Mercantilism Revisited

This is a follow-up to the questions I asked about mercantilist policies and the predictions of the Austrian School.

The rise in prediction of prices by the Austrian School appears to be correct, but because of the way most mercantilist policies operate, the inflation occurs in the value of assets (land and capital) rather than in regular commodities. This results from an artificial expansion of capital. Because the expansion of capital is usually geared toward industry rather than consumer spending, however, the inflation occurs more noticeably in specific areas rather than the economy as a whole.

The policies of loose credit eventually lead to speculation and overvaluing of assets which in turn eventually start to creep into inflation in the rest of the economy. This overvaluing of assets eventually leads to an unsustainable bubble when credit is closed off to prevent widespread inflation from occurring in the rest of the economy. This is what happened in post-Bubble Japan. This may also be what happened in post-Civil War U.S. (the Great Sag/Great Deflation - normally attributed to increased efficiency in production). This will likely happen in China as well where consumer prices are not increasing, but land and asset speculation may be out of control.

All of this cannot occur without a central bank, of course, to control the supply of money. We have seen this is the U.S. with the housing sector. Consumer prices remained steady while the price of housing increased dramatically. Then we started to feel inflationary pressure, so the central bank (the Fed) tightened credit. This led to deflation in the housing market. The question is whether nor not we will do like Japan and have the central bank pretend bad loans don't exist or if we will let those who speculated take their lumps.

If we do like Japan, as the Bush administration seems inclined, we will have a stagnant economy and deflation for the next ten years.