As stated above, banks are not putting the money into the street... but rather into their balance sheets in the form of excess reserves. They're killing the velocity of money. a picture's worth a thousand words... so check out this chart from teh St Louis Fed... http://research.stlouisfed.org/fred2/series/EXCRESNS The raise that you see in 2008, which makes the rest of the nearly 100 years chart look as flat as the horizon is Helicopter's legacy. The day that banks feel comfortable and start lending out this money (bringing back velocity) inflation could start rising rapidly and since there's such a massive amount of money on it, slowing it back down may not be possible (think of an overweight train going down a very steep hill)... in that case inflation could really get out of control... If on the other hand, the banks keep hogging every dime they can get their hands on and reduce velocity of money... then the paradoxical deflation pointed by the OP is on the horizon... What worries me about this paradox is how the system is going to react to it... if says... not enough inflation = print more money, it could further increase excess reserves of the primary dealers... without changing the underlying reasons for the deflation. ...
Part of the problems is people are not buying the debt anymore. When you borrow money from the bank they bundle it up and sell it on as a credit derivative. This where is the problem originated and why everyone says it is a credit crunch. The banks cannot lend the money because there is no market. Even with QE the lack of demand for this credit derivative is not there anymore. Things will never be like they were before 2008 or at least for a few decades.
So the banks got so used to the idea of not holding debts till expiration and collect small cashflows for teh next 30 years while the morgage matures... (old school, boring, traditional banking)... that now they're so hooked with the quick fix of just wrapping the debt into a derivative and cashing out that they don't want to lend any money?
So ...... continuing on with the analogy. What effects do interest rates have on the balloon? Where does the money for interest paid come from anyways? We all used to grow food and barter before the money pumping system came into being. Now we have a derivative (money for that) for it. How did we get stuck on this money pumping system and why? There is a drain on the balloon as we all have a small hose siphoning off some of the balloon's contents to live. Why are savers hated and attacked by the money? Why are those who consume balloon contents without pumping enough loved? Which group(s) controls the siphon hoses with no matching contribution pump?
Right now much of the world is afraid to spend what they have although they are willing to bid up assets: stocks, metals and until a few weeks ago oil etc. At some point much of the world will be afraid to hold the cash they have. They will realize that it has become a horrible store of value. If deflation gets out of hand there will be enormous pain for billions of people. When (not if) hyper inflation kicks in there will be chaos. This film ends badly. Worse than Godfather III.
Heard a guy on Bloomberg radio the other morning while driving to work. He claimed that back in the 80's for every dolla of government stimulus that 9 dollars were created in the economy. Now he said its two to one. This is the same thing that happened to Japan and for the same reason which is our banks have too much bad debt and the government is not making them write it off.
No it is that people are not buying the debt. No one will buy these products because they no they will default.
What I'm saying is, back in the day banks didn't package their debt into collateralized derivatives... they held it to expiration and collected cash flows... the money they lended out came from savings... pretty simple and pretty boring business... that forced them to be careful when lending out money... because they wanted to get paid... (btw... all the BASEL I & II rules are build assuming this old fashion banking model) Now they're hooked on derivatives like a crackhead and won't lend money out unless they can sell their derivatives... so the money is pilling up in the balance sheet...