Someone just sent me this video (http://www.youtube.com/watch?v=YDEe0Ai6lTM), which came from a graph I circulated a month or two ago, showing the rate of government money-printing going up like nothing ever seen in history. Note that the source is the Federal Reserve. (Look closely at the blue line -- it's vertical in 2009.)
Someone else asked me the other week why this graph is so devastating -- why printing a lot of money causes inflation. I answered, if you had a pile of goods and another pile of $1000 in bills which represented those goods, and you doubled the amount of dollars representing those goods, what would have to happen to the price of those goods? They'd go up. And if the pile of goods was the entire world? My friend got it.
In a real economy inflation doesn't start up instantaneously when you double the pile of dollars because it takes time for them to enter the system -- initially they're held by banks who must lend the money out to people, but surely as dumping a large tank of water into an under-sized swimming pool, the effect will ripple through and sunbathers will drown.
But how fast will this occur? If the Fed doubles the number of dollars, and prices must eventually double, what rate of inflation will get us there?
For instance, at 20% per year inflation, what power of 1.2 equals 2.0? 1.2 x 1.2 x 1.2 x 1.2 = 2.0736, if the inflation rate was uniform over 4 years. If inflation built up gradually, it could be 1.06 x 1.1 x 1.5 x 1.7 = 1.982. That is, 6%, 10%, 50%, 70%.
But you can be sure that as inflation heats up the Feds will try to do something to control it.
For awhile they don't want to, of course -- they are *counting* on inflation to effectively reduce the national debt by devaluing the currency. If it takes twice as many dollars to represent the same goods, the value of a dollar becomes 1/2 what it used to be, and the national debt is 1/2 what it used to be. This is another way the Feds rob us. When you're talking a national debt of 10's of trillions of dollars, however, it becomes a big deal. A trillion here, a trillion there, and pretty soon you're talking some real money. It's the cheapest thing they can do to effectively shuck debt in a short time.
Someone has to pay for that, of course -- everyone who owns T-bills and money market funds, everyone who holds debt at fixed interest rates, or variable rates that lag the inflation. A lot of individuals and companies and most of the countries of the world.
Even the people who have borrowed will lose. Initially, they might appear to be getting a good deal in the largest wealth-redistribution scheme in history. But their paychecks won't keep up (if they keep a paycheck, that is) and the decline in economic output will eliminate enormous numbers of goods and services that benefited them. It will be the good fortune awarded a hobo. (As a well-known humanitarian of the 1930s remarked after returning from Soviet Russia, "It was so wonderful to see them all so equally shabby!")
But inflation is ultimately seriously destructive. It is *not* a good thing for the government to reduce its debt by printing money. All they are doing, you see, is stealing the same sum of money through a back door that doesn't require us to pay more taxes. If they manufacture a crisis that scares the bejeezus out of our behinds so that we give them the authority to print whatever they want, it's effectively like doubling our taxes.
I'm not suggesting the real crisis was intentionally manufactured -- at least, beyond the intentions that created the Fed, expanded lending to unqualified borrowers, increased regulations on business (like putting a straightjacket on every automobile driver to reduce accidents), fired CEOs at the whim of government auto-rats, nationalized industries, ad infinitum -- but in presenting the case to Congress they wanted to make the crisis look as dire as possible to get the authority they needed. Both Bush and Obama did exactly this with Tarp1, Tarp 2 , the Stimulus Bill, the G20 Summit last week, and stay tuned (same Bat time, same Batty channel). The result is the same.
If you can see that doubling the taxes of the entire country in one move would be catastrophically destructive to the economy, you can see the effect of doubling the amount of dollars in circulation and devaluing the currency.
I may be understating the problem a bit, however. That graph showing the number of dollars in circulation to be doubling doesn't mean prices must double. There is some leveraging effect. Banks lend, borrowers spend. I think I'm correct in saying that doubling the amount of dollars multiplies the price of the goods by more than 2. How much I'm not sure, but at a wild guess (pick your own number greater than 2), I'd say the leverage is at least 2X.
You can check this approximately by comparing growth in the monetary base with inflation of the dollar, but beware -- not only are government inflation indices like the CPI wildly deceptive, they don't factor in more efficient production from things like new technologies. Most people don't realize that in fully laissez capitalism, prices decline. Every year, for most goods.
Look at computers -- in 1985, a desk-sized Apple "Lisa" computer with a 20 Mega-byte hard drive was $10,000. Today, what can you get it for?
Looking at that graph above, it shows 200 billion in 1982, a year I remember so fondly as the high point of Jimmy Carter's reign of incompetence. In 2008, it was about 850 billion. That's a growth of 4.25. In 1982, engineering salaries in my field averaged about $30k. Today, more like $130k. So maybe I'm wrong, but I won't bet a plugged C-note on it. Today I have to work many more hours and most families are two-income to break even. It's so much more complicated than looking at a Consumer Price Index that compares the price of bread and gasoline between now and then.
Inflation doesn't just stop. It becomes built into business contracts, government policy and people's expectations, and generally takes as long to decline as it took to build up. So the costs goes way out into the future.
As inflation heats up many businesses also fail -- running a business in a climate of variable hyper-inflation is like running in high winds on a high-wire made of sewing thread. Risk and failure multiplies enormously. The number of goods falls (increases prices), more people go out of work (less demand for goods), government raises taxes (they never lay people off), etc.
The effective rate of inflation, after factoring in that lost "opportunity cost" caused by government interference in markets could look more like 10% 20% 40% 30% 50% 20% 100% 40% 70%.... forever. Until government gives up the printing press, which they will only do in the form of replacing the dollar with the American Peso -- the next step beyond the printing press is the shell game of a new currency.
There will be many factors pulling prices up and down to modify those rates of inflation. It's just too damned complicated for anyone to keep track of or fully predict, beyond the general principle that printing money is ultimately destructive of wealth. But of course, the Feds think they know better. On that you can bet the bottom of your dollar.
P.S.: I sometimes use terms that people have forgotten the meaning of. For instance, "Same Bat Time, Same Bat Channel" was always used in previews to the old "Batman" TV show, a farcical dramedy from the 1960's mocking an out-of-shape superhero in tights and cape battling villains like the Riddler with over-the-top statements and exotic gadgetry that doesn't work in reality. There's the U.S. Government for you.
My term "plugged C-note" comes from the term, a "plugged nickel'. When coins were made of precious metals, to "plug" a coin meant to remove its center and replace the missing part with a worthless metal like lead or tin. Thus you held onto your gold or silver because a "plugged nickel" allows you to put fake money into a vending machine (for instance) to get goods you don't deserve. In the age of printed money, plugging a C-note, as I've coined the term, means getting candy from the vending machine of the U.S. economy by putting a bullet in every taxpayer with a printing press. A similar effect.