Here's the thing: if inflation cranks up, the Fed is going to have to unload a buttload of debt, really fast. The only way to sell that much debt, and take excess cash out of the economy, is to sell at fire sale prices.
So, if there is inflation, the Fed is going to take truly ginormous capital losses on the debt it will have to sell. But this is exactly Bernanke's plan, the one he is so sure will work to prevent inflation. Big Ben's talk at the AEA meetings made much of this policy. But who in the world is going to buy CDOs in this market?
The lagniappe: Lots of the CDOs are based on fixed interest rate mortgages. If there is inflation, the capital value of those gets hammered. All the rest are based on ARMs of some kind. And for those the PAYMENTS skyrocket with nominal interest rates, and defaults go up, and AGAIN the CDOs' capital value takes it right up the ol' gazoch, with a red hot poker.
This is not really a good policy.
All of this is true... if inflation cranks up in the short-run. What do the markets think about inflation? Here is the most recent TIPS spread (the difference between nominal T-bills and inflation-protected T-bills, which represents the market's expectations about inflation):
This indicates that the market does not anticipate inflation to "crank up" any time soon. In fact, it means that we are at a much greater risk of deflation than inflation. Which means that the Fed policy is actually a very good policy, given the circumstances.
Of course, Munger is free to disagree with the markets if he pleases, but a libertarian should do so at his own risk.
As Krugman says, the danger that we'll end up in a Japan-style situation is much greater than the danger that we have rampant inflation in the short-run. In the medium-run, sure. But by then the Fed will have had plenty of time to off-load its risky assets at acceptable prices.