The Road Ahead: Inflation or Deflation?

Just wanted to provide a quick comment on a certain debate that rages in the world of Austrian economics.

It is accepted by all Austrian economists and proponents of the Austrian school in general, that the United States economy is in a Federal Reserve induced credit bubble.  The expansion of the money supply, which pushes down interest rates and encourages excessive borrowing immediate consumption, gives rise to an economic bubble. We see the prices of assets and money markets throughout the economy rise and the financial commentators and talking heads declare that We’ve Never Had it So Good.

This is the boom.  But it is fake.

This boom was not sourced in the decision by individuals in the market to save and invest.  Thus, this boom cannot be described as “growth.”  Growth occurs when capital expands. But in a Fed-manipulated bubble, there is no capital expansion. Thus, the boom will necessarily turn into a bust.  It is unsustainable.  Something has to give.  What is going to happen in the economy as the bubble begins to break down?

That is where the debate rages.  Will there be a hyperinflation? Will the Fed try to print their way out of doom?  There are many who think this is the case. I disagree with this group. I am in the deflationist camp. I am awaiting a credit contraction.  I think that every economic bust is a credit contraction which follows the credit expansion.  The Austrian Business Cycle Theory (formulated by Mises and Hayek) shows that busts are deflationary because the credit markets collapse.  The boom is sourced in the credit market, and therefore so is the bust.

Printing lots of cold hard cash and giving it out nonstop is the road to hyperinflation, Zimbabwe style.  But the Fed is not printing lots of cold hard cash. It is creating lots of digits on a screen and crediting those digits to accounts as debt.  Once the digits are eliminated in credit crisis, there is no cash to prop up the price of goods.  Prices plummet. Investors and capitalists lose on their financial risks.

When you read of hyperinflationary scare pieces in the libertarian world, don’t assume that this is the Austrian perspective.  Yes, there are Austrians (Peter Schiff) who see a hyperinflation coming, but the Austrian view does not demand this.  I like Peter Schiff on many issues. I disagree with him on this one.  I prefer the foresight of Mike Shedlock and David Stockman.

One more note on the use of words: the mainstream commentators will use inflation and deflation to refer to rising and falling prices respectively. This is not historically the proper use of these words. Inflation should mean an expansion of the money supply and deflation should mean a contraction.