At the risk of validating Fed researcher Kartik Athreya's argument that bloggers are stupid and have no business opining on economics, I've been intending for a while to write more about why I think inflation/devaluation is inevitable.
First, a few assumptions. These are unambiguously true in my view, but if you disagree with any of them, you'll likely disagree with the rest of the argument.
1) This is not a typical cyclical recession but a huge bust created by the bursting of the Mother of All Bubbles.
2) We have huge structural, not cyclical, job losses. No vast new labor-intensive industries will soon spring up to replace the millions of construction workers, realtors, and mortgage brokers who have lost jobs or suffered greatly reduced incomes in the housing bust, nor the retail and related jobs created by home equity withdrawals.
3) Fiscal stimulus has been a complete failure. We've wasted a trillion dollars on political pork and paying people to stay unemployed for 99 weeks. We are running huge deficits of 10%+ of GDP, and getting only 3% GDP growth from it. Since government spending translates directly into GDP mathematically no matter how badly it is wasted, 3% GDP growth during 10% deficit spending indicates that the non-government economy is in a severe depression.
4) Without government and/or Fed intervention, housing prices will return to historically normal price/rent and price/income levels. Indeed, signs of another leg down are already occurring after the recent expiration of the house buyer tax credits.
The fourth point is the nightmare scenario. Another big drop in house prices would cause a huge new vicious cycle of strategic defaults and foreclosures, would wipe out the net worth of millions of households, and would bankrupt the entire banking system and dump hundreds of billions or trillions more losses on the taxpayers via Fannie, Freddie, and FHA. Then of course all of the cities, counties, and states would have their budgets destroyed by reduced property values and reduced economic activity. And then all the pension funds that own bank debt and equity would take a huge hit and be unable to ever pay their promised benefits. In short, the Mother of All Depression Spirals.
The primary obstacle to economic recovery is widespread insolvency among households and banks (meaning liabilities exceed assets). A consumer who is broke cannot spend, and a bank that is broke cannot lend. Devaluing the dollar would reduce the real value of the debt (increase the nominal value of the assets), rendering millions of households and most banks instantly solvent. A simple example: a family has a $200,000 mortgage on a house now worth just $150,000, and they also carry some credit card debt and are underwater on an auto loan. A 50% devaluation of the dollar would mean a doubling of general price levels, making the house worth $300,000 and allowing the family to sell or refinance the house and/or car, pay off the credit card debts, and go from a negative net worth to a substantial positive net worth.
A secondary benefit to devaluation would be improvement in American labor competitiveness. Currently labor costs are too high in the U.S. relative to the rest of the world, leading to both automation and overseas outsourcing. If the U.S. devalues the dollar faster than other countries devalue their currencies, American manufacturing and exporting will become more viable.
If inflation is the only way out, how best to achieve that inflation? As I've pointed out before, Bernanke's current mechanisms are not working. Zero interest rates and buying assets from the banks serves only to bail out Wall Street and create asset bubbles that benefit asset owners, but this doesn't get money to the broad mass of consumers. The misguided theory seems to be that if the banks are made healthy, they'll eventually start lending to the little people. But people don't need more debt. Too much debt is what got them here in the first place, and more debt will only make things worse. What people need is cash to pay down the debt. If Ben Bernanke really wanted to solve the problem, he'd stop giving money to the banks and follow through on his "helicopter drop" threat to get the money where it's needed, to the people. One mechanism would be a printing-financed tax refund: give everybody a refund of all the federal income taxes they've paid for the last three years. Cap the amount for the rich and give some to the non-taxpaying poor to get the money where it will help.
It gives me no pleasure to call for debasing the currency. I hate what the Dirty Fed has done to our dollar and our country. But by blowing bigger and bigger bubbles to try to prevent normal, healthy recessions from occurring, the Fed has painted itself into a corner.
Obviously there are great risks to devaluation/inflation, with Weimar Germany and Zimbabwe being cautionary examples. Is it possible to pull off a one-time devaluation followed by a sound money regime? I don't know, but I don't see any option but to try.
I'm still formulating my thoughts on the subject. I'd love to hear your thoughts.
UPDATE: How much would have to be printed for the helicopter drop? The government collects around $1 trillion per year in individual income taxes. And the top 1%, 5%, and 10% of the rich recently paid 40%, 61%, and 71% respectively of all income taxes. So you could cap tax refunds for the rich somewhere in that range and give everybody else a full refund of the past three years' income taxes paid for around $1 trillion to $1.5 trillion. That's on the same scale as what Zimbabwe Ben has already printed to bail out Wall Street, and it's not too much more than Obama has stolen from our children for his $800 billion porkulus.