An economy in equilibrium when pushes in one direction result in counter moves that push them back. This is different from chemical equilibrium, where the rates of different reactions balance. A classic example of economic equilibrium exists in supply and demand, where prices going up lowers consumption and encourages substitutions, until the economy uses all of the available scarce resources. An economy in disequilibrium is the opposite: actions produce positive feedback. A classic case here is hyperinflation, where a government printing more paper reduces confidence in the paper, and this in turn forces the government to print another round of paper to avoid the economic or military collapse it fears.

However there is a third state, that of complexity, where the sign of feedback is not predictable. In equilibrium inflation and deflation can be seen as opposites; in disequilibrium however they are the same state with a different key decision, generally the monetary authority deciding on the money supply. In equilibrium and disequilibrium the vectors of commodities and the vectors of currency are opposite, and the interest rate acts as the means by which money and commodities are converted, and can then be used as fulcrum. The attempt has been to prove that monetary and fiscal policy act in the same way, with one being the reduction in private borrowing costs, the other being the arbitrage of the difference between government borrowing and private borrowing. Where this proof stumbles is that in complexity, monetary and fiscal policy are not the same.

In equilibrium vectors of supply and consumption have opposite signs. In disequilibrium they have the same signs. The valence of equilibrium is therefore approximately 0, where in disequilibrium it tends towards an asymptotic limit, either positive or negative. This means that we can, in both cases, talk about the general level of prices, since the availability of currency effects all things in the same way. Simply put, in general we can speak of macroïnflation as a monetary phenomenon because money swamps all other effects, and people have no intrinsic preference for consumption or investment, but select one or the other based on their own personal utility. In disequilibrium the supply of currency makes one choice or the other much more attractive, and the economy tilts over.

Disequilibrium has relatively simple, if often painful, solutions. If over consumption cut aggregate demand, if underconsumption, raise aggregate demand. Return to a state where money itself doesn't matter in decision making. This often involves incentives and socialization or desocialization of risks.

However in complexity the situation isn't so neat. It is easily possible in complexity to have some prices going up quickly while other prices go down quickly. Paired complexity in an economy is normal. At any given time the largest gains in productivity will be where a new product is cannibalizing an old product. This pairing will move with an incredible fluidity even in an economy where most other commodities are relatively static.

When an entire economy enters complexity it is possible for some goods to pair with others and enter an almost free fall. This is the situation in the United States right now, where housing and wages have effectively entered freefall against commodity rents. We are seeing nominal macroïnflation because the freefall in housing asset prices are not counted in nominal macroïnflation. This is why we have, and will continue to have economic and financial crisis, a feedback loop has been established.

This feedback loop is simple: the financial system was way over-leveraged against the actual returns on investment. This lack of investment supply meant that more and more money ran around searching for something that isn't possible: above market returns at market levels of risk for a large body of investors. Welcome to Woebegone Fund, where all investors are above average.

To prop the banking system up, without actually regulating it or nationalizing the direction of it, Bernanke and others have poured money into the banking system. However, that money cannot go and invest in say houses or global consumption, and investment in consumption supply is already burning hot as it can, it is impossible to mechanize China any faster than it is, and indeed as the recent quake shows, China is mechanizing faster than is really possible. Thus it must go into rent, and that means commodities.

OK so that means commodity prices go up, and that leads to two effects. The first is that all of the investment in consumption supply in the world doesn't help, and in fact makes it worse. No matter how much factor floor is made in China, it will not extract one more barrel of oil. In fact, the reverse - the more factories need to be fed, the more pressure on commodities. The second effect is that it makes the houses built less economically viable, thus eroding the US monetary base, and making more problems for the financial system.

This is merely time three through the spin cycle here. The first was the dot bust, when it was clear that the internet was not going to create new goods as fast as people liked, nor would it put bricks and mortar out of business. The second was in 2005 when we got a foreshock with Katrina. This is time three, and it will be ameliorated as oil comes on line in Iraq. Even another 300,000 barrels a day will reduce inflationary pressures a great deal. However, the spiral down in housing prices will continue, because the expectations of profits have been cut already, and that means the wages to buy the houses aren't happening.

So simple terms: the more money Bernanke gives to banks to bail them out, the more goes into increasing the price of oil, and that erodes the assets those banks have. The banks are engaged in self-castration of their asset base in order to make short term profits.

This is why the present looks like the stagflation of the 1970's: low growth and high inflation. What we have right now is asset push inflation where the increases in investment demand are pushing up prices. This is why some will see dangers of deflation, and others of inflation. Because the economy is in complexity and commodities and asset base are paired, as one moves up, the other moves down, both are happening. This means this is not purely a monetary effect, though it could easily generalize if the wealthy continue their consumption binge on private jets and towers to nowhere in Dubai.

So here is where I am going to introduce a simple concept that will help. There are three kinds of investment. Investment in maintaining rents, investment in consumption supply, and investment in scarcity supply. An example of the first is advertising to keep a brand, or the other activities of maintaining a business in competitive equilibrium. This is most of investment actually. The second is increasing the ability to convert ultimate scarcities into goods. Not a bad thing in itself, more goods mean more people can have them. The last category is reducing the pressures on scarcity, whether by finding more, or finding substitutes.

Each of these is paired with an element in the IS-LM. Rent is about increasing the real rate of interest. Consumption supply is about increasing the supply of labor. Scarcity investment is about increasing the supply of commodity itself. Basically, if the problem is that real interest rates are too low investment will go to rents, if the supply of labor is too low investment will go to consumption supply, and if the supply of commodity is too low, investment will go to increasing it. It can be seen that often these three pairs will be in tension. Those investing in rents don't want the supply of scarcity, labor or commodities as the case maybe, to go up. Thus there will always be a matrix vector in favor of the first two over the last one. However, in equilibrium this is self-correcting: the higher rents are, the more factories there are too feed, the more incentive there is for finding away around existing rents and feeding the factories. It may require some government action, because this is part of the intrinsic tendency of free markets to become unfree, however the advantages of not running out of gas in a war are so obvious that most governments try and avoid it.

The American Thermidor cycle however, made it so that there was continued systematic investment in rents and consumption supply over scarcity supply. This was invisible because it takes decades for scarcity supply to come on line. For example oil discoveries peaked in the late 1960's. Oil supplies haven't quite peaked yet, almost 40 years later. The United States is still the third largest producer of oil globally, even though the United States is not even in the top 10 of global proven reserves. Iraq is number three, which is why we invaded and occupied.

What happened is that as wages stagnated people consistently made the decision to under invest in long term supplies, and instead in the immediate gains. The returns on building houses, or off-shoring factories were right there, where as the returns for long term research were not. One reason we don't have better fission, fusion, or other energy sources, is that we didn't invest in them. As the line from It's a wonderful life goes, "You weren't there to save him, so he wasn't there to save them."

That is now coming home to roost, because supplies are going to be tight for almost a generation as we work things through. It also means that the situation of deteriorating assets and increasing commodity prices is going to be normal for the polity, as much as macroëquilibrium with localized complexity was normal.

In the short term this means that the most useful thing that we can reëngineer, is money itself.

What I mean by this is that the global monetary base for some time has been a tension between what were, effectively, two central banks. The Federal Reserve was the bank that determined aggregate consumption, OPEC was the bank that determined aggregate supply. The Bank of Japan was used as an intermediary to increase consumption supply, and therefore drive down the price of labor. This worked against Japan's own long term interests, but in favor of the short term interests of their own elites and upper middle class rents. Japan wanted to be the managerial class for offshoring in the Pacific Rim.

Now the Fed's asset base is predicated on US real estate. This asset base however, is not static. We can't simply collect up all the houses in America and put them in Fort Knox. The cost of maintaining their value is in... commodities such as oil. The cost of doing this can be roughly estimated as the difference between a GDP/unit energy of Europe, and GDP/unit energy in the US. The US uses roughly double that of Europe, and so we can take half of the energy consumption in the US and say that, in one form or another it goes to maintaining the US asset base. This is the defense department, gasoline for commuting, franchisedom and everything else that allows the sprawlconomy to work.

No other single reëngineering act, for any technology, comes close to the value of reëngineering money. Nothing. Nor does any proposed substitution of one energy source for existing ones help in anyway. Put new energy on line, and it will be soaked back up into the asset base, because, like mining gold in a gold standard economy, creating new asset base is, effectively, making it possible for an individual to collect a bit of inflation tax. They get to spend the asset base first, and others deal with the reduction in buying power. We aren't seeing the brunt of inflation, other places are.

This reëngineering will happen one way or another. Right now the global financial order is propped up by the major players being in terror of a dollar meltdown. This will keep things alive for a little while, but at the moment that there is even a chance to decouple, others will take it. It is already happening, the question is simply when the Chinese can build enough workable Sedans to ignite their internal economy. The Indians are buying old car equipment from England and igniting their internal economy. The Chinese will do the same thing: find some old car industry that some former national system no longer needs, and buy it up.

At that point they can ease their own inflation pressures quickly by dumping dollars, sloughing off much of their low value added labor, or offshoring it to places like Vietnam, which is happening fast, and inshoring to their own interior. How do you feel about Yuan/Dollar parity?

Dubai is being built in the expectation that with the collapse of the dollar as the intermediary of oil consumption, that there will be a spiral of competition to burn oil now. This is the fundamental inflationary pressure in the economy, and why we are not in a period like the 1930's economically. The 1930's were based on a failure to be able turn a vastly increased supply of energy and labor into demand. That's why Keynes kept repeating that aggregate demand was the solution. Just as now the solution is to dramatically increase the amount of investment supply. We would like to get back to a time when we have FDR's problems. Instead we have Teddy Roosevelt's problems, the solution is to find radical short cuts and dramatically loosen supply.

Thus since it is going to happen one way or another, the best thing is to get there first. America under Bush tried to run the Boer War play: if an asset base is in short supply, go out and make more the old fashioned way, we tried to steal it.

This has not worked out. Nor could it have long term. Not one barrel of oil has come out of Iraq, or will come out of Iraq, that would not have. All this did was burn vast amounts of oil in pursuit of nothing. That oil is not ever coming back, it is gone.

So how to reëngineer money? Well Bernanke, like the good Hooverite he is, did a part of what needed to be done, without the other part. He had the government take on the risk of the capital supply, that is the stock market, without taking any of the authority. People who take on risk without getting returns or control have a name in the financial world. That name is "sucker." The Fed has proven that it is the dumbest money on the planet.

The second step however is a redirection away from a society that invests so much in rents and consumption supply. The easiest way is to break down rents, and transfer that money to supply. This means reducing the value of holding on to rents. However, this is one pressure that will be hard. This is because information rents are the one thing the old powers think they can collect from developing countries and holders of energy rents. There is a pressure to make copyrights last forever, because that is a counter-rent. The counter-rent strategy is failing rapidly, in part because the value of these counter-rents is falling quickly, but also because they consume vast amounts of money to maintain, and are collected primarily from people in the developed world. It's worth protecting patents, Mickey Mouse, a lot less so.

This step will require more political will than currently exists in the United States, since both parties are driven to rentiers for the sustenance of their political machines. Obama is no more going to get money out of politics than George Bush is going to get Americans out of Iraq. If anything, he's going to be driven to make sure that every dollar in politics comes to him.

As a result the prognosis for America on this next leg is poor, until people have had their equity in home rents utterly destroyed, they will continue to protect them. That is why the most conservative of the major candidates for the Presidency in the Democratic Party is going to be the nominee: people have taken a hair cut, but they still have profits. They want to protect those profits that are left, not fundamentally shift direction.

This means that there will be one last vast push to gut future investment to pay for present consumption. And with it will be a lull, as the present wave of inflationary pressure passes, only to return with double and triple force later.

Because you see, at some point, probably when Obama is safely the President Elect, Bernanke will have to become a born again inflation fighter. And at that point, however conservative in instinct candidate Obama is, he will face the choices of getting radical with fiscal policy, or becoming the next Jimmy Carter.