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Mark R. Crovelli

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Gold, Inflation, And... Austria?


By Mark R. Crovelli          Printer Friendly Version

May 31, 2006

The nation of Austria probably doesn’t come immediately to mind when you think about inflation, gold, and the business-cycle—but it should.

I’m not talking about gold Austrian Shillings or bullion sales by the Austrian central bank. 

I’m talking about the Austrian School of Economics and the Austrian theory of the business-cycle. 

That’s because the Austrian theory of the business-cycle offers the only plausible explanation for the cyclical boom-bust pattern we have come to expect in the U.S. and global economies, and which is partially responsible for the exponential increase in the price of gold over the past five years. 

What is the Business-Cycle?

The term “business-cycle” refers to the recurring pattern of “boom” periods in the economy which are seemingly inexplicably followed by a “bust” or recession phase.  The term business-cycle does not refer to individual events that cause a recession (like a massive hurricane or a plague).  The term refers to periods like the roaring 1920’s which were followed by a sudden, unforeseen and terrible recession, and the booming 1990’s which were followed by the recession which began in 2000. 

Why Do We Need A Theory Of The Business-Cycle?

The reason why we need a sound theory of the business-cycle is that the very existence of the boom-bust business-cycle is perplexing.  Why is it that the economy suddenly experiences a boom-phase (with low rates of interest, high consumer spending, and massive investment by businesses in their productive capabilities)?  And why does this boom phase suddenly slow down or collapse?  Why are huge numbers of business owners and investors unable to foresee this sudden slowdown in the economy and take precautions which would lessen its severity?  Why doesn’t the economy progress at an even rate?  Why, in other words, is there a boom-bust cycle at all?

The Austrian Theory of the Business-Cycle

The Austrian explanation for the business-cycle is simple and comprehensive. 

What causes the business-cycle, according to the Austrian School, is tampering with the rate of interest by the government (specifically, the Federal Reserve in the United States).  The Federal Reserve instigates the boom-phase with its “easy credit policy” by reducing the rate of interest below what would be established on the free-market.  This lowering of the interest rate tricks business owners into believing that further investment in their productive capabilities would be profitable, and they borrow more capital than they would have at the higher free-market rate of interest.  The capital that is loaned out, moreover, is not backed by any real savings (as it would be under a gold standard)—it is simply created out of thin air by the fractional reserve banks in collaboration with the Fed. 

The inexorable effect of this artificial lowering of the interest rate is a boom-phase, during which capital is invested in lines of production that would not have occurred at the market rate of interest.  (The market rate of interest is determined by the amount of actual savings in the economy, and the rate at which people prefer goods today versus more goods in the future.  The more people prefer goods today versus goods in the future, the higher the market rate of interest, and vice versa). 

The boom-phase cannot go on forever.  At some point, the business owners who have increased their productive capacities in areas that are not really desired by consumers (because they have been tricked by the low rate of interest), come to recognize that they have over-invested, (because they are not earning a return on their investment that is sufficient to cover their loans), and they must liquidate this overinvestment. 

This is the beginning of the bust-phase, or the crisis phase.

The bust-phase of the business-cycle is the period in which the malinvested capital from the boom-phase is liquidated and moved to more productive uses.

The Austrian theory of the business-cycle, therefore, identifies an increase in the money supply as solely responsible for the cycle.  Not just any increase in the money supply will cause the cycle, however.  Only an increase in the money supply that takes place specifically in the credit markets that causes the boom-bust cycle.  Tampering with the rate of interest produces a situation in which business owners are misled and investment is squandered.

(For more detailed discussions of the Austrian theory of the business-cycle, see the works of Ludwig von Mises, Murray Rothbard, and Jesus Huerta de Soto at

What about Gold?

What can the Austrian theory of the business-cycle tell us about the price of gold over the past two decades? 

First, during the boom-phase of the 1990’s the artificially lowered rate of interest spurred investors to channel their investments into the ostensibly booming industries that were receiving the influx of new credit.  In the late 1990’s this new credit particularly inflated the residential and commercial real estate markets.  At the same time, the world’s central banks released massive amounts of gold bullion through bullion banks which dramatically depressed the price of gold.  As a consequence of these two phenomena, investors dramatically shifted their investments away from gold (the price of which was depressed by the influx of central bank bullion) toward the booming industries receiving the new credit (like real estate).  The boom-phase of the business-cycle lowered the price of gold dramatically below what would have been established on the free-market in the absence of these government-caused phenomena.

This boom-phase suddenly and unexpectedly slowed in 2000-2001. 

We are now in a position where the commercial and residential real estate markets are poised to rupture violently, which will release a massive amount of capital from these inflated sectors of the economy for investment in more productive areas.  The problem is, the U.S. dollar is itself in a dangerously precarious position, and investors are wary of investing in U.S. dollar assets. 

In other words, the market is ripe for an incomparably massive investment in gold and other precious metals when the tear in the 1990’s boom inevitably turns into a massive rupture.

Don’t be fooled by the temporary correction in the precious metals markets.  As the Austrians have shown, the massive boom-phase of the 1990’s will sooner or later produce a massive bust-phase.

You will not want to be left without gold when the impending bust-phase inevitable hits. 

Mark R. Crovelli
PhD Student
Department of Political Science
University of Colorado, Boulder