I have been skeptical of a follow-up recession — of the “Austrian” type — occurring, and originally I planned for a post explaining this skepticism in light of today’s re-print of a recent piece by Michael Pollaro predicting just that. But, looking at the evidence, I have become more skeptical of my skepticism. At first, my doubts were based on the idea that industrial production remains low and below-trend, but mostly that industrial recovery has been stagnant.* The first part is true, but the second not so much. Industrial production has grown, even though it remains depressed relative to pre-2007, and so we cannot look at this index and totally discount the possibility of an “Austrian” recession.

Also, a few weeks ago I uploaded a graph showing trends in the producers’ price index and consumers’ price index to offer some light empirical evidence in support of the Austrian theory as a viable explanation of our recent recession. The indexes, especially the former, have their shortcomings (namely, does it track the prices of the relevant producers goods — the answer is: not completely), but maybe they will do to give a broad picture. Also, the way I set up the graph (using the same base year, but each with its own index) was misleading, as it does not show a divergence between the two prices during the first few years illustrated, but sufficient for the time-period we were looking at. In any case, I think it helps support Pollaro’s prediction. Take a look (I set it up differently here),

Here is the original,

The reason it is misleading is because someone that does not understand the graph very well can easily assume a lack of divergence around 2000, or even similarity in aggregate price. But, the two lines should be read separately and only compared in rate of change. The point is to show only that the price of producers’ goods has been affected more than consumers’ goods, and that is exactly what Austrian business cycle theory explains (and, it assumes level or only slowly-incrementing consumer prices).

In any case, we clearly see divergence in growth rates during the past two years, although most strongly during the past year and a half. And, I am not sure what savings statistic is the best to follow, but personal savings have been decreasing since the recession, meaning that an increase in demand for producers’ goods has not correlated with an increase in savings. (As a quick aside, as I am not sure where to fit it, is that there are transmission mechanisms to investment outside the loan market, including the purchase of private bonds, the stock market, and government transfers to higher stage firms.)

My now-shaken skepticism, though, is not towards the possibility of recession — I was only doubting the existence of intertemporal discoordination. I have always thought that a possible default in southern European debt would trigger a credit contraction in the United States. A lot of this has to do with capital controls, but a lot of it is also natural, since banks facing a sudden contraction in assets (the liquidation of investments) will have to increase cash reserves to meet liabilities. This happened during the beginning of the Great Recession, since banks had to scramble for liquidity or meet franchise closure due to inadequate capital reserves (it also had to do with the sudden re-assessment of the risk attached to assets held, increasing capital reserve requirements for what were previously considered some of the safest assets on the market).

I think this can still happen and, in fact, I think this will be the trigger that Pollaro is less willing to predict (since these types of things are, honestly, impossible to predict). It is just that the consequent contraction will be more complex than I was willing to recognize and it will include the liquidation of malinvestment. What this also means is that we will be much poorer than we would have been, simply because more capital is being consumed in the process of malinvestment. For those with heavy investments in the stock market, including precious metals, I expect a crash and, with commodities like gold, a rebound.

* Also, it is important to remember that what counts is money in circulation, not total money in bank reserves. So, it is misleading to look at certain monetary aggregates and decide that there is malinvestment. I did not want to incorporate this more completely to avoid confusion and unnecessary complexity, but it something that ought to be looked at. I have not studied Pollaro’s “true money supply” well enough to know what he is including in that aggregate.