Why Austrians call for a return to free-market money.
by Thorsten Polleit
For a full essay, see
The Dark Side of the Credit Boom
Austrians maintain that international monetary affairs have entered a vicious cycle: a credit boom, epitomized by a relentless expansion of circulation credit and money supply that is bound to collapse at some point. That said, could the world then enter a period of deflation, comparable to the scale of output and employment losses witnessed in the early 1930s of the 20th century?
As things stand it seems that inflation rather than deflation remains the real danger. Whatever the relative costs and benefits of inflation and deflation might be, deflation is now feared much more than inflation. And indeed it seems that the path the Great Depression took had much to do with the monetary and economic paradigms prevailing back then.
Anna Jacobson Schwartz and Milton Friedman wrote in their famous book A Monetary Historic of the United States, 1867–1960 that the US Federal Reserve
[…] was operating in a climate of opinion that in the main regarded recessions and depressions as curative episodes, necessary in order to purge the body economy of the aftereffects of its earlier excesses. […] regarded it as desirable that the stock of money should respond to the “need of trade,” rising in expansion and falling in contractions; and attached much grater importance to the maintenance of the gold standard and the stability exchange rates than to the maintenance of internal stability.
Today, as soon as the credit pyramid showed the slightest signs of potential unwinding, central banks would be pressed to lower interest rates. This is because the public at large sees lower borrowing costs as a remedy against crisis — rather than its cause. What is more, highly indebted social groups have a preference for inflation, and an aversion to deflation. That said, a highly leveraged society might even be ready to accept a deliberate policy of (”controlled”) inflation rather than agree to a period of declining prices.
Critics of the Austrian School might argue: The rise in credit growth and debt ratios has been going on for decades now. Credit has been expanding, but so have incomes and real wages. In fact, no major disaster, at least not on the scale predicted by Austrian economists, has occurred so far. Isn’t there a flaw in their theory?
The answer, say the Austrians, is that it is still too early to reject their prediction as false.
In fact, the credit boom is not, in the words of Murray Rothbard, a “one shot”:
It proceeds on and on, never giving the consumers the chance to reestablish their preferred proportions of consumption and saving, never allowing the rise in cost in the capital goods industries to catch up to the inflationary rise in prices. Like the repeated doping of a horse, the boom is kept on its way and ahead of its inevitable comeuppance by repeated and accelerating doses of the stimulant of bank credit. It is only when bank credit expansion must finally stop or sharply slow down, either because the banks are getting shaky or because the public is getting restive at the continuing inflation, that retribution finally catches up with the boom.
Seeking to prevent the final crisis — which would most likely entail a debasing of the currency — Mises concluded: “The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” Being fully aware of the dark side of the credit boom — that is its socially destructive ramifications — Mises argued for returning to free-market money, which he saw as the only monetary regime that would allow preserving the ideal of the free society.
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