The Application of Austrian Business Cycle Theory

by Gregory B. Christainsen

Las Vegas, April 7, 2003

The Great Depression and Recent Cycles in the US and Japan

Austrian Business Cycle Theory

• Nonneutral Injections of Money, Misdirection

• R: Capital Goods vs. Consumption Goods

• Later Reversal in Relative Prices and Resource Allocation

• Frictions, Unemployment

A Metaphor: Pour in Honey

PK PC

“Secondary Deflation”

• The Gold Standard

• Nonperforming loans, withdrawals from questionable banks, decline in the MS and/or its velocity

• What to Do?

Updating the Theory

• Responsiveness of C to R

– Durable Goods

– Proceeds from Refi’s

• Wealth Effects on C

• Duration of High-Tech Company Investments (dot.com cash flows)

• “R” vs. “Cost of Capital”

Bubbles

• Money and Financial Markets

• Technology

• Psychology/Animal Spirits

THE JAPANESE BUBBLE

• Money Growth and Misdirection

• 1991

• Nonperforming Loans

• mm, MB, Secondary Deflation

• Insolvent Banks, Depositors

• Recapitalization

• Fiscal Policy?

Stock Prices Before and During the Great Depression

0

5

10

15

20

25

30

35

1922 1929 1933

S & P Composite Index

CPI

S & P

Share Prices: Japan vs. US

CPI-Japan

Capital Goods vs. Consumption Goods

(US)

Money and Prices:Broad Measures

1998: The Plot Thickens

• Monetarists Call for Rate Hikes!

• Russia’s Default• LTCM• September, October, &

November Rate Cuts?!

Jerry Jordan’s Dissent, May 1998

“Mr. Jordan...noted that the monetary and credit aggregates had accelerated further from already rapid growth rates in 1997. In his view, these high growth rates were fueling unsustainably rapid increases of real estate and other asset prices...the Committee would face a choice between smaller increases in interest rates sooner versus larger increases later.”

November Dissent

“Mr. Jordan dissented because he believed that the two recent reductions in the Federal funds rate were sufficient responses to the stresses in financial markets that had emerged suddenly in late August. An additional rate reduction risked fueling an unsustainably strong growth rate of domestic demand.”

1999: A Tiger by the Tail

Monetary Base Growth (annual %)(3-mo growth rate, 7/98-12/99)

0

5

10

15

20

25

30

35

40

July Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

[Despite 3 Rate Hikes; Note Y2K]

2000: The Bubble Bursts

• Hiatus for Base Growth

• Misdirections Revealed

• Tech Wreck-- Lucent et. al.Lucent

2001-2002: Go-Stop-Go Amidst Deflationary Pressures

Base Growth: 2001-2002

-5

0

5

10

15

20

25

30

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep

An

nu

al

Gro

wth

Ra

te (

%)

The Outlook

• Cautious Optimism

• Still a Tiger by the Tail?

• Housing Bubble?

Housing Price Bubble?

1975 1995 2002

HOUSING

CONSUMER GOODS

Current US vs. Other Cases

• Aggressive Central Bank

• Dependable deposit insurance

• Diversification, securitization and risk management

• But note J.P. Morgan Chase, housing loans

Assessment

• The Fed Cannot Escape a Good Part of the Responsibility for the Bubble in Asset Prices and the Subsequent Recession

• 2004: Asian Central Banks, Housing!

• Not All--or Even Most--Knowledge Is in the Hands of Government Authorities

• Hindsight Is Easier than Foresight

Denationalizing the Creation of Base Money

• The Market as a Spontaneous Discovery Procedure

• NZ as an alternative

• The Myth of Central Bankers as ‘God’