Frank Shostak is an Austrian School economist. He is an adjunct scholar of the Mises Institute. His consulting firm, Applied Austrian School Economics, provides in-depth assessments and reports of financial markets and global economies.
Some key moments:
There's a need to build up the wealth base of all Western economies and this requires, of course, reducing government involvement.
The economy is full of a lot of parasitic entities dependent on loose monetary policy. This is now changing.
The fallacy of mainstream economics is not everything can be measured, not everything can be seen. The important thing is to understand things. Once you know that, you realise that printing money destroys real wealth of an economy.
The current banking crisis shows the fiat currency system is on the verge of collapse.
Fed easing when banks are unwilling or unable to expand credit is useless. Expansion of central bank balance sheet is not leading to expanded money supply.
There is a risk, therefore, of deflation not inflation.
Meyrick Chapman
Well, hello, and welcome to Exorbitant Chat. Today I'm joined by Frank Shostak who I've known for approximately 10 years. Frank is from the Austrian School of Economics. He's an adjunct scholar at the Mises Institute. He has his own consulting firm that I highly recommend. I think that their work that they do is is very useful. Very helpful in analyzing markets and developments. It provides assessments and reports of financial markets and also economics. Frank was born in Riga in Latvia. He left quite early in his life and received his bachelor's degree from Hebrew University in 1970, a master's degree from Witwatersrand University in 1978, a PhD from Rands Afrikaanse University in 1983. He's a scholar at the Mises Institute, as I said, and a member of a board of editors of the Quarterly Journal of Austrian economics. He writes, he's written numerous, numerous articles for financial journals, including the Wall Street Journal and academic journals as well, both in Europe and the US. Thank you for joining me, Frank. It's really great to talk to you again.
Frank Shostak
Thanks for having me.
Meyrick Chapman
So amazingly, many people are not really familiar with Austrian economics. It seems there is a censoring by the economic orthodoxy of Austrian economics. So perhaps you could tell me a little bit about how you see the world and how Austrian economics sees the world.
Frank Shostak
Yeah, look, you know, like first of all, I'll just like to provide us a slight, define the meaning of Austrian economics, which I personally believe that like most most economic mainstream economics today, they deal with GDP, Consumer Price Index variances, economic indicators, and that's really what they're talking about. But Austrian economics, they, they don't emphasize economic indicators as such. They don't ignore them, but they don't emphasize. They're basically saying that the economics is about human beings. It's about the interaction between human beings. And this type of interaction, it's about various activities, which are which are providing benefit to all and well-being to human being and ultimately, it's been summarized by one great Austrian thinker. Ludwig von Mises, who basically coined this word that economics is about human action. Human Action is basically conscious and purposeful behavior. Oh, in in a different word. They use it use the use the term, a praxeology. That's really that's the, the if you want the essence of Austrian economics, which is not always how people grasp it immediately. But it's very, very, very useful in terms of trying to understand how the world of economics of the real world are the facts of reality are what they are actually. And that's that's that's the key approach to start with in Austrian economics, that economics is about human beings, interaction about among human beings, and, and the actions are always purposeful. Just in this month, a small example for instance, we can observe people walking on the street or dining in a restaurant, or driving a car. So the the, the essence of what they're doing is there is a purpose what they're doing, right that's the essence. And so for instance, the the essence the essence of of driving a car is to reach a particular destination. And so the goal is to reach from A to B. The essence of dining in the restaurant, is again a purpose there. One is to fill your belly but another could be that you trying to get a business from the other guy, right? And etc. So so the activity is always purposeful and conscious, individual are conscious. It's not it's not a robotic behavior. So from all that Mises, the the champion of Austrian economics, derived that causality, causes in economics, are not mechanical like something from outside what they mentioned economists called exogenous variables or whatever that's that's not valid at all the the causes of what triggers what triggers action, are individual himself, he decides whether he wants to buy or not to buy is not a robot is not a man is not like a mechanical robot. And that's really the difference between the mainstream and the Austrian approach the mainstream presents without maybe always aware, being aware, human or robot, which is they call human being but it's not it's just a robot was.
Meyrick Chapman
I have sort of a personal feeling for what you're describing, because when, whenever anybody mentions inflation, which we'll come back to, because it's a big deal right now, but whenever people mentioned inflation, we think about inflation. Quite often I have a great deal of discomfort. Talking about inflation, because behind this number, are millions and millions of interactions that are taking place by different actors, and somehow to distill this notion of inflation into a single number of misses, misses the human element. And this kind of chaos behind the the number which, in a way, denigrates the individuals involved so sure, a macro economists, economists can't talk about millions of different transactions, millions of different interactions by millions of individuals. So of course the number gets distilled, and yet I do feel that conventional economics misses this individuality it misses it. So why why is like, it sounds as if that might mean that my natural feeling about how these numbers work, sympathetic to the Austrian approach, but why why has Why do you think Austrian economics has been so? It has not been incorporated except maybe we'll come back to this. But when I will talk about it now. It says except it seems by people like the BIS the BIS actually seem highly sympathetic to the Austrian point of view.
Frank Shostak
Well, you know, like the the big problem of the millennium, let's say the setting was a problem. The the emphasis of the Austrian economics, or at least the champions of the Austrian economics is to define terms accurately. So, as much as possible. Definitions are very important. And mainstream economics, they hardly talk about definitions. They say on the one hand, on the other hand, they just say that's why were they talking, everybody's laughing at the economist, because the sets one handed the economist or two handed economies whatever it is, and Austrian economics, the struggling at precise definition of the of terms. So for instance, if we look at inflation, how the Austrian economists define inflation. So Mises, for instance, defined inflation as an act of embezzlement. That's the same applies to Murray Rothbard. Now inflation is embezzlement, nothing more, nothing less. And, and one of the tools of an important tool for the exercising embezzlement is printing money. So basically, inflation is about increasing money supply the act of embezzlement which has been done by the through increase in money supply. And by the way, the definition of inflation is increasing money supply. This is the old definition of the classical economist, and all the smart people in England and other places of the in Europe. That's that's how they defined inflation that didn't define said inflation. It's manifest symptoms of it that talked about inflation as increase in money supply. And so so once you define or provide an accurate definition of the essence of what the inflation is, you will reach different conclusions. For instance, if you if you know that inflation or at least you believe, you know, that inflation is increase in money supply, then how do you counter inflation by trying to counter the increase in money supply, not not trying to suppress symptoms, that's what they do now, but to counter increase in money supply, but the moment you're you're saying that inflation's is a bad increase in money supply, then obviously, you're entering an area of power of politics because then people ask and who is in charge of money supply here? Surely government central banks so in other words, they're they're basically don't like to be seen as causing damage to people right? So therefore, therefore, it's much easier to pervert all that and present inflation as increase as increasing the consumer price index prices, right? So if prices are rising fast, you have inflation. If if price is slowing down, you have less inflation. That's really how there isn't right? And that's terrible. That's why they will never be able to to counter inflation because the fighting the the wrong the wrong factors. They should they should reduce the money supply grows, but they don't they're not. They're not aware that inflation is increasing money supply, side rewards. It's again shouldn't be compared with Chicago approach which was championed by Milton Friedman, who was saying inflation is caused by money supply. Now, Austrians are saying inflation is increase in money supply not caused by money supply because for Friedman, an increase in money inflation for him it's also increase in prices, which is also wrong.
Meyrick Chapman
I'd like to talk a bit more about money supply because it's really relevant, has been since 2020. Really, by by some metrics, I took some series from the NBER in the US and stitched it together with M2 which began I think in 1960 or something 1959 And looking at the annual growth rates there. So now here I've now got a series which runs from the beginning of the 20th century to now and there are ebbs and flows in the annual growth of money in the US using that series. But the growth in M2 in 2021 was 23%. I believe from memory. There's only been exceeded once which was in 1943 kind of the peak of money printing which which accompanied the war economy of of the Second World War. So that's that's an extraordinary growth rate. What happened after World War Two was there is actually a quite a sharp contraction of my supply Exactly as as you described. Do you think? Well, I think first of all, we can point to this extraordinary growth in money supply in the US and say that is the cause of inflation that is that is inflation. There it is, as you say, is caused by the dollar because so many commodities are denominated in dollars. It's the expansion of the dollar money supply cascades through the entire global economy. And, and it's also accompanied by dollar strength which of course also increases inflation outside of America because the commodities denominated in dollars and our price more highly in local currencies. There's an enormous monetary overhang, which I don't think this is an Austrian expression. It may went may well not be but I think it applies that the economy simply hasn't yet found a final home for this money. And so inflation is likely to continue but what's your view?
Frank Shostak
Well, first First of all, the fact that the central banks everywhere in the world in particular in the US were aggressively pushing money and still pushing aggressively money, money and also so so, so they engaged in, in the act of the destruction because we do know that when you print money, you when basically money is honest, let's say nobody prints money. It says it's basically fulfills the role of the medium of exchange. We exchange something for money and money for something else with the help of money which means something for something. However, when money is printed, or created out of thin air doesn't matter who brings it it sets in motion and exchange of nothing for something which means consumption without preceding production, that basically taking out of the pool of wealth and adds nothing in return until the the pool of wealth get get it's the gets depleted. And that's the end of the story. That's really what tends to happen. And so, so, as far as monetary policy everywhere, the the money was loose. They deliberately were by pushing money from all sorts of channels. Major channel is of course, the banking system itself, which is currently we see the the symptoms of the bankruptcy or 10 about the likely bankruptcy of the banking system. And the reason being because the banking system in the world everywhere operates on a fractional reserve system, which means that out of small a number of dollars or Sterling's or whatever, you can pyramid massive amount of of deposits, so, so they have created massive amount of deposit which are not supported by anything, empty money, and this empty money was sloshing around and creating lots of false activity until one day it's basically got stuck then the whole thing is falling apart because the reality is revealed. And the other the other. The other way of creating money is fiscal policies. Now government instead of let's say government wants to establish a particular project somewhere and and it requires funding. So what they do they normally they would raise taxes and take the resources the means to create this project out of somebody from somebody else. But if they're politically not inclined to do such things, then they're saying they're approaching the central bank issuing treasury bonds or government paper and central bank buys it which means central bank prints creates new money, and that's really the source of money creation. And, and unfortunately, today in particular in America, the government's outlay some massive understanding of of monetization outlays doesn't exist. And so we are in the process of total demolition, demolition of the real stuff. So the real stuff is getting diluted, depleted. And until we were maybe already reached the stage where the pool of real wealth is maybe so, so, so tiny that nothing can can move ahead any longer. And when government or central bank comes and tells you we got all the tools to fix it. That's all lies because all illusion because government does not create any real wealth. It can only, or the central bank, they can only print money, but by with printing more money, you cannot create real stuff. They cannot create potatoes, tomatoes, all the real things that people require. So basically, we are at this stage and they just you know, the fact that we had this initial symptoms of the financial crisis of banking crisis, that's really an indication that the fractional reserve banking is bankrupt today. It's cannot continue like that. Doesn't matter whether you small bank or large bank. The problem is the same. They allow to lend lend against something that they don't have. Because normally, normal lending has to be backed up by savings. So somebody saves and you take the money in you lend it. Today. No questions asked. If people place money, let's say in demand deposits today. This is immediately used by banks to lend to lend it out. But that's not the money's in fact, economically speaking it belongs to somebody who deposited it this morning. In fact, this whole story started in 1811 in Britain was a case car against car and somebody deposited money. At the bank. And they put is an A site and they put his marks on the on the notes. And then a couple of months later, he came back and said I would like my money now. So they gave him something else. So but he said I want my money with the ones that are marked. So the judge so so he took that they took the bank to the court and the court passed a verdict that the bank was was okay right to do it. And since then, we have the fractional reserve banking now the banks, banks can can help themselves and take your monies, some portion of the money that you have the demand deposits, and that's how it started though.
Meyrick Chapman
I think what that what you're expressing and explaining there, a banker would say, well, that's fine. I do the due diligence, I do the credit analysis, on the people I'm lending the money to and they convinced me their venture is going to be profitable, and that the interest rate they will pay on the loan is appropriate. So isn't it isn't that fine? Well, I can think of reasons why it might not be particularly if we have been through an era of extraordinarily low interest rates. So credit credit assessments actually are kind of irrelevant if you've got interest rates at zero that the credit, credit assessments are kind of don't don't matter. But we're no longer in a world of zero interest rates. We're in a in a world where all those credit decisions that were based on an assumption that interest rates would remain below 2% are now invalid. Is it is that a is that a natural consequence of what the Austrians or the Austrian business cycle?
Frank Shostak
Yeah, look, I mean, apart from business cycle which is one can explain the the whole issue here that the banks, the banks, you know, like, the banks are not lenders, the banks supposed to be just mediator, but the problem started when they decided to become lender.
Frank Shostak
GM also lenders that's where the problem started, because then what they what they were doing, they were attacking, and that's the serious issue problem here. They're using what we call mismatch that taking a one day money, let's say, and lend it for one year, right? So, so I'm the so they're there. They're not in the position to they don't have enough cash, when the the the power the money they borrowed is maturing now. So so so so each time they are risking running a risk of getting being bankrupt they they cannot, on a daily basis. They if if there wouldn't be any interference by Central Bank, most of the banks will be will be bankrupt because they they cannot clear the checks. They wouldn't be able to clear the checks right. But, but the existence of the central bank prevents all that in what sense the central banks are pushing enough money to prevent joint bankruptcy of many banks. And and and as long as this system continues they supposedly look okay, what one of those days the there is a there's a tendency to abuse the system to such an extent what that what we're seeing now, coupled with was the very, very generous monetary pumping. We're ending up in a situation where things are falling apart, because the moment you print money, you destroy the real ability of the businesses to generate wealth or in a different language the net worth of companies starting to come under pressure, right and the moment the net worth the value of liability starting to exceed the value of assets you bankrupt and that's what normally tends to happen. And and that's the situation right now so so it doesn't matter how big you are or small you are because as long as you practicing the this particular fraudulent system where you can, although it's legally allowed, that, that you can borrow somebody's money without his consent, then it's you're looking for trouble and that's so the only way to stop it. Either the central bank will will tell everybody all the banks, you have to keep 100% required reserves, then it will stop or or the the central bank has to shut its doors disappear and the free market will not tolerate such a things that will be immediately revealed in the free market and the guys the banks will that have to be the go under will go under. So everybody will understand the role the role of the free market but today the required reserves could be less than 10% Maybe 3% 4%. So everybody says well, I'll be stupid not to participate in this this game and try to make money. In fact, the SVB prior to this bankruptcy was pronounced as the most profitable bank.
Meyrick Chapman
Yeah, I actually there's something I've been looking at quite a lot over the last year is the banking system itself creates its own reserve requirements. Irrespective of the central banking, which is the suggestion there is well what is the purpose of central banks if the if the if the banking system itself says collectively it doesn't say but it iteratively can be calculated that a certain amount of deposits require a certain amount of reserves in the system? Yeah, reserves are significantly higher than that. The current estimate by the Fed is that reserves are around three required reserves required by the system rather than required legally the required reserves are something like 3 trillion, not not the well in fact, last year, fed abolished reserves effectively.
Meyrick Chapman
But I want to turn to a headline which you have on your website, because it's quite it's got to be commented upon. It says "The most important chart in 100 years" question mark the US monetary cycle switches from boom to bust, and it's there's a picture there of the yearly adjusted money supply growth from 1950 to 2022. So that's a fairly challenging headline. I wonder if you could are we Is this the bust that you just been talking about? Is that where we're headed?
Frank Shostak
No, no, I'm basically uh, well, I recommend the bust already started. Yeah. But the the important thing you know, about business cycles is such, just just for the audience. That the that when when you when you print money out of thin air, you create you're generating various activities, which we'll call them bubble activities, which are not but not not not productive, that on their own in a free market environment that probably wouldn't survive. But right now, they're like a parasite. You give them money, like a counterfeiter, and it takes they're take from the real stuff and helping themselves that's really what happens and but once you once you and they're prospering and there's this prosperity is false because they haven't created this prosperity. Once you once you basically tighten the monetary stance, you're printing less money than it starts starts to affect those bubbles. And they come under pressure and that's really So previously we had the boom now we have a bust. So so what we observe right now in the in the US economy and other economies also the momentum of money supply is really declining rather sharply. We need to discuss why it's declining, but but once it's the it's actually starting to weaken. Obviously, this is this exactly what it does to various bubble activities. It's undermines bubbles, bubble activities, and that's why we in the process of having a bust.
Frank Shostak
The bust could be could take various shapes and forms whatever right. But usually as a rule, banks are going to suffer because banks banks are the major or the major lenders here. And the moment the quality of assets starting to deteriorate, they're in trouble, right. They're in trouble. And so, so, so so that's why we still hold that the you know, we the the major economies in the world that the ones who got proper statistics are having already for a series bust. They're already in the process of a serious recession. So now, can this can this be stopped? I don't think so. Unless the Polo wealth is still there. Now. The kitty is still there, and it can move the things irrespective of what the money supply is doing. But given all the symptoms or signs of the banking crisis, whatever we are of the view that the bottom line of the American economy and other economies are in very in very bad shape, which means that you that the chances that it can recover, just like that problem zero. In order to have recovery. There's a need to build up the the whales base this requires of course, reducing government involvement. Don't don't tamper with financial markets, and all this is not there. So we're probably heading for a very serious type of disaster. We're already there. And and the only way to stop it is first of all for for the central banks to stop. Act be active in the financial markets, but they continue to be active. They continue to tamper with interest rates, and which of course supports the monetary monetary fluctuations. So eventually, we can only conclude that it could be a very serious type of recession. And the recession again, is because they managed to destroy on account of past policies, the what we call the real wealth the pool of real whales in decimated, there's nothing that left so so there is like a bank or fancy fancy fancy, says, Mr. John, John's, your bank account is empty now. There's nothing that we can do for you. And that's the situation the bank account is empty. There's there's no real stuff left. Very little of it left.
Meyrick Chapman
Yeah, well, I think yet had looks at Yellen has extended the debit insurance to us which you know, is is government interference in in the banking system. This time to stop a planning it'll be you know, there's creeping statism it's not so much creeping now it's actually rushing in to stop the proper to stop Mr. Market doing what Mr. Market wants to do, which is to remove the excesses. I want to talk a little bit about your long history of picking economic turning points because although it's very clear that you disapprove of the money printing, but it's also true that the money printing is actually you've identified that money printing is associated with asset booms and changes in asset prices to such an extent that it looks as if it's become quite a reasonable predictor of what's going to happen in markets. And this is something which I have evolved myself with your help to be fun to be honest, I think I followed some of some of your leads and it's been very productive. I see a a symbiotic relationship between financial markets and money printing now. Which is I'm amazed that more people don't look at this. Why? Why do you think more people do not look at this and they scramble around to say, Well, the reason share prices are going up is because expected earnings are going up and expected earnings are something I'm prices go up on will thinking rather than actual money. If actual money goes up, then actual stock prices go up.
Frank Shostak
Well, it's again, lack of definitions. So first of all, if we come back to inflation, they define inflation as increase in prices. Second, the, the they haven't defined what price is, what do they mean by price? Because price again by Austrians, it's amount of dollars per year of something, right? So in order to have an increase in prices, you have to have an increase in money and all things being equal. If you don't have it, then it's not possible. Or for instance, when people are saying price of oil is going up, and this will push the general price prices and not necessary because if you don't have increases in money, then nothing is nothing nothing's going to happen. What will happen is that people lie more oil but then they'll spend much less on something else. So all in all, you want having a general increase in price, but all this simple. Logic then disappears completely. If in the mainstream economics, and one of the reasons they're not always fair to him, and Milton Friedman, for instance, was pushing the idea that inflation is always monetary phenomenon, right. But but then then is forecast sometimes went wrong. Right. And, and, and because of that, economists said, Well, we had an idea since not early 80s. We had financial regulations, all those things that happen and as a result of that the importance of money vanished. It's not it's not it's not a series any longer, and therefore, it's just counterproductive to follow money supply. That's really the conclusion from since early 80s. And therefore, since then, they said, Well, we have financial regulation, the demand for money became unstable. They said, the velocity of money is unstable. And therefore, why should we follow something which doesn't help you to predict anything? But that's that's again, the biggest fallacy of this in this type of mainstream methodology because not everything can be measured, not everything can be seen. The important thing is to understand things. So once you know that, printing money destroys wealth, you can't really depict all wall was how the wells have been described. The economy is too complex. But you know that that's what it does. Logically speaking, you can derive this and therefore that's where we're, that's That's why information on on money supply is very important, but they don't publish it. Any longer. They don't they don't publish publicize the importance, although the figures are still published, because it's, they can the Congress requires demands it But economists forgotten about it, they don't even so my view is anybody who ignores money supply, or ignores the origin of inflation of rising prices, and boom bust cycles is not in a position to say anything about boom bust cycles. How can you say anything about boom bust cycles without looking at money supply? How can you say anything about future increase in prices of the decrease in prices without looking at money supply? For instance, today, most people most analysts are focusing on on the Fed, expanding its balance sheet again. And they'll have therefore the same that's contributes that basically, we see now witnessing a sharp increase in manager but not all the economies but some economies and therefore based on this, they are saying that the monetarist economists in fact, saying we're going to have now acceleration in price inflation. In other words, we have right now 6% It will jump to 810 whatever right now, but the one important factor that that is overlooked here is that the role of the banks because banks are a major contributor to money supply such so if banks will go will come under pressure or they're already under pressure, they will start falling apart and they will not lend what we call the inflationary credit not credit which is not backed by anything, then money supply will not expand, despite the Feds attempt to do it. And this could be a repetition of what we had in 1930s. The Fed was pushing on a string that was pushing money, but money supply was collapsing. Now this is a myth by Friedman and other guys who are saying that fed failed in 90 theories because it didn't bring enough money. Money fell by 33%. The money fail but there is represent, despite said, pushing a lot of money fed that accumulated large holdings of treasury bonds which means printing money, but but this wasn't what didn't work because banks were going under the balance sheet were wiped off. So demand money disappears on account of banks. And so as a result, we had we had a continuation, continuous decline in momentum of money. And therefore the we had the price deflation prices were falling apart collapsing. And this is this could be the case also now, not what everybody's talking about. Possibility of runaway inflation, but nobody says anything about possibility of having a price deflation. This could happen.
Meyrick Chapman
Yeah, yes, it could. That's a that's an area which I'd like to quiz you on, which is the role of the dollar the dollar has been the dominant unit of account internationally. Yeah, the Second World War and there are moves by China and others to shift away from the dollar. One suggestion is that they peg their currencies. To commodities. This is something that's been advanced. That sounds a little bit along the lines of an Austrian solution. Do you think it's practical? Do you think it's likely?
Frank Shostak
Well, look, you know, I reckon that the sole fiat system paper system is on on the on the verge of being collapse collapsing. And at some stage, it will just one function that only longer. So it doesn't matter whether we'll have Chinese money or Japanese money or European or whatever, right? It's, it's the paper money is coming may come to an end. And eventually people will go back to the natural market medium, which was gold commodity money, right? Maybe some other commodity? I don't believe it'll be Bitcoin. That's what the bitcoin is saying in I just can't see why Bitcoin should be should be invalid, so much as tritiated Right now, but so so I think we will go with this according to the Austrians, some of Austrians not all of them, we could end up in a we'll return back to the commodity money and gold is the primary candidate. So to be the dollar backed by gold, in other words, you you should be in a position to convert your not dollar notes into gold. Yeah, that's really the proper money because otherwise otherwise you give the power back to the politicians, and they can create as many dollars as they like, or in many pounds sterling is the way and that's that's the tragedy we have politicization of the means of exchange.
Meyrick Chapman
Well, Frank, this has been very useful. I think every investor should take note of your notes and your assessment it I find it very, very useful and very, very rich actually. I mean, that in a in an intellectual sense, it must only be rich in a monetary sense. intellectual sense. And I want to thank you for joining us today. It's been super interesting, and I'm sure the people who listen to this podcast will find it. So as well. So thank you very much.
Exorbitant Chat, Episode 7: Frank Shostak