American Economy: The Bailout

Josh,

Maybe you can help me. I am trying to apply an aging physicist brain to the current economic situation and I could use some help.

Admitted bias upfront, I tend to see things more positively by reflex.

Premise 1

Inflation is caused by an increase in the "money supply" without a corresponding increase in goods and services causing more money to chase the unchanged supply of goods thereby increasing the price.

Premise 2

The value of "bad" mortgages was part of the "money supply" when the mortgages were good and therefore marketable. Now that the mortgages are "bad" and unsellable they are no longer part of the "money supply", or have radically decreased in value, thus the "money supply" has decreased as a result.

Question 1

If the government prints money to e. g. buy the illiquid mortgages, (for less than 100 cents on the $)is it not just replacing the money which the illiquidity of the mortgages removed, and thus is "neutral" effect on the "money supply"?

Premise 3

The root of the problem is the decline in housing prices which "removes" wealth from the system,
and is thus "deflationary".

Question 2

Does not the effect of Premise 3 give the treasury room to "print money" to balance it without
increasing the overall money supply and thus being neutral on the inflation front.

Sincerely wanting to understand,

Unc

P.S. Henry Paulson is: A. a socialist B. an idiot C. Someone whose career evidences a solid understanding of the system, and who is a believer in "capitalism". D. Other (Please specify)

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Hey Unc,

I've had a chance to think about your questions, and while I don't have any conclusive answers, I do have some thoughts that might help flesh out the picture a bit.

For starters, I will observe that your premises/conclusions are based on an oversimplification that is typical of most mainstream discussion of economics – i.e.