The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Jay Taylor, J. Taylor’s Gold and Technology Stocks
Ultimately, debt becomes such a burden that it can no longer be serviced. And when that happens systemically through the economy, as it does every 60 or 70 years in the Kondratieff cycle, we get a major economic contraction that results in massive bankruptcies, debt repudiation, high levels of unemployment, and plunging prices. If policy makers would not engage in manipulation, the markets would self-adjust on an ongoing basis in a gradual manner and there would be minimal upheaval. Unfortunately, politicians and their crony banker friends are helpless market manipulation addicts who can’t resist intervention. So, imbalances are pushed to an extreme until they reach a breaking point. The correction and restoration back to equilibrium is enormously painful and disruptive.

Why does the system ultimately break down? Why can’t Mr. Bernanke or his successor simply print enough money to avoid a day of reckoning forever? In very simple terms, there are two factors. First, the more excessive the amount of money, the more artificial is economic growth. That is, resources are allocated in a very inefficient manner. So for example, during the 1990s high-tech stock market bubble, we saw billions upon billions of dollars lost in tech stocks because those enterprises were not viable businesses.

Had we been on a gold standard and money had been hard to come by, capital resources would not have been misallocated. Instead we would have had capital allocated to businesses that would have generated profits. But here is the real problem. Even though money is carelessly thrown into mal investments as a result of the excessive creation of money via the banking system, the debts from which this money was manufactured remain to be repaid. And so you get a situation where debt is growing exponentially while income is constrained by the physical laws of nature. In other words, in a fiat currency system like the one we have now, in which debt is the raw material from which money is manufactured, it is possible—for a time—to create the illusion of wealth via the “printing press.” But it is not possible to create sufficient income from bad investments with which to repay the debt.

Secondly, I am not so sure that the Fed cannot afford to turn us into a deflationary collapse if it is faced with the prospects of the U.S. dollar becoming increasingly worthless vis-à-vis other currencies and the U.S. losing the benefits of owning the world’s reserve currency. If the dollar tanks, I do not see why we cannot expect a repeat of 1980, when Volcker saved the dollar by stomping on the monetary breaks and causing real interest rates to rise to their highest levels since the Civil War. Had Volcker not done that in 1980, the U.S. would have been toast back then. The same people, or at least the same ruling-elite families who were in charge then, are in charge now. I do not see why they would relinquish their power as “landlords of the world” now by allowing the dollar to head toward zero vis-à-vis other currencies and gold.

Yes, I know we have much more debt now and that we are a debtor nation and a similar policy now would really send us into Ian Gordon’s Kondratieff winter. While the elected officials and even the Fed chairman may need to act like they care about the pain and suffering of common, ordinary Americans, their willingness to inflate wealth away from us does not suggest they care two hoots about common people. I believe the establishment will inflate as long as they can get away with it, but that they will once again pull a 180 degree policy turn on monetary policy and interest rates if draconian measures are required to save the dollar as the world’s reserve currency and the Anglo-American controlled world economy.

Steve Saville, Speculative Investor
Inflation is an INEVITABLE consequence of the current monetary system. It is inevitable because the current monetary system is, in effect, a giant Ponzi scheme (a scheme that can only continue as long as there is enough money coming in from new investors to pay previous investors), and once you've created a Ponzi scheme you can't just stop paying people for a while. This is why there won't be an intervening period of deflation between now and when inflation eventually destroys today's money; rather, the inflation will continue -- interrupted by the occasional deflation scare but not by actual deflation -- until a monetary collapse occurs.

The current monetary system's Ponzi-scheme-like nature stems from the fact that each new dollar borrowed into existence creates a liability in excess of one dollar due to the obligation to pay interest. This characteristic has, over the decades, resulted in the obligations to pay dollars becoming many times greater than the total supply of dollars, so the dollar supply must continue to expand in order for the system to survive. Or, putting it another way, if there ever was a chance for the Fed to allow the US to experience a 'cleansing' period of deflation that chance is long gone. The issue, therefore, is not whether the Fed will ATTEMPT to maintain the inflation (it doesn't have another option), but whether it will be ABLE to maintain the inflation.

As long as the laws of supply and demand remain in force then someone who can increase the supply of some 'thing' by an unlimited amount will always be able to reduce the value of that 'thing' if that's what they choose to do. The central bank has the power to create an unlimited amount of currency, so those who argue that the Fed will be unable to prevent the dollar's purchasing power from rising are claiming, in effect, that the laws of supply and demand don't apply to money. Such claims are patently false.

By engineering a $180B increase in the money supply within the space of only a few days during September of 2001 the Fed demonstrated just how effective its direct money-creation powers can be when 'push comes to shove'. The devastation wrought by terrorists that prompted this sudden injection of money came without warning, so just imagine what the Fed could do given a few months to plan.

But despite a) the Fed chairman having clearly explained why the central bank will never be at a loss when it comes to reducing the purchasing power of the currency and b) the fact that there is solid empirical evidence of the Fed's power to inflate under adverse circumstances, many analysts continue to argue that the Fed will be powerless to inflate if the US consumer ever begins to cut back on his/her borrowing.

What we think the Fed fears more than anything else -- certainly a lot more than it fears deflation -- is an uncontrolled surge in inflation expectations. The dollar's slow-motion collapse can continue almost indefinitely, with the Fed injecting money in response to the occasional deflation scare and pushing short-term interest rates up when inflationary pressures begin to show through, as long as the public doesn't come to believe that the dollar will lose its purchasing power at an ever-increasing pace. However, if the public began to anticipate acceleration in the rate at which the dollar loses its purchasing power then prices would begin to rise much faster than would be justified by increases in the money supply alone, and bond yields would rocket upward. This is why the Fed must keep hiking short-term interest rates until inflation expectations are most definitely under control, regardless of how much damage the rate hikes are perceived to be causing to the economy. If they overdo the rate hikes they can always inject enough new money later to re-energise the inflation trend, but sharply rising inflation expectations would be a life-threatening problem for the current monetary system. The bottom line is, soaring long-term interest rates -- a guaranteed effect of letting inflation expectations get out of hand -- would be far more damaging than any problem caused by overly tight monetary policy.

Yes, we know this is exactly the opposite of conventional wisdom. Almost everyone thinks that the Fed will do anything -- including tolerating a much more rapid decline in the purchasing power of the dollar -- to mitigate the risk of a deflationary outcome. And Fed representatives never miss a chance to bolster this line of thinking because such thinking is necessary in order to keep the game going. After all, who would invest in 30-year US Treasury debt yielding 5% if it were known that there was no chance of deflation and that an additional large decline in the purchasing power of the dollar was all but guaranteed? The Bank of Japan might, but no private investor in his/her right mind would.

The truth of the matter, as we see it, is that the Fed has the tools to keep the inflation going and it KNOWS it has the tools to keep the inflation going. The Fed's biggest fear is that everyone else figures this out…

Mike Shedlock, Mish’s Global Economic Trend Analysis
It seems that everyone feels the Fed is all-powerful, and that the Fed can defeat the business cycle by forever printing money. That is the fallacy of the inflationist arguments. It cannot be done. The root cause of the great depression was an overexpansion of money and credit. "Helicopter Drop Bernanke" could no more cure that by printing more money than I could take on Michael Jordan in one on one basketball at his prime.

Banks can print but they cannot force consumers to either borrow or spend. If bankruptcies expand faster than borrowing, the net of money supply and credit will contract. That is deflation.

Although Japan [in the 1990s] was rapidly printing money, a destruction of credit was happening at a far greater pace. There was an overall contraction of credit in Japan for close to 5 consecutive years. Property values plunged for 18 consecutive years. The stock market plunged from 40,000 to 7,000. Cash was hoarded and the velocity of money collapsed. Those are classic symptoms of deflation that a proper definition incorporating both money supply and credit would readily catch. Those looking at consumer prices or monetary injections by the bank of Japan were far off the mark. Yes, the US is different than Japan. We are far worse off and much deeper in debt. That adds to the deflationist case. Wage fundamentals are much worse now especially with outsourcing and the internet. That adds to the deflationist case. Ultimately it comes down to the question of "will the banks destroy themselves and their wealth" to bail out consumers deep in debt.

The answer to that question is "Of course not. Why would they?"
 
So why has there been persistent inflation since 1940? The answer to that is the Kondratieff Cycle. Three fourths of the cycle there is inflation. Each season is long (18-24 years). By the time we get to deflationary winter, many (most) people that have only known inflation all their lives dismiss the idea. No one believes that deflation can happen. They have seen nothing but inflation all their lives.

If housing is the bubble of last resort, what would happen if the Fed turned on the pumps? I suspect money would go into gold and silver, but no jobs would be produced, certainly nothing like the housing boom produced. That last sentence should explain why many deflationists like gold. That answer is also why it would be game set and match for the Fed. Yes the Fed could in theory drop money out of helicopters, but only if they wanted to destroy themselves. There is theory and there is practice. If consumers are finally at the end of their ropes as I suspect, inflationists are in for one rude shock.

Doug Noland, PrudentBear Credit Bubble Bulletin
The current Financial Structure, dominated by Wall Street securitizations, leveraging, derivatives, and asset/securities speculation, inherently incites and then feeds runaway Credit, asset and speculative Bubbles. 
 
“Resiliency” is a defining attribute of contemporary “Wall Street Finance.”  As they demonstrated (again) this past quarter, if market dynamics dictate that particular segments of the brokerage/proprietary trading/securities financing/investment banking/derivatives/global finance business face tougher headwinds, it is simply a matter of tacking a bit in another direction. If one sector or region is struggling, just push the others. If one area of the market falls somewhat out of favor, simply fashion and offer buyers (increasingly hedge funds) the type of securities, instruments and/or derivative products with the return, risk and liquidity profile they demand. If clients prefer to leverage U.S. or global securities, fine; need financing to buy companies at home or abroad, no problem; or any complex derivative strategy for any market – now so easily accomplished.  And, importantly, championing booms in the relatively better performing areas, sectors and regions works to buttress liquidity for the enjoyment of all (hence, bolstering the lagging – as we witnessed with market pricing this week).

Recalling how the bursting technology Bubble welcomed the emerging housing finance Bubble, it is today imperative to remain cognizant of the fledgling Bubbles waiting to be over-financed at home and abroad. The expansive “energy/energy-related” sector is primed for unprecedented investment, spending, speculation, waste and fraud. There are as well intense inflationary biases throughout global finance, bolstered by a confluence of massive trade imbalances (foremost the U.S. Current Account Deficits), energized Credit systems across the globe, the ongoing Chinese/Asian boom, frenetic worldwide M&A activity, frenzied leveraged speculator community activity, and the swelling liquidity being accumulated by the oil exporting economies. And as much as the Fed expects inflation to abate, the bottom line is that it is a fact of economic life (and history) that inflationary pressures have a stronger propensity to amplify and broaden than they do to dissipate.

So, should we expect today’s financing infrastructure of unprecedented dimensions to be willing to moderate and downsize, or will the intense expansionary (inflationary) bias persist?  Inflated stock prices – and massive stock option grants and share repurchases - point to the latter. Thus far, rising short-term rates and contracting lending margins have incited a push for lending volume (bank Credit up 11.3% annualize y-t-d). Stagnating mortgage profits have to this point nurtured aggressive expansion in capital markets, trading, international and prime brokerage (hedge fund services) businesses. Until proven otherwise, I will stick with the view that the profligate Financial Sphere expansion will run unabated until it is interrupted – and perhaps terminated – by financial crisis or some exogenous event.