Usually, "follow the money" implies some type of corruption. Here I will use it in a different sense to suggest that the current crisis can be approached by looking at money, which includes credit, especially in an economy that is debt-financed instead of financed through savings and investment, as the US economy has been for several years.

In an economy with a fiat currency and a central bank managing interest rates and money supply, the cause of economic expansion and contraction is essentially a function of inflationary and deflationary trends. The trick is to manage inflation so that it remains moderate during expansions and to avoid both excessive inflation and spiraling deflation at all costs.

There are three possibilities: monetary stability, inflation and deflation. Milton Friedman showed that these factors are functions of the money supply, which includes credit since the use of credit as debt puts more money into the system, while also extracting money from the system as interest, i.e., rent on borrowed money. In fact, credit has recently been the predominant factor, since most money was created through the use of abundant low-cost loose credit.

Broadly speaking, the central bank (CB) controls the money supply by loosening and tightening credit rather than actually printing currency. When interest rates are low, debt increases, and when interest rates are high, debt contracts, putting money into the system or taking it out.

Debt is essentially use of credit. It is not enough to supply credit; the credit must actually be used. When the cost of renting money - interest rate - is low, then available credit is used. When risk is perceived to be low in relation to reward, then available credit also gets used. Use of credit is a function of both cost and risk. Usually these are related by not always. For example dislocations are produced when interest rates are held artificially low due to the action of the CB, and risk is mispriced due to error or misrepresentation. All of these factors and more were involved in the making of the present crisis.

When the money supply, largely through extension of credit, expands then debt increases as credit is used, and an inflationary trend begins to develop, whose momentum will increase unless it is controlled by the CB's raising interest rates. When interest rates are low, it is advantageous to borrow, not only because the rent on money is less, but also because money is decreasing in purchasing power due to inflation, so incurred debts are declining over time since they will be paid back with less valuable dollars. Bond vigilantes know this, so as inflation increases, they demand more rent for money loaned through higher interest rates, putting a break on the increase in credit use as the cost of carrying debt rises.

Conversely, when credit extension contracts, then the use of debt drops, and there is less money in the system. This results in a declining volume of transactions, meaning that business slows down. Generally, when this happens, pressure on interest rates decreases, and the cost of borrowing comes down, fueling another cycle.

However, there is another factor in credit availability, namely risk. At the top of inflationary trends, abundant credit is used to debt-finance over-consumption and over-investment. Over-investment leads to declining profit from production and distribution, and so credit is then used for speculation. Low interest rates encourage the use of leverage, since the cost of carrying debt is less than the potential gains from leverage use when markets are rising, as they do at the top of inflationary cycles, unless interest rates are quite high relatively.

Moreover, there is an incentive to speculate not only because of the lack of opportunity for productive investment, but also outsized returns are needed to offset the loss of purchasing power of money due to inflation. Risk also appears lower than it is because of the effect of forward momentum on market psychology in bull markets.

Similarly, as deflationary cycles progress, there is little demand for credit since the opportunity to profit from investment or speculation is low, so interest rates decline, until at the bottom interest rates are so low that the cost of renting money makes borrowing to fuel investment practical again.

After a period of monetary stability, a new inflationary cycle begins as expansion takes off and eventually overheats as capacity is exhausted. At least this is the theory.

However, this has not turned out to be the reality at this juncture for a variety of reasons, notably the actions of the CB coupled with some chicanery masked by lack of transparency, as will collusion among major factors including business, rating agencies, the CB, and government due to the old boy networks and revolving doors.

What is happening now is that after being extraordinarily loose for some time, credit has now frozen, for two principal reasons. First, lack of transparency and accounting chicanery have muddied the waters about the solvency of major financial players who are the primary sources of credit other than the government as loaner of last resort.

Secondly, it is not profitable for these primary players to loan the way the game is now structured, because of rising risk as well as dislocations in interest rates between market rates and rates set by the CB. So a liquidity trap has developed, where instead of loaning, hoarding is taking place. This hoarding is a deflationary sign that freaks out central banks and treasury departments, as well as economists and business people in general. This is why Paulson and Bernanke are having fits.

Most people don't see the coming scenario, however, until, the economy is in recession and they are feeling the brunt. So many are foolishly saying that nothing needs to be done. While the Paulson plan is essentially flawed and cannot be fixed by revising it, something does need to happen. But even Milton Friedman agreed that this needs to be applied at the bottom, not the top, by stimulating the real economy instead of trying to liquify banks.

Instead of loaning at a risk or loss without much higher interest rates, funds are being parked, e.g., in T-bills, and economic activity is slowing for lack of financing other than at onerous rates. As financial activity slows, the real economy follows.

Fixing this jam up in the credit markets is what the bailout or rescue, or whatever, is about. But the real issue with respect to causality has to do with money. The normal cycle of economic correction have been disrupted by top down management, to the extent that severe dislocations have developed. We are now at the cusp of a cycle in which the value of paper money is coming into question as the answer to all problems is monetization. This is the real issue that the US and world is facing economically.

While it appears that the financial system is breaking down, the underlying issue is that the monetary system is creaking, and we are already hearing rumblings from abroad about the dollar. The reality is that massive debt, both governmental and consumer, a military budget larger than the rest of the world combined, endless war without sacrifice, massive outflows of paper for oil, and now huge sums necessary for financial rescue, are putting a strain on the once almighty dollar, as the US slips into becoming the largest debtor in the world.

The administration, Congress, the candidates, and the media are largely ignoring or suppressing this. Moreover, the bailout proposal under consideration would simply throwing gasoline on the fire without really fixing the problem other than at the edge, while rewarding bad behavior and increasing the risk of more by ignoring the key fundamental of free markets: action, responsibility, consequences, accountability.

What is not being said is that even if it were fixed tomorrow, the economy is not going to resume the binge it was on that was fueled by abundant, loose and low-cost credit. Now that the dust has settled, the glow is off the forward momentum of markets due to massive de-levering, and it will take another cycle of deflation and inflation to return to former heights of consumer finance and speculative excess.

The idea that a bailout or rescue package will fix the credit lockup by returning to an era of abundant low-cost loose credit is a pipe dream. Risk appetite has diminished for exotic vehicles, the credit default market is in disarray, the consumer's have run up against the limits of their ability to assume more debt for non-essential expenses.

The fundamental flaw in logic at this point in time is that the freezing up of credit stopped the forward march; hence, unfreezing it will result in its going forward again. This ignores the fundamentals of debt to savings ratios, prohibitive cost of essentials like housing, and the implosion of the financial schemes that fueled the run up.

Therefore, the failure to consider the bailout/rescue plan in the context of unfolding events is folly, and the nay-sayers were right to withhold approval for a more well-considered alternative.

Unfortunately, the vote is being misrepresented in the media as an up or down vote on a rescue, rather than what it was: the rejection of a proposal that was ill-considered and gave too much power to the very faction responsible for created the problems in the first place, completely nullifying accountability.

The situation appears complex because the generally level of economic education is low. Therefore, those in the know can easily get away with spinning the situation to their advantage with only a few experts who don't have much of a voice any the wiser.

The challenge and opportunity, then, is to provide this economic education as quickly and clearly as possible. Dennis Kucinich appeared on The Rachel Maddow Show tonight and made a good stab at it in the short time allotted. Kudos to him. But a whole lot more work needs to be done by blogging, writing letters to the editor, contacting Congress, feeding supportive resources like show hosts, and so forth.

This is a real crisis and if it a short term, short-sighted solution is adopted, and the real issues overlooked or suppressed, then down the line there will be very real consequences to both the dollar and the economy as a while, which will have important global consequences for America extending far into the future.

This is my stab at articulating the situation as I understand it. I'm not an economist by training, so I welcome correction.