Mises knew that breakdowns of economic activity were the inevitable outcome of government interference in the monetary sphere. However, public opinion has not correctly diagnosed the root cause, regularly blaming instead the free market system — rather than the government — for the malaise. In times of crisis, people call for more government intervention in all sorts of markets, thereby setting into motion a spiral of intervention which, over time, erodes the liberal economic and social order.
It is therefore a rather discomforting truth that today’s governments the world over produce fiduciary media, the very kind of money Mises had warned us against.
It is an inflationary regime. The relentless rise in the money stock necessarily reduces the purchasing power of money to below the level that would prevail had the money supply not been increased. Early receivers of the new money benefit at the expense of those receiving it later.
What is more, the creation of fiduciary media artificially suppresses market interest rates and thereby distorts the intertemporal allocation of scarce resources. It leads to malinvestment, which must eventually erupt in collapsing output and employment. FULL ARTICLE
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All that money inside that garbage can would make a nice fast fire if one would drop a match in it.
We can discuss the vagrancies of the government not printing money and the gold standard solution. But that’s not reality. Reality is that the government is printing money. How do we best prepare for the future? How do we best protect our assets? What industries will benefit from this out of control spending? If we can put ourselves in the best financial position, then we will one day become the policy makers. Then we can put our theories to the test.
HayeksHeroes, Fritz Matchlup wrote a paper back in the 1930′s showing that a great deal of newly created money goes into the stock market and was the main reason for the stock market boom of the 1920′s. We witnessed the same phenom in the 1990′s and after the 2000 crash. New money tends to go first into assets, with cpi inflation happening later. I doubt there will be another bubble in real estate soon and the bond market is already very high, so the stock market is the logical asset for the next bubble. Clearly, the state of the economy doesn’t justify the recent run up in the stock market, so the cause must be monetary pumping.
I’m betting on the stock market because I don’t see the Feds lightening up on the flood of new money for quite a while. Just think, if you had bought a NASDAQ index somewhere near the bottom you would be enjoying a 35% return in 6 months, or 70% in a year.
I got close to the bottom and now am $25 richer!
PS, when you want to protect against cpi inflation, commodities appear to be a much better bet than gold as they are more sensitive to monetary pumping. Also, real estate, especially ag, is a good hedge against cpi inflation.
I like the Casey Report, which recommends investments based on Austrian principles. They have a solid track record.
http://www.caseyresearch.com
Are index funds still a good option? I don’t have time to research sectors or individual stocks.
HayeksHeroes, If you don’t have the time to do much research, you can always subscribe to a newsletter, like Casey’s, or Mark Skousen has a good one too. If you don’t want to spend the money on a good newsletter, there is Peter Schiff’s and Frank Shostak’s funds. Otherwise, index funds are a still a good idea.
The key is knowing when to get out of an asset, especially the stock market. Based on Hayek’s business cycle, look for news about records profits. The market will tank soon afterwards.
Fundamentalist: “I doubt there will be another bubble in real estate soon and the bond market is already very high, so the stock market is the logical asset for the next bubble.”
Fundamentalist has succumbed to the price illusion. Yes, the US stock market may rise in nominal terms. The US stock market priced in real terms will almost certainly fall over the next several years.
It is possible for newly created money to drive up commodity prices first. The distinction between early stage “asset inflation” and late stage “cpi inflation” is false.
Returns over a 6 month period are meaningless. Invest for the long run. Take the long view. Avoid the US stock market if you’re bearish on the US economy. Invest in “real stuff” if you think price inflation will be an issue in the coming years.
Anon, you’re right about the differences in real and nominal stock market values, but HayeksHeroes asked about protecting his wealth from the inflationary policies of the gov. The stock market does just that if the nominal value keeps pace with monetary inflation.
As for the between early stage “asset inflation” and late stage “cpi inflation”, that’s not a hard/fast rule, but we have seen it since the early 90′s and we’re witnessing it today.
Of course returns over a six month period are meaningless for the long run. You can get those levels of returns only at the beginning of a rally from the depression. My point was that my confidence in the ABCT encouraged me to get back into the stock market near its bottom. I was certain that much of the new money pumped by the Feds would go into the stock market.
Yes, you can do reasonably well by avoiding the stock market completely and investing in real stuff. I assume you mean real estate and commodities. But why not make even more money by using the insights from the ABCT to game the system?
fundamentalist,
It seems to me that the game is to wait until the fed starts worrying about inflation, and in their first interest rate hike, you get out of the market. Isn’t this the ABCT take on things, that once the rates are increased, or the money pumping stops which should be the same thing, that this is when the house of cards starts to crumble.
Of course we also have the issue that Austrians always add that they can predict trends, but not exact dates. So, just how do you intend to game the system?
Eric, Modern Austrians emphasize the Fed interest rates and ignore Hayek’s version which focuses on the Ricardo Effect. In “Profits, Interest and Investment” Hayek showed that profits do the heavy lifting and that interest rates were a secondary feature. In fact, he shows why interest rates aren’t very effective in directing investment. I haven’t found a good reason to abandon the Ricardo Effect, so for now I’m sticking with it. In the latest depression, the Feds started raising rates in 2006, but the economy didn’t tank until the Fall of 2007, according to the BEA. If I remember correctly, the stock market climbed until early 2008. But record profits made the news in the summer of 2007, which is when I got out of stocks.
When you get out of stocks, you want to jump to gov bonds because interest rates will be highest at that time. Until the depression bottoms, you will earn high interest plus principal appreciation as interest rates fall.
If this seems too high risk, then stick with real estate and commodities, but study the Austrian business cycle. Commodities peak near the end of the cycle. Also, buy as much as you can with borrowed money because inflation will make it easier to repay the loans. But you have to know when to get out of those, too, just as with stocks, because as we have all seen, they can tank, too, just before the depression hits.
I wrote above that the Feds started tightening in 2006. It was actually 2004 and ended in 2006. I think the yield curve inverted in 2006, though.
HayeksHeroes,
If you want to profit from the coming inflation wave, just buy “stuff” — preferably on credit. If you’ve got older vehicles, get loans for a new one. If you can, pull $$$ of your home or buy one. Buy rental property — the debt will be inflated away and the rent will be indexed for inflation. If you can get financing, undeveloped land typically rises faster than developed land (the structure is depreciating). If you can finance some ag land, you’re in a great position since you’re indexed for higher commodity prices and increases in land prices — while your debt will decline in real terms.
Has anybody every considered the possibility that the public WANTS high levels of inflation? Total private debt is much higher than government debt — how many Americans want a “reset”?
“Evidently, the longer the “false” monetary boom goes on, the bigger and more speculative the borrowing, the more wasteful the errors committed and the longer and more severe will be the necessary bankruptcies, foreclosures and depression readjustment.”
Where are we in the cycle? The Feds may be pumping money into the banks. The banks are not lending to consumers and small businesses. Most small businesses have seen their lines of credit slashed or cancelled. Where is this money going? Who has access to it?
HayeksHeroes,
Excess bank reserves sit at around $800 Billion:
http://research.stlouisfed.org/fred2/graph/?chart_type=line&s1id=WRESBAL&s1range=5yrs
With a reserve requirement of only 10%, banks could loan out up to $8 trillion dollars.
The eight trillion dollar question is: why aren’t banks loaning out this new money?
The simple answer is that banks cannot find investments worthy enough to loan money to. However, once the clusters of errors in the economy are wiped out and the economy recovers, this money will be loaned out and inflation will go on a tear. Please look at the amount of base money created by the fed since last fall:
http://research.stlouisfed.org/fred2/graph/?chart_type=line&s1id=WRESBAL&s1range=5yrs
The Monetary base has increased $800B since 10-Sep-08, and excess reserves have increased $800B since 10-Sep-08.
Virtually none of the new high powered money created has been loaned out.
The only thing I cannot figure out is why bond markets have not prices in inflation, while the stock market clearly has…
Don’t you think, guys, that advising anyone to invest in real estate right now, especially in the us is way off base? I mean, the valuations are still quite a bit over the long-term trend, and we know that major real estate corrections last many (like 10-20) years and undershot the trend by a good margin. Plus, the liquidity of the market is very poor in times like this. You have been warned
And if hyperinflation would be to come (it isn’t, but some fear it), real estate is about the worst hedge you can imagine. Just look up the Weimar Republic data. Durable low-order consumer goods would be best for that scenario – cigarettes and booze especially. Maybe arable land, but as a working asset – if and only if you can support the production infrastructure (ie you’re actually into farming).
And please, please, guys. Don’t listen to ANYONE, even in this forum, that suggests you should invest head over heels OPM (other people’s money – debt). Go figure trading margins, historic interest rate volatility, equity wipeout etc.
panika2008,
It is reasonable to expect real estate prices and rent to rise with inflation. With your debt load in real terms for the same assets declining, tax deductibility, and the equity you build up — you should expect a nice real gain.
If the price level doubles over 10 years (7% inflation over 10 years), that’s a real return of 4.1% over the same period. Factor in tax write-offs and equity build-up, and the return is even higher.
panika2008,
Of course, I left out a lot of factors. You have your inflation-adjusted rental income on a down payment of 20 or 25%. Pretty nice return.
HayeksHeroes, We’re still in the last days of the depression, unless we get a double dip. But eventually the economy will turn around and irrational exuberance will begin again. We could enjoy a 5-6 year boom in stocks. I wouldn’t get worried until the Dow hits 12,000 again.
panika2008: “Don’t you think, guys, that advising anyone to invest in real estate right now, especially in the us is way off base?”
I agree if you mean residential housing or commercial properties. I think farm land is a good bet. As for inflation hedges, commodities seem to be the best, which is one reason that farm land is a good idea.
But keep in mind that serious cpi inflation won’t hit until more people are working and that could take a couple of years. That’s pure ABCT. Meanwhile enjoy the benefits of asset price inflation.
As for borrowing money, that’s a personal decision concerning the effort you want to put in to learning Hayek’s ABCT which includes the Ricardo Effect. It can be risky if you don’t want to put in the effort. But if you understand the theory, it’s not so risky. Without the theory it’s very risky.
Hmmm, I’ve seen a new estimate that put us at only about 40% max of total foreclosures due to sub-prime/ARM resets & recession job-losses. They are projected to rise through the next year into mid-2010, and then taper off back down to base-line foreclosure rate. I’m fairly certain this prediction is based on a roughly V-shaped recovery, though not necessarily one more optimistic than our last barely-V-shaped faux-recovery.
That’s a lot of foreclosures to go, all while the FHA is trying to single-handedly replace Fannie and Freddie, currently on track to reach the Trillion mark in primarily sub-prime, low-downpayment loan guarantees (? or bought loans ?) by end of ’10. They’re already in Bear-Sterns leverage terroritory at over 30:1, and their foreclosure rate is over 7% with over 12% 30-day delinquents.
While I think it is ‘possible’ that the Fed could “paper-over” this Decession and put us back into a few years of a ‘bull’ stock market, another faux-recovery, I really don’t think that is in the cards. There are just too many things that could happen to put an early end to the most vigorous wall-papering the Fed can do. While I’m not predicting hyperinflation, I could certainly see a Great Stagflation that would make Jimmy Carter look like a great President. Consequently, my retirement savings have been transferred out of the US dollar.
Anyway, I bought a house in Dallas over 7 years ago, and am now living in Austin. I rent the house out. The valuation when I bought is roughly what it is now, so I’m not upside down or anything. That’s pretty much how most of Texas is right now. Pretty even keel.
I’m wondering, do I sell it and pay off debt (goes against the theory of using inflation to my favor), or do I keep it and keep trying to rent it out? Since I’m afraid of all the enourmous bank inventory of housing having to be put on the market at some point, and the number of foreclosures yet to come, my gut says to just get out of it while the getting is good. Of course, that enourmous bank inventory is mostly NOT in Texas, and we’re benefitting somewhat from an influx of refugees fleeing the Socialist Zombies roaming the landscape of California (and other places), so there is increasing population and demand for housing here. So, hmmmm.
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