Are we past the first stage of a crack-up boom?

June 19th, 2008

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Around 15 months ago (when we first wrote Have we escaped from the dangers of inflation?), there are many people who believed that the world was in an unprecedented boom and prosperity. Indeed, many economists called this the “asset-driven growth.” The truth is that, this boom was nothing more than inflation in disguise (see Myth of asset-driven growth written in January 2007). As long as price inflation was conveniently confined to asset prices, no one complained. In fact, the masses loved it because it made them feel rich. However, the ‘prosperity’ that those in the West enjoyed was an illusion. Back then, while the Western masses enjoyed soaring asset prices and benign price inflation, they failed to notice that their ‘wealth’ was borrowed from and paid by the Chinese. Millions of rural Chinese left their farming villages to toil in the factories in conditions that we in the West will find appalling. It was these factories that churned out cheap goods that gave us the illusion of low price inflation. As we said before in The Bubble Economy,

In recent years, Chinese productivity had soared, which means overall, the Chinese economy was producing more and more goods at lower and lower costs. In China itself, that had a good deflationary effect – the fall in the consumer price levels. As China exported more and more of its cheaper goods to Australia, the effect on Australia was disinflation (decelerating growth in consumer price inflation). That helped keep a lid on the Australian consumer price inflation.

We have to remember that much of the rise in Chinese productivity could be attributed to their seemingly endless supply of labour procured from their vast countryside.

Today, the generous credit that the Chinese had extended is coming to an end. They are running out of skilled labour to continue churning out goods to match our inflation in money and credit (if they can continue to inflate at all). Also, it’s time that they start to look after themselves by investing on their own nation. Now, price inflation all over the world is spilling over to consumer prices with a corresponding deflation in asset prices. The masses’ mood is souring. This is hardly surprising to us. As we explained (back in November 2006) in How will asset-driven ?growth? eventually harm the economy?,

When central banks expand the money supply artificially, it creates distortions in the economy which will eventually result in a recession, which is a correction to the distortion. In the case of the US (and the British and Australian as well) economy, the housing bubble was caused by the inflation of money supply.

The correction of this distortion manifests itself in the form of credit crisis and deflation. To fight this deflation, central bankers have been desperate to pump more liquidity into the global financial system. But the asset bubble can no longer be re-inflated with this new pumping. This time, it is oil and commodity prices that are being inflated. Inconveniently, such price inflation will lead to the inflation of consumer goods. It is indeed worst of both worlds for the masses in the West- deflation of asset prices (which makes them feel poorer) and inflation of consumer prices (which make them feel yet even poorer). This is what we call stagflation (see Supplying never-ending drugs till stagflation).

We are now entering the second stage of what Ludwig Von Mises calls the “crack up boom.” In the next article, we will explain to you what this crack up boom is all about in more detail.

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