Frank Shostak: Savings-Investment-Production-Consumption

Frank Shostak is an applied Austrian School economist. By this, I mean that he is an adherent of the Austrian School of economics who uses his theoretical knowledge to run a consulting firm, Applied Austrian School Economics. He also writes articles for the Von Mises Institute. I have always found his articles be helpful in explaining current economic phenomena via the lens of Austrian School economics.

His most recent article is titled “The Monetary Tsunami is Coming”. In this article, Shostak makes the case that the waves of high consumer price inflation predicted by many due to the unprecedented actions by the fed and other major monetary socialist planning boards (aka central banks) in conjuring vast amounts of money to bail out politicians and those who bribe them is about to devastate the economy. Here is Shostak’s explanation of what is occurring:

“The yearly rate of growth of our measure for banks’ inflationary credit jumped to 8.2 percent so far in August from 4.3 percent in July. A visible strengthening in commercial bank inflationary credit, i.e., credit “out of thin air,” will provide the “necessary” monetary stimulus. This means that the massive amount of money pumped by the Fed since 2008 (over $2 trillion) is starting to be funneled into to the economy by the banks.

This has long been the hope of the Fed, and the goal of the huge increases in bank reserves that have been created during the downturn. Until recently, these reserves have been stuck in the system — unable to find lenders and borrowers willing to make a deal. This has been a good thing because prices have been held somewhat in check.

That is now changing. As the pace of lending picks up, and the fractional-reserve system of loan pyramids kicks in, we could see new floods of money pouring through our economic life and causing untold damage.

For the time being, the pace of pumping by the Fed remains buoyant. The yearly rate of growth of the central bank’s balance sheet stood at 23.6 percent so far in August against 23.1 percent in July. The growth momentum of our monetary measure for the United States (AMS) jumped to 13.1 percent this month from 11.8 percent in July.”

One aspect of Austrian School economics that Shostak stresses in many of his articles is the often forgotten facts that in order for an economy to support consumption, there must exist prior production of consumers goods. These consumers goods, goods of the lowest order, must be produced by producers goods, the produced factors of production, also known as higher order goods. Such goods require prior investment, which in turn requires prior savings. Shostak refers to this as the real pool of savings and repeatedly makes the point that this fund can be exhausted when an economy has a savings rate that is too low to support the current structure of production. Additions to this fund of real savings can be thwarted by inflationary monetary policies. Thus, Shostak writes: “any increase in demand must be fully backed up by an increase in the prior production of final goods and services. This increase in demand must be supported by the prior increase in saving and not by loose fiscal and monetary policies.

Neither monetary pumping nor any form of stimulatory policy can generate more real funding; rather they lead to the diversion of funding from wealth-generating activities to non-wealth-generating activities. These types of policies reduce the amount of available real funding to wealth generators and thus undermine the process of real wealth generation — economic growth comes under pressure on account of these policies. (It leads to capital consumption. Instead of planting the seeds in order to reap a crop in the future these policies cause people to consume the seeds. Obviously one shouldn’t be surprised that no future crop could emerge as a result. Yet policy makers are trying to convince us that one can eat the seeds and also have a crop.)”

This is an important point about the endgame of yet another failed experiment with government issued paper money that many non-Austrian critics of the fed fail to realize. All to many pundits focus on the effects of reckless monetary policy on the economy that are “seen”, meaning that they can only perceive prompt or first order effects. They fail to perceive “that which is not seen”, the higher order effects. This is akin to viewing the world as linear when in reality a more complicated function is required. By constantly seeking higher order effects, Austrian School economists are able to explain complex economic phenomena in a way that eludes adherents of other schools of economic thought.

There is a famous quote attributed to the great mathematician Pierre-Simon Laplace, “Lisez Euler, lisez Euler, c’est notre maître à tous” (Read Euler, read Euler, he is our teacher in all things [or he is master of us all]). Substituting Bastiat for Euler would be an appropriate quote for political economy.

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