"Inflation hawks" = dodo birds

First, let us discuss money. Money is anything you can exchange for something else of value. We could use, say, potatoes, but we mostly use green pieces of toilet paper with pictures of dead Presidents on them, simply because that's what the government wants for its taxes and everybody accepts these and they have a fairly stable value since only the government is allowed to print them, unlike, say, if we used potatoes for money, where every fall potatoes flood the market and every early summer potatoes are hard to come by and potatoes aren't exactly the most portable money around. I mean, have you ever tried carrying potatoes in your pants pockets? It'd make Commander Codpiece's codpiece when he landed that jet on that aircraft carrier look comfortable, yo.

So, anyhow: Houses are money. Say wha, you say? But yes. You can exchange your house for a lot of green pieces of toilet paper, which you can then exchange for other things of value. So your house is money, even if once removed.

So anyhow, in 2008 alone housing values here in the United States fell by $5 *TRILLION* dollars. That's $5T in money that evaporated out of our economy. Gone. Kaput. No longer present. Mostly it affected banks, since they'd traded those houses for money via "mortgage-backed securities" and the folks who'd bought those securities now wanted their money back 'cause the securities weren't paying, but if banks are out $5T, *everybody* is out $5T. And that's 2008.

Now, what happens when you lose $5T out of your money supply? It's called *DEFLATION*. As I previously pointed out, monetary deflation does *not* generally lead to price deflation at least in the short term, because of price stickiness -- if the materials and labor to make Gizmos costed Gizmo Inc. $5, they are *not* going to cut the price of Gizmos to $4. That would be insane. They'd be selling each Gizmo at a loss, and soon be a *former* business! Instead, they're going to keep the price of Gizmos at something like, say, $5.50 -- so they can make at least a *little* profit to cover their overhead. Thing is, there's less money in the economy. There used to be enough money in the economy to buy a million Gizmos at $5.50 apiece. Now there's only enough money in the economy to buy a 800,000 Gizmos at $5.50 apiece. So Gizmo, Inc., sells only 800,000 Gizmos. Since they're selling only 800,000 Gizmos, they have more Gizmo factories than they need, so they close a couple of Gizmo factories and lay off 500 workers. (Note: I'm using Gizmo Inc. as a proxy for the economy as a whole, because the whole economy works this way).

In short, the immediate short-term effect of deflation is UNEMPLOYMENT. And you can measure the current state of monetary inflation and deflation not by looking at prices -- which are sticky, as I point out above (and as we have actually measured both in the Great Depression and now in the Great Recession) -- but by looking at the unemployment rate. If there was more money circulating in the economy, there would be enough money in the economy to buy a a million Gizmos at $5.50 apiece and we'd have full employment. But there isn't.

In short, if you look at the unemployment rate as a proxy for the inflation and deflation rate, rather than prices and wages (and wages are sticky for a *different* reason that I'll discuss later), it is clear that since we have close to 10% unemployment, inflation is not in the cards. People worrying about the currency being "debased" are either full of shit or don't have the foggiest clue, because if the currency was being "debased", we'd have so much money circulating in the economy that Gizmo Inc. would not only be able to sell all 1M Gizmos that it's capable of selling, but it'd be borrowing money to build new factories so it could make even more Gizmos. Instead, Gizmo Inc. is sitting on a pile of cash that it's not willing to invest -- because if it can sell only 800K Gizmos at a price that allows it to make a profit, yet has the capacity to make a million Gizmos, why would Gizmo Inc. invest in more factories?

When unemployment falls below 7%, then come and tell me that we need to worry about inflation. Until then... well. We lost $5T in asset values in 2008. The Federal Reserve hasn't printed $5T in money to make that up, and besides, the real estate asset bubble collapsing led to other deflationary events (such as the money multiplier basically disappearing). The end result is that we've hit the zero bounds in interest rates, to the point where last week the U.S. Treasury sold some T-bills at *NEGATIVE* interest rates. Yes, people actually paid $120 for $100 worth of T-bills! And once you hit the zero bounds, you leave the realm of Chicago-school monetarism and enter the realm of Depression-style Keynesianism, where printing money simply results in the money disappearing under mattresses rather than circulating because it'll be worth more in the future -- thus why people are willing to pay $120 for $100 worth of T-bills, they are expecting $100 in the future to be worth more than $120 today. I.e., they're expecting deflation, and the only reason they're buying T-bills is because their mattresses aren't spacious enough to stuff enough cash under there.

So how do we get Gizmo Inc. selling a million Gizmos again? Well, there's two ways we can do that. First we can put more money into the economy. The time to have done that would have been in mid-2007 as the bubble started bursting, but monetary easing really didn't start until mid-2008, and was woefully inadequate in scale (roughly $2T printed to deal with $5T in asset value losses). The Fed's QE-2, just started, is projected to be another $500B in monetary easing. Big fuggin' woop, not going to accomplish a thing. The second is to put the money into the hands of people who are willing and ready to buy Gizmos -- but that's most effective with strings attached saying they have to *spend* this money, not put it under mattresses. That's why infrastructure projects, where government prints money to build roads and bridges, are so effective at ramping up the economy -- the money goes to contractors who are required, by law, to spend most of that money on steel, on hiring people, on actually building stuff. And the steel company has to spend money buying ore, and coal, and on steelworker wages. And coal mines have to spend money on lawyers to keep regulators from regulating mines, on coal miners to die in those mines, and... err, you get the point. Stuff starts *moving* in the economy, people start getting hired. Gizmo Inc. is selling more Gizmos as all those newly-employed workers spend that freshly-printed money on stuff they'd put off buying while unemployed. And the economy recovers.

So how can we get back to full employment without a massive government infrastructure program to get consumption kickstarted again so that Gizmo Inc. can hire back those two factories worth of workers that it had to lay off when deflation meant there was no longer enough money circulating in the economy to buy all their Gizmos? Well... we can't. Which is why the next two years of the Party of No will be economic stagnation and continued high unemployment, and why notions of inflation are utterly ludicrous -- any freshly-printed money will simply disappear under mattresses, either as people save it (to compensate for the ludicrously low unemployment compensation here in the US), or use it to pay off credit card bills, at which point it disappears back into the Fed's vaults as bank reserves and as far as the economy is concerned no longer exists, since it's no longer being used for the exchange of goods and services.

And that, my friends, is reality: The unemployment rate makes a great proxy measure for whether we're entering monetary deflation or inflation. And right now, it says we're deflating, not inflating, yo. Worries about debasing the money supply via excessive printing, given that reality, are just plain debased, pure and simple.

-- Badtux the Economics Penguin