The monetary policy of the last two decades has been:
The money supply can be quietly increased at a high rate, as long as large amount of that new money is ultimately sequestered or pooled into places where it will be slow to feed into the consumer side of the economy.
If consumer prices and wages don't rise too quickly, the psychology of inflation will be avoided and trust in the value of the dollar will remain high. For a long time this has worked.
Immense amounts of paper (digital fiat money) have been created over the last 20 years, but the generalized effect on consumer prices has not kept pace because of the channeling and pooling of the money. (The term bubble has also been used, but I think pool is a better analogy because it suggests that the money is held within boundaries)
The money pools have been: China, real estate, stock market, central banks. New money is easily spent into these asset pools making the early spenders feel rich and increasing the paper values of these assets. However, the cash is slow to seep out of these asset pools, tending to sit in place until used as collateral for a loan to buy more such assets.
China was a huge "money sink" in part because it had just opened to the western economic system and was virgin monetary territory hungry for US dollars. China further played into the game by reserving and recycling much of the money back into US Treasuries and focusing its spending within its borders and in places like Africa.
Now that system is breaking down. Large amounts of less liquid assets like real estate have been devalued, and other less liquid assets like commodities and stocks are being exchanged in favor of liquid cash and Treasuries. Central banks are compensating for the losses in real estate with very liquid cash infusions into banks and elsewhere. Right now, all of this new cash is being hoarded, creating a new and very liquid pool that is currently frozen by fear. Governments will continue to borrow and create and spend money into this pool until it thaws, and then there will be a flash flood.
I think that when the fear subsides, the hoarded liquid money pool will flow very quickly as soon as it decides where to go. That money will multiply rapidly through fractional reserve lending, and then it will go into....what?
* In a depressed economy, most equities will not be appealing
* A flood of US Treasury borrowing will drive up yields, making
bonds values go down..bad deal
* Real estate...we just got burned on that one.
* Foreign markets: even a bigger mess than the US
Disruptions caused by the current credit crunch may result in surprising shortages in food and other critical commodities. Available money will be unfrozen and deployed as much as necessary to buy what is needed, causing rapid price spikes.
The flood of Treasury borrowing will weaken the US dollar as China refuses to lend because it needs to spend the money at home and US consumers are not sending more. The Fed may have to monetize by becoming a buyer of unwanted Treasuries to cover massive US debts, further inflating.
The weakening dollar will make everything more expensive in dollar terms, and, along with shortage-induced price spikes, a general price inflation cycle takes off. Money will pour into Gold, (which is currently near its highs in terms of Euros and British pounds) to escape the declining dollar and to follow the momentum.
The question is timing. Will this happen in 6 months or 5 years? My guess is 12-24 months