The Bear Crying Wolf

A perennially bearish hedge fund manager with an Austrian economics bent recently appeared as a guest on the Tom Woods Show.  Tom Woods opened the discussion with:

What do you say to somebody who says, “The trouble with you Austrian-influenced financial guys is that you’re always bearish, so of course you’re going to be right when things go wrong.  Why should I listen to you now?”

Great question.  Are we Austrians eventually right, but always early?  Is this one “big, fat, ugly bubble” that, when it bursts, will vindicate all of us?  Are we just flat wrong?  Is Austrian Business Cycle Theory (ABCT) out of touch with reality?  Or are we stopped clocks, right twice a day, but miss out on a lot of opportunities the rest of the time?

Current Prices on popular forms of Silver Bullion

The answer is not that simple.  It never is.

The problem starts with group dynamics and oversimplified narratives.  Intellectually, we all tend to gravitate to one camp.  Get too close, and we breathe the same air, chew on the same ideas, and insulate ourselves from outside views and feedback.  Often a common narrative forms which never measures up to the complexity of the real world.  Sometimes a group can achieve overnight success, attracting camp followers who pick and choose those ideas that best fit their own narratives, ignoring the rest.  As a result, the group gradually moves away from reality towards soundbites and clichés.

Democracy is clearly susceptible to these tendencies, as Alexis de Tocqueville observed on his travels to America from 1835-1840:

Generally speaking, only simple conceptions can grip the mind of a nation.  An idea that is clear and precise even though false will always have greater power in the world than an idea that is true but complex.

The Austrian-libertarian camp is remarkably dedicated to the pursuit of truth and thrives on critique.  But is it immune to group tendencies?

Let’s return to the question at hand: are most Austrian-influenced financial prognosticators (present company included) nothing more than blind squirrels who find an acorn every once in a while?

I believe there is some truth to this criticism.  Austrians tend to focus on the damage done by government intervention, especially the boom-bust cycle caused by monetary inflation.  We practically genetically suffer from confirmation bias towards the negatives and filter out good news.

Are there signs of human progress?  They’re all around us and impossible to ignore.  Tom Woods gushed about them:

Internet, smartphones… the things that these have done for speed and productivity are incalculable.  Things that I, as an average person, can now do are amazing.  I can only imagine how fast and efficient things are now in the business world where, boom!, I can have a Skype webinar with some kind of a conference call all over the world.  We can accomplish things really quickly…

What are the pessimists missing?  Massive market-driven deflation.  In the past 20 years, engineers squeezed 1,000 times more transistors onto a silicon chip, while the price of bandwidth has plunged 99%.  In 2000 the first human genome was sequenced at a cost of $1 billion.  Today it can be done for less than $1,000.  Jeff Tucker recently wrote about the importance of “the advance of knowledge and the opportunity to act on ever better information about the world.”  Imagine when the wheel was first invented.  The faster the news spread, the better for material progress.  Today, the cost of disseminating information has dropped through the floor.

All of this should have led to an innovation-led deflationary boom for the ages, yet the 21st century has ushered in a housing bubble and bust, followed by the weakest post-WWII economic recovery on record… by far.  Meanwhile, the Consumer Price Index advanced 2.2% per year.

Tom Woods posited an explanation:

I always felt that that should’ve yielded an explosion of economic growth.  And during the ‘90s, when [the Internet] was still in its infancy, the growth was fine, but we haven’t seen that.  I think that there probably has been an explosion in it, but that’s been… It’s  just my theory, but there would’ve been if we hadn’t had all these offsetting tendencies – government offsetting tendencies – the figures would be much higher.  So I think that government is parasitically living off the high we’re getting from living through a revolutionary time.

If Woods is right, the Internet boom has provided cover for all kinds of mischief on the part of government planners.  Since 2008, this is reflected in a quintupling of the Federal Reserve’s balance sheet, doubling of the national debt, chronic $500 billion deficits, the added burden of Obamacare, and Lilliputian interest rates that discourage savings and seduce investors to reach for yield and clamor for risk assets.  Exhibit A: The S&P 500 is up 3 ½ times from its March 2009 low.

In response to the meltdown of 2008, the world’s government bureaucrats blasted the economy with unprecedented doses of fiscal and monetary stimulus.  The new kid on the block was China and they were a quick study.  In 2009 money supply grew 30% and bank lending doubled.  The new money and credit largely financed an infrastructure boom.  At its height, China accounted for over 40% of the world’s copper demand with just 10% of global output.  The resulting commodity bubble peaked in 2011 and has since burst.  The stimulus kept flowing, leading to a stock market bubble – with wild public participation and record margin debt – that topped out in 2015 and has since reversed.  For all of its trouble, China is sitting on slowing economic growth (even according to inflated government statistics), a host of empty cities and an additional $20 trillion in debt, mainly at the corporate, household and local government levels.

The question before the house: with all of this goosing of the economy – spending from roughly $60 trillion in new debt globally and the Internet revolution, why is real growth in GDP in the U.S. an anemic 2.1% per annum the past eight years?  Something is very wrong with this picture.

Austrian economists offer a key insight: “stimulus” is actually a depressant.  Real economic progress comes with delayed gratification.  Putting the consumption cart before the production horse consumes resources and erodes the economic foundation.  Artificially lowering interest rates often creates the illusion of a boom, while sowing the seeds of a bust.

This monetary illusion may be masking the underlying decay, but cracks in the foundation are already visible and widening.  Personal bankruptcies are rising and real median household income has gone nowhere.  Middle aged mortality due to drugs, alcohol, and suicide has doubled for non-college educated white males since 2000.  Retailers are actually experiencing recession-level declines in same-store sales.  Some of this is due to the growth of e-commerce, but certainly not all.  Many middle-class consumers who aren’t benefitting from the stock boom are hurting.  Rising auto loan and record student loan delinquency rates are further evidence.

This is not the first time a technology-led deflation has masked a monetary inflation.  During the booming 1920s, automobiles, radio, telephone and electrification should have been pressuring prices lower, yet the consumer price level was remarkably flat.  The leading authorities thought all was well thanks to their scientific management of the economy.  In 1929, Irving Fisher, head cheerleader for using monetary stimulus to keep prices from falling, gave Herbert Hoover, who served as Commerce Secretary from 1921-1928, much of the credit:

Mr. Hoover is a practical economist and one to whom is due more largely than to any other one man improvement in our prosperity…  Mr. Hoover knows as few men do the terrible evils of inflation and deflation, and the need of avoiding both if business and agriculture are to be stabilized.

The rub, of course, is that market-driven deflation is always an unmitigated blessing while fighting it with monetary inflation is a terrible evil.  This history lesson apparently fell on deaf ears with former Fed chairman Ben Bernanke, who boasted about having the courage to act in 2008 to rescue the financial system and set us on our current path of inflationary prosperity.

Today the interventionist bulls are confident that every dip is a buying opportunity, just as Irving Fisher was in October 1929.  The Austrian-influenced bears will have their day.  Kick us while we’re down at your peril.