Deficits, Debt, Inflation and Have a Nice Day

I have made some market calls here, expressing my pessimistic view regarding US Treasuries based on the major political developments of the day.  I am heartened that no less than WSJ Op-Ed legend George Melloan agees with me.  He takes to those familiar pages today to warn us, Obama - with Bernanke's complicity - is basically destroying the dollar, the Fed, and ultimately, our standard of living.  It's a must read.

Now might be a good time for people to get acquainted with the Debt Theory of Inflation, most ably espoused by U of Chicago economist John Cochrane.  Here is a quick read on it and here are a few nuggets:

As a result of the federal government's enormous debt and deficits, substantial inflation could break out in America in the next few years. If people become convinced that our government will end up printing money to cover intractable deficits, they will see inflation in the future and so will try to get rid of dollars today — driving up the prices of goods, services, and eventually wages across the entire economy. This would amount to a "run" on the dollar. As with a bank run, we would not be able to tell ahead of time when such an event would occur. But our economy will be primed for it as long as our fiscal trajectory is unsustainable...

The key reason serious inflation often accompanies serious economic difficulties is straightforward: Inflation is a form of sovereign default. Paying off bonds with currency that is worth half as much as it used to be is like defaulting on half of the debt. And sovereign default happens not in boom times but when economies and governments are in trouble.

Most troubling is that establishment types don't see it this way, in a classic case of the Reaganite truism that it isn't that liberals are dumb, it is that so much of what they know is wrong.  Says Cochrane:

Most analysts today — even those who do worry about inflation — ignore the direct link between debt, looming deficits, and inflation. "Monetarists" focus on the ties between inflation and money, and therefore worry that the Fed's recent massive increases in the money supply will unleash similarly massive inflation. The views of the Fed itself are largely "Keynesian," focusing on interest rates and the aforementioned "slack" as the drivers of inflation or deflation. The Fed's inflation "hawks" worry that the central bank will keep interest rates too low for too long and that, once inflation breaks out, it will be hard to tame. Fed "doves," meanwhile, think that the central bank can and will raise rates quickly enough should inflation occur, so that no one need worry about inflation now.

Even if they're looking, they're looking at the wrong things.  Elites have failed us before you know.  One iron rule of Donny Baseball's Highly Refined and Usually Correct World View is that your real risk is not what/where you think it is. Cochrane says "check".

All sides of the conventional inflation debate believe that the Fed can stop any inflation that breaks out. The only question in their minds is whether it actually will — or whether the fear of higher interest rates, unemployment, and political backlash will lead the Fed to let inflation get out of control. They assume that the government will always have the fiscal resources to back up any monetary policy — to, for example, issue bonds backed by tax revenues that can soak up any excess money in the economy. This assumption is explicit in today's academic theories.

While the assumption of fiscal solvency may have made sense in America during most of the post-war era, the size of the government's debt and unsustainable future deficits now puts us in an unfamiliar danger zone — one beyond the realm of conventional American macroeconomic ideas. And serious inflation often comes when events overwhelm ideas — when factors that economists and policymakers do not understand or have forgotten about suddenly emerge. That is the risk we face today. To properly understand that risk, we must first understand the ideas underlying our debates about inflation.

Bottom line, we are in absolutely uncharted territory, and the elites are dismissing the dangers because they feel that they have it all figured out.  Be afraid.  Be very afraid.