by Claudio Grass, Claudio Grass:
The great Ludwig von Mises first described the concept of a crack-up boom as part of the Austrian business cycle theory, based on real life events that to an unsuspecting bystander might have appeared unconnected, or perhaps even quite bizarre and counterintuitive. Indeed, such a bystander might think the same of today’s economy and would likely have trouble making sense of the picture painted by stock markets, by our monetary and fiscal policies and their inflationary impact and by metrics reflecting the financial state of the average household.
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They each tell a different story and it can be hard to discern which is the right one. In fact, they’re all right, in a way. As von Mises aptly observed, it’s not different stories we’re seeing at all; it’s all the same story but from different angles. The core idea of the crack-up boom, in summary, describes the collapse of a monetary system, due to out-of-control inflation expectations by the market participants, that were in turn caused by extreme increases in the money supply. The stages before the crash, however, can appear more than a little paradoxical on the surface. And while it is clear that we’re not close to bombastic end of this phenomenon, it can very easily be argued that what we’re currently experiencing bears all the marks of the stages that precede it.
It all starts with increasingly and consistently loose monetary and fiscal policies. As governments try to boost the economy, usually for political reasons, they and their central banks keep printing and spending. As we all know from all that we’ve seen after the last recession, it doesn’t take long for the economy and for the markets to get “hooked” on easy money and low rates, which makes it politically impossible for any government to effectively and meaningfully pull that artificial support without risking wreaking havoc with the whole system and seeing their approval ratings nosedive. So they keep going down that same path, more printing and more spending. Inevitably, inflation begins to rear its ugly head, but it doesn’t affect all asset classes or all products and services at once. This would be the stock “boom” we saw in the past years, that “inexplicably” persisted, despite all indicators of the state of the real economy pointing the exact opposite way.
An economy can be stuck in this phase for some time. In our example, most normal workers and consumers naturally failed to notice the asset bubble, since their paychecks where going to basic living expenses instead of stock market speculation and most of those didn’t see dramatic price jumps at the time. However, once governments decided to go to extremes during the covid crisis and push their already loose policies to the breaking point, the inflationary impact, quite predictably, reached all corners of the economy. On top of that, all the covid restrictions and the forced shutdowns created artificial shortages and effectively super boosted that impact. That’s when people start to notice and this is where we stand today. What happens next, is critical: Since all fiat money is faith-based and backed by nothing but blind trust, the public’s beliefs and expectations can make or break them. And once doubt reaches a critical mass, the currency goes downhill fast.
Today, even though the majority of the population in most advanced economies is feeling the price increases very directly, most still believe that it can be tamed. Be it by government or central bank interventions, or by some other external event, they believe that things will eventually return to normal and that we’re just going through a rough patch, that is really nobody’s fault. Or even if it is, it’s President Putin’s and it’s all because of the Ukraine war and totally unrelated to the trillions that were injected in their economies. And so, they save what they can from their paychecks and they try to limit their expenses, in the belief that prices will eventually comes down, so they’ll spend their money then.
Now, that being said, there’s currently a rapidly growing part of the population that either always knew the nature of our monetary system, or, more commonly, has just recently caught on. They understand that inflation is not an “unfortunate event”, it’s not even a “regrettable side effect” of their governments’ policies. Inflation is a policy in and of itself. And this is why there aren’t and will never be any real attempts to reverse it.
These people clearly see through all the public statements of their political and institutional leaders and they recognize the need to take action by themselves and for themselves. So they do what any rational economic actor would do: Foreseeing that inflation is here to stay, and that the pieces of paper in their wallets will just continue to lose value until it hits zero, they try to get rid of them while they can still get something in exchange. They convert their fiat money to any real asset they can access and afford.
As the inflationary era drags on, this part of the population will continue to grow. But when it reaches critical mass, the effects of their financial decisions can turn cataclysmic. As more and more people try to get rid of their dollars and their euros, they push prices even higher. Run-away inflation becomes a self fulfilling prophecy, as the fear of rising prices causes those prices to rise and rise. And the trust that sustained fiat currencies is gone, they collapse and take the entire monetary system with them.
From our present vantage point, it is impossible to predict if and when such an event will come to pass. We might be stuck in this current phase for months or even years. But the one thing we can tell for sure, is that the sole winners in any scenario will be those who understood in time that the only sensible investment decision is to sell what has been artificially inflated for decades and to buy, hold and own undervalued real assets without counter-party-risks, such as physical commodities and physical precious metals, outside the banking system. Regardless of whether inflation stays around the current levels for the foreseeable future or whether it explodes tomorrow, that’s the “safe and sound choice” for any rational saver and investor.