This post at debt deflation is the best thing I have read in awhile. It touches on some things I realized a few months ago that I included in my last letter. It also explains (much more eloquently) why I believe if we get inflation in the short term (next year or two) it will be because of trust deterioration, not because of a dramatic increase in the money supply though that will contribute. It is also why I don't think anyone knows whether it will be an inflation world or a deflationary world over the next couple of years. The U.S. government has said we may fail but it won't be because of deflation. Well the most recent realization is that they are a long way from making that a reality. If that mindset is really true, the printing presses are in pre game.
This writeup is very technical and I read some of it three times to wrap my mind around some of the true implications (and I still probably missed alot) but is at the heart of what I think is important as investors continue to try and grasp the inflation versus deflation scenario. This is also at the crux of Hoisington and Kyle Bass arguments on why deflation is the fear in the short term. Big thanks goes to Ron.
Thus causation in money creation runs in the opposite direction to that of the money multiplier model: the credit money dog wags the fiat money tail. Both the actual level of money in the system, and the component of it that is created by the government, are controlled by the commercial system itself, and not by the Federal Reserve.
However, neoclassical economic theory never caught up with either the data, or the actual practices of Central Banks—and Ben Bernanke, a leading neoclassical theoretician, and unabashed fan of Milton Friedman, is now in control of the Federal Reserve. He is therefore trying to resolve the financial crisis and prevent deflation in a neoclassical manner: by increasing the Base Money supply.