If Austrian economics adds valuable insight into the understanding of economics, can it be used to make money? Hell yes it can! With an understanding of Austrian economics you can navigate the markets more effectively than your average citizen, even your average investor. Just imagine being able to see the housing bubble and the dotcom bubble before they collapsed. You might have avoided buying that huge house with the adjustable rate mortgage or that silly website that was represented by that weird sock puppet on TV. However, at the same time, it can be challenging to invest with an Austrian perspective because Austrian Economics does not really make predictions per se but people that use it can understand long term trends. For example, an Austrian Economist investor would not say that the stock market is going to drop tomorrow or that a bubble is going to pop on a certain date. The housing bubble lasted for years and most Austrians were not sure when it was going to pop. This makes investing challenging because if you stay out of a bubble all together you will miss much of the profits but you will also avoid the inevitable crash. The key is to be able to identify where the next bubble is likely to happen and to put your cash there and pull it out before it pops. This may seem pretty obvious but it can be challenging.
Austrian Economics describes how central banks create bubbles through inflation. The Federal Reserve has had interest rates near zero for three years and has used two large quantitative easing programs (money printing) to goose the economy. From the Austrian Perspective, this monetary stimulus is destined to fail because no amount money rushing into the economy can create new wealth or invigorate “idle resources” but instead leads to malinvestment and future bubbles. This knowledge gives people with an understanding of Austrian Economics a distinct advantage. Unlike most pundits and investors that think the economy is “turning around”, Austrian investors know that this is a false recovery. The question now becomes what will happen next.
Will the Federal Reserve be able to create another bubble on the scale of the housing bubble that will lead to another crash down the road or is the economy a “dead man walking” where no amount of monetary inflation will revive the economy due the last two decades of malinvestment? Both of these scenarios will lead to a crash but for an investor, these two scenarios imply two dramatically different ways of investing.
From my point of view it appears that the Federal Reserve will fail at inflating another big bubble, there might be a couple small ones, but it is unlikely that we will have anything like the housing boom before we have a very serious economic crash. There are many different reasons for this but from what I can tell these are some of the most important.
- The economy is unresponsive. The economy has barely budged even with a totally unprecedented amount of inflation from the Federal Reserve. This is very unusual considering the steps taken dwarf anything in the history of theUnited States. Greenspan was able to inflate another bubble rather quickly after the dotcom boom with a comparatively modest lowering of interest rates compared to the trillions in both monetary and fiscal stimulus and much lower interest rates for a much longer period of time that the Federal Reserve and the Government used after the housing crash. It like a man that has had repeated heart attacks and each electrical shock by the doctors to revive him has to be larger and larger. This latest round of electrical shock has kept the patient from dying but his heart is so damaged that he can no longer walk. It is just a matter of time before his heart gives out. This is what the Federal Reserve is doing with the economy, it can barely keep it alive but it can no longer bring it back to normal. It can only watch as it slowly dies. It can either choose to let it die (stop inflating) or try a couple more times in what is a lost cause.
- Inflation creep. The Federal Reserve will likely reach a point where he it can no longer stimulate without a serious problem with inflation. True inflation as measured by shadowstats.com is somewhere around ten percent (The government does not calculate inflation like it used too, it does not include Food or Fuel in the CPI and also uses what is called econometrics that understates real inflation.) Bernanke will likely face two dire choices, stimulate and risk out of control inflation or let the economy fall into a major depression. Politically, inflation is the easier route but it is not as easy as it used to be. Today the public has a much better idea where inflation comes from as opposed to even a few decades ago when in the 1970s people wore Alan Greenspan inspired WIN (Whip Inflation Now) shirt buttons as if the public, by sheer determination, could end inflation themselves instead of demanding the Federal Reserve stop printing money. In addition, the Ron Paul campaign has brought the Federal Reserve into the national political debate for the first time in 100 years, Federal Reserve chairmen simply don’t have the leeway that they used to. When faced with another massive stock market drop will Bernanke blink and inflate? The question is still out but in the near term I believe the answer is yes but eventually he will have to answer to the public for out of control inflation and likely put the brakes on.
- Public and private debt. Simply put, the debt held by the American government, American business, and the American public is unimaginably huge. Any recovery will have this black cloud hanging over it in the future. Economists generally agree that when government debt reaches close to 100% of GDP, economic growth falters. Add to this the debt held outside the government in private markets and we reach some really scary numbers. Markets are built on confidence and this kind of debt is confidence shattering. This debt creates further problems as well because our monetary system depends on ever increasing debt. The public is desperately trying to deleverage but for government inflation to stimulate the economy, more debt is required. Right now it looks almost impossible for the private sector to willingly accept more debt so the government will try to pick up the slack by running even larger deficits. Eventually though, even governments can leverage themselves too far and default. Whether this default happens through hyperinflation or by stiffing social security recipients and the Chinese is still unknown but default is inevitable.
- Unstable global monetary system. As predicted by Austrian Economists since the collapse of the Bretton Woods 1971, the global monetary system is starting too break down. Actually, the fact that it has lasted so long is pretty amazing but the flaws of a world wide fiat dollar system are becoming exposed. Under the Bretton woods system, central banks from around the world could exchange their dollars for gold. This allowed every central bank in the world to hold dollars instead of gold because they could exchange these dollars for gold at the New York Federal Reserve bank. Today, these dollar bills are sitting in central banks around the world and can no longer be exchanged for gold. This leaves the whole reason to hold dollars in the first place irrelevant. Foreign central banks have willing held these dollars for the last thirty years because the dollar has been relatively stable but this is changing. The dollar is quickly loosing value and foreign central banks are going to start losing a lot of money because of the Federal Reserve’s inflationary policies. For now, foreign governments that are large holders of dollars follow an export mercantilist model of economic planning. Presently, exports to theUnited Statesare the most important priority for these mercantilist governments and therefore, they will keep buying upU.S.debt but once again, this has a limit. Inevitably, importing so much newly printed money from theU.S.will have inflationary effects upon their own citizens and they will likely pull out of the dollar to protect their own domestic economies. When this happens is uncertain but it is unlikely that the dollar will remain the world’s reserve currency for more than a ten years.
How to invest in a stagflation/depression scenario
Assuming no new large bubble is inflated what should an investor be looking at?
First it is always positive to diversify your assets to some extent but if you believe that an inflationary scenario is approaching (as I do) then I would advise investing to hedge against such a scenario and possibly making a lot of profit as well.
Commodities and Safe Currencies
The key to investing in an inflationary environment is investing in commodities and companies in countries that have strong currencies.
Gold- The most common commodity that is a hedge against inflation is gold. This is because gold has a long history of retaining value, especially when currencies are being devalued. Many people consider gold a “barbaric relic” and not a true investment vehicle because it does not earn dividends. I would advise these people to consider that central banks all around the world hold ton upon ton of gold in their vaults. This is not held without reason, especially when considering how many countries are so in debt that selling their gold could provide them with much needed revenue but they don’t do this. Why? The answer seems to me that central bankers know that paper currency backed by nothing has some risks. Hyperinflation and loss of confidence in a national currency has happened repeatedly around the world over the last fifty years. Though the West has largely been spared from crises, it does not imply that it is immune. Central banks hold gold for a reason, citizens should be mindful of what those reasons are.
Silver- Silver is a precious metal like gold but also has industrial properties as well. It is the most efficient conductor of electricity in the world and is used in a variety of electronic products. As the increased digitalization continues and the populations of developing countries likeChinaandIndiastart adopting modern technologies, the demand for silver will likely continue to rise. Silver investing is not without risks, its industrial properties also incur the risk of a drop in price if another recession or depression hits, especially a deflationary one. Any potential investors should research silver thoroughly before jumping all the way in.
Oil- Like silver, oil has some advantages and disadvantages. Oil is critical to the global economy and will always be in demand but a world wide economic slowdown could very likely take the down the price like it did in 2008. Oil should do well in the next ten years but once again caution is advised.
Land-Land, more specifically farm land could be a potentially wise investment. Already we are seeing a huge run up in farm land in the last five years and it is likely to be in bubble territory soon. If you can get in and get out at the right time you should do fine but you can also invest in farm land for piece of mind in a worst case scenario economic collapse.
Agricultural Commodities- Agriculture will likely do very well in the future because the demand for food will continue to rise with population growth. In addition, people in first world countries consume much more calories than people in third world countries, as more countries become industrialized, the same amount of people will demand more food. There are other reasons as well such as an inflationary scenario. This will drive up food prices because people will rush into tangible assets while fleeing investments that are vaguer, like the financial industry.
Currencies- Investing in currencies can mitigate the risk of further dollar devaluation as well. Countries likeSwitzerland,Norway,Australia, andNew Zealandhave not devalued their currencies to near the extent that Fed and ECB have. In addition, all these countries have large natural resource economies. Canadahas these qualities as well but its proximity and dependence onU.S.trade makes investment inCanadariskier in my Opinion.
Foreign Companies- The foreign companies that should be invested in should be the same as the ones suggested under currencies.
Cash- There is some debate about how practical it is to hold cash with the coming inflationary scenario but there will be many opportunities to invest where cash comes in handy. We will likely see huge swings in the markets and for a wise investor that can buy low and sell high, cash may be a wise choice.
Well, these are just my thoughts but here are some resources
Investment Companies with an Austrian Perspective
– Casey Research
– Euro pacific Capital
Precious Metals Web Sites
– Bull moves in Bear Markets
– Rich Dad’s Guide to Buying Gold and Silver