Last week was momentous in many respects. The S&P 500 index went down 6 percent. The price of gold on the Comex fell by 8.5 percent. Silver, copper, and crude oil also fell in price, although not as much as gold. The CBOE expected-volatility indexes for the S&P 500 (VIX) and gold (GVZ) were at 40, when the normal level is between 15 and 20 for both. All the major currencies also fell with respect to the U.S. dollar. The Euro, for example, fell by 1.5 percent, and the British pound declined 1.6 percent.

This was a major turning point. Up until this time the value of the U.S. dollar was declining as measured by market data, as opposed to the Consumer Price Index. The latter is a notoriously bad indicator and is used almost exclusively by the Federal Reserve as a guide to monetary policy.

It has been known since the trailblazing works on monetary policy by Milton Friedman, Anna Schwartz, and Alan Meltzer that the value of the dollar is determined by changes in the money stock. (Demand for money is usually stable, or at least more stable than the supply of money.) Thus, inflation and deflation are a monetary phenomenon controlled by the central bank.

Over the past year, the seasonally adjusted M1 money supply has been clipping along at an annual rate of 14 percent. This is much more rapid than is appropriate for the Fed's inflation target of 2 percent. Milton Friedman suggests that in such an instance the inflation will appear after 24 months-in this case after the presidential elections.

Moreover, during June and July 2011 the M1 money supply was increasing at an annual rate of more than 40 percent. This is a huge rate of increase and suggestive of a coming burst of inflation in 2013. However, in the first half of September 2011, the Fed applied the brakes, with a vengeance. The seasonally adjusted M1 money stock was actually decreasing at an annualized rate of almost 5 percent. Although this is less than the decrease of 30 percent during the Great Depression of the early 1930s, it could push the economy deeper into a double-dip recession. And this could occur before the presidential election of 2012.

The Federal Reserve is in a deep hole. The first policy rule when one is in a hole is stop digging. I fervently hope the Fed will. But I do not expect to read about it in the minutes of the Federal Open Market Committee.

This essay was written by a former millionaire. The "fair share" of his assets already has been taken by the government's fiscal and monetary policies. There is no need to tax him further.

Jim Johnston (jjohnston@heartland.org) is an economic policy advisor to The Heartland Institute.