Wednesday, November 12, 2008

Austrian Inflation

Ben asks a good question. I'm talking about inflation, but prices are falling. What gives? Are there two different kinds of inflation? Yes. Austrians actually only consider monetary inflation to be inflation (sorry, Ben, I didn't tell you quite right.) They mostly ignore "general prices levels." Austrians expect that a stable money supply will result in slowly decreasing prices as increasing productivity puts more goods in the market ever more efficiently over time, while the money supply remains the same. Actually, you can see this in a few industries which are developing rapidly, like computer technology. $1000 buys you a lot more computational power than it bought last year or 10 years ago. The advances in computing are much faster than the rate of monetary inflation by the government. If you're a mol-bio geek like me, you also know about DNA sequencing costs which are doing the same thing. Probably other folks can think of other markets. Cell phones, digital cameras, lasers, etc. These products appear to buck the trend of inflation due to technological advances. The real difference comes down to the differing perceptions of exactly what money is. To most economists, money is a very special thing, a "store of value" or a "measure of value" for an economy. It is also a valuable tool for regulating economic growth. This is why they want to adjust the money supply to get stable prices, or low unemployment or whatever. To Austrians, money is not all that special. Money is just "stuff," like everything else. It has what value it has, and everything else can go screw itself. The only thing that distinguishes money from other "goods" on the market is that all economic actors deal in it, so you can trade it for virtually anything if you have it. Gary North would call it "the most marketable good." To an Austrian, there are no fixed "buyers" or "sellers," only traders. It is just as accurate to describe a grocery store as "a place people go to sell money for groceries" as it is "a place that sells groceries for money." OK, so they don't really talk this way, but its a good illustration of the idea. "Price inflation" is the empirically observed phenomenon of a general increase in prices. To Austrians, this is "Keynesian" or "Monetarist (Chicago school) talk" and not of general interest. It is an indication that money in general is becoming worth less as measured against other goods, and in the long term is usually the result of the more important phenomenon, monetary inflation. So how is it that you see a general reduction in prices (price deflation) at a time when the money supply is increasing dramatically (monetary inflation), as I showed in the AMB chart the other day? There are several answers. Number one is that that dramatic increase is currently being hoarded by the mountain trolls we call bankers. They aren't letting the money out into general circulation so that it can't be used to bid up prices at this time. That's the whole "pushing on a string" concept I talked about yesterday. Once the dam bursts and the money moves out into the market, expect inflation to start again. First, on the things that are bought on credit... (remember the Austrian business cycle theory (ABCT)?) Number two is that we are facing a recession. Money is the most marketable good, remember? We face uncertainty. We don't know what will happen to us in 6 months. So we hoard our cash if we have it in case of impending emergency. At that time, it will help us get through the rough patch. So we cut back on buying today. Money has become more valuable in this respect in relation to other goods. So prices (the exchange rate between money and other goods) falls. Number three is that an awful lot of people have an awful lot of bills to pay right now that they ran up during the credit bubble. They need cash to pay the bills. They don't have it. So they sell their goods to get it, putting more goods into the marketplace all at once and driving down prices. Especially the leftover capital equipment from failed business ventures that were destroyed by the popping of the recent bubble. If you don't believe me, go into a pawn shop and see how many roofing nail guns and drywall cutting reciprocating saws you can find. Now would be the time to get one cheap if you really want one. If you have been a saver recently, and have cash in your pocket, you are king for the next 6 months or so. Everybody wants the good you have. Money. You are the real estate agent or the homebuilder/developer of 2 years ago. I suggest you make good use of it while you can. If the AMB chart is telling us anything, it's that it won't last long. Of course, I'm just an amateur economist. I fully acknowledge that fact. You are perfectly free to screw up your own life in any way you see fit. Whatever you do, don't blame me when it blows up in your face. One other thing: notice what the effect of trying to keep stable prices is. We know that technology will produce cheaper goods in the future, due to increasing productivity. Yet as Keynesians/Monetarists we use the FED to try to keep the prices stable. The result: a built in bias favoring monetary inflation. We will always have bubbles so long as we try to keep prices stable. Its just a fact of life.

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