Austro-liquidationists are winning

So says Ambrose Evans-Pritchard in The Telegraph. Evans-Pritchard is always fun to read and his 2012 outlook (mostly in jest / exaggerated style) is worth the time it takes to read it all. One paragraph though caught my eye in the sense that it seems to reflect the mainstream’s lack of appreciation for Austrian Economics.

Central banks have the means to prevent a 1930s outcome, even with rates at zero, if willing to deploy Fisher-Friedman monetary stimulus with conviction, buying assets from non-banks and targeting nominal GDP growth of 5pc. But policy defeatism is in the air, and Austro-liquidationists are winning the popular debate.

Is A E-P throwing his weight behind the NGDP crowd (nominal gross domestic product)? Has he been reading this Economist article on heterodox economics and fallen prey to its traps?

Central bankers have been teaching us to accept inflation in our lives. After all the product they sell is little pieces of paper which are notionally demand promissory notes, but in practice are nothing like promissory notes. These pieces of paper – called currency notes – may be exchanged only for other pieces of paper. For a central banker to “sell” more of the paper, they need to convince the public that inflation (price inflation through an expansion of the monetary base) is good.

Expansion in nominal GDP brings some good feelings. As long as inflation is somewhat contained the masses will not rise in rebellion against the central banks, the politicians can keep spending without paying for it, and the people can be happy. But eventually real output should pick up so that the inflation adjusted GDP (real GDP) also grows. It is this last bit that the fiat monetarists forget.

Austrians are keenly focussed on real GDP. They would rather the monetary base remain constant, and real growth is truly reflected in our feeling of well-being. Price adjustments should be relative. Of course the nominal rigidities of some prices notably labour is a key reason why fiat money is such an easy choice for policy makers.

Expansion of the monetary base leading to inflation is a genie that cannot be bottled once it is let out. In India for example the price rise over a period of time has been scary. Forty years ago (my mother tells me), you could buy 30 bananas for one rupee. Today it takes between three and five rupees to buy one banana. A devaluation by a factor of 90-120. The same can be seen in other prices (land / real estate, gold, etc.)

At the start of my working career over a decade ago, I made the mistake of not saving enough. In hindsight that looks like a great decision. Any savings from then in fixed income instruments would have devalued in real terms. Investments in equities have hardly fared better.

What I should have done is leverage myself. Since debt has been devalued so much, I should have borrowed and bought real assets (maybe a house). In hindsight the decision not to save was right, but not implemented in full. I should have dis-saved.

The lesson of devaluation is that the population will tolerate some inflation for some time. But there will come a time when the people will rise in anger at the sharp fall in their savings. I fear that the outcome would be similar to other recent hyperinflations in history – Zimbabwe or Weimar Germany.

Much as the Reserve Bank of India has failed to keep up the purchasing power of the rupee, I fear that other central banks around the world are now engaged in a full fledged beggar-thy-neighbour devaluatation spree. This is not going to end well.

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