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Hussman: Illusory Prosperity - Ludwig von Mises on Monetary Policy



January 09, 2011 – Comments (10)

Excellent post by John Hussman, the whole thing is worth a read. This excerpt is especially right on.


Illusory Prosperity - Ludwig von Mises on Monetary Policy

"Credit expansion cannot increase the supply of real goods. It merely brings about a rearrangement. It diverts capital investment away from the course prescribed by the state of economic wealth and market conditions. It causes production to pursue paths which it would not follow unless the economy were to acquire an increase in material goods. As a result, the upswing lacks a solid base. It is not a real prosperity. It is illusory prosperity. It did not develop from an increase in economic wealth [i.e. the accumulation of savings made available for productive investment]. Rather, it arose because the credit expansion created the illusion of such an increase. Sooner or later, it must become apparent that this economic situation is built on sand."

Ludwig von Mises, The Causes of Economic Crisis (1931)
Historical note - The U.S. stock market lost more than two-thirds of its value over the following year

If one looks back to the recent housing crisis, it is clear that the policy emphasis on easy money was one of the primary elements that created the illusory prosperity of the housing bubble and eventually led to crisis. The same is true of the various other crises that we have observed over the past decade. At present, I am convinced that the misguided policies that have been pursued in response to the recent downturn will again be reflected as significant new strains within a few years, if not sooner. While we will exercise as much latitude as possible to accept moderate investment exposures when the evidence is supportive, we have to be aware of the longer-term outcomes that are being set in motion by the present course of monetary and fiscal recklessness.

Perhaps more than any other economist, Ludwig von Mises got the theory of money and credit right, because he made distinctions between various forms of money and credit that are often conflated by other theorists. The amount of real physical investment in the economy is, and must be, precisely equal to the amount of output not allocated to consumption but instead to savings. Unlike many other economists, Von Mises not only recognized this identity, but carried it through to what it implied for monetary policy. Specifically, he observed that all real investment in the economy must be financed by real savings, while the creation of financial claims (which he called "circulation credit" or "fiduciary credit") in the absence of those savings tends to distort prices rather than output.

10 Comments – Post Your Own

#1) On January 10, 2011 at 12:48 AM, checklist34 (98.91) wrote:

i just saw your thread from jan 4, nice.

these are extremely difficult times, and like many, mr. hussman has probably missed the ride ont his rally.  I think alot of the frustration, on all sides, and, frankly, the enthusiam is a product of 2 things

1.  messing something up.  getting caught in the crash, or the housing crash, or the commodities crash, or the correction last summer.  On the other side, missing out on the housing bubbles potential profits, missing out on the 08 commod ride, missing out ont he market rally from 3/09 to 4/10 or from 7/10 to 1/11.  

2.   hope that their newthesis and direction will let them win this time around...  

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#2) On January 10, 2011 at 6:26 AM, outoffocus (24.08) wrote:

Hey Binve,

Have you seen this documentary? Its pretty darn good.

It was originally posted by devoish.  I highly recommend it. 

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#3) On January 10, 2011 at 9:17 AM, russiangambit (28.86) wrote:

> Credit expansion cannot increase the supply of real goods. It merely brings about a rearrangement. It diverts capital investment away from the course prescribed by the state of economic wealth and market conditions

Yep, rearrangment of wealth from those who produce it into pockets of those who skim it off via various financial alchemy. No wonder our best and brightest from Ivy Leagues go into investrment banking.

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#4) On January 10, 2011 at 9:30 AM, binve (< 20) wrote:


Thanks man.

I think you are completely right. And I will definitely include myself in that group, at least for equities. I have been a Gold and commodity bull for years, and I bought Gold and Oil in particular heavily in Dec 2008. I also bought equities in March 2009 but sold them in July-ish 2009.

I went bearish (cautious) far too early. And then went bearish (short) far too early, and got stopped out several times.

My macro thesis is still long term bearish, but that doesn't really matter for the short term (what can happen in the space of a year), and even the short term can present excellent opportunities that I am completely missing.

I recently revisited my macro assumptions, and really thought about a lot of ideas that are similar to your 'flop-flation' post ideas, and look at historically volatile bear markets. I put up a post if you are interested: The chart with the green projection at the end of the post is the one you will find interesting.

outoffocus ,

Hey! I have not seen that documentary. I will check it out! Thanks!..

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#5) On January 10, 2011 at 9:31 AM, binve (< 20) wrote:


Exactly man..

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#6) On January 10, 2011 at 10:36 AM, checklist34 (98.91) wrote:

my thesis is that we have 5+ more years of a secular bear that will probably include one more cyclic bear to cap it off.  basically I think this because the nasdaq must now become at least nearly as bad as the DJIA in 1929--- , which took 25 years to reach a new nominal high.  So I think once at 2025 or later we will see the nas below its 2000 high of 5200 or whatever it was.  Thus settin a new record. 

And with two very sizable bubbles, this overall secular bear must outpace the secular bear of 68-82 for both length and severity (already done on the severity side). 

But...  we are still nearly 20% below the highs of almost 11 years ago, and remember that in the presence of inflation that 68-82 secular monster saw highs higher than the pre-bear-market highs and indeed the last cyclic bear inside it crashed to the peak level of 1968 before the crash...  

So to remain in what history will remember as a massive secular bear, we don't need to drop to 800 again or anything...

Of course, inflation was heavy around that time, and in real terms the indices may have bottomed in 1982 (or was it still 1974), so in the absence of inflation the markets could behave differently this time, but... if you are an inflationist that isn't fully conducive with being short stocks.

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#7) On January 10, 2011 at 6:46 PM, rfaramir (28.60) wrote:

We will have inflation, and possibly hyper-inflation, so shorting stocks based on nominal values will be very hard.

I'm definitely bearish on equities in real terms. Just not certain how to execute that. So I stay with a few chosen equities, mostly gold, silver, and oil, along with CEF for trustworthy gold and silver bullion exposure.

It's good to see Mises quoted and studied. He was always correct and often ignored in his lifetime. To start with, his "Theory of Money and Credit" explained how banking should be in 1912, but in 1913 we got the Federal Reserve, instead. Then the quote above in 1931 on monetary policy. Then Human Action (in English) in 1949, but we got Keynesianism, instead.

I hope Ron Paul gives the Fed hell for the next two years!

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#8) On January 10, 2011 at 8:02 PM, checklist34 (98.91) wrote:

barring completely unforseeable circumstances, like nuclear war or the end of the world, the US has a 0.00000000001% chance of hyperinflation. 

significant inflation, possibly, hyperinflation essentially zero.  

the inflationists are maybe a little prone to dramatizing things

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#9) On January 11, 2011 at 12:39 PM, ikkyu2 (98.55) wrote:

None of the good stockpickers I read try to estimate macro trends.  They are looking for good companies, well managed, who can execute and have a moat in their market; and whose stock price underestimates their future performance.  Ludwig von Mises doesn't help me find those - so nuts to him!

Unless you're Ben Bernanke, I'm guessing you have very little control over Fed policy or macro trends.  I would suggest paying more attention to the things you have control over. 

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#10) On January 11, 2011 at 3:42 PM, rfaramir (28.60) wrote:

I, too, read good stockpickers, but I read macro analysts as well. The latter I understand better via Mises.

The micro-accomplished stockpickers do well until a macro event undermines them. Knowledge of macro helps me see that coming and adjust accordingly. The nature of human action does not allow for either control or precise timing, unfortunately. If it did, it wouldn't work, as such adjustments would be anticipated and included in further actions. Mises' regression theorem may help here.

You don't have to guess that I "have very little control over Fed policy" as you know very well that almost no one does. That's the problem. They spend more than *Congress* and are not accountable.

Audit the Fed, then End it! Until we do, we will continue to suffer from the Business Cycle.

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