave is deflation and the beach bum with the fire hose is Bernanke.

One confusing part of this puzzle is the cross-currents where there seem to be rising prices in some assets and falling prices in other assets.  Here is the key to understanding this dynamic: assets which are purchased with credit will fall in value, while assets that are purchased with cash may rise in value.  The wrench that gets thrown into this explanation is that many items that were traditionally purchased with cash (e.g., food) have in recent years been increasingly purchased with credit (e.g., with credit cards that can't be repaid).  The people who are expecting inflation in food and energy prices may be disappointed simply because people will reduce their spending on food and energy as their willingness (or ability) to take on additional levels of debt is reduced.

Remember, too, that interest rates on ANYTHING are an implicit bet that future economic growth will be sufficient to cover today's interest, plus tomorrow's consumption.  When future economic growth begins to look less certain (because more of tomorrow's output will be needed to pay for yesterday's bad debts), that should translate into lower interest rates in the present.  What I am talking here, though, is a REAL interest rate that is lower, not a central bank manipulated interest rate that is lower than what the market would set on its own. 

A generation of misguided monetary policy is causing current market participants not to understand that interest rates right now REALLY SHOULD BE VERY LOW for a variety of reasons, one of which is that a huge debt overhang will necessarily reduce the amount of future economic output that is available for future consumption (in other words, future economic output won't support interest payments above a certain level, which translates into lower interest rates today through the market's discounting function).  That is why it is so critically important for an economy to have some method of liquidating bad debts quickly following a financial crisis.  Rather than recognizing this need, however, we have gone the opposite direction, allowing banks to carry bad debt on their books at silly prices and attempting to hold debtors to the terms of their debt obligations even in the face of an obvious inability to pay (student loans are a great example).  It's a bit like carrying a backpack full of lead into a 50 mph headwind--it makes an activity that looks easy (e.g., simply moving out of an economic soft patch) very difficult in practice.

As for future inflation, in the U.S. where will the money come from to pay these higher prices?  Are U.S. wages going to rise?  Will consumers begin living on credit again?  What will be the collateral for this credit if consumers' homes are worth less than what they owe on them? 

What happens when prices rises as a result of cost-push inflation and the consumer doesn't have any extra money to pay the higher prices?  In the short term, consumers will buy less of some things in order to pay the higher prices on essential items.  In the longer term, however, higher prices against a backdrop of stagnant wages and credit contraction simply means more economic contraction.  This is exactly what we saw in early 2008--inflation started to get traction, people realized they had no more credit lines to tap, their wages were stagnant and BAM the economy hit stall speed.  There is no reason to think that any future price shocks won't lead to the same outcome in a debt saturated deleveraging economy.

The fact that we have a bunch of Keynesians driving this bus is cause for even less optimism about the future.

I don't know what's going to happen, but whatever it is it will have to address the points above, since those are the factors that will mold our future economic realities.

The one thing I know is that deleveraging is a process that will take a LONG time.  I would say that, at a minimum, it will take half the period of time it took to accumulate the un-repayable debt in order to purge the system of its effects.  That's where my early 2020s prediction comes from.

As for the government's balance sheet, that simply ensures that all of us will be that much poorer in the future, whether it is through eventual inflation, higher taxes, a currency crisis, outright default, elimination of transfer payments or something else.  If a debt can't be repaid it won't be. 

The process by which changing future possibilities translate themselves into revised present perceptions of the future is fascinating to observe.  It is the macroeconomic equivalent of telling a person that he has five years to live rather than the 25 years on which his previous plans were based.  What if this person, however, was 90 years old and the five year life extension was actually great news?  I think that many years of bad policy has caused people to have similarly misguided perceptions of prosperity and entitlement and it has caused a sort of collective untethering from reality which has simply manifested itself in the form of ridiculous and utterly un-repayable debt levels.

[Lone Wolf]

Great discussion.  There's a lot to think about here.  I still can't shake the belief that a sufficiently reckless government can create as much monetary inflation as it likes so long as fiscal and monetary policy work in tandem (meaning, the Fed shakes all pretense of independence and the government spends like crazy.)

If the US government paid off everybody's mortgage and simply printed up the money to do this out of thin air, I would expect really bad inflation as a negative consequence.  It was through a simple mechanism like this that the Weimar government was able to essentially confiscate (via inflation) nearly every last bit of their citizens' wealth.  This improves nothing and destroys much, but inflationary it is (or so it would seem to me.)  If there is no such negative consequences, you can bet that this would have already been tried!

I must be missing something big, but I do not know what it is.

[MediumTex]

I must be missing something big, but I do not know what it is.

Velocity of money.

If I print a brazillion dollars and bury it in a hole in my back yard, is that inflationary?

Bank balance sheets are a similar hole.  The assets are sitting on these balance sheets because sooner or later they will be needed to offset the staggering losses in the banks' loan portfolios.

Even if you sent a check for $10,000 to every person in the U.S. I'll bet it wouldn't have much of an inflationary impact, since so much of the money would be used to pay off debt or would otherwise be saved.

It's weird, I know.

For an example of what this process looks like over many years, see Japan.

I believe that we are in the early stages of some very significant shifts in what we all think of as economic reality.

Lest I completely hijack this thread, I think that the deflationary concepts I am describing demonstrate the same stages of coping that inflation does--they are both examples of how new economic and financial paradigms arrive and are psychologically assimilated by the people affected by them.

[LNGTERMER]

Excellent analysis all, MT I have a question though. You have characterized the market as all powerful untaimable beast. It seems the market consists of a finite number of participants. That means its power must be limited and hence it can be controllable and manipulated. I can think of the analogy of a crowed in a building with limited number of exits, if these are blocked then the crowed may have no where to go and indeed maybe trapped. So, if the currency, interest rates and the other set of fininite parameters that affect the market participants are controlled, the market will be directed.  , What is the problem with this logic?

[MediumTex]

Excellent analysis all, MT I have a question though. You have characterized the market as all powerful untaimable beast. It seems the market consists of a finite number of participants. That means its power must be limited and hence it can be controllable and manipulated. I can think of the analogy of a crowed in a building with limited number of exits, if these are blocked then the crowed may have no where to go and indeed maybe trapped. So, if the currency, interest rates and the other set of fininite parameters that affect the market participants are controlled, the market will be directed.  , What is the problem with this logic?

No one can control my preferences and perceptions of value and I'm sure no one could control yours either.

What would make you think that entire markets could be controlled for more than perhaps a short period of time, given that markets are little more than collections of individuals?

[LNGTERMER]

MediumTex, I am playing devils advocate here, your above analysis is excellent and indeed might be one of the likeliest outcomes, however, this characterization that the markets are powerful and uncontrollable is common, so perhaps it may warrant a bit of reflection. I do agree we posses consciousness, freewill and in charge of our individual destiny including our perceptions and therefore actions however, one can be presented with limited number of choices in a closed system. Now, our markets are vast and huge in comparison to others but still of a limited sized and of finite players. The parameters that affect the markets are also finite. So, if we can direct the controlling variables why not manage the economy and in the process prevent these dire outcomes of severe inflation/deflation. 

[MediumTex]

MediumTex, I am playing devils advocate here, your above analysis is excellent and indeed might be one of the likeliest outcomes, however, this characterization that the markets are powerful and uncontrollable is common, so perhaps it may warrant a bit of reflection. I do agree we posses consciousness, freewill and in charge of our individual destiny including our perceptions and therefore actions however, one can be presented with limited number of choices in a closed system. Now, our markets are vast and huge in comparison to others but still of a limited sized and of finite players. The parameters that affect the markets are also finite. So, if we can direct the controlling variables why not manage the economy and in the process prevent these dire outcomes of severe inflation/deflation. 

Wasn't that the substance of Marx's argument for communism?

Bill Bonner wrote a nice column on this topic the other day and his argument was that no one knows what kind of interference (if any) a market needs to operate efficiently.  If the proper amount of interference is unknown (and un-knowable), then maybe this is an argument for just leaving markets alone.

[craigr]

The argument here is also what the advocates for the Fed used to create another central bank. The arguments were that a central bank would forever prevent market panics, depressions, etc. through wise management. Didn't work out that way. Central planning never does.

As to controlling the markets. There may be an illusion of control to some, but really the markets aren't under anyone's authority. Friedman made this point about the Fed's failure to manage inflation in the 1970s with their actions. He stated (paraphrasing) that if the Fed really did control the markets would they have allowed interest rates to climb to over 20%? Probably not. So there is an illusion of control, but there is no promise the markets are going to follow along quietly no matter how big a player someone thinks they are.

[LNGTERMER]

Wasn't that the substance of Marx's argument for communism?

I am arguing for precisely the complete opposite. Markets function best when fully free but with fair and clear rules for all to follow. That is in essence how nature works, it follows the laws of physics, it does not bend them. I do believe however, what applies to a single human being also applies to a group of humans. A single individual can be manipulated and mislead hence same can apply to a group of people. My argument is that essentially the markets are manipulatable even if it's for a short period of time to the detriment of all. Interferences such as those that produce crony capitalism are deviating from the clear and necessary rules that are essential for the proper functioning of the market and as such are manipulation.

[craigr]

Tex you'll be happy to know that I posted about the possibility of deflation all the way back in Spring 2008 on the Diehards forum. This was when oil prices were reaching $200 a barrel and people thought inflation was coming:

That was a good call.  You do lose some Prognostication Points for calling gold and silver "incredibly expensive" back in April 2008, but this is still good.   :)

Nobody can predict the future!

[Lone Wolf]

Even if you sent a check for $10,000 to every person in the U.S. I'll bet it wouldn't have much of an inflationary impact, since so much of the money would be used to pay off debt or would otherwise be saved.

Sure, I could see that happening with numbers like that.  But now imagine that Paul Krugman berates you from the pages of the New York Times and convinces you to increase it to $50,000,000 per person.  (Any good reductio ad absurdum begins with Paul Krugman.)  Now you've got all mortgages and debts paid off.  You can choose to either save the remaining $49,000,000 or spend it.  I can now buy a Rolls Royce using a very small percentage of my total net worth at current prices.  If other people get the same idea, they will begin to bid up the limited number of Rolls Royce automobiles with (virtually) unlimited dollars.  Thus, the first person in gets the best deal (similar to how the person closest to the point at which inflation occurs gets a better deal than those to which the inflation percolates.)

From what I see, this degrades into the Prisoner's Dilemma.  If you and I both hang on to our money, prices will stay reasonable and our savings will be "worth something".  However, if either of us goes for it and starts buying, they get a better deal than anyone who spends their dollars later.  And people that spend last get the worst deal of all, as all prices have been bid up with the new money.  Ultimately, the currency becomes worthless.

So it seems to me that if you are talking about a government crazy enough (one always unafraid to reach for a bigger and bigger firehose), you could always get inflation (really bad inflation, in fact.)  If inflation were not a consequence, why wouldn't a government simply print up enough money to pay off everyone's debts (including its own), let the Fed limp along with a hunk-a-junk balance sheet forever, and simply wipe the slate clean?

This must feel like talking to the slowest kid in class (the one who eats paste and always thinks inflation is coming.)  Thanks for your patience.

For an example of what this process looks like over many years, see Japan.

I believe that we are in the early stages of some very significant shifts in what we all think of as economic reality.

Japan is an interesting one.  Huge asset nosedive but their CPI really hasn't fallen much at all.  Very large levels of indebtedness but very low interest rates.  Currency strong-ish but not rapidly appreciating either.

But then you've got Iceland experiencing simultaneous asset deflation with a nice currency crisis thrown in.

A wise man once said that we live in an uncertain world.  Sounds right to me.

Nobody can predict the future!

Heh... if you keep talking like that, we're going to have to ask you to turn in your CNBC Fortuneteller Mystic Robes.

[MediumTex]

Even if you sent a check for $10,000 to every person in the U.S. I'll bet it wouldn't have much of an inflationary impact, since so much of the money would be used to pay off debt or would otherwise be saved.

Sure, I could see that happening with numbers like that.  But now imagine that Paul Krugman berates you from the pages of the New York Times and convinces you to increase it to $50,000,000 per person.  (Any good reductio ad absurdum begins with Paul Krugman.)  Now you've got all mortgages and debts paid off.  You can choose to either save the remaining $49,000,000 or spend it.  I can now buy a Rolls Royce using a very small percentage of my total net worth at current prices.  If other people get the same idea, they will begin to bid up the limited number of Rolls Royce automobiles with (virtually) unlimited dollars.  Thus, the first person in gets the best deal (similar to how the person closest to the point at which inflation occurs gets a better deal than those to which the inflation percolates.)

Given that the government could only send out checks like that to people by borrowing the money from someone else (including future taxpayers), I still wonder if that would be inflationary.

If you sent me a $50,000,000 check and said "oh, by the way, your future taxes just went up by at least $50,000,000" (not to mention the interest that will have to be paid on that borrowed $50,000,000 in the interim) I still don't know how excited I would be about spending it.

In a debt based monetary system, there is no such thing as printing money.  It's more like running up a tab that must be repaid in the future.

Where does all this borrowing from the future to try to stoke some inflation in the present lead when taken to absurd levels?  I think the Japanese will find out much sooner than we will.

An interesting question is what happens to an economic arrangement when the assumptions on which it is based begin to be invalidated.  Our current system relies on future economic growth and current expectations regarding future economic growth in order to function properly (without the assumption of future economic growth the dynamics of debt issuance in the present change dramatically).  What happens when people realize that current debt levels basically already account for a level of future economic growth that may be completely unrealistic?  I don't know, but it will be interesting to watch it all unfold.

[Lone Wolf]

If you sent me a $50,000,000 check and said "oh, by the way, your future taxes just went up by at least $50,000,000" (not to mention the interest that will have to be paid on that borrowed $50,000,000 in the interim) I still don't know how excited I would be about spending it.

In a debt based monetary system, there is no such thing as printing money.  It's more like running up a tab that must be repaid in the future.

As a further thought experiment, imagine that you get your $50,000,000 on Monday knowing that everybody else in the country will be getting it on Tuesday.  This means that you get first crack at making purchases before prices are driven up.  How do you behave?

I don't presume to speak for anyone else but I'd be turning much of that cash into something else, pronto.  I'd be soon finding out how much freeze-dried food I can fit in my pantry and where I can find a desert island to bury 10,000+ ounces of gold.

In the same sense, whoever acts first with this new liquidity enjoys the most purchasing power.  The guy who refuses to turn that cash into something else ends up getting screwed out of his purchasing power by the guy who doesn't hesitate.  I think once such a situation is set up, you are past the hyperinflationary "event horizon" after which a currency rapidly loses value.  You've defeated monetary deflation (with a cure that's thousands of times worse than the disease.)  Of course, this leads to mass chaos, starvation, and death, all without curing the underlying asset deflation problem.

However, I hear you on the debt repayment issue.  I have a few assumptions baked into this cake that perhaps I'm not calling out.  First and foremost is that when it comes to our monetary system, government makes the rules and government can always choose to change them.  In a bad enough situation, I think politicians are capable of absolutely anything.  So long as the Fed is willing to help roll over debt at extremely low interest rates for as long as is required, this can go on for a very long time.

This ability and willingness to change the rules is why I don't think we will ever see a true deflationary spiral in a fiat currency regime.  I don't count as a "spiral" a gentle Japan-style situation where CPI drops by a couple percent over many years.  Once the United States threw in the towel on the gold standard, the deflation of the 30s ended very rapidly (although the Depression did not) and it's been more or less continuous inflation ever since.  (The end result being that the dollar lost roughly 95% of its value since that time.)

[Storm]

Lone Wolf, you bring up a very good point.  Imagine you get $50 million, along with every other man, woman, and child in the US.  Do you really think you could walk into any Rolls Royce dealership and pay cash for a car?  I think every business would be immediately increasing the prices of their goods and services to reflect the actual value of the money.

"I'm sorry sir, the price on that vehicle is now $1 billion."

[moda0306]

MT,

I find your "contrarian" view on inflation very interesting, and it's a very necessary part of the macro-economic debate.  If you really think the fed's actions can't be inflationary until people begin spending, then why do you have some sort of problem with Keynesians driving the bus.  It's the Keynesians that realized the exact same thing you are... that after a certain point, monetary policy can't do much more and you have to use fiscal policy.  If we could increase inflation expectations, it would 1) get the money out from under the mattresses (thus being a sort of self-fulfilling prophecy) and 2) decrease the real value of both government and private debt.

Here's the way I see it... because of the fed's ability to print money, as well as the size of our government, it has a lot more flexibility with debt and spending than do most Americans and corporations (as well as countries like Greece) with similar balance sheets.  Interest rates demanded by the public can be effected by a debtor's 1) Default risk, and 2) Inflation risk.  There's other risks, but those are the two we're talking about at a macro level.  Since the US doesn't have default risk (the fed can always credit accounts), all you're left with is inflation risk.  Right now, I'm pretty glad the fed has the ability to print money, as I'd rather be in our position, than in the euro zone where individual countries have no control over the euro printing press. 

I like to look at it in terms of balance sheets.  A dollar enters the economy through stimulus by the treasury.  That dollar is going to a private individual who 1) will spend the money, 2) will pay down their own personal debt, or will 3) save the money... all of which seem to help either the recipients balance sheet or at the very least save a job cuz they are buying something.  So the private balance sheets actually improve from government spending.  It's the only way, in fact, to get rid of their debt overhang without plunging us into huge depression.... so now onto the public balance sheet.  Yes, they had to borrow the money, so the US balance sheet is worse off... but the government is paying much lower rates than the private individuals they are giving the money to, so I'm seeing a net benefit for interest payments.  But here's our trump card.  Any debt we go into can be printed away by the fed. 

That gives us, as a nation, huge flexibility when times get really tough.  We have no default risk and can manufacture enough inflation to improve our citizens' & government balance sheets as well as stimulate businesses income.  It's a fickle thing to fool with, but I don't see how people think that our NOT being tied to a gold standard or another currency is a BAD thing at this point.  Why would we bind our hands now, after the bonds were already bought by China & others, and we're already in recession.  If inflation was out of control, nobody would buy our bonds, etc, I could see us saying "ok, we'll tie it to gold... come invest in US bonds tied to a gold standard" but people are trying to say our fed's ability to pay down debt with printed dollars and manufacture inflation is a BAD thing... when it's exactly what we need right now, and this is exactly why we have a fed to begin with... so we don't end up like Greece, with our hands tied, default risk imminent, and interest rates rising in the midst of high unemployment and a recession.

MT... sorry for the long rant... I think we're almost on the same page, but I'm not understanding part of your view/argument.  I appreciate your constant input to these discussions.

[MediumTex]

MT... sorry for the long rant... I think we're almost on the same page, but I'm not understanding part of your view/argument.  I appreciate your constant input to these discussions.

I am simply arguing that the Fed may find it harder than anyone imagines to actually create inflation and inflationary expectations that result in an increase in the velocity of money.

Von Mises explains the aftermath of a boom driven by easy credit and it matches almost exactly what we are seeing right now.  The bad news is that it is a hangover that takes a long time to go away and it CANNOT be cured by more easy credit.  I am troubled by the Keynesian bus drivers because easy credit seems to be the only trick they know how to perform.

Von Mises would say that what we are going through now is simply the manifestation of decades of misguided policy and that the window for actually taking corrective action (such as allowing interest rates to reach their market rate without central bank intervention) closed long ago.  It's a bit like cancer showing up many years after exposure to a carcinogen.  By the time you begin to feel sick, it's basically over.

With all that said, I don't have a clue what will actually happen, but if I see a game of musical chairs with three or four chairs and dozens of players walking around....I know it may not end well.  I think that there is far more un-repayable debt in the world than anyone imagines.  I have yet to see or hear any realistic way of liquidating all of that debt.  So far, I think few people seem to grasp that "printing money" in a debt-based monetary system is simply issuing more debt, and as I noted above, a financial crisis triggered by too much debt simply can't be remedied by issuing even more debt.

I think all of these things will become clearer in the fullness of time....or I may be wrong about all of it and something entirely different may happen.  The wild card is political instability and the military conflict that it can lead to.  A political crisis can short circuit an economic crisis and I think that is one of the reasons that the two seem to travel together through history.

[Storm]

Moda, here's where I think you go wrong:

A dollar enters the economy through stimulus by the treasury.  That dollar is going to a private individual who 1) will spend the money, 2) will pay down their own personal debt, or will 3) save the money...

The dollars entering the economy from the Fed are not being given to private individuals.  They are being given to banks who park them at the Federal reserve and try to loan them out to businesses and individuals.  The key word here is "try."  They can try to loan money all day long at 0% interest, but if nobody qualifies (because their house is underwater) or nobody wants their easy money (29.99% APR credit cards?  Hello!) then the money just sits there doing nothing.  It's just a few extra zeros on a balance sheet somewhere.