 Our guest this weekend is our own Dr. Mark Thornton, a senior fellow here at the Mises Institute, and our topic is booms and busts. Falling stock prices are in the news lately, so Mark and I will talk about how and why central bankers don't understand deflation, whether they're really Keynesians or some variant thereof, what a crack-up boom might look like, i.e. deflationary rather than hyperinflationary, and what the skyscraper index and other forms of irrational spending might tell us about the future of the global economy. Stay tuned for Dr. Mark Thornton. Dr. Mark Thornton, happy new year to you and welcome back to Mises Weekends. It's great to be here. Mark, I'd like to begin by quoting from an article in today's Wall Street Journal. It is Friday, January 22nd. The title of the article is almost surreal to me. It says inflation lows vex central bankers. And the article talks about how central banks need to respond to persistently low inflation tied to slow growth and falling commodities prices. Last time I checked, most of us liked paying less for gasoline. But anyway, they quote Mario Draghi as saying, we don't give up. We are not surrendering in front of these global factors. And they also quote from the Bank of Japan, Governor Corote is saying, the credibility of Bank of Japan policy will likely take a hit if the central bank doesn't act. I mean, it's almost surreal, isn't it, hearing these central bankers talk about how they need to prop up inflation. Give us your thoughts on it. Well, it seems like we're living in 1984 and everything is upside down. Everything is backwards. It's a world where inflation is a good thing and deflation or falling prices is a bad thing. And it is a crazy, insane world that we're looking at out there, whether it's Japan or Europe or the United States. All the major economies of the world are in trouble and it's caused by central banks and they don't have a clue as to what they should be doing. Well, you mentioned deflation, let's talk about that. Deflation seems to be the constant boogeyman of central bankers. From an Austrian perspective, what is deflation and how should we think about it? Well, we think about it as a falling money supply, but of course, everybody else talks about deflation as falling prices. All of mainstream economics and central bankers fear deflation. They have a phobia about deflation or falling prices. And actually, of course, most of the people in the world, they love deflation. They love paying less for gasoline, for example. They love paying less at the grocery store. And so, Austrians and everybody in the world view deflation as a good thing and central bankers and mainstream economists view it as the most awful thing possible in the world. Well, and when we're talking about deflation, we also mean deflation of stock market prices, right? When you talk about booms and busts in your own work and in writing, central bankers fear busts more than anything, whereas Austrians will view busts as painful but necessary corrections. What is the central banker mentality about booms and busts? Since they don't accept Austrian business cycle theory, how do they view booms and busts? Well, they don't like deflation because they associate it with a great depression. They don't like it because of big government debt that is harder to pay off. So there are some tangible reasons that they see. They don't want to see falling stock prices because that hurts psychology and the economy. But Austrians have a view of deflation as it's a necessary process to correct the mail investments that are caused by central banks artificially low interest rate policy. So yes, in a correction, stock market prices fall a tremendous amount. The price of land falls by a tremendous amount. The price of warehousing space and retail space, all those leasing rates has to fall dramatically. But you know the price of milk and the price of toothpaste and the price of paper goods, those are all relatively stable. And so as capital prices, land prices and wage rates decline, while consumer goods don't decline very much, that creates an atmosphere where entrepreneurs out there see profit opportunities in producing existing goods as well as producing brand new goods. And so the correction and the crash phase in the business cycle gives entrepreneurs this great environment to put resources back together to hire workers, to buy land, to buy office space and all that and produce more goods because they see tremendous profit opportunities. And so during the correction phase, this is when we see a lot of new firms put together small dynamic companies that are producing brand new goods. And so if you go back and you look at the formation of all the great companies, you'll see that a lot of those new ideas took place during previous crashes and corrections. Well, it's interesting you talk about prices falling across asset clout in a depression. This is one of the big myths of investment advice, right, that if you diversify, you'll protect yourself. But what we saw certainly with the crash of 2008 is stocks, bonds, real estate, all kinds of investments all came down at once. So diversification doesn't really protect you from central banking. No, it doesn't. And Irving Fisher thought that back in the 1920s that if you diversified your investments that you would somehow be protected, but of course, mutual funds that are widely diversified lost just as much money as the overall marketplace. But this view of deflation really gets at the idea of, you know, this error of central bankers and mainstream economists fixation on consumer price index measures and GDP measures. When Austrians look at it, we're looking at, you know, capital prices, wage rates, consumer goods, we're breaking those prices down into their separate categories and you get more information. You understand how the economy works and how jobs are actually created. They don't have any idea of how jobs are actually created, how new companies form, and how businesses grow because they don't understand the workings of the economy because they're fixated on the consumer price index and GDP. Now, earlier you mentioned that one reason central bankers hate falling stock market prices is because of the psychology behind it. Let's talk about that. I know Mises talked a lot about the psychology of entrepreneurs and the psychology of the economy and praxeology, economics being a subset of greater human action. We've heard politicians say, well, let's be careful not to talk ourselves into a recession. Talk about the role that psychology plays in the cycle. Yeah, you would be amazed at how much economists are fixated on psychology in the marketplace. They really view psychology, and this goes back to John Maynard Keynes and before, they think that psychology is moving the marketplace in terms of jobs and GDP and stock markets and that sort of thing, but that's not really the case. There's got to be real factors that make for the psychology. Austrians look at central banks artificially reducing interest rates, leading to a boom in the economy where everybody's making money, where all investments seem to be profitable. Of course, the psychology gets very, very positive during that phase. There is psychological changes, but it's caused by the instability of central bank policy. It's not caused by mass hysteria. And so as the bust phase comes about and businesses are losing money, people are losing their jobs, homes are being foreclosed on, naturally this leads to a depressed psychology out there in the marketplace, but it's caused by real factors and it's caused ultimately by the instability of central bank policy. And so the central banks are trying to fight this psychology when actually they are the ones that are causing those psychological mass phenomenon. Well, when we use this term Keynesian to describe central banks, do you think we use it too loosely? In other words, Keynes himself evolved throughout his writings and we often accuse mainstream economists of criticizing Austrian works without having really read them very thoroughly or understanding them very deeply. Are we guilty of the same thing as Austrians of throwing the term Keynesian around too loosely? Do you think? Probably to a certain extent. There's a lot of diversity of opinion in mainstream economics. There's of course the neoclassical synthesis. And then there are probably seven, eight, nine other heterodox versions of economics. But I would say this, that when push comes to shove, they all seem to react to, for example, the economic crisis in pretty much the same way. They see the economy going into a crisis. They see this change in psychology. And so they resort right back to Keynesian stimulus policies. And of course they have a diversity of opinion there. But ultimately, it means increasing the money supply, reducing interest rates, deficit spending, public works projects. And so yes, there is a diversity of opinion within mainstream economics. But ultimately, they all resort back to the same general ideas, whether it's Ben Bernanke, whether it's Paul Krugman. They just have different recipes, but they're all cooking the same game basically. But to some extent across this range within mainstream economists, they're all encouraged by the same idea that Keynes did have was that the policy of governments and central banks should ever and always be to create demand side stimulus. Is that maybe a catch all way of looking at Keynesianism? I would think so. Yeah, that's what the aggregate demand, aggregate supply story is all about, is that when there's a faltering in terms of the quantity of production that's going on in the economy in terms of GDP, then you have to come up with some way to stimulate the demand side in the economy to keep GDP growing, to prevent the unemployment rate from rising. They're pretty much, of course, there's supply ciders as well. They're kind of on the fringe of the economics profession. And they see correctly that tax cuts can stimulate aggregate production in the economy. So Mark, in his book, The Theory of Money and Credit, which is now more than 100 years old, Mises talked about the limits of monetary policy. He wrote about what he called a crack-up boom, where at some point no amount of stimulus created by a central bank can stave off what he described as a potentially hyperinflationary scenario. Now, I've heard critics of the Austrian school say no, no, no, a deep recession or a depression is actually deflationary because debt is shed either through bankruptcy or insolvency or marking it to market. And as debt contracts, obviously the money supply contracts. So really, Mises was wrong and that a deep depression is deflationary. So help us better understand what Mises meant by a crack-up boom. Is it necessarily a hyperinflationary event or, as critics say, is a crack-up really a deflationary event? Well, it can go either way. I mean, generally speaking, central bankers and public policymakers have pulled back. They've said, okay, this isn't working. We're going to have to raise interest rates to quell inflation. And so generally speaking, they pull back from the edge and the economy goes into that correction phase. But there is the outer limit where you can get an inflation that they keep feeding, basically, and that inflation does eventually is very high rates. It extinguishes long-term contracts like bonds. They become relatively worthless. And then it's just a matter of they keep feeding money into the economy and prices start rising. And at some point, people realize that the money that they're getting is losing its value. And so they decrease their demand for money and the economy would spend into a hyperinflation that has happened in numerous cases. Zimbabwe is the latest case, but it's not the only case. And it's not just third-world countries that have experienced these types of hyperinflation. So it remains a possibility at the outer limit, as Mises described. Mark, one last question for you. You talk and write a lot about the skyscraper index. Nobody can know or perfectly time a boom or a bust phase exactly. But what are some of the indices you look for? You talk about skyscrapers. We can see anecdotal things in the media like Silicon Valley firms that don't make any profit, but they're so full of venture capital that they have these fabulous Christmas parties in Las Vegas. These are the kinds of anecdotal things we see that feel a lot like 2008 to us. So tell us about some of the things you look for in predicting a bust. Well, the skyscraper index is when you have a record-setting skyscraper telling us that it's going to be an economic crisis in the world. And China just set a record last year. And of course, it's experienced a lot of negative pain in its markets. It's not doing very well at all. And there is a world record-setting skyscraper being built in Saudi Arabia scheduled to be completed, I guess, later this year, next year. And of course, Saudi Arabia is in an economic mess as well. But you also look for the irrational exuberance, the intensive luxury spending, people going, doing just crazy zany, luxurious spending. And of course, you can see some of that out in Silicon Valley with Apple and Facebook and Salesforce and all these companies building record-setting skyscrapers in California and just Uber, luxurious corporate headquarters in all those social media high-tech companies. And so it doesn't have to be a world record height in terms of skyscrapers, but it can also be any kind of lavish over-the-top spending out there in the economy. Well, it's starting to feel like 2008, and let's hope it's not feeling like 1929. Dr. Mark Thornton, thanks so much for your time. Ladies and gentlemen, have a great weekend.