We’ve just returned to the office following an extended Easter break. We feel refreshed. We’ve had time to think. We flicked though some old books…they reminded us that some things, like human behaviour, never really change.
Economics, and markets, at their core, are just a reflection of human behaviour. Academics and central bankers like to think they can model this behaviour and fine tune it to achieve their desired outcomes. And we would like to believe they can do so. If you’re a land or asset owner, you want to believe the wealth effect is not just a short term mirage…a money illusion.
Well, sorry to break it to you, but in the aggregate, it is. Ludwig von Mises told us why in his epic treatise on economics, Human Action. He was adamant that credit expansion built on the issuance of money (and not backed by an increase in real productive capital) would end in a bust.
He tells us that state directed credit expansion (which is what’s going on in China, and in the world’s major economies via their QE programs) is simply a policy to buy everyone off…to make us believe in a fake form of wealth.
‘Credit expansion is the governments’ foremost tool in their struggle against the market economy. In their hands it is the magic wand designed to conjure away the scarcity of capital goods, to lower the rate of interest or to abolish it altogether, to finance lavish government spending, to expropriate the capitalists, to contrive everlasting booms, and to make everybody prosperous.’
If you think back to the 2008 bust, it is widely recognised by those employing a modicum of common sense that the preceding boom caused it. That is, low interest rates and rapid credit expansion in the US in the early 2000s led to a historic house price boom and subsequent bust. Unfortunately those that need to recognise it the most — government officials and central bankers — have failed to do so.
But has it ever been different? Nearly 70 years ago, Mises wrote:
‘Although no official — whether he works in the bureaus of a government’s financial services or of a central bank, or whether he teaches at a neo-orthodox university — is prepared to admit it, public opinion by and large no longer denies the two main theses of the circulation credit theory: viz., that the cause of the depression is the preceding boom and that this boom is engendered by credit expansion.’
Given that officials of all stripes ignored the causes of the 2008 bust, it should not have surprised you that they chose to remedy the situation by going down the inflationary path again, this time by creating a credit boom in government debt securities.
Mises foresaw it all:
‘All governments are firmly committed to the policy of low interest rates, credit expansion, and inflation. When the unavoidable aftermath of these short term policies appears, they know only of one remedy — to go on in inflationary ventures.’
Which, as you’ve seen, is exactly what’s been going on over the past five years. But as Mises said:
‘If, however, the government resorts to the cherished inflationary methods of financing, it makes things worse, not better. It may thus delay for a short time the outbreak of the slump. But when the unavoidable payoff does come, the crisis is the heavier the longer the government has postponed it.’
The crisis got underway in 2008…it was then postponed through massive and unprecedented credit expansion. The postponement phase, driven by plunging interest rates and then the policy of QE, has been going on for over six years now.
Has the crisis gone away, as nearly everyone believes? Or are we just at the peak postponement phase? Here’s our final quote from Mises on the issue:
‘The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion, or later as a final and total catastrophe of the currency system involved.’
This actually relates pretty well to the situation in Australia too, not just the global economy. Over the past few decades, the real cash rate in Australia has been on a downward trend. Except for a few tightening phases necessitated by our historic commodities/terms of trade boom, the Reserve Bank of Australia has constantly lowered interest rates to avoid recession.
Real interest rates in Australia’s economy (which is the nominal rate minus inflation) are now negative. That’s hugely stimulative. Yet we’re struggling to get back to a trend rate of economic growth. This suggests that our economy is poorly structured and lower interest rates only have a one-off impact.
If that’s the case, most of the interest rate stimulus has already flowed through the economy. We wrote about this in detail in the latest issue of Sound Money. Sound Investments. We said it would first show up in the housing market.
Due to the lag effect of monetary policy, you should expect to see housing markets in Australia (actually, in Sydney and Melbourne) plateau out between now and June, before turning down (in the absence of more rate cuts) later in the year.
This is simply how a credit addicted economy works. It needs constant injections of credit to remain afloat. If it doesn’t get it, prices start to sink.
Ludwig von Mises wasn’t the only guy warning about the perils of inflationism. He had a number of contemporaries, mostly from the Austrian school of economics, and their philosophical debates with the ‘Keynesians’ were legendary.
Over the years, those that benefit most from a policy of inflation have marginalised dissenting voices. But one man has managed make a convincing argument about the fragility of the financial system without aligning himself to any economic theory. He simply follows a logical and common sense argument.
That man is Jim Rickards, who you may be familiar with. His latest book, The Death of Money clearly explains why the current policy of inflationism will result in a systemic breakdown in the not too distant future.
for The Markets and Money Australia