Robert Murphy is my favorite contemporary Austrian Economist. See his short article copied below titled: Investors Finally Fear the Inflation Precipice. It is no coincidence Murphy calls himself a “proud member of the fuddy duddies who have predicted return to serious stagflation.” Count me one too. The Murphy article triggered the following reflections….
Einstein said "We can't solve problems by using the same kind of thinking we used when we created them." Conventional mainstream economics got us into this mess; it won’t get us out. Why I prefer the Austrian framework is because I believe it allows us to see problems before convention mainstream economics is capable of seeing them.
This is because the conventional model is focused primarily on the consumer price index as a key anchor for macro economic stability. As long as CPI is stable, we are supposed to assume the economy is stable. The Fed takes it one step further. It claims that if it maintains stable, low CPI it will ensure macro stability. This is circular logic.
According to the Austrian school model, inflation is not the CPI. CPI is the tail of the inflation dog. CPI is the result of inflation, it isn’t the thing itself. Inflation is credit expansion; inflation is a debasement of the currency. Currency debasement is easily measurable via the gold price. When the gold price goes up, we know there is “inflation.” it really is that simple.
History has now proven in two painful episodes how silly the claim is by mainstream economics that stable CPI leads to stable macro performance. We have the Great Depression and in the latest 2007/8 crisis as living proof of the folly of pegging monetary policy to the CPI. In the 1920s we pegged to WPI, but the idea was basically the same back then. As long as the general price level was low and stable (which is was in the 1920s) there was no reason to worry about anything else, such as the massive global asset, credit, growth bubbles being fueled by the Fed’s low interest rate policy (implemented to help the UK recovery from post WWI recession). IT is a historical fact that the Fed kept interest rates artificially low in the 1920s behind which it fueled (what I would call) a massive “inflation” bubble which led directly to a stock market bubble / bust and then on to the Great Depression!
The Austrian School focuses on the cause of the Depression in the policies leading up to it, not in the policy mistakes made after the credit/asset/ growth bubble burst. The key focus of policy attention for the Austrians is avoiding the credit boom (which they consider inflation) in the first place. once inflation shows up in the general price index it is too late!
Again according to the Austrian school, it wasn’t what we did after the Crash of 1929 that caused the Depression; it was the easy money policy we pursued ahead of it. Now we have a central bank governor who is obsessed with avoiding the “mistakes” the Fed made AFTER the stock market crash in 1929 which he argues led to the Great Depression – i.e. keeping monetary policy too tight. Yes, Bernanke seems to have avoided a repeat of the Great Depression with his QE1 and 2. But that doesn’t mean he hasn’t sown the seeds for a Great Stagflation, which is what I believe he has done.
Printing money may be enough to avoid a Great Depression redux, but we have no clue what the second round effects will be of the money printing done ostensibly to avoid a deflationary spiral. Well we actually do have a clue that the second round effects will be: we see them already, e.g. raging commodity price inflation. What we still don’t know is how all of this will play out. We don’t know how the exact narrative will play out in terms of what markets will be stressed to the breaking point. but it will happen. We are already seeing signs of stresses in Egypt with food prices fueling political instability. We are seeing stresses I China and in many other parts of the world fueled by the global USD inflation facilitated by the Fed. I didn’t know sub-prime would derail the US economy in 2007, (some smart analysts did identify sub prime as bubble market) but what I did know is that that we were in a boom / bust cycle thanks to the gold signal.
There is an old french proverb that says you find your destiny on the road you take to avoid it. no matter what Bernanke does, the damage that was done to US economy and financial markets was done in the easy money policy leading up to the credit crisis of 2007/8. Most Austrians focus on the easy money period of Greenspan’s Fed in fueling the housing bubble. I focus on the second easy money period from 2005 and 2007 as a vital part of the story. this second easy money period wasn’t caused by the Fed doing anything wrong per se, except to use the CPI as its inflation indicator.
In my unique framework, the second inflation was caused by a massive adverse shock to money demand which led to massive liquidity bubble – on top of bubble already fueled by Greenspan. But in my hypothesis, we wouldn’t have had the Great Recession of 2008 without the second big money inflation. this part of my story is outside the Austrian School framework. (it is no coincidence <Murphy doesn’t talk about the gold signal in his article.)
The gold signal told us we were in a global liquidity / credit / “inflation” (in classical sense) bubble was brewing in 2005-2007 while the fact that CPI remained low was used as an excuse to keep the good times rolling. The IMF, Federal Reserve, World Bank and most mainstream economists were talking about how great the world economy very late into 2007. Bernanke continued to claim sub prime was containable. All because he had no context for appreciating the gold signal.
The return of commodity and gold price inflation tells us we are in the middle of another mini-cycle of what I believe will turn out to be a secular global liquidity super cycle. When the bust happens the Fed will just keep printing money to reflate markets. Each reflation cycle distorts the economy even more because liquidity is pumped into economy at zero interest rates and thus goes to projects it wouldn’t otherwise go to if not for the easy money underpinning the low interest rates. Ultimately, that means stagflation of one sort or another.
The fix as I’ve said before is a trifecta of policy measures none of which seem remotely possible in the current political environment:
Sound money, entitlement reform and massive supply side de-regulation.
We are getting the exact opposite. How can it end well? Do we really believe the Federal Reserve can micro manage a soft landing for the economy via enlightened money printing?
In 2005 to 2007, the gold price was screaming to us that we were in the middle of a massive credit / liquidity bubble. but mainstream economics and mainstream monetary policy makers had no way to foresee a credit/liquidity/inflation bubble because they were erroneously fixated on CPI. “We” continue to remain erroneously fixated on CPI! It makes no sense. We keep the CPI target because it is convenient. No other target is consistent with having a Federal Reserve piggy bank that both the political right and left want to fund their big government priorities. We don’t blame the CPI target for the boom / bust because we don’t want to face the painful tradeoffs that would come with a new sound money framework organized around a new inflation target, such as gold or a commodity basket. So what we do is create a narrative that explains the bust in the proximate causes of the crisis and then we go around fixing the proximate causes with more “enlightened” big government interventions. It is no coincidence the narrative explaining the Great Recession of 2008 is essentially the same narrative used to explain the Great Depression: that these cycles were caused by greedy investment bankers, lax regulation, evil new financial products (margin lending in 1920s, derivatives today), assete bubbles.
What is clear to me is that the underlying cause of the Great Depression and the Great Recession of 2008 is easy money. The perfect storm of proximate causes of both historical events could not have occurred without the Federal Reserve manipulating interest rates lower than they other wise would have been without the central bank.
The 40% increase in the gold price since 2008 is telling us that we are right back where we started: in the midst of a global inflation bubble facilitated with Fed policy QE1 QE2.
the article copied below doesn't include charts. to view charts go to orginal article at:
Rethinking IP by Stephan Kinsella
Daniel Bernoulli and the Founding of Mathematical Economics by Murray N. Rothbard
Well it's about time. The headline on Monday's CNBC article announces: "Investors Starting to Believe That Inflation Threat is Real."
For some time, I have been a proud member of the fuddy duddies who have been predicting the return of serious stagflation. Thus far, our prognostications have clearly been half-right — the "real economy" is indeed caught in a terrible rut, far worse than most of the Keynesian economists recognized even in late 2008.
However, on the (price) inflation front, things are not as clear-cut. Although asset prices and producer prices have surged in response to Bernanke's monetary pumping, retail consumer prices (at least as officially reported by the Bureau of Labor Statistics) have not been rising at alarming rates.
I am not the first economist to explain this apparent anomaly by reference to Wile E. Coyote: The serious inflation won't hit until everyone thinks it is going to hit. And although the "fundamentals" of serious price inflation have been in place since late 2008, we are seeing more and more signs that Bernanke's dam of obfuscation is starting to crack.
A Simple Picture
Simplistic as it may seem, I still cannot shake the feeling that the below chart is all we really need to know that eventually, we will experience large price hikes:
Yes, yes, there are all sorts of sophisticated arguments for why there's nothing to see here, just keep moving along, the dollar will be fine. In particular, there are arguments about the demand for holding "base" money totally offsetting Bernanke's injections, and the huge increase in excess reserves means that the new money isn't "leaking out" into the broader economy.
However, when the serious price inflation comes — as I still believe it will — I think we will all look back at the above chart and be shocked that people were worried about deflation in 2008-2010. And there is precedent for this sort of thing; remember that in 2005 and 2006 plenty of really smart people (including Ben Bernanke) denied that there was a housing bubble[1]:
In Bernanke I Don't Trust
It is true that Bernanke could reverse course before things are too late, as far as the purchasing power of the dollar is concerned. But this would entail devastating pain to the banking sector, since the Fed would have to reverse the policies that bailed out the overleveraged titans in the first place. If Bernanke has to choose between saving rich bankers or the dollar, I am confident he will choose the former.
When Bernanke made his infamous appearance on 60 Minutes, most analysts understandably focused on his absurd claim that he wasn't printing money. But the thing that most alarmed me was this exchange (starting at about 7:20 in this video):
BERNANKE: There really is no problem with raising rates, tightening monetary policy, slowing the economy, reducing inflation at the appropriate time. …
Q: You have what degree of confidence in your ability to control this?
BERNANKE: A hundred percent.
Now that should be terrifying. Realistically, Bernanke shouldn't have 100 percent confidence that he can control his toaster. I mean, he might turn the dial up too high, or someone might spill water on it. It could happen.
By the same token, there are all sorts of scenarios where the natural "unwinding" of the Fed's extraordinary policies won't work as planned. In particular, if even official CPI inflation starts creeping above 4 and 5 percent on an annual basis, while unemployment remains above (say) 8 percent, then it will become apparent that Bernanke's "exit strategy" leads into a brick wall.
"Well, If the Fed Started Monetizing the Debt, Then I'd Worry About Inflation …"
One of the more absurd stances rejecting the inflationist warnings comes from people who think Federal Reserve policy is completely divorced from the Treasury's fiscal position. Such naïve analysts think that Bernanke's decision to soak up more than one trillion in government debt had nothing to do with the massive deficits that the government has been and will continue to run.
Those pooh-poohing our current situation will concede that interwar Germany or modern Zimbabwe got into trouble all right, but those were situations where the central bank "monetized the debt." This supposedly stands in sharp contrast to the scientific monetary policies of the "independent" Federal Reserve.
To put these claims in context, note that in the 2nd quarter of 2009, the Fed's absorption of Treasury debt amounted to 48 percent of the new debt issued in that period. And ZeroHedge posted the following chart showing that the Fed is currently the world's largest single holder of Treasury securities, surpassing China:
Conclusion
No one knows the future for certain. But given the economic and political realities, I still remain confident that prices quoted in US dollars will continue to escalate, not only in commodities and certain asset classes, but eventually in most consumer goods. At some point it will be so obvious that not even Ben Bernanke will be able to deny it.
When will the breakout occur? Again, no one can know such things for sure, but there are growing signs that "the market" will soon recognize that Bernanke & Co. have painted us into a very tight corner.
Robert Murphy is an adjunct scholar of the Mises Institute, where he will be teaching Anatomy of the Fed at the Mises Academy this winter. He runs the blog Free Advice and is the author of The Politically Incorrect Guide to Capitalism, the Study Guide to Man, Economy, and State with Power and Market, the Human Action Study Guide, The Politically Incorrect Guide to the Great Depression and the New Deal, and his newest book, Lessons for the Young Economist. Send him mail. See Robert P. Murphy's article archives.
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Notes
[1] To my eternal shame, I was one of those (hopefully) smart economists who overlooked the dangers for far too long. So when I say that people can latch on to arguments to dismiss warnings, and later wonder what in the world they were thinking, I speak from personal experience.
Rethinking IP by Stephan KinsellaDaniel Bernoulli and the Founding of Mathematical Economics by Murray N. Rothbard
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