How to Avoid the Inflation

Dated 18 May 09

Here's an item I was putting together back before I started this blog. It was for my Google-site. But this was just when I was starting to figure out the difference between a website and a blog. Anyway, I knew this post wasn't meant for the website and I just left it as litter on my desktop. 'Til I found it this morning.

Policy: Eventually, no option.

The Federal Reserve and the Bank of England are printing money like crazy, and everybody on the internet is worried about inflation. But it has to be done. And there is a way to avoid the inflation.

We can avoid the inflation. We just have to make sure all that newly printed money doesn't get into circulation where it can bid prices up and up and up. And there's a trick to it. The trick is to look at what we did wrong. To look at it, and turn it around, and do it right this time.

Until the crisis hit, printing money was not the problem. The problem was the borrowing. It was borrowing that created the money that caused the inflation. Borrowing, not printing, that caused the inflation. Now, maybe that's a bold claim. So be it. The debt is proof. A dollar of debt is the footprint of a dollar somebody borrowed and put into circulation.

Debt is footprints. If we printed that money, we'd have money instead of debt. But we didn't print it. We borrowed it. So instead of having money, we have debt. Footprints. We have places where money is supposed to be, where we expect money to be, but there's no money there when we need it. Only debt.

A lot of it is government debt. A lot of it is consumer debt, subprime debt and credit-card debt and equity loans and personal loans and whatever else the modern penchant for "financial innovation" has managed to create. And a lot of it is business and corporate debt and even -- get this -- financial debt.

Debt is debt. You don't have to understand derrivatives. You don't have to know what 'subprime' means. None of that matters. Debt is debt, and too much is too much. Creating imaginative new names for debt may postpone and magnify disaster. It does not prevent disaster.

All of that debt together gives us an idea how much money was borrowed and put into circulation, where it drives prices up.

So anyway, until the crisis hit, it wasn't printing money that caused inflation. It was borrowing. But apparently our policymakers never figured that out, because they chose to fight inflation by restricting the quantity of money instead of the level of borrowing. As a result, we ended up with the worst possible combination of circumstances. We ended up with plenty of debt, and not enough money to pay it off.

On the one hand we borrow money and accumulate debt in a process that creates money and causes inflation. And on the other hand the Fed takes money out of circulation. They leave us our debt, but no money to pay it off.

In the end we have all this debt, and we don't have the money to pay it off because the Fed took the money out of circulation. As long as the economy grows, debt accumulates and money is restricted. Because of this economic policy, people find it more and more difficult to pay their bills. Eventually the process becomes unsustainable. One day it all hits the fan. And then we have a "credit crisis." At that point, the only thing that can be done is to print money and print money and print money, until some measure of balance is restored between money and debt.

And that is where we are today. That is why the Federal Reserve and the Bank of England have to print money like it's going out of style.

Now, here is what should have been done: Instead of letting the Fed take M1 money out of circulation (while all that debt accumulated), we should have been using the M1 to pay off some of that debt. That would have taken money out of circulation, and put it into the banks. Doing it this way, we would fight inflation, and reduce our debt, and make the banks stronger and more stable and ready to lend again. All at the same time.

And it is good when the banks want to lend more, because that helps the economy grow. Also, our existing debts are reduced by this new policy. So the accumulation of debt is less, doing it my way, than doing it the way we've been doing it. Doing it my way, everything works together. Everything falls into place. Everything fits.