Monetary Policy Playing With Fire: Inflationary Momentum Cannot Be Controlled

This is an excerpt from In Gold We Trust 2015, released by Incrementum Liechtenstein:

In the meantime, there are more and more voices arguing in favor of raising inflation targets as the only practicable solution to lowering debt ratios. Thus Eric Rosengren, president of the Federal Reserve Bank of Boston, argued that inflation targets should be raised, in order to finally jump-start the economy’s sputtering engine.45 IMF chief economist Olivier Blanchard, one of the most influential architects of the international financial system, has averred several times already that higher rates of price inflation should be targeted.46 Due to the impossibility to control the momentum of inflation described in more detail by Murray Rothbard below, we believe this is akin to gambling.

First, we take a step back and note that there is no such thing as a “general level of prices”. There exists a vast array of price relations between different goods and services. The primary purpose of money is to facilitate exchange. Similar to every other good in the economy, money has a price – namely its exchange rate versus all other things that are traded for it. Money is therefore subject to the forces of supply and demand like any other good.

Murray Rothbard’s book “The Mystery of Banking” contains important thoughts on the reasons for hyperinflation. Rothbard defines the desperate fight against deflation and the associated priming of the pump as the cause of most hyperinflation events. The collapse in the demand to hold money is a crucial factor thereby, which is at best underestimated by the mainstream, but in most cases simply ignored.

Rothbard identifies three phases of the inflationary process:

  • In the first phase, the money supply is increased, but prices barely rise. Since people assume that the money supply expansion is only a temporary policy, they continue to prefer saving money instead of spending it. This phase is like the Land of Cockaigne for politicians, as it appears to be possible to finance deficits and buy votes without consequences, without creating price inflation.
  • In the second phase, the public slowly but surely begins to anticipate rising prices. Rothbard writes: “Rather than hold onto its money to wait for price declines, the public will spend its money faster, will draw down cash balances to make purchases ahead of price increases. In Phase 2 of inflation, instead of a rising demand for money moderating price increases, a falling demand for money will intensify the inflation.”
    At this precise juncture, policy-makers are facing a fork in the road: Either they allow a natural deflationary process to happen and accept a recession, which will help to painfully correct excesses, or they continue on the path of easy money and risk the emergence of the third phase.
  • Phase three is commonly called the “crack-up boom” after Ludwig von Mises (in the German original: “Katastrophenhausse”, which literally translates as “catastrophic boom”). The public becomes aware that there is no intention to halt the momentum of inflation, and that it is steadily accelerating. People abandon the currency system in a concerned mood and choose alternative currencies. Rothbard describes this phase as follows: “A frantic rush ensues to get rid of money at all costs and to buy anything else. In [Weimar Germany circa 1923], this was called a ‘flight into real values.’ The demand for money falls precipitously almost to zero, and prices skyrocket upward virtually to infinity.”

In our opinion, it is quite possible that we are in the transition period between phase 1 and phase 2. However, forecasting the turning point with precision is impossible according to Rothbard:

“There is no scientific way to predict at what point in any inflation expectations will reverse from deflationary to inflationary. The answer will differ from one country to another, and from one epoch to another, and will depend on many subtle cultural factors, such as trust in government, speed of communication, and many others.”

We explained last year why it is impossible to regulate the momentum of inflation. The widely held belief that the Fed is able to push the “inflation genie” back into the bottle without any problem is based on numerous fallacious assumptions. Thus, the time lags of an inflationary process are underestimated. Enormous monetary inflation has already taken place, but has so far only affected asset prices. Strongly rising food prices are generally viewed as disastrous, while rising house prices are celebrated. Both, however, indicate a decline in money’s purchasing power, it matters not whether it is expressing itself by rising food prices or rising house prices.

Current developments correspond precisely to the textbook Austrian Business Cycle Theory (ABCT). In the course of the inflationary process, the prices of capital goods (=asset price inflation) thus rise first, and consumer prices begin to rise (=consumer price inflation) only later. The asset price inflation that is currently underway is impossible to overlook. Apart from substantial price increases in real estate and stocks, the prices of antiques, luxury goods, fine wines, vintage cars, works of art, etc. have increased considerably.


We are currently witnessing one of the greatest experiments in human history. History teaches us: Neither mainstream economics nor central bankers are aware of how to control the specifics of inflationary dynamics. The pitiable attempts to regulate the level of inflation like a thermostat are testament to the hubris of monetary policymakers. Waves of price inflation happen unexpectedly and in very compressed time periods. As the following chart shows, this is confirmed by numerous historical episodes.


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