I was reading Charles Krauthammer's essay on the various bailout schemes, and he is right in some regards but wrong in others. In his description of the shortcomings of the Democrats' maximal bailout, including its buyout and government management of Detroit, both to preserve the unions and to enforce green orthodoxy, he is right on the money. My only complaint is the ease with which he accepts the smaller Republican bailout.

Now, many economists have recently argued that the distortions created by the excess subprime loans were a distortion of the market, so we are justified in ignoring the market in correcting it. However, that is specious reasoning, akin to saying, alcoholism is a deviation from sound health practices, so to cure alcoholism we should ignore health practices as well. We can try to ignore the market in fixing the problem, but the market will get its revenge. Ignored or not, the market continues to function, and our choice to disregard the laws of economics does not mean they cease to function.

The problem, in a nutshell, is that we created money out of nothing and exerted inflationary pressures which led to an inevitable deflation. Now we have two choices in dealing with this deflation. We can either face the music now, suffer through the crisis and come out on the other side with a stronger economy, or we can postpone it in one way or another, and as a result suffer greater consequences in the future.

The problem is, we are never willing to face the music. Part of the reason the situation became so bad is that, in addition to bad loans explicitly subsidized by Fannie and Freddie, both the Clinton and Bush administrations tried to stave off recession and continue strong economic growth by tinkering with interest rates. In other words, rather than face a readjustment of the money supply, which was necessary, Clinton and Bush continued to inflate, making the problem worse, but putting off the eventual consequences. We are now at the point where we are facing those consequences, and our only debate now is how to put them off even farther.

Any bailout is going to be yet another form of inflation. That is a point Krauthammer ignores, and one he should not. Our $700 billion is not coming form spending cuts or tax increases. Were that the case, it would amount to actually facing the music. Then again, it would not really do much good, as it would amount to simply shifting the burden of the deflation from the financial sector to the taxpayers as a whole, or to those businesses hit by government spending cuts. So, instead, the bailout will be financed through credit, either borrowing or explicit inflation, or a combination of the two, any of which will exert yet more inflationary pressures. In other words, once again, we are pushing the problem off into the future, making it still worse.

We cannot put off payment indefinitely*. The thought of economists, at least those who recognize that monetary inflation is harmful (as opposed to brainless Keynesian devotees who believe that money supply tinkering can somehow make everyone rich indefinitely), hope that while they inflate, eventually economic growth will catch up with their inflation and wipe out the worst of the consequences, but the truth is that will never happen. Even if we were to suddenly experience massive growth, it would not wipe out our inflationary past, as the monetarists would take that as a sign for an even greater monetary expansion, while the politicians would revel in the increased revenue and bloat spending to an equal degree, boosting borrowing and the subsequent inflation. So in boom times inflation keeps pace with growth, while in bad times it grows even faster as we try to avoid facing the inevitable crash. So there really is no end to all this inflation**, at least none until the money supply becomes so bloated we are forced to face the music, as we did during the Carter years, the Great Depression, the dot com crash, and a few other lesser and greater economic crises.

We can probably postpone this recession, or at least part of it. We may have to face some consequences, while inflating our way out of the worst of it, but is that a good idea? Yes, facing it will hurt, and will do damage tot he economy. But it will be worse for us in the future should we postpone it. If it is "too bad" to face now, how much worse will it be later? Is it not better to face the music now, accept the deflation, let the economy right itself, and then move on with a sound economic base? Or do we want to keep pushing the eventually collapse into the future, like a gambler borrowing to pay off previous loans, hoping the loan sharks never catch up with him?

The economy always catches up with us, and when we have to pay off it will be worse the longer we have put it off.

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* To those who think this is an unprecedented crisis, second only to the great depression, I would point to the S&:L collapse, which involved even more assets. The big difference being that Reagan had put an end to the Carter inflation, suffered through a strong deflationary period, and thus had some room to inflate his way out of the problem. Of course, I disagree with that policy as well, we should have really bailed out the S&Ls with taxes or spending cuts, rather than inflation and borrowing, but at least when we inflated our way out of that crisis, we were not at the peak of an expansion of the money supply as we are today. It was adding a couple tablespoons to a nearly empty glass then, today it is adding a shotglass to a cup filled to the brim.

** Actually, even if economic growth did outpace inflation, and we could moderate our inflationary tendencies enough to allow growth to wipe out our previous inflation, it would still not be without cost. By inflating, we effectively "used up" the economic benefit of that growth. Where that growth would have increased real wealth, it now is simply keeping pace with our previous expansion of paper wealth. One can see the real effect of growth without government inflation in the 1870's when we experienced the "paradox" (to Keynesians and Monetarists, anyway) of strong economic growth coupled with strongly falling prices. The reason is simple, with a relatively stable gold supply, money tied to gold, and a growing economy, the value of gold relative to good was increasing, so a fixed quantity of gold bought more. Thus falling prices during economic growth. It makes perfect sense to anyone but a deluded Keynesian.