What Is a Crack-Up Boom?
A crack-up boom is an economic crisis that involves a recession in the real economy and a collapse of the monetary system due to continual credit expansion and resulting in unsustainable, rapid price increases. This concept of a crack-up boom was developed by Austrian economist Ludwig von Mises as a part of the Austrian business cycle theory (ABCT).
The crack-up boom is characterized by two key features: 1) excessively expansionary monetary policy that, in addition to the normal consequences described in ABCT, leads to out-of-control inflation expectations and 2) a resulting bout of hyperinflation which ends in the abandonment of the currency by market participants and a simultaneous recession or depression.
- A crack-up boom is the crash of the credit and monetary system due to continual credit expansion and price increases that cannot be sustained long-term.
- In the face of excessive credit expansion, consumers' inflation expectations accelerate to the point that money becomes worthless and the economic system crashes.
- The term was coined by Ludwig von Mises, a noted member of the Austrian School of Economics and personal witness to the damages of hyperinflation.
Understanding a Crack-Up Boom
The crack-up boom develops out the same process of credit expansion and the resulting distortion of the economy that occurs during the normal boom phase of Austrian business cycle theory. In the crack-up boom, the central bank attempts to sustain the boom indefinitely without regard to consequences, such as inflation and asset price bubbles. The problem comes when the government continuously pours more and more money, injecting it into the economy to give it a short-term boost, which eventually triggers a fundamental breakdown in the economy. In their efforts to prevent any downturn in the economy, monetary authorities continue to expand the supply of money and credit at an accelerating pace and avoid turning off the taps of money supply until it is too late.
In Austrian business cycle theory, in the normal course of an economic boom driven by the expansion of money and credit the structure of the economy becomes distorted in ways that eventually result in shortages of various commodities and types of labor, which then lead to increasing consumer price inflation. The rising prices and limited availability of necessary inputs and labor put pressure on businesses and causes a rash of failures of various investment projects and business bankruptcies. In ABCT this is known as the real resource crunch, which triggers the turning point in the economy from boom to bust.
As this crisis point approaches, the central bank has a choice: either to accelerate the expansion of the money supply in order to try to help businesses pay for the increasing prices and wages they are faced with and delay the recession, or to refrain from doing so at the risk of allowing some businesses to fail, asset prices to fall, and disinflation (and possibly a recession or depression) to occur. The crack-up boom occurs when the central bank chooses and sticks with the first option.
Economist Friedrich Hayek famously described this situation as like grabbing a "tiger by the tail." Once the central bank decides to accelerate the process of credit expansion and inflation in order to head off any recession risk, then it continually faces the same choice of either accelerating the process further or facing an even greater risk of recession as distortions build in the real economy.
As part of this process, consumer prices rise at an accelerating rate. Based on current price increases and market participants' understanding of central bank policy, consumer expectations of future inflation also rise. These create positive feedback that leads to accelerating price inflation that can far outstrip the rate of central bank money expansion and become what is then known as hyperinflation.
With each subsequent round of credit expansion and price increases, people can no longer afford the high prices, so the central bank must expand even more to accommodate these prices, which pushes the prices even higher. Instead of rising a few percent every year, consumer prices can rise by 10%, 50%, 100%, or more in a matter of weeks or days. The value of the currency depreciates drastically, and the financial system faces extreme stress.
The "crack-up" part of the crack-up boom occurs as money in the economy begins to lose its economic function as money. Price inflation accelerates to the point that money fails to fulfill its economic function and people abandon it in favor of barter or other forms of money. Under normal circumstances, money functions as a generally accepted medium of exchange, a unit of account, a store of value, and a standard of deferred payment. Hyperinflation undermines all of these functions, and as market participants stop using and accepting the money, the system of indirect exchange based on the use of money that makes up a modern economy "cracks-up."
At this point, further expansion of the supply of money and credit by the central bank, no matter how rapid, has no effect as the economic stimulus or staves off recession. The economy turns the corner into recession despite the central bank's intention as the monetary system simultaneously breaks down completely, compounding the economic crisis.
History of the Crack-Up Boom
The developer of the idea of the crack-up boom, Ludwig von Mises, who was an advocate of laissez-faire economics, a staunch opponent of all forms of socialism and interventionism, and a noted member of the Austrian School of Economics, wrote extensively on monetary economics and inflation during his career.
In the early 1920s, von Mises witnessed and decried hyperinflation in his native Austria and neighboring Germany. Von Mises played an instrumental role in helping Austria to avoid a crack-up boom but could do nothing but sit back and watch as the German Reichsmark collapsed one year later. He was adamant that not keeping credit expansion in check could pave the way for a deadlier dose of hyperinflation that would eventually bring the economy to its knees.
Von Mises describes the process later in his book Human Action. "[I]f once public opinion is convinced that the increase in the quantity of money will continue and never come to an end, and that, consequently, the prices of all commodities and services will not cease to rise, everybody becomes eager to buy as much as possible and to restrict his cash holding to a minimum size," he said. "For under these circumstances, the regular costs incurred by holding cash are increased by the losses caused by the progressive fall in purchasing power."
Examples of a Crack-Up Boom
Several economies, other than Germany, have caved in after a period of credit expansion and hyperinflation, including Argentina, Russia, Yugoslavia, and Zimbabwe. A more recent example is Venezuela. Years of corruption and misfiring government policies have led the South American country's economy to collapse in a drastic fashion. As a result, millions of Venezuelans face poverty, food shortages, and blackouts. According to the International Monetary Fund (IMF), Venezuela's economy contracted by over 35% between 2013 and 2017. Rampant inflation hasn't helped.
By mid-2019, inflation in the country was reported to be as high as 10 million percent, meaning that a product that once cost the equivalent of one bolivar went on to cost the equivalent of 10 million bolivars. Things have gotten so bad that a monthly salary in Venezuela was reportedly not enough to even cover the cost of a single gallon of milk.
A crack-up boom is something that can only happen in an economy that relies on fiat money (in either paper or electronic form) and (usually) fiduciary media, as opposed to the gold standard or other physical commodity money, because the available stock commodity places a physical limit on the quantity of money that can be issued and the market discipline imposed by a convertible gold standard helps prevent the overissuance of credit. In the event that they ever become money, electronic cryptocurrencies whose underlying algorithms place inflexible limits on the quantity and rate that new units can be created (or mined) may provide a similar benefit of preventing hyperinflation and a crack-up boom.