I was introduced to Austrian Economics through the works of Ayn Rand. From the first works that I read, I knew I had encountered a school of thought that would describe the real world. I have not been disappointed.
I tell you this to answer the question that was posed to me: on what do I base my belief that the FED’s actions, since the beginning of the sub-prime crisis, will lead to an exacerbation of the recession in the US?
Here is a simplified explanation of my reasons. If you want to have full understanding read Rothbard’s book:
Austrian Economics teaches that recessions are caused by an increase of the money supply. As a result of such expansion there is a misallocation of investment . At some point, (especially where the money supply rises much faster than productivity) the misallocation causes crises (sub-prime, Bear Stearns, Indy Mac etc) or results in an inflation rate that forces the excess funds to be mopped up (e.g. raising rates). (See America’s Great Depression by Murray Rothbard). Recessions follow if the market is allowed to correct the malinvestment; depressions follow Government intervention.
The charts below are from ShadowStats. The site does a superlative job in providing a true picture of the US Economy.
Figure 1 shows an exponential rise in M3 since mid-2006. There is a lag between the time the money supply expands or declines of 9 to 12 months. However since the end of 2007, we have seen an ever rising CPI. This is true even on the ‘official’ figures. Officially, since end 2007, the CPI has risen from 2% to 5.5 % – an increase of 175% in less than 12-months. And given the rise in M3, there is more to come in terms of CPI increase.
Figure 2 shows the CPI increase.
What this means is after the elections when the excessive fiddling with the CPI numbers ceases (if historical patterns hold true), we’ll see a sharper rise in the CPI numbers. Bernanke will have to raise rates or be faced with hyperinflation.
But as Figure 3 (Unemployment) and Figure 4 show (GDP), the US economy is still far from robust. A rise in the interest rates will depress the economy and the recession will exacerbate. If Bernanke fails to act promptly, he’ll eventually have to raise rates anyway but the later he leaves it, the greater will be the increase needed and the greater the adverse effects on the US economy.
So folks, we can expect a deepening set of economic problems in the future. Bear Markets anyone?
FIGURE 1 M3 (supplied by ShadowStats)
FIGURE 2 CPI (supplied by ShadowStats)
FIGURE 3 Unemployment (supplied by ShadowStats)
FIGURE 4 US GDP (supplied by ShadowStats)