Introduction
Currently, the United States is witnessing a sizable uptick in general inflation levels in quantities unforeseen for decades. So far, from Q1 through roughly the midpoint of Q2 in 2021 alone, the CPI is up 4.2 [1], representing the greatest increase since the 2008 subprime mortgage recession.
According to an analysis from Euro-Pacific Capital CEO Peter Schiff, the extrapolated trends from the beginning of the year assuming the current growth rates continue, the CPI could describe 20% increases for 2021 [1]. Meanwhile, this year’s Core CPI has broken a high record from 1981 prior to the finish of the 2nd quarter [1]. These figures are in excess of what professional mainstream economists have predicted.
To the Austrian economists wary of the pernicious effects induced by loose monetary policy, this situation is not surprising. However, many within the school have been subject to error in their forecasts of destabilizing hyperinflationary risks. It is the aim of this article to rectify the persistent misunderstandings of colloquial references to inflation by taking recourse to the more hidden mechanics of price fluctuations to venerate Austrian theory proper. In doing so, current inflationary conditions which inspired this effort are more comprehensively measured.
Preface on Terminology
Meaningful discussions of technical economic matters often prove prohibitive with terminological imprecision. Inflation is no exception, with disagreements over what it exactly describes numerous.
When properly understood, inflation refers to a resultant increase in prices irrespective of the factors responsible. Specific causes are variant, including those such as a genuine shortage in select goods and markets in which prices rise to communicate the new scarcity, an increased demand for money in present terms which is of particular importance when explaining monetary and financial institutions through monetary disequilibrium theories, or an artificially expanded money supply which stands in discoordination with the comparatively scarcer supply of real resources or money demand such that the marginal purchasing power of the newly inflated currency falls.
The last of these factors is often confused with the definition of inflation itself as teleological price increases. Although the general theory behind this description of inflation is correct, improperly attributing all inflation to this one cause excludes competing factors behind inflationary events, such as monetary disequilibrium irrespective of central bank liquidity injection. This nuance has two prominent implications. First, inflation is not unmistakably destructive. Second, by reference to the contrasting event, deflation is conditionally proactive.
While not all of these descriptions are directly relevant to the following analysis pertaining to the specific current events of 2021 which compelled this essay to be written, they are nonetheless important prefaces to any discussion of a concept subject to lasting confusion from semantics. With this basis established, a meaningful discussion of inflation can now be entertained.
Unfounded Alarmism?
Many critics of Austrian economics identify the school’s unrealized forewarnings about hyperinflationary concerns of the US dollar in recent history despite persistently loose monetary policies from the post 2008 recession Federal Reserve as evidence against its theoretical propositions. Notably, this criticism is shared by those within the Austrian school of noteworthy proficiency as well.
It stands to reason therefore that much of the conventional wisdom spread by casual followers of the school pertaining to inflation premise their concerns on dubiously oversimplified descriptions of how the perverse effects of inflation manifest. Namely among them and central to this analysis, these persuasions maintain that rapid hyperinflation across the market for all goods in manners similar to what occurred in Weimar Germany, Zimbabwe, and Venezuela in the twenty-first century are common results from the loose monetary policy response managed by central banks.
With proper recourse to greater and more precise insights made, Austrians need not be concerned by these objections of crying wolf at inflation, because succinctly, rapid price inflation in final order consumer goods are not the only evidence of its destructive effects. The theoretical framework of Austrian monetary theory is sound and capable of explaining why inflation is a palpable threat even in the absence of this overt uptick in endmost consumer prices with proper recourse to understanding the non-neutrality of money and its corollary in the Cantillon effect, the monetary disequilibrium position, and the speciousness of economic stabilization alleged to be constitutive of sound money.
Even though the current period is starting to witness inflation in these final order consumables, a more peripheral analysis into the markets of other goods of higher orders coupled with a heavy emphasis on how catallactics function is necessary in appraising the severity of what led to such condition per Hazlitt’s dictum that proper economic analysis consists not of what is immediately present, but unforeseen initially.
The Utility of Prices and Monetary Non-Neutrality
Whereas the plurality of mainstream schools of thought emphasize the costs of inflation and deflation relative to the aggregate price level, the Austrian emphasis on relative prices illustrates how costs incurred by unsound money result from distortions to the marginal, microeconomic coordination process. Disruptions can be either inflationary or deflationary when such changes render the prices scant information signals.
Another notable distinction between conventional theories and that of the Austrians is that economic growth is posited to induce price deflation when assuming monetary equilibrium. This is because the productivity increase characteristic of economic growth affords cost saving inputs within the structure of production which are passed onto the markets for final goods; not to mention competitive pressures between firms contributing to the like effect. Persistent false growth and inflation in the present economy is an imposed political artifice where the growth is speciously hiding unsound fundamentals.
Current conditions are much more akin to a stagflation in real terms despite metrics which by way of their own limited inclusion of all relevant variables such as stock market performance and GDP data suggest otherwise. As an aside, such is opportune to bolster the affirmative case for a disaggregated causal realist methodological precedent which does not make causal inferences from ambiguous empirical aggregates of prices and other phenoms of limited explanatory merit when conducting economic analysis.
Inflation caused by this aforementioned artificial credit expansion is not disruptive entirely because its specific rates are often unpredictable given the lack of transparency with central banks and their malleability to suit ambiguously forecasted political objectives. Saying so would concede that inflation is harmless if its patterns can be forecasted. Even when generously assuming inflation rates are expected, however, the inflation effects different prices at different times as it moves throughout the economy per the inherent characteristic of money’s non-neutrality.
Monetary non-neutrality is best understood as the description by which prices change at variant correction speeds, meaning relative values change in ways which given this property cannot be neutral. The effects of this to be disruptive are greatly amplified given the uniquely Austrian emphasis on relative values within a marginal framework that parts company with aggregate stabilization metrics as sound measures of fundamental economic performance. Signal extraction errors therefore prevail given the discoordination to relative prices enabled by this artificially induced non-neutrality.
This change in specifically relative prices from adjustments to the money supply is otherwise known as the Cantillon effect. It greatly complicates the already spurious effort of anticipating inflationary results. While the more mainstream quantity theory of money correctly states that issuing new money will only inflate prices if not offset by an increase in money demand or represented real resources, failure to consider the subsequent Cantillon effects can only have limited use in describing inflationary results ex post rather than actively measuring the changes through time starting with the induced disruptions where the new money enters the factor markets.
The Stabilization Myth and Free Banking
Contrary to more orthodox pro market persuasions, sound free market monetary systems are not characterized by price level stability understood through reference to growth expectations. Rather, it establishes monetary equilibrium which allows the price level to move in response to changes with real market precedent. Only under these conditions are prices truly emergent instead of comporting with ad hoc engineered changes to its value that fail to represent the revealed preferences of engages.
With respect to stabilization and inflation, attempting to maintain price level stability in an economy experiencing productivity gains will lead to undue inflation because the price level should otherwise be falling per organic market mechanics. Applying the monetary disequilibrium while assuming this artificially maintained price level stability persists, the resulting stability is concealing an underlying inflationary boom because productivity gains should have been deflating prices had the market functioned unhampered. Economic stabilization policies, contrary to their namesake intent, therefore inhibit prices from communicating real values.
The very predicate behind stabilization, that sound money is one which sees limited or expected variance, is wrongheaded. Sound monies are characteristically those which comport with actual conditions in relative scarcity and time preferences such that microeconomic price coordination occurs in value and time preferred manners. It is to be noted further that stabilization does not exclusively refer to measures undertaken by a central bank’s monetary policy. When a mistaken appraisal of what sound money precisely is erroneously informs the actions facilitated by private creditors, similar disruptions can occur. Granted, since these private institutions are competitive firms and subject to market redress when in error, the losses are concentrated to liable parties.
The losses from poorly capitalized banks misallocating resources pursuant to feckless investments is also essential to the market process of economizing wasteful projects which should not have been undertaken. Even the most poorly managed private bank is evidenced to disincentivize unfruitful risks and redirect capital more effectively then many in the mainstream commonly suppose. “Too big to fail” is a monopolistic privilege afforded to politically entrenched banks insulated from market redress. It is not a description of predatory market firms.
Although somewhat departed from the direct subject matter in question, it is important to understand that it is remiss to characterize the lending practices done by well capitalized, audited, and contractually obligated fractional reserve banks as akin to loose money open market operations the central bank regularly engages with. The distinction is present in how the latter issues credit which fails to account for depositors’ time preferences. Temporal disequilibrium results while consequently exacerbating monetary non neutrality such that signal extraction errors result. By contrast, free market fractional reserve banks ensure the supply of money is tied to the demand to hold money. Maintaining this links the market interest rate to the natural rate, hence the money values are accord with depositors’ time preferences.
Historical Precedent
The economy of 2021, where the prices of endmost consumer goods are starting to increase while underlying inflation has been chronically persistent, is eerily similar to Rothbard’s characterization of the monetary causes of the Great Depression of the 1930s.
In his 1963 book America’s Great Depression, Rothbard principally argues that the preceding Roaring ’20s was an era of unsustainable monetary expansion mainly evidenced by excessive credit issuance to time deposits. Even though consumer prices were relatively stable throughout the 1920s, the underlying inflation in time deposits which reached levels as high as 126.1% [5] over the decade explains how weak fundamentals were hidden by surface normalcy; an effect that would only come to roost when the internal pressures from unsound money eventually inflated consumer prices. The concomitant effect was revealing a situation far worse than initially anticipated.
This is the tremendous concern for the present: Consumer price inflation is only the beginning of a much wider and more expansive economic downturn characterized by weak monetary fundamentals thanks to decades of persistently loose credit facilitated in defiance of stagflation forewarnings. COVID-19 was only the final nail in the coffin revealing an already weakened economy. This ought be concerning, especially since incumbent President Joe Biden has frequently voiced support for “bold federal action” to combat recessions.
The historical track record of such programs is decisively against what the eager interventionists within the Biden administration are inclined to acknowledge. Many contemporary historians even agree that the Great Depression was of such considerable length due to the persistence of New Deal programs. In contrast, the United Kingdom and Canada were similarly impacted by the Depression yet recovered sooner than the United States thanks to a comparatively more neoclassical liquidation-informing political leadership. In the case of Canada especially, better capitalized and deregulated banks corrected for the monetary distortions more expeditiously than the United States as well.
Overall, economic growth periods must be assessed neither by stable prices nor ambiguous metrics premised on dubious assumptions but rather fundamental conditions of sound money and the integrity of credit issued banking institutions.
Conclusion
While predicting a Depression scale downturn is imminent with a strong degree of certainty may be overstating the potential risks, it is nonetheless a palpable one. At the very least, it is more likely to occur than many, especially mainstream practitioners and pundits are inclined to admit. What can be said with greater confidence, however, is that unless current trajectories change, which is unlikely as what is economically sound is seldom politically tenable, an expected outcome is a more pronounced stagflation period reminiscent of the 1970s.
The situation is analogous to earthquake prediction. Every now and then there will be little disruptions along localized fault lines contributing to general instability, representing the inflation in the market for higher order capital goods and temporal disequilibrium from monetary injections incongruent with real values. These more inconspicuous pressures mount, however, and eventually boil over until the “big one” hits.
The “big one” in this case is a substantial inflationary episode felt in markets normally immune or slower to adjust from economic downturns and instability to fundamentals such as final order consumables rather than just intermediate capital goods, time deposits, and the prices of portfolio assets. It would therefore be remiss to dismiss correctly formulated forewarnings as mere alarmism, but likewise erroneous to suppose the start of every minor fault was going to be a “big one”.
Throughout this all in reference to the fundamental theory of money, it is important to remember that money is a product of the market itself. Created as a spontaneously byproduct of trading individuals to resolve the impasses formed by barter and its limitations of trading with the double coincidence of wants, it is an emergent commodity existing as the most marketable form of a commonly accepted good denoted as a medium of exchange. The mechanics of supply and demand apply to it as any other commodity money is used to purchase is, making artificial disruptions to it par the course with non-market inflation germane for a litany of issues.
In true closing, this work has been heretofore value free, yet there are many ethical gripes to be had with the political economy of engineered inflation. Its many forms are united in being an asymmetric gain of governments and their enabling central bank creditors. It is a veiled, confiscatory tax that siphons private wealth to zero sum government plans. Savings become depreciated to extents where conservatively managing money is a cost prohibitive venture in the name of expending political favoritism and protections from what the market would otherwise curtail. High risk investments and higher time preferences are incentivized as a national standard to the detriment of average depositors and private interests.
In looking to solutions, it is easy to identify solutions pursuant to what is symptomatic of the matter, yet fails to most directly address its main causal impetus. In this instance, that factor is the government-sanctioned and enabled centralization of banking, finance, and money. Disabusing this authority away from the political class and towards a reconstruction of true free market banking and money issuance are the surefire means towards making sure events of this nature are not allowed to happen.
- Schiff, Peter. The Peter Schiff Show Episode #690. 2021. Apple Podcasts. Podcast.
- Horwitz, Steven. Microfoundations and Macroeconomics. 2009. Routledge. Print.
- Yeager, Leland B. The Fluttering Veil: Essays on Monetary Disequilibrium. 1997. Liberty Fund. Print.
- Selgin, George A. Less than Zero: The Case for a Falling Price Level in a Growing Economy. 2018. The Cato Institute. Print.
- Rothbard, Murray N. America’s Great Depression. 1963. The Ludwig von Mises Institute. 2000. PDF access file.