Many critics of Austrian economic theory on the causes of business cycles suggest that the lack of significant CPI-based inflation shows the Austrians are all wrong. Yet, as I have argued earlier, CPI inflation is NOT what Austrians are concerned with. Rather the central banks artificially lowering interest rates leads to malinvestment and a distortion of the capital structure. In layman’s turns, the Fed’s lowering of interest rates causes entrepreneurs to invest in projects because of central bank policy, not based on true consumer demand.
As we’ve seen more significantly over the last month, investors are trying to adjust their stock portfolios in front of a change in Fed policy–from $85B monthly QE bond purchases, which has led to stock and bond market gyrations. I don’t think anyone would deny that uncertainty over Fed policy is at least contributing to the market vicissitudes, with the obvious implication that people deploy capital in response to the incentives people face as a result of Fed policy. Yet that is the essence of the Austrian claim–that central banks distort capital investments, and the inevitable change in policy will unveil the malinvestments. But until the policy changes, individual investors are rational in trying to make the best of the hand they’re dealt–a world dominated by central planners in central banks. As Citi’s Chuck Prince notoriously and aptly said prior to the last Fed bubble bursting,
“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing,”
People are trying to figure out now when they need to stop dancing. They’re just not sure how long the music is going to keep playing, w/Mr. Bernanke our merry DJ.
The Fed is not the solution to our economic problems; indeed they are a large part of the problem.