Austrian economist Antal E. Fekete has an interesting piece out arguing that many modern day Austrians misunderstand the relationship between speculators and central bankers and the means for which inflation takes hold in a credit-based economy. This misunderstanding has lead some to incorrectly predict hyperinflation in the U.S. following the 2008 financial crisis and unprecedented expansion in the Federal Reserve’s monetary base . Here is the relevant excerpt (emphasis mine):
These views hang the picture upside down. In actual fact, the Fed and the U.S. Treasury desperately want to beat down the value of the dollar. The greatest obstacle frustrating their effort is the stubbornly high and still increasing value of U.S. Treasurys. Captains of the world’s monetary system are yanking levers and twisting throttles which are no longer connected to anything. The captains are no longer in control. Yet they continue to wave their batons feverishly and pretend that the orchestra is paying attention. They want Jim Willie, Jeff Nielsen and everyone else to believe that the falling interest-rate structure is the outcome of their deliberate monetary policy. In fact, the Fed and the U.S. Treasury are trying to stop the rate of interest from falling further. They instinctively realize the threat of falling interest rates brings deflation and depression in its train. The dollar is much too strong, contrary to the wishes of policy-makers.Fekete’s position is interesting to say the least. One of the main criticisms of the Austrian Business Cycle Theory (proposed by Tyler Cowen) is that market participants are endowed with perfect knowledge to preempt central bank monetary policy and not be induced into a false exuberance over a bubble. The intertemporal discoordination between various structures of production can’t happen as investors and speculators are supposed to know exactly what central planners will attempt next. Of course perfect knowledge can never be held by any market actor but Fedekete seems to be implying the same concept here. If investors and speculators knew Bernanke was going to send interest rates plummeting and engage in a couple of rounds of bond easing, they could take advantage now by purchasing bonds before their price goes up as rates drop. From another Fekete article on the same subject:
Like Mises, I also object to the use of the word hyperinflation, albeit for a different reason. It suggests that the phenomenon is linear and follows the laws of the Quantity Theory of Money. The more money is printed, the higher do prices go.
However, we are here facing highly non-linear phenomena. Our economy is torn to pieces by runaway vibration. We are victimized by the self-destruction of the monetary system subjected to oscillating money-flows boosted by the resonance of fluctuating interest rates resonating with fluctuating prices.
When the central bank intervenes in the market to control the rise of interest rates, it inadvertently makes prices fall; and when it intervenes to stop prices from falling, it inadvertently makes interest rates rise. The upshot is that the central bank intervention, rather than tempering movements, aggravates them.
At the present junction the Fed is buying bonds to combat deflation. Bond speculators know this, will buy the bonds first, driving down interest rates in the process. The result is more deflation, not less.
The Keynes-inspired central bank action is counterproductive. Policy-makers are blind and don’t see this. They stick to their selfdefeating monetary policy. They actually become the quartermaster general of the depression they are trying to avoid. As if cursed by a particular kind of madness, policy makers saddle society with the vampire of risk-free speculation.
The majority of hard-money analysts call for a hyperinflationary collapse of the dollar. Their analysis is faulty. Like a cornered rat, the dollar is capable of putting up a vicious fight for survival. In the words of Mark Twain, all the obituaries on the dollar are premature. The dollar is not a push-over. A yen-yuan coalition (or any other combination of existing or yet to-be-invented fiat currencies) cannot send it into oblivion.
When a central bank increases the monetary base three-fold in three years, this is a clear invitation for bond speculators to move in and make a killing. But what the central bank utterly fails to understand is that, contrary to its hopes, new money is not going to the commodity market. Speculative risks there are far too great. Instead, new money is going to the bond market where the fun is. Bond speculation is risk-free. Speculators know which side the bread is buttered.Fekete assumes, like Cowen, that all market participants hold enough information to gauge exactly what direction the Fed is going in order to make an easy buck off the bond market. To some extent, he is correct in that central bankers have a tendency to resort to the printing press when things look dire. Also consider the fact that Bernanke has made it clear he intends to keep interest rates low till at least 2013 which means bond buying will continue if rates start to inch up. With the chaos going on in Europe, and to a certain degree China, the dollar is seen as a safe haven which gets in the way of Bernanke’s dreams of a weakening it further. All of these factors combined lead to a disincentive on the behalf of banks to lend to businesses and consumers and thus extend credit and gin up inflation- which says nothing about the rotten mortgages still dragging down some consumers.
None of this is a positive endorsement of Fekete’s theory however, but his ideas are certainly worth considering. He is correct in that some Austrian minded folk were incorrect in predicting a large degree of inflation to take hold after the Fed’s shenanigans of 2008 (including even this author). This wasn’t expected:
There are some stubborn facts that don’t play into Fekete’s theory however. The CPI is currently running at 3% annually, the core CPI is at 2.2% (above the Fed’s unofficial target), energy is up 6.6%, and food is up 4.7% according to the Bureau of Labor and Statistics. These are not exactly sure signs of impending deflation given a continually expanding money supply.
All of this just adds to the kind of complex factors which encompass a market economy composed of billions upon billions of individual transactions every day. Unfortunately for Keynesians, monetarists, and believers in econometrics, economics is not a science to be analyzed in closed experiments. That pesky thing called “free will” often gets in the way of central planners trying to engineer a perfect society: or at least one that is perfect from their point of view. If there is one thing we can all agree on, the Keynesian cure of cheap money and fiscal deficits certainly isn’t bringing the prosperity promised by Paul Krugman and the like. As Fekete writes:
Cheerleaders for fiat money in academic circles, in the media, and in financial journalism will not be able to live down the shame that will be their lot when the world economy collapses. The excruciating economic pain that people will suffer as a consequence will be their responsibility. The break-down in law and order will be their fault. As history and logic conclusively prove, fiat money is not a viable monetary system. It is prone to succumb to the sudden death syndrome. Whether caused by inflation or whether caused by deflation, sudden death is assured.(H/T to Mish for pointing these articles out)