Since the 1930s, money has been created to finance government expenditures, ostensibly to correct the flaws perceived in the private sector. This was added to the money creation for consumer purchases (mostly for homes) in the 1920s. It's almost an afterthought to include the notorious money creation to finance acquisition of speculative shares on Wall Street by people convinced that share values would always go up. Even Irving Fisher, considered by Nobel Laureate Milton Friedman to be "America's greatest economist," was caught up in the speculative frenzy and lost millions. Fisher was bailed out by Yale University to protect his reputation as someone who actually understood money, credit, banking, finance, and — of course — economics.
Clearly Yale's effort to protect Fisher's reputation was successful, if one of our most renowned recent defunct economists could consider him "America's greatest economist." It remains to be seen, however, whether the federal government's current efforts to save the reputation of the financial industry (possibly a misnomer in that the financial "industry" doesn't actually produce anything) will be equally successful . . . at least in the short run.
The problem is that Yale's bailout of Dr. Fisher, and the federal government's bailout of troubled financial companies are fundamentally different. Yale used endowment funds (unrestricted, we assume) to bail out Fisher. That is, Old Eli took some of his boola moolah, existing accumulations of savings donated by Bulldogs past and present, and spent it — which is what savings are for, anyway. This benefited Fisher (and Yale, which benefited by protecting the reputation of their Greatest Economist in America), and harmed no one, except (perhaps) future generations of Yale students who had to pay higher tuition and fees to make up for the shortfall. Far from being inflationary, a bailout using existing savings is deflationary, for it effectively cancels money in the economy that should have been used for genuine consumption instead of to make up for speculative and gambling losses.
The federal government, however, is creating money to bail out companies in danger of going into bankruptcy. The money is not coming out of existing accumulations of savings, but out of the government's power to collect taxes in the future — wealth that doesn't yet exist (and may never, at this rate). Because the money being created is being used to make good losses, the effect is the same as if the money was being created for consumption, speculation and gambling, or to finance a greater government deficit.
Under the "Real Bills" doctrine, when money is created to finance a project that is expected to pay for itself out of future revenues generated by the project itself, the infusion of new money will not be inflationary. The money is created by extending a loan to pay for the project, and secured ("backed") by a lien on the asset being created. As the loan is repaid, the money is cancelled. Service fees and risk premiums charged by the money creator reenter circulation as the money creator pays expenses and distributes profits, so that the amount of money created exactly matches the amount of money cancelled, everything else being equal.
Matters are slightly different if the project being financed does not pay for itself out of future revenues generated by the project itself. In that case, the money creator seizes whatever the borrower put up as collateral, and (hopefully) sells the collateral for enough money to meet its obligation to cancel the money that it created to finance the project. This will also result in no inflation.
The problem with the current government bailouts, and the reason the effort is purely inflationary, is that they are, essentially, creating collateral out of nothing so that the troubled companies can make good on investments that went bad. Unlike traditional collateral, however, the government bailout is not using existing accumulations of savings, as, for example, Yale University did to bail out Irving Fisher, thereby allowing the savings to be put to its "proper" use of being spent.
Instead, the government is, in effect, creating "savings" without first having to save . . . a Keynesian "solution" that operates by doing what Keynes in his General Theory declared was impossible. The money is "backed" by assets that have so little value that they have been called "toxic." Worse, money had previously been created to purchase the toxic assets in the first place. Essentially, then, by bailing out the troubled companies instead of letting them reorganize under Chapter 11 or go decently bankrupt under Chapter 7, the government is allowing two dollars to be created to finance one dollar of gambling losses: the original dollar created by the commercial banking system when, e.g., the toxic home mortgages were "securitized," and another dollar created by the government through the Federal Reserve to replace the first dollar that went down the drain.
The bottom line is that the inflation rate can only accelerate as the program gets into full swing, and money is created to replace gambling losses to the detriment of investment in capital projects that will create wealth instead of throwing it away. A proposal to create money for actual investment instead of to reward incompetence be examined tomorrow.