Boom or Bust!

True, governments can reduce the rate of interest in the short run. They can issue additional paper money. They can open the way to credit expansion by the banks. They can thus create an artificial boom and the appearance of prosperity. But such a boom is bound to collapse soon or late and to bring about a depression.  

-Ludwig von Mises

Where are we in the inflation, artificial interest rate, money-printing game right now?

We’re right in the middle of it.  Which is why we are in a gold bull market.

The great economist Ludwig von Mises who provided us the epigram above, is who people think of when they think the Austrian hangover theory.  It is a cogent and easily understood explanation for our modern inflation.

And it will shine a light on where we are going!

It’s actually called the Austrian malinvestment theory or business cycle theory.  But a hangover is pretty easy to understand.  It’s an explanation that fits the bill perfectly.  It likens central bank monetary management to the bouts of drug and alcohol addicts. 

In the early stages a little inflation seems to have some pleasurable effects, so central banks like the Federal Reserve print money to juice the economy.  They even call it stimulating the economy. 

But in truth, when interest rates are artificially low, lower than the abundance of capital would provide, or near zero, people overextend.  Borrowers borrow more.  The stimulated economy looks like it will run forever.  Never mind that the signals that are being broadcast throughout the economy are misleading about real conditions of money and credit.  Businesses expand, stocks roar, homebuyers buy bigger more expensive homes.  

It’s like a first-time user.  He may experience a novel high or get blindingly drunk.  But then comes the hangover.  The free, loose money, or artificially low interest rates will eventually end.  The bubble will burst and it can be very painful.  We have seen it before:  when the stock market has been fueled by unsustainably cheap credit; when people have purchased homes that they couldn’t normally afford; when builders have built more homes than can be sold under normal conditions.   And inevitably the bubble bursts. 

The hangover is the economy’s effort to liquidate or correct unsustainable conditions.  The economy is clearing excesses and returning to normal conditions.  A recession is a correction of those excesses, as consumers tighten down and companies lay off workers.   

But during the hangover, in the aftermath of the binge that should never have happened to begin with, the pain of withdrawal is so great that Wall Street/Big Banks/consumers/politicians plead for another fix:  Lower interest rates again!  Give us another hit of monetary stimulus!  More inflation? Sure, who cares?

Rather than letting the toxic effects of the binge get metabolized, the addict takes another fix; for the alcoholic, the hangover is answered with another drink. For chronic addicts the old doses eventually lose the desired effects. 

You can see where this is going.  The old dosages don’t give the user the same high.  

When you read about some celebrity dying of an overdose it’s usually the same sort of thing: bigger and bigger doses to get the same high they got when they first started. In the economy, bigger doses of monetary easing are required try to re-inflate the bubble.

So the Fed puts the pedal to the metal.  And starts lowering rates to offset the pain caused by its prior monetary interference.  The addict takes another hit.

And that is where we are today.  We are staring at a recession.  Credit card debt is running away as consumers try to pay the higher prices engineered by the last round of inflation.  Consumers saving are in the tank because 44 percent of respondents in a recent survey said they aren’t making enough take-home pay to cover their daily expenses. 

The Fed wants to avoid the painful consequences of its own policies.  So it will compound the problem with more of the same policies.  It has telegraphed that it will start cutting rates – inflating – pronto!    

The gold market has been setting new all-time highs because it sees exactly where this is headed.