We really are living in unprecedented times right now. The Federal Reserve has quadrupled the adjusted monetary base over the last 5 years. Yet we haven't seen high price inflation due to low velocity and a huge increase in excess reserves held by banks.
There was a severe recession in 2008. There were severe misallocations that needed to be corrected. Unfortunately, since that time, the Fed and the government have done almost everything to make it worse. It lessened the blow of the recession then, but it has caused even bigger distortions. The government continues to spend well over $3.5 trillion per year. Add in the trillions by state and local governments and a huge chunk of capital is being sucked up and misallocated. It is a huge waste of resources. In addition, the onerous regulations hurt productivity even further and make us that much poorer.
This all needs to shake out. Austrian school economists often get criticized because some people perceive their views as pessimistic. But Austrians are just trying to be realistic. It is not that Austrians want a recession and a lower standard of living. It is just that Austrians will point out the inevitable. When the government spends vast amounts of money and the central bank creates huge amounts of money out of thin air, there are going to be major distortions in the market and there are going to be consequences that people don't like.
While I don't really like making predictions, I do have a sense of what might happen over the next 10 years or so. It is impossible to predict with certainty. One major point that Austrian economics teaches is that economics is based on human action. We cannot predict with certainty how humans will act in the future. Perhaps Bernanke and the other Fed members will wake up tomorrow morning and decide that all monetary inflation should stop. Perhaps Congress and Obama will decide we need massive spending cuts and a balanced budget.
Of course, we can make strong assumptions that it will not play out this way. So I am only offering what I think is a probable scenario for the next 10 years.
At some point, I think we will be faced with another recession. Perhaps it will play out similarly to 2008. But regardless of whether it is more mild or worse than 2008, I expect the Fed will step in one last time. We will see more monetary inflation. The Fed will try its best to prop up housing and prop up the overall economy. Of course, it will also take care of its number one mission, which is to save the big banks.
I think we will eventually see a point where consumer prices go up. The Fed has been playing the Goldilocks game of not too hot and not too cold. While they say they want the banks to lend, in actuality they are quite happy with the banks not lending too much right now. If the banks started lending more and lowering their excess reserves, then price inflation would pick up quickly.
But at some point, I expect to see a surge in price inflation. We will likely see higher gold prices. We will probably see higher oil prices. The Fed will continue to walk a tightrope, but it will eventually run out of line to walk on. We will eventually get a scenario where price inflation is high (maybe 10%) and the economy is still struggling with high unemployment and stagnant growth.
The Fed will eventually have to choose between more monetary inflation (and risking hyperinflation) or stopping monetary inflation (and allowing a severe recession). I think the Fed will ultimately stop short of hyperinflation. They will not want to lose the U.S. dollar's status as the world's reserve currency. They would lose complete credibility if we saw price inflation jump completely out of control.
Eventually, we will see a major shakeout. The Fed will stop its monetary inflation, except perhaps to save the big banks. If the Fed has to choose between keeping the big banks afloat and buying government debt, it will choose in favor of the banks. Congress will be forced to cut back its spending dramatically. There will be no one to buy the government's debt at low rates.
Overall, I think things will play out somewhat similarly to the 1970s and early 1980s. Of course, as the saying goes, history never repeats, but it does often rhyme. I think this time will be far worse than the 1970s. Perhaps the price inflation rate will not be worse, but I expect the temporary drop in living standards to be far more severe. I don't think most people are prepared for what is coming their way.
I say all of this not to be pessimistic. I am just being realistic. The Fed can't quadruple the monetary base in 5 years without there being severe consequences. In addition, we will be faced with baby boomers hitting retirement age and unfunded liabilities of hundreds of trillions of dollars. People are going to be forced to work harder and longer than they expected.
I think we will eventually see better times ahead, but it is going to be a bumpy road to get there. You should be prepared, especially mentally.