Money - Spare a $trillion?

Recently two world famous economists saw the economy in dire straits, for opposite reasons. Allan Meltzer sees crippling inflation and Paul Krugman sees the potential depression era deflation.

So the government is going to borrow (and essentially print) a trillion dollars on our behalf. What does this mean?


Since most new money comes from loans, add up all the money in America and it will not cover all the debt (because of interest). The banks essentially create money when they lend money for construction or other projects, so long as they don't max out their deposits/loans ratios. When they stop lending to their historical rate, they are taking trillions out of the economy, which left to its own devices will result in massive deflation. Defaltion (the dollar increasing in value and prices going down) like this, is not in itself a bad thing once the process is finished since all prices will be proportionately less, but getting there is hell. Everyone will have to take paycuts and pricecuts since there will not be enough cash in the economy to pay everyone at the old rate. There will be strikes and lawsuits everywhere. Debts in place before the deflation period will be too big to pay back since money will get scarser. Everyone will start conserving cash since they will expect the dollar will be worth more in the future.

So the government creates a trillion dollars out of thin air (using an IOU) and spends it on government programs. So there are two possible outcomes:

(1) The goverment doesn't cover the hole left by the reduction in loans by the banks and the amount of money in the economy shrinks, hence scary deflation.

(2) The government is going to overshoot the amount of money the banks are taking out of the economy(by reduced lending) and set the country awash in dollars. This will cause serious inflation.

What the government is doing is risky. By, in effect, printing money (or borrowing it on our behalf) they are subtly reducing the value of everyone's dollars unless its put into production or assets that are exactly worth the money borrowed, but if they match exactly the shortfall coming from the banks, we should be back in the same place as an economy although different people will end up with the money. The main difference is that the banks historically would target people that would show a direct "return" for this investment and try to direct loans to production or productive people, whereas the government will redistribute wealth to favored senators, lobbyists and some civil-service-bureaucracy-determined needy project. This will result in assets and production that will absorb a trillion but only fetch a fraction of that in a "theoretical" open free market. In this way, they will have devalued the dollar directly and caused inflation, as if they had a giant basket of money and given half of it or more to favored sons of the government. The wealth redistribution will be clumsy, inefficient and perhaps a little corrupt, but if the government doesn't do it no one else will and as a result I reluctantly support it. We will take the surgeon with the bent fork instead of a scalpel because there are no other surgeons around. We all allow this because we believe that desperate times call for desperate measures. However, bureaucrats spending trillions of dollars can be addictive, and a lot of people will become powerful that were not powerful before. There will be no taking back the largess without a fight. So, the trillion dollar question is, will they be able to dial it back completely before the tail wags the dog? History says probably not.