Doubling Down in Washington

We wish that our 200th posting could be a little happier.

In the ultra high stakes political games played in Washington, DC, $1 million is the lowest chip. The amount on the table at risk is usually measured in billions. According to the headline in today's Washington Post, however, Mr. Obama has raised the stakes in his game of Big Buddy Bailout to more than $1.5 trillion, just as we predicted in this blog last week. This is more than double the original wager of $750 billion.

Mr. Obama appears to be "doubling down." Doubling down is a technique in Blackjack in which you double your bet after receiving your first two cards. The difference, however, between straightforward gambling and what Mr. Obama is doing is that the president hasn't been dealt any cards. All he has is a blind faith that failed and disproved Keynesian economics will, despite decades of evidence to the contrary, finally pay off and allow the American economy to break even.

The problem, as we've been pointing out for several weeks, is that you can't create money in any amount without expecting inflation, unless you are careful always to link creation of new money to new production (not unsold past production), or to the financing of a project that will generate new production. Creating additional purchasing power for existing inventories simply makes each unit of currency worth less than before, redistributing existing wealth from current holders of financial assets to those receiving government payments.

This form of money creation can lead directly to hyperinflation, the surreal condition in which the price level rises faster than money can be created. Ordinarily, of course, the price level rises in response to the creation of additional purchasing power for existing inventories. When carried out on the massive scale that Mr. Obama is now demanding, however, the amount is genuinely beyond the power of the ordinary human mind to grasp.

The response of any producer or retailer to such a gargantuan influx of essentially worthless money will be to raise prices as fast as possible to make up for an anticipated inflationary loss that cannot, in human terms, be quantified — how do you visualize $1.5 trillion? The State then gets into the position that the Reichsbank faced in the early 1920s at the height of the hyperinflation.

The German central bank simply could not create money fast enough to meet daily transactions demand for currency, much less keep up with the inferno of the rising price level. Producers stopped producing, for there was no assurance that they could trade what they produced for anything of value. Farmers refused to sell their produce in exchange for crates of worthless currency, and there was virtually no industrial production generating anything that could be used for barter. The validity of Say's Law — that we can only purchase to the extent that we produce — was proved in the most vivid and devastating manner possible.

The German and Austro-Hungarian economies faced the paradox that unfettered money creation caused prices to rise so fast that there wasn't enough money in circulation to purchase what little was for sale. This was at a time when one U.S. dollar was "worth" 4.2 trillion Reichsmarks at the official exchange rate, and nearly 16 trillion on the black market. There were mountains of paper money in circulation, but it was worth more as waste paper and fuel than as currency. A famous photograph shows two little girls holding an American dollar, and in the background a colossal pile of German currency that, on that day, equaled that dollar.

Hyperinflation is a logical and expected outcome of Mr. Obama's proposal. Germany was ultimately saved because they gave a monetary and fiscal genius, Dr. Hjalmar Schacht — the "Old Wizard," a man with the unusual middle name of "Horace Greeley" — full power to do anything necessary to stop the hyperinflation. This he did by demonetizing all the old currency, creating an asset-backed non-legal tender but fully convertible parallel currency (the Rentenmark), and absolutely forbidding any new issuances in excess of the value of the asset backing.

The situation was stabilized, but the fear inspired by the hyperinflation was so great that the German, Austrian, and Hungarian peoples demanded absolute guarantees of future stability, as well as victims to blame for the virtual apocalypse of the war and the subsequent financial meltdown.

Adolph Hitler provided both.