On Ellen Brown's money-printing solution

Economics writer Ellen Brown has suggested that California, or any state, could solve its budget problems by creating its own state bank and essentially printing its own money. As long as the new money goes into new production, this policy is not inflationary, she argues; in fact, issuing new money can create economic miracles.

Generally speaking I believe she is wrong. In a functioning economy, the issuance of new currency to the people will increase prices by more than the rate at which the new money is issued, which means it actually creates deflation in real terms. This is because, in a functioning economy, putting currency into the people's hands also makes currency change hands more quickly. That is, you not only increase the money supply, but you also increase money velocity. Remember that

MV = PQ

When governments increase M, they eventually increase V. This means that the PQ side of the equation (prices x quantity of goods) will rise at a faster rate than M. You might give someone 10% more money, but if prices have gone up by 14% you've only made their situation worse. The government's hope is that if MV increases, production (Q) will increase, but the problem is that production can only grow just so fast, and it basically tops out when full employment is attained.

In short, when you print more fiat currency in a functioning economy, the common people experience a deflation in purchasing power. You harm the economy.

And yet, Ellen Brown points to three historical examples in which money-printing brought economic salvation: the early American Colonies, the island of Guernsey in the English Channel just after the Napoleonic War, and Germany under Hitler. In these instances, the new money spurred production and brought economic relief, and certainly not the deflation in real terms I mentioned above. So what gives?

It occurs to me that these three examples are not representative, and not relevant in today's industrialized world, because in those instances production was at virtually zero. In the early Colonies, there was tremendous room for increased production. On Guernsey, the economy had been decimated:

At the beginning of the nineteenth century, as a result of the Napoleonic wars, the trade of Guernsey was practically extinguished and the people were in despair. Unemployment was rife, the sea defences were breaking down, there were practically no roads, public buildings were in disrepair and, above all, a new market house, where the islanders could exchange their produce, was urgently needed.

And as one economist described it:

The Nazis came to power in Germany in 1933, at a time when its economy was in total collapse, with ruinous war-reparation obligations and zero prospects for foreign investment or credit.

These are cases in which, in the MV = PQ equation, Q was not much above zero, or certainly it was a great deal less than full production. This made it easier to translate increases in the supply of money (M) into increases in production (Q), without rising prices. Also, if you have almost no economic activity and no inventories to speak of, velocity cannot skyrocket because there is initially nothing to trade. Therefore, they did not experience a sudden jump in MV that would have caused prices to jump. Instead, increases in the money supply led to higher levels of production along with price stability. Purchasing power was maintained, while economic activity surged.

The American Colonies example is unique, in that Europeans were multiplying and spreading over the land, thus production could increase almost indefinitely. In the post-war examples, there were skilled and educated people living in an absolutely ruined economy, thus production could increase rapidly once rebuilding began. But in circumstances that are not so dire, in economies which are still functioning, the printing of new fiat currency will translate into real-terms deflation as purchasing power is lost. The perceived solution to this want of money will be to print more currency, causing yet worse deflation in real terms, as prices spike faster than paychecks and savings lose purchasing power. And so begins the hyperinflationary spiral.