answer to the above question is no, meaning that "Austrian
Economics" makes no prediction about whether the future will be
inflationary or deflationary. That's why some adherents to
"Austrian" economic theory predict inflation while others predict
deflation. An economic theory can give you an idea of what will happen if certain
policies are implemented; it doesn't tell you what will happen regardless of
policy choices. To explain what we mean we will zoom in on two famous quotes
of Ludwig von Mises, the most important economist
of the "Austrian" school.
Here's the first quote:
"There is no means of avoiding the
final collapse of a boom brought about by credit expansion. The alternative
is only whether the crisis should come sooner as the result of voluntary
abandonment of further credit expansion, or later as a final and total catastrophe
of the currency system involved."
The first sentence of this quote is sometimes
taken out of context as part of an argument in favour
of deflation. It could be construed, if considered in isolation, as a
statement that a period of deflation must follow a credit-fueled boom.
However, no good economist, let alone the greatest economist of the past
century, would ever claim that price deflation was inevitable regardless of
what was happening to the money supply. To do so would be to claim that the
law of supply and demand did not apply to money. In the real world there will
always be a link between money supply and money purchasing power. The link is
complex, but it will always be possible to reduce the purchasing power of
money by increasing its supply.
The second sentence provides the necessary
clarification. In essence, it says that a boom fueled by a great credit
expansion can collapse in one of two ways. The first is by voluntarily ending
the credit expansion. This would generally involve doing nothing or very
little while a corrective process ran its course. The other is by
relentlessly persisting with credit expansion in a non-stop effort to avoid a
crisis. This would lead to a total catastrophe of the currency system,
meaning that it would lead to the currency becoming completely worthless.
The first of the two alternatives is the
deflation path. The second is the inflation path (relentless monetary
inflation leading to hyperinflation and, eventually, to the currency becoming
so devalued it no longer functions as money). Note that money can only
collapse due to inflation. Deflation makes money more valuable.
The Fed is presently heading down the
inflation path, but it doesn't have to stay on that path. A change of
direction is possible.
We now move on to the other Mises quote mentioned in the opening paragraph:
"This first stage of the inflationary
process may last for many years. While it lasts, the prices of many goods and
services are not yet adjusted to the altered money relation. There are still
people in the country who have not yet become aware of the fact that they are
confronted with a price revolution which will finally result in a
considerable rise of all prices, although the extent of this rise will not be
the same in the various commodities and services. These people still believe
that prices one day will drop. Waiting for this day, they restrict their
purchases and concomitantly increase their cash holdings. As long as such
ideas are still held by public opinion, it is not yet too late for the
government to abandon its inflationary policy.
But then, finally, the masses wake up. They become suddenly aware of the fact
that inflation is a deliberate policy and will go on endlessly. A breakdown
occurs. The crack-up boom appears. Everybody is anxious to swap his money
against 'real' goods, no matter whether he needs them or not, no matter how
much money he has to pay for them. Within a very short time, within a few
weeks or even days, the things which were used as money are no longer used as
media of exchange. They become scrap paper. Nobody wants to give away
anything against them."
The gist is that if the inflation policy
continues for long enough then a psychological tipping point will eventually
be reached. At this tipping point the value of money will collapse as people
rush to exchange whatever money they have for 'real' goods. Mises refers to this monetary collapse as the
"crack-up boom". Prior to this point being reached it will not be
too late to abandon the inflation policy.
Today, the US is clearly still in the first
stage of the inflationary process. If it continues along its current path
then a "crack-up boom" will eventually occur, but there is no way
of knowing -- and "Austrian" economic theory makes no attempt to predict -- exactly when such an event will
occur. If the current policy course is maintained then the breakdown could
occur within 5 years, but it could also be decades away. In addition, there
is still hope that policy-makers will wake up and change course before the
masses wake up and trash the currency.
The upshot is that "Austrian"
economic theory helps us understand the damage that is caused by monetary
inflation and what the relentless implementation of inflation policy will
eventually lead to. That is, it helps us understand the effects of various
policy choices. It doesn't, however, make specific predictions about whether
the next few years will be characterised by
inflation or deflation, because whether there is more inflation (there has
been inflation and nothing but inflation for generations) or deflation will
depend on the future actions of governments and central banks. Regardless of
how they are defined, at this stage neither inflation nor deflation is
This essay is excerpted
from a commentary originally posted at www.speculative-investor.com on 19th August 2012.