Chaos, Confusion, and the Crack-Up Boom

Chaos, Confusion, and the Crack-Up Boom

Australia is finally in for a dose of Europe’s energy crisis. Funnily enough, it’s all a matter of diesel — a fuel that went from green-tech solution to pariah faster than most such government policies. In Australia, supply chain disruptions involving China have put our fuel on the line.

But this is just the Australian version of a rather extreme phenomenon, which seems to be happening all over the place in all sorts of economic arenas.

In Europe, it’s gas that’s running short. In the global car market, it’s computer chips. A few months ago, it was lumber. Before that, toilet paper. The list goes on.

Why is this happening?

Is there any economic theory that can explain all this chaos? A lot of it seems to make no sense.

People don’t poo more or less during a pandemic, they just do it in a different place, using the same amount of toilet paper. Wood doesn’t suddenly disappear, so any surprising supply and demand problems seem a bit odd.

Supply chain issues are just as surprising. For a while, the UK media could at least blame Brexit. But then the same problems started occurring elsewhere.

Aside from the shortages, we’ve also seen prices spike for all sorts of goods. Inflation is now running at multidecade highs in key economies. And producer price inflation measures, sometimes known as factory-gate-prices because they’re what companies pay for their inputs, are soaring even faster.

Then there’s the government and central bank response. Who would’ve foreseen the combination of 0% interest rates, vast QE, low unemployment, decent GDP growth, and the highest inflation in decades? That combination would’ve triggered a collective heart attack in Germany not so long ago.

Speaking of which…[redacted].

I’m here to tell you today that all of this economic chaos is not just easily explained, and it wasn’t just explained well about 100 years ago, it was also predictable.

The theory which does all this is known as the crack-up boom. Or, if you translate the original German ‘Katastrophenhausse’, you get ‘catastrophe surge’ or even ‘catastrophe bull market’.

Before I explain, consider how Investopedia sums up the theory, with my emphasis added:

Understanding a Crack-Up Boom

The crack-up boom develops out the same process of credit expansion and the resulting distortion of the economy that occurs during the normal boom phase of Austrian business cycle theory. In the crack-up boom, the central bank attempts to sustain the boom indefinitely without regard to consequences, such as inflation and asset price bubbles. The problem comes when the government continuously pours more and more money, injecting it into the economy to give it a short-term boost, which eventually triggers a fundamental breakdown in the economy. In their efforts to prevent any downturn in the economy, monetary authorities continue to expand the supply of money and credit at an accelerating pace and avoid turning off the taps of money supply until it is too late.

In Austrian business cycle theory, in the normal course of an economic boom driven by the expansion of money and credit, the structure of the economy becomes distorted in ways that eventually result in shortages of various commodities and types of labor, which then lead to increasing consumer price inflation.

Investopedia goes on to explain what happens next in this process. But consider just how spot on the description is so far…

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Central banks are continuing extremely loose monetary policy ‘without regard to consequences, such as inflation and asset price bubbles’. That’s precisely what’s happening. In stocks, certain commodities, and now consumer prices too.

Inflation rates in key economies worldwide are multiples of inflation targets, but the QE and 0% interest rates persist. That combination would’ve been thought catastrophic 15 years ago.

Even central bankers are warning about asset price bubbles these days. Including housing bubbles in Australia. But are they tightening policy to stop them? No, they continue to fuel them.

Similarly, government spending continues to veer out of control in many places. Some politicians even argue that government spending reduces inflation!

Who would’ve thought that the US would engage in a US$1.9 trillion stimulus package while inflation is running at 6%, unemployment at 4.2%, and GDP growth expected at 4.8% for the current quarter of 2021? It’s madness.

The distortions that the crack-up boom theory describes are what we’ve been puzzling over in 2021. Investopedia explained that government and central bank involvement ‘triggers a fundamental breakdown in the economy’. Goods shortages, an energy crisis, and the oil price even went negative at one point. Not to mention my favourite example of used cars selling for more than the same model brand-new, because of the waiting time.

None of it makes sense unless you understand the crack-up boom theory, which is all about the economy’s structure and how prices lead to decision making. Muck with prices, as governments and central banks do, and you get chaos. It’s a bit like spinning all the road signs in the world by 90 degrees. That’s why Japan is doing comparatively well so far. They don’t have street names.

Stories about labour shortages are another key issue because of how the crack-up boom shifts incentives for people. They take on speculation as their past time, instead of working, as asset prices are bid up while wages stagnate in real terms. Early retirements hit en masse as people don’t want to put up with government regulations at work. Unemployment becomes viable under extreme amounts of government welfare. And so businesses are forced to offer extreme pay-rises, like Amazon’s $3,000 signing bonus for warehouse workers.

I keep getting cheques in the mail from the Japanese government for no apparent reason. Big ones too.

It’s truly remarkable how well the idea of a crack-up boom conforms to our present plight. And that’s just the Investopedia version.

But what does it tell us will happen next?

The Austrian Economist Ludwig von Mises explained that there is no escape from the eventual pain of a boom engineered by governments and monetary policy. It’s just a question of when and how society is willing to take it:

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

That identifies two possible outcomes. But first, another quick description from Investopedia:

The rising prices and limited availability of necessary inputs and labor put pressure on businesses and causes a rash of failures of various investment projects and business bankruptcies. In ABCT [Austrian Business Cycle Theory] this is known as the real resource crunch, which triggers the turning point in the economy from boom to bust.

In the UK, energy companies are going bust because they can’t acquire gas at prices they’re committed to sell at. In Germany, factories are shutting down over energy prices. In China, Evergrande’s property crisis has begun and is spreading. In Australia, there’s fear over a diesel shortage. In the US, businesses have had to close because they can’t find workers.

That’s just the beginning of how a boom turns to bust. What happens next?

Option one is basically the recession that we saw in the early ’80s in the UK and US, when monetary policy was tightened to rein in inflation, despite the economic damage this did.

This time, the same cure would likely taste a lot worse given how much more debt we’re in, making interest rate hikes all the more painful.

Option two is hyperinflation, as Mises lived through in the ’20s. That’s what happens when governments and central banks do not rein in their excesses and try to keep the party going with evermore money, often to try and fund the government.

Once people realise this symbiotic relationship between central bank and government, known by economists as ‘fiscal dominance’, they also realise that the inflationary policies will continue. And that’s when inflation really takes off.

For now, we’re stuck in the confusion and misallocation phase. But be careful what you wish for. What comes next could be worse!

Until next time,


Nick Hubble Signature

Nickolai Hubble,
Editor, The Daily Reckoning Australia Weekend

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