The Austrian school of economics is unique in the field largely due to its reliance on deductive reasoning over empiricism. This doesn’t mean that empirical evidence has no value, only that it is used to confirm rather than develop hypotheses. The use of deductive reasoning led the early leaders of the Austrian school to develop theories in marginal utility, time preference, and the business cycle.
The advantage to such an approach is consistent, logic based argumentation; it is difficult to counter a contention when it is built on soundly applied logic. With sound reasoning, policy decisions can be prescribed with confidence not in their predictive nature but in the certainty that they are pointed in the correct direction.
Since Ludwig von Mises, Austrian economic theory has been grounded in what he termed “praxeology,” the science of human action. With the individual as the starting point, the tendencies of individual action lead the Austrian economist to develop broader economic theory. The fact that an item possessed today is of greater value than the same item possessed tomorrow, for example, enabled Austrian economists to develop theories of interest as it relates to time. These theories could then further be extrapolated, logically, to show how interference with interest rates creates false signals regarding individual time preferences and ultimately leads to mistakes in investment. These mistakes cause the business cycle. The most complex theories put forth by economists of the Austrian school can all be traced back, logically, to the actions of individuals.
The typical household labors under a number of constraints. This is true regardless of the household’s location, size, cost, value, occupancy, income, and condition. The inhabitants of the household contribute to its persistence by securing an income. The money and assets amassed are then applied to the upkeep and/or expansion of the household. When the occupants of a household exceed their ability to pay for upkeep or expansion, they can borrow money to maintain the level of existence to which they are accustomed or curtail spending, doing without the desired amenities. When the inhabitants of a household can no longer borrow money, they are finally forced to curtail spending.
In a federal republic like the United States, similar restraints exist on the individual states comprising the union. The inhabitants of the state contribute to persistence of the state through taxation. The money and assets amassed are then applied to the upkeep of the state and the services deemed necessary or desirable. When a state exceeds its ability to pay for upkeep or services, it can borrow funds, raise taxes, or curtail spending, doing without the desired services. When a state can no longer borrow money, it is finally forced to curtail spending, as is currently the case with Illinois.
In the second scenario, funds were amassed at the point of a gun via taxation and spent by progressive politicians on programs that will purchase more votes for those same politicians. Now that Illinois is unable to pay for the votes purchased by their politicians, will fiscal common sense emerge and who will pay for future votes?
When state actors speak of inflation, they refer specifically to increasing prices or “price inflation.” Monetary inflation, on the other hand, is what states do to cause increasing prices. As has been explained here before, the natural tendency of prices is to decline over time. Monetary inflation almost always results in price inflation.
Prices can inflate on their own if, for example, demand exceeds supply. When this occurs, there is generally no fraud or theft present in the market. However, price increases due to monetary inflation occur because the purchasing power of the monetary unit is diminished. In other words, wealth is stolen from those possessing money that is being inflated.
We can see monetary inflation most easily in the United States when we review the balance sheet of the Federal Reserve. For the uninitiated, the Federal Reserve has the ability to loan to banks money which exists only on their balance sheet. Rather than printing money, the Federal Reserve simply loans money on paper thereby inflating the money supply.
This brings us to the most recognized medium of exchange: gold. In an environment of monetary inflation, the expectation would be that prices of all things, including media of exchange, would rise with the increase in money. However, while the Federal Reserve balance sheet reflects an introduction of over three trillion dollars into the economy since 2008, the price of gold, which more than doubled between 2008 and 2012, currently sits around $1,300 per ounce. In other words, while the money supply increased over 400% during this time, the price of gold increased less than 50%. While we wouldn’t necessarily expect a matching increase in gold prices, we would certainly expect something more closely reflecting monetary inflation, that is unless someone were tampering with the precious metals markets.