Booms and busts

On Tuesday, I wrote about a new course at Edinburgh Business School that will deal with stock market bubbles. Patrick Crozier commented that inflation was low (or zero) in the UK and Roland Watson wrote that extra money had been created in the UK but could go into stock market and housing and not necessarily into consumption of consumer goods. I think that is correct.

According to the Bank of England's website, the UK money supply increased every year between 1970 and 1990 by percentages in double figures. The rate of increase slowed down a bit in the early 1990s but increased again to 9.9% in both 1995 and 1996 and then 11.9% in 1997. The latest estimates show money supply increasing at an annual rate of a bit over 8%. So why is "inflation" so low in the UK?

I think that two separate forces are operating. Since 1989, the former communist countries have entered the world trading system offering considerably lower costs. We see factories moving from high-cost Western Europe and North America to Eastern Europe and especially China. This is keeping the cost of consumer goods steady along with improving quality. Hence the very low inflation figures in the UK. So where is the extra money going? The inflation figures in the UK don't include house price increases! In Business AM yesterday, it was reported that the average British worker "now earns more from his property than his job" with the typical house increasing in value by £1,602 per month. The extra money is going into the housing market and had also been going into the stock market.

The Austrians say that:

Even more damaging (than the price rises) are the business cycles of booms and busts that monetary inflation causes. In broad outline, when government inflates, it lowers the interest rate below the proper market level, which depends on saving. The artificially low interest rate misleads businesses into making uneconomic investments and creates an inflationary boom. When the credit expansion slows or stops, investment errors are revealed and bankruptcies and unemployment result. Central banks like the Federal Reserve will inevitably create the business cycle.

The credit expansion has slowed to some extent and we have seen that: "investment errors are revealed and bankruptcies and unemployment result". Of course the response of the Fed and the Bank of England is to lower interest rates so as to counteract what the Austrians see as the inevitable result of the prior monetary expansion. If the Austrians are correct, and I think that they are, we shall see more stock market turmoil ahead. I am but an amateur "Austrian" but last year I switched most of my pension fund out of a "with profits" investment into a cash fund returning a modest 4%. By doing so, I locked into the accrued bonuses earned to date and missed out on this year's savage cuts.