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NOTE Inflation and Austrian Economics

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Welcome back and joining us live from Auburn, Alabama in the Mises Institute is Dr. Mark

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Thornton.

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Mark, how are you doing today, buddy?

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I'm doing great, Al.

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It's great to be on the show with you here Monday morning.

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Well, it's good to have you on.

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What based on our email exchange over the weekend, you know, I had a listener send me

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an article from a guy who gets into some detail on fractional reserve banking and using that

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That is the reason that we're not seeing any inflation at the moment.

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I argue based on the way inflation was tallied under Ronald Wilson Reagan and also under

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Bill Clinton that we are seeing inflation.

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In fact, we are seeing a lot of it in the equities market and we're exporting a bunch

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of it.

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Could we first speak to how the U.S. exports inflation?

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Well, that's a very complex question, Alan, but basically, if the Federal Reserve is printing

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money here in the US and it's trying to drive down the value of the dollar in order to enhance

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our exports, what happens is that other countries react to that and they start inflating their

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own currencies to try to keep their currency value in line with the US dollar or even driving

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The Central Bank of the United States, China, Japan, and the European Union, and the European

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Central Bank, they're all trying to drive down the value of their currencies.

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And so we're seeing big-time inflation, you know, here in the U.S. and a lot of different

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areas, you know, when the Fed is printing money, prices are going to rise somewhere

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in the economy.

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It doesn't necessarily show up in the CPI, especially the one that the government is

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managing and editing over time.

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But we're exporting this inflation, and so, you know, the Chinese are trying to stay level

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with us and that's causing their prices to rise and even riots over there and they're

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rushing into the market to try to buy gold and silver.

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Prices are rising in Japan, prices are rising in particularly like in Brazil.

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They're having a hard time keeping inflation in check there in Brazil.

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So there, you know, we have a federal funds rate of one quarter of one percent.

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Their actively managed interest rate in Brazil is over 10%.

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They're trying to keep inflation at bay over there because we're exporting that inflation

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to countries like Brazil and around the world.

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Well let's talk about Japan for a moment.

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They're what, over 20 years now into destroying their currency and I know from the most recent

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Economic Report that came out of Japan their trade deficit has swollen and it's

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because I mean it it was increased basically because they're paying more

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they're not importing any more than they were a year or two ago it they're just

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paying more for it so I'm always baffled by how these countries think that

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weakening their currency is somehow helpful to their population well Alan

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And that's a great example of how this beggar-thy-neighbor policy amongst central banks actually backfires

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on the consumers and the citizens of the country that we're looking at.

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So Japan tried to push down the value of the yen, its currency, in order to stimulate exports.

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But as most people know, Japan has to import virtually all of its raw materials, all of

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in the end and so they're just as you as you point out they're not their quantity

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hasn't of imports hasn't risen but the price of them has and so that is what

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causes the trade deficit so that they're buying more than they're selling and you

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know and so they basically shot themselves in the foot as far as that

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aggressive inflationary fighting deflation process and you know countries

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is all over the world. It's not just Japan. It's all the major economies as well as Switzerland

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is trying to keep the value of its currency competitive, so to speak, against the euro.

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And Norway and Sweden and Finland are also trying to keep their currencies level with

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the euro. And so everybody's following this song and dance initiated by the Federal Reserve

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Where is it, though, that they get taught all this stuff?

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I mean, it just seems to me that it's common sense that the stronger your currency, the

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better for your people.

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And yet, these central bankers have always taken, at least for the bulk of my lifetime,

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in the opposite position, that they'll talk a strong dollar, but they do the opposite.

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They are always striving to weaken the dollar.

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Where do they get off thinking that that is helpful?

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I just cannot connect those dots.

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Well, they shouldn't be connected, Alan.

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It's mainstream economics, the economics that's taught in college classrooms around the country

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is very wrong-headed.

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It's Keynesian based, it's an economics where the government is playing social engineer

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with the economy and you know they're raising and lowering taxes, they're raising and lowering

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the budget deficit, they're raising and lowering the trade deficit and they're raising and

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lowering the interest rates as if they were an engineer on a locomotive on a railroad trying

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and from all the participants are accounted for in market prices, market interest rates,

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market value of the currency, all of those parameters have to be adjusted by marketplaces

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that are free and open and unmanipulated by government bureaucrats.

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And so it's a basic failure of economics in the classroom and the fact that Austrian

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and Economics is basically not taught in classrooms about how markets work.

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If you go into a standard, everyday, ordinary classroom around the United States, basically

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you'll walk in and they'll be talking about some kind of market failure.

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And those market failures are generally caused by previous government interventions.

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And so it's basically an entirely wrong-headed approach that's been in place now for half

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a century.

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Keynesian Revolution occurred during the Great Depression. It never has succeeded in practice.

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And basically, as you point out, the basic common sense of it, or lack thereof, means

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that it's never going to succeed. It's always just going to pile up increasingly larger

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errors, mistakes in the economy.

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Didn't Keynes himself recant his economic theories towards the end of his life?

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So you know, he didn't live very much longer than after his book basically came to fame.

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But a lot of observers think that Keynes would be horrified by what his practitioners and

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followers have succeeded in implementing once they gained power and that Keynes had more

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respect for markets and had more respect for the foibles of bureaucracies because he himself

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was a bureaucrat. Certainly a lot of the blame has to go to Keynes himself, but there's also

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additional blame to be dealt out with to the followers and practitioners and the people

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who have so-called advanced Keynesian economics. There's post-Keynesian economics and new

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Keynesian economics. There's all sorts of variations of Keynesian economics, but it

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It all basically boils down to the fact that one form of Keynesian economics or another

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basically is mainstream economics.

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It's what's in the textbook.

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It's what's taught in the classroom.

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And it's a mistaken foundation of economic analysis and it's very harmful to the economy.

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And when Keynesian economics is ignored and markets are allowed to work in places like

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Hong Kong and Singapore, Japan and Germany after World War II, we've seen is a great

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flowering of economic prosperity and when Keynesian economics is put into place as it

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is now in central banks around the world, we see this increasing economic chaos.

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Mark, can you stay with me for another segment?

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I'd love to.

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We're speaking with Mark Thornton, Dr. Mark Thornton of the Mises Institute and when we

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Welcome back and joining us for another segment is Dr. Mark Thornton of the Mises Institute

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over in Auburn, Alabama.

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Mark, thanks for staying on with us.

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It's great to be on the show, Alan.

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Well, I always enjoy having you on.

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When I like to talk economics, can we switch over and talk about now the money supply and

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a lot of the central planners, and I've heard this narrative over and over again, I heard

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one guy say if you hooked the inflation rate up to a heart monitor, it'd be flat lined

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and yet we're seeing evidence of pricing inflation everywhere, but can we first of all define

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Inflation in its historical context, how that was morphed into pricing inflation, and then

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the various ways we measure the money supply?

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Yeah, certainly, and this is a very important distinction to be made between Austrians and

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mainstream economists.

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Now, the Austrians following history dating back until the existence of money has always

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viewed inflation as an increase in the money supply.

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I think the standard definition of it before central banking in the United States, say,

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100 plus years ago, was a political increase in the money supply.

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In other words, where the government engineered an increase in the money supply beyond the

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natural flows in terms of the values of gold and silver.

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And so that's what the Austrians key in on.

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I think everybody should key in on what the central bank is actually doing to increase

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or decrease the money supply and of course the natural historical tendency is for the

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central bank to increase the money supply and especially so when there's no constraints

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on it and of course the central bank doesn't have the constraint on it today that the money

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Money that increases has to be backed by gold and silver.

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And so since the establishment of the central bank in the United States in 1913, we've seen

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this ever-increasing tendency for government to increase the supply of money to its own

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benefit of course.

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Now on top of that, on top of that increase from the central bank, the banking system

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and the system itself can increase the overall amount of money in the economy by increasing

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the amount of loans that it creates in the economy.

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And so once the central bank increases the supply of money, the banking system, because

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it's a fractional reserve banking system, has what's often referred to as leverage,

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and that they can increase the supply of money simply by creating loans.

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No single bank can effectively increase the money supply on its own, but the banking system

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as a whole has this ability to increase the leverage that the Federal Reserve creates

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when it initiates increases in the money supply.

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It's all a very complicated process, but you can think of the banking system has the ability

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to Increase the Money Supply $10 for every $1 that the central bank creates to initiate

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the process.

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Okay, so the theory of the people who say we don't have any inflation right now is that

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due to the lack of lending, and I think that article totally overlooked how much lending

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Banking is being done to the federal government, but due to the lack of lending, that has the

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reverse effect of fractional reserve banking and then that actually takes money back out

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of the money supply.

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Well there, you know, obviously banks have shown a lot of reluctance to lend money into

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the economy.

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Now there's a lot of money, as you say, being lent to the government itself.

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And then there's a lot of money just sitting on the sidelines.

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Banks have, as a result of the Fed, they have a tremendous amount of excess reserves because

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the Fed is paying them interest not to lend the money.

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And so they've got a sure bet at a very low interest rate where they can lend money that

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that they've basically received from the Fed back to the Fed and get a small return, but

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it's not a very large amount.

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We're talking about more than, I think it's almost $2 trillion of excess reserves.

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Now in the past, the banking system as a whole has not held any excess reserves because they've

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always found it profitable to lend it out.

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But in this environment, banks are very reluctant to lend money long-term because they rightfully

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We feared that there could be price inflation and that all the loans they make today would

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end up being underwater for them over the long haul.

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So they're not interested in lending money long term to businesses and to households.

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And as a consequence, that's had a dampening effect on price inflation.

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And if that money gets out, what we're going to see is a tremendous amount of price inflation,

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No matter how you bother to measure it, whether it's the government CPI or your own personal

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basket of consumer goods that you have to go out and purchase every week and every month.

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But if we look around in the economy, that money is leaking out.

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It is increasing prices.

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The commodity prices in a lot of areas, even gold prices are approaching $1400 an ounce.

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So if you get beyond the spike up to $1800, gold is really at the historically extremely

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high levels.

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And so oil prices approaching $100 a barrel.

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So if you look at the broad spectrum of things, if you look at the cutting edge prices, the

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This is on world markets, which Americans eventually see, but not necessarily do you

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see them immediately.

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On all these marketplaces, you see very high prices, historically very high prices, and

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so that money is getting out, and what I fear is that if all those excess reserves of banks

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ever got cut loose and into the economy and then got leveraged up through the banking

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System, you know, I just can't imagine where prices would end up.

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Mark, let's talk about that notion, and we're down to about three minutes, of Bernanke is

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creating money out of nothing, lending it to the banks for virtually nothing, and then

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paying them interest on the money that the Fed lent them not to lend the money out to

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the rest of us.

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How in the world could that be helpful to the economy and what stretch of the imagination

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does it take to say that that activity would lower the unemployment rate?

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Well, it doesn't help the economy and the facts speak for themselves.

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What it does do is it helps the big banks because it stabilizes them.

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It's like giving them an IV, a morphine drip and oxygen and all that kind of stuff to try

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Stabilize the Patient, which is the nation's five or six largest banks that are being impacted

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by these policies.

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Those are the ones where, and Bernanke basically wrote his dissertation on what caused the

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Great Depression and his conclusion was that it was a failure of the central banks to bail

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out the large banks that caused the Great Depression.

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And so, you know, if you were looking around for a guy, you know, if you were a large bank

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and you were looking around for a guy who was interested in and willing to bail out

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the big banks, well, Ben Bernanke is your man because he's the guy that virtually wrote

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the book on, actually wrote the book on why you need to bail out the big banks if they

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get in trouble and that's exactly what he's done.

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But bailing out the big banks is not the overall economy.

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It's not Main Street. It's not the average ordinary economy out there. That's basically

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how it lines up. There's no, I don't have any expectations that bailing out the big banks

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is going to help the economy over the long run at all.

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Mark, it's been a pleasure, buddy. It flies by. This is Mark Thornton, Dr. Mark Thornton

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of the Mises Institute in Auburn, Alabama, and we'll have Mark on again real soon. Mark,

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thanks a lot, buddy.

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