Look at the photo of a dollar below:

See where it says “Federal Reserve Note” and where it says “This note is legal tender…”?   Dollars are notes or debts, that is, obligations of the Federal Reserve.  When the Federal Reserve buys US Treasury Bonds from the open market  and pays for them with dollars (a process some refer to as “monetization” or “printing money”), it and the marketplace has simply exchanged one form of debt for another.  The supply in the hands of the market of one kind of debt (dollars) increased while another (Treasury Bonds) decreased.   Long before the Federal Reserve got involved to exchange dollars for Treasury Bonds – when the Treasury bonds were first created and sold to the public – that’s when the notional value (that is, the proceeds) of those Treasury Bonds was attached to goods and services.  Increases in government debt, as well as increases in private debt (net), are inflationary.  But not the monetization of the debt by the Federal Reserve.

At present, we have a situation where private debt is being reduced faster than government debt is being increased so that, in aggregate, total debts are declining – this is deflationary.

Technically, the total supply of debt can increase in an amount equal to the amount which society saves each year without inflation.  Conversely, total debt (including new equity shares) must increase by the amount of savings each year, or… we will have deflation.

You don’t have to be a bank to inflate or deflate.

Jimmy Songwriter sitting at the bar has a flash of inspiration and quickly writes down a new song.  His somewhat inebriated friend, Joey Songsinger hears the song once and enthusiastically offers to buy it for a price equal to “whatever it takes – even if it’s the whole income of the United States”.   Jimmy Songwriter, as a joke and to teach his friend a lesson, tells Joey he will sell the song for $13 Trillion and that he would finance it and Joey signs a note to Jimmy for $13 Trillion.  This single transaction goes on record as the highest price ever paid for a song… drives up the average price of all songs by a factor of thousands…and doubles nominal GDP  and the average price of all goods and services in the United States.  The next year at Christmas, when the note comes due, Jimmy sends his friend Joey an email offering to “settle” the note for $500.  Joey gladly agrees.  After all they both knew that’s what the song was truly worth …and what Joey could pay.  That year, nominal GDP falls from the previously inflated level by roughly 50% with a 50% deflation in the price level as there are no more songs sold (and financed) for such exorbitant prices.


1. We didn’t need banks or the Federal Reserve to create the price inflation or the price deflation which followed.  All we needed was debt creation and then the subsequent de-leveraging and return to “normalcy”.

2. Neither Jimmy nor Joey had the legal power to “print” or coin “money” and they did not need it to affect the price level.

3. Most importantly, what Jimmy and Joey do can offset and overwhelm whatever the Federal Reserve and the banks do.

John Mauldin is in the “mild” inflation camp, while Bill Bonner is in the deflation camp.  Mauldin cites the elements resulting in a tendency toward deflation as rising unemployment, massive wealth destruction, decreased final demand, low capacity utilization, massive deleveraging and a very weak housing market. But, then he bravely argues that our powerful, benevolent Federal Reserve will allow neither Bonner’s deflation scenario…nor large rates of inflation as posited by Peter Schiff:

The Fed is going to do what it takes to bring about inflation (in my opinion). But they will not monetize US government debt beyond what they have already agreed to. If they need to “print money” to fight deflation, they can buy mortgage or credit-card or other forms of private debt, which have the convenience of being self-liquidating. Read the speeches of the Fed presidents and governors. I can’t imagine these people will recklessly monetize US debt. You don’t get to their level without having a stiff backbone.

Mauldin’s apparent  blind faith in an effective, competent, and non-captured FED seems out of character.  It’s probably not naivete’ , but whatever else it is, it’s dangerous advice to bet on a potent FED in these times.  For our own part, the elements supporting deflation, as listed by Mauldin, are outside the FED’s control.  If they were within the FED’s control the FED would never have allowed them to begin in the first place.

So…since inflation benefits the people who owe lots of money and hurts people who are savers…guess who the economists want to benefit?  That’s right!- we figured you’d get it.  According to Bloomberg, since May, economists have been calling for inflation to trick people into spending/consuming rather than saving and to “lessen” the burden of the “debt bomb”.  Funny thing, the debt is owed to someone and it’s those people who are owed that suffer when they are paid back with devalued dollars.  So who is the group that benefits most directly from inflation?  You might think people who owe home mortgages.  But, since they are NOT seeing any wage inflation, they’re not benefiting…  It’s the banks- they are levered to the hilt and they get to pay back their debtholders with newly printed money.  Recently, a long list was published of economists who advocated “independence” of the Federal Reserve – independence meaning freedom from Congressional oversight. We suppose all economists aspire to work for the Federal Reserve and that’s why they all protect the FED at the expense of savers.  But even though the FED may be free from Congressional oversight, the FED is never free from its legal owners – the very same levered banks who benefit most from inflation.  IStockAnalyst has a good piece on this here.

Global Macro Speculations suggests that, if all else fails, the FED can simply print up a bunch of bucks and mail ‘em to us:

“Here’s how it would work, the administration working with congress would receive a advice from the Fed chairman to go ahead and issue a tax cut to virtually all citizens for an gigantic amount(Say 50% of US consumer spending, $5T), the fed would stand behind the bond auctions and monetize to make sure the government would have no problem financing it. The US consumer would suffer an gitantic ‘wealth effect’ of receiving such windfall gains in networth and its very likely to spend a significant fraction of the tax cut(as the history of the wealth effect shows, people spend when they get big jumps in networth).”

But of the $5T it may be, with the current propensity to save, that only about $1T will be spent….maybe that will still be enough….  As an indicator of what folks would do with a “printed windfall”, take a look at the comments to Smart Money’s request for responses to their question: What Would You Do With $100,000?

Here’s a couple of example responses:

50k to charity/church/world missions
25k would be invested in equities
13k would get spent partly on an engagement ring/honeymoon
12k would go to parents debt payments

pay off $34,000.00 mortgage.
keep $20,000.00 in interest bearing saving account for ‘rainy day ‘ expenses.
buy $40,000. in high interest preferred stock.
Donate $1,000.00 to charity

The responses indicate they will definitely NOT go on a shopping spree…many more simply want to pay off debt burdens.

From FP Comment:

“One test of whether we are witnessing the end of America is how many more times Americans put up with congressional show trials of individual business people and their employees, slandering and vilifying them for their actions and motives. And for how long will they tolerate a President who berates business and corporations as dens of crime and malfeasance?  If the majority of Americans come to accept the caricatures of business as true, then America is closer to the end of its life as a global leader, as a champion of markets and individualism.”

“…the Fed will have to be prepared to absorb all the excess money it has poured into the U.S. economy. It will be a technical and political challenge unlike any central bank has ever undertaken. The future of America is at stake.”

We at Swampreport.com think the odds of successful removal of those reserves once loaned out is a very long shot indeed.

Mint.com says one trillion greenbacks could fund an inflation-adjusted New Deal twice over. Not only are we paying two much money for what we get, we are giving up our freedom too.


Simon Johnson in RGE Monitor:

As [Bernanke] sees the world, there is only one course of action remaining: print money and hope for a moderate degree of inflation.  The money part was, of course, the announcement yesterday from the Fed….The inflation part is a leap of faith…if you can explain to me exactly why oil prices rose as they did during the first part of 2008, despite the slowing global economy, I might be greatly reassured that we are not heading immediately into a runaway inflation spiral. “

Hmmm, we are having difficulty explaining it…so Dr. Bernanke may not get just a moderate amount…