“So should we worry that this financial crisis and its fiscal costs will eventually lead to higher inflation? The answer to this complex question is: likely not.”

Anon 2:03, thanks for the response… I have read Bernanke’s famous speech. Like everyone else, I’m just trying to figure out what actually could happen and succeed given the many constraints (Roubini mentions a couple). Roubini may be wrong about the Fed’s willingness to inflate but his track record has been impressive so far…

Once you get to the point where interest rates are at 1%, you’re injecting money directly into various firms, and things are still falling – real interest rates remain high – then you start having to do things like mass purchase Treasuries to try and drive real interest down.

The problem with that is that you’re then pretty much handing out money to anyone who wants it – there are $10t of Treasuries out there and a whole lot of people who would love some money.

It also creates a new difficulty in that everyday financing of government debt is a direct counterbalance to treasury yields – you’re hitching program spending directly to the monetary base at that point. You end up with little to no “fiscal space” – the ability for a government to operate without ruining the economy. This is one of those signposts on the road to sovereign default, so it’s highly discussed in IMF/World Bank papers.

It’s generally considered that at some point along the road people start noticing that money is appearing faster than the Treasury yield — the latest figures for the shadow M3 put it at “only” $14t – so if you need to buy more than $420b ($14t*0.03) of Treasuries in a year to try and keep the yield at (say) 3.00, something’s gotta give. You then have a Bad Time.

I suggest RMB.

the Fed’s expansion is inflationary. The definition of inflation is printing more money. But they are running into the Japanese dilemma and that means they are pushing on a string — this is due to the Great Deleveraging that you speak about.

And it is the base money supply that counts domestically and abroad. The broad money supply is just a manifestation of leverage. The more leverage and credit, the greater the money multiplier and the more effective inflation is.

The Japanese flooded their economy with Yen, but as no one wanted to lend, the money supply did not expand. In fact, what happened is that money fled the Yen and started a carry trade as domestic investors started to invest abroad.

Effectively, Japan was exporting its inflation abroad.

As for the U.S. being insolvent, I am being a bit tongue-in-cheek. When you have the world’s reserve currency, it is pretty hard to default. That does not mean that one is not effectively insolvent.

But no one can repossess their assets, so all that can happen is monetization of the debt. This happens when the Fed buys bonds directly, which is already planned.

Here’s a paper from the St Louis Fed Review, December 1984, detailing the process and what effects it might have.

“They [China] are in a catch-22 situation – they lost big-time, but they must stay in this game, and help the United States. [...] We heard a rumour [...] that Henry Paulson has been calling China on a daily basis in the past few weeks, since the crisis struck, and saying, ‘Don’t sell anything. Don’t go away.’”

He implied the rumour came from sources in the government. I believe him.

Show details, including an audio link — most of the first 20 minutes is very very elementary, just defining terms; then it gets into details of possible G20/IMF changes, nothing too exciting. Jiang seems to have the most new information, from Beijing – his rumour comes around the 25 minute mark.

However I do agree that an increased reluctance to hold dollars relative to other currencies could trash the value of the dollar.