Robert Murphy has a good piece today, appearing on the Mises Institute’s website.  I consider Murphy to be one of the best economists there is in Austrian economics and I consider Austrian economics to be the only major school of economics which gets things right.

Murphy concludes his article with this paragraph: “Austrian economists know to be wary of looking at financial data and drawing conclusions about what ‘must’ happen.  The future is always uncertain, the result of volitional human action.”

This is something that I harp on quite often.  The main theme of Austrian economics is that humans act.  Therefore, knowing this, we should know that it is impossible to accurately predict what the economy will do and what investments will do because it is impossible to predict how each individual on this planet will act.

With that said, it wouldn’t make for very exciting commentary if I just repeated that every day and did no more analysis.  What we can do is take the data that is known to us and try to guess at how humans are likely to react.  For example, if the government announces that it is passing a new marginal income tax rate of 99%, we can take a good guess that this is going to discourage people from working beyond a certain income.  We could be wrong, but we can take a good guess that most human beings will react negatively and will not work beyond a certain point just to keep 1% of their earnings.

Moving on from this subject, there is one other specific issue in Murphy’s article that I would like to examine.  He talks about the excess reserves held by banks and correctly points out that this has helped in keeping price inflation in check.

He then shows the Fed’s latest figures on excess reserves.  He suggests that the reserves might be leaking out and that big price inflation might be around the corner.  While he tempers his comments and says that this might just be a blip, I would like to address it a little further.

I actually see no reason to get excited (or perhaps panicked is a better word) at this point.  The excess reserves are almost the same as they were two months ago.  They are down less than $8 billion from June 15 to August 10, which seems like a lot, except that we are talking about a total of over $1.6 trillion.

This actually makes sense.  The excess reserves have had an almost perfect correlation with the adjusted monetary base, which is the monetary inflation that the Fed directly controls.  QE2 stopped around the end of June, so the monetary base has been basically flat for the last two months.  It would make sense that excess reserves are not increasing and we can always expect small fluctuations.

As Murphy says, we will have to continue to watch this data to see if the trend holds.  I will keep watching, but I am skeptical that these reserves will leak out.  It is slightly interesting to see that the required reserves have been increasing, but again, the amounts are too small at this point to get excited.

I expect more inflation (monetary and price), but I am skeptical that it will be huge any time soon.  People are afraid and the bankers are afraid to lend money out.  I don’t see this changing right now.  We will continue to monitor this data to see if there are any significant changes.  If excess reserves drop by a few hundred billion dollars without a drop in the monetary base, then I will start to sound the alarm of imminent price inflation.