How Do Austrian Economists Predict Bubbles?

With the coming financial bubble bursting before our eyes in Europe how is it that some economists, Austrians, always seem to get it right and others, Keynesians, seems to be completely clueless?

Austrian Economist Ludwig von Mises 1881-1973

The short version for why the Keynesians (the 90%) always get it wrong is that they believe in fairy tales. When you believe in propaganda, lies, and are a shrill for the rich elites, it is really difficult to get anything right. Ask Keynesian, 2008 Nobel Prize winner, Paul Krugman. He never gets anything right.
Keynesians serve no other propose than to advocate for the elites who get wealthy on government and the Federal Reserve inflationary policies. They are completely useless for making predictions and advocating any economic policy that would help Main Street USA. They provide cover for our politicians and the Fortune 500 elites, nothing more.
So what is the Austrians secret?
The first secret is they read economic history.
Can this be boring?
For 99.9% of the population yes it is but for a few it is not. Only by reading economic history do you get familiar with what is a fool’s errand, what always fails, and what works. Good books can come from the left and right. “Lords of Finance” by Liaquat Ahamed, “History of Money and Banking in the United States” by Murray Rothbard, “Money, Sound and Unsound” by Joseph T. Salerno. No economist can be worth a damn without a fundamental understanding of sound money, banking, and history.
Maybe this is why banking history it is never taught in our universities?
Learning banking history exposes very unpleasant facts such as;
We have had three central banks in the United States. The first two were killed due to inflation, scandal, and corruption.

1974 Nobel Prize winner and Austrian Economist F. A. Hayek

Since the founding of the Federal Reserve our dollar has been devalued 98%.
The Federal Reserve Bank of New York lowered the stock market reserve requirements to purchase stocks from 100% to 10%, fueling the artificial stock market boom and bust of the 20s. Is this fact in a government text book?
The Federal Reserve intentionally lowered the value of the dollar in the 20s to appease England and England’s pursuit of a strong pound thereby further fueling real estate and the stock market speculation in the United States. Capitalism did not spontaneously “explode” in 1929, the exposition was fueled by the Federal Reserve’s cheap money policies.
Not knowing history leaves economists blind and gullible fools for the official propaganda from the White House and Federal Reserve.
Understanding sound money practices makes understanding “bubbles” extremely easy. Every Austrian economist nailed the housing boom and bust. Peter Schiff of Euro Pacific Capital made a career out of predicting the bust on business shows and at hotel conventions.
How?
The simple version is as follows;
When excess money is created by the Federal Reserve it has to go somewhere. In the 1920s it went into real estate and the stock market. In the 1990s it went into the dot com bubble and bust. In the 2000s it went into housing. The secret is to;
1. Recognize when the Federal Reserve is inflating the money supply.
2. Recognize where the money is being invested onto, what is the “bubble?”

Austrian economist Lew Rockwell can see a money bubble 10 miles away

Usually it is pretty obvious when the Federal Reserve is inflating the money supply. Without boring readers with M1, M2, monetary base, and other numbers the quick easy way is to compare the inflation rate with the Federal Funds rate.
The simple rule good Federal Reserve Chairmen like Paul Volker (1979-87) follow is you put about 3% to 4% distance between the inflation rate and the Federal Funds rate. Volker did this in 1981 even when the inflation rate reached 15%, peaking out the Federal Funds rate at 19%. He understood basic banking principals. If you want to grow the economy you need to save and invest. If the inflation rate is 15% you need to attract savers. To attract savers you need to offer a interest rate ABOVE the inflation rate. Volker followed his principals and the US economy turned around under Reagan and the rest is history. Reagan left office with a 5.4% unemployment rate, in part thanks to Volker’s sound understanding of basic bank principals.
Profitable savings rates is how the banks attract funds that will be invested to grow the economy. Getting paid a return above the inflation rate attracts savers.
This is not the same as printing money and shoveling cheap dollars at bankers. Savers defer their preference for consumption, not using recourses that investors can now use. Printing money means both fight for the same resources creating inflation. This is a big difference between the Austrian economists and the Keynesians.
Allowing bankers to use savers money to make investments into the economy benefits the rest of society with jobs, production of goods, services, and an increased standard of living.
Bankers need to have a little leeway when they make loans. The fudge factor. The spread between inflation and interest rates give bankers some flexibility and freedom to make riskier loans. Not all loans will pay off and a little room for error is needed. Today with a 3.9% inflation rate and a 30 year prime fixed mortgage rate of 4.3% disaster is right around the corner when the inflation rate increases to 5%, 10%.
So what happened in the 2000s that tipped Austrian economist off that there was a housing bubble?

To quote Glen Beck "The Federal Reserve needs to pack up its stuff and go away."
In 2000 the inflation rate was 3.4% and the Federal Funds rate was 6.24%.
In 2001 the inflation rate was 2.8% and the Federal Funds rate was 3.89%.
We had a recession in 2001 and the Federal Reserve was “fighting” the recession with artificially lower rates. Meanwhile the housing Index jumped from 4.2% annual rate from 1990 to 2000 to a 7.6% increase in 2001.
Housing construction actually increased during a recession!
This was misinterpreted by Federal Reserve Chairman Alan Greenspan (1987-2006), Krugman, and the other Keynesians as the easy way out of the recession.
In 2002 the inflation rate was 1.6% and the Federal Funds rate was 1.67%.
The Housing Index increased 6.3% in 2002.
Federal Reserve Chairman Greenspan had clearly abandoned sound banking principals of rewarding savers with SOME profit over inflation. Instead from 2001 to 2004 the M-3 (discontinued in 2006) measure of money growth increased 6.9% annually and the monetary base (coins, paper money, and commercial bank reserves) increased 7.1% annually.
Now both capital users (home builders for this bubble) and consumers were using the same resources, setting the stage for disaster that would inevitably follow.
In 2003 the inflation rate was 2.3% and the Federal Funds rate was 1.13%.
The Housing Index would increase at a astonishing 8.1% annually from 2003 to 2007.
In 2004 the inflation rate was 2.7% and the Federal Funds rate was 1.35%.

Austrian economist and Euro Pacific owner Peter Schiff made his reputation predicting the housing bubble

If Peter Schiff was hesitant in 2002 and 2003 about the housing bubble by the time 2004 came around it was clear to Schiff and any Austrian economist that this was going to be a monumental bust of historic proportions.
In 2005 the inflation rate was 3.4% and the Federal Funds rate was 3.21%.
In 2006 the inflation rate was 3.2% and the Federal Funds rate was 4.96%
In 2007 the inflation rate was 2.9% and the Federal Funds rate was 5.02%.
Alan Greenspan resigned in 2006 and Ben Bernanke finally popped the housing bubble with the standard inflation rate plus 3% difference. The consequences of Greenspan’s actions are 4.2 million unsold homes and another 2 million in the pipeline that have not been foreclosed on.
If sound banking principals were used the Federal Funds rates would have been 5.8% in 2001, 4.6% in 2002, 5.3% in 2003, 5.7% in 2004, 6.4% in 2005, 6.2% in 2006, and 5.9% in 2007. On Main Street these Federal Funds rates would roughly translate into rates of 8%, 7.5%, 8%, 8.5%, 9%, 8.5%, and 8%.

Austrian economist Tom Woods wrote the best seller "Meltdown" explaining the housing boom and bust

Would there have been a housing boom and bust if the going interest rates were 8% combined with a 20% down payment?
No.
Sound banking principals were not followed by Alan Greenspan and the Federal Reserve. Congress and the President compounded the problem with the social justice nonsense Community Reinvestment Act and other crap. Fannie Mae and Freddie Mac further distorted the market by buying up bad mortgages. If the free market was allowed to operate none of this would have occurred.
So how do Austrian economists know there is another bubble occurring today?
Same principals. Federal Reserve creating money, artificially low interest rates, and enormous investment into a selected sector of the economy.
So where is all this money invested?
Government and Wall Street.
The money bubble we are experiencing today is a government money bubble. Unlike housing where we have houses with government we get nothing for our investment. Nothing but a memory of food stamps and cash for clunkers.

Austrian economist Gary North

What is happening with inflation and Federal Funds rates?
In 2008 the inflation rate was 3.8% and the Federal Funds rate was 1.93%.
In 2009 the inflation rate was -0.4% and the Federal Funds rate was 0.16%.
In 2010 the inflation rate was 1.6% and the Federal Funds rate was 0.18%.
In 2011 the inflation rate is 3.9% and the Federal Funds rate is 0.08%.
It certainly looks like Ben Bernanke is doing exactly the same thing Alan Greenspan did.
Do the money supply numbers show a dramatic increase?
Yes they do.
While M-3 was discontinued in 2006 we still have M-2 which has increased 6.7% annually since 2008. The monetary base has increased 54% annually since 2008.

Austrian economist Murray Rothbard

Where is the money going?
During the Clinton years the federal government grew at an annual rate of 3.2%. Clinton reduced the share of the federal government’s consumption of the Gross Domestic Product (GDP) from 22.1% to 18.2%. Inflation averaged 2.6% annually under Clinton.
During the Bush years the federal government grew at a annual rate of 6.6%. Bush increased the federal government share of the GDP from 18.2% to 20.7%. Inflation averaged 2.8% under Bush.
During the Obama years the federal government grew at an annual rate of 7% including a astounding semiannual growth rate of 12.7% in the second half of 2009. Obama has increased the federal government share of the GDP from 20.7% to 25.3%. Inflation has averaged 1.7% under Obama.
Clearly anyway you look at it the federal government is getting the majority of the cheap cash.
And who is the other recipient?
Wall Street.

Fredric Bastiat figured out the government plunder game centuries ago

The Federal Reserve has been pumping billions into Wall Street banks who then use the cheap cash to speculate, buy T-bills, park the money back into the Federal Reserve, buy diamond rings for the mistresses, and squander it if they so desire.
Reserve balances with the Federal Reserve have increased 17,154% since 2007. Wall Street has trillions in “liquidity” that is being squandered or sitting idly.
Before you condemn the banks for holding onto this cash imagine first if, with fractional reserve banking, the banks loaned out, say $15 trillion all at once in a $15 trillion dollar economy. Ka-Boom!
The 3.9% inflation rate we have today is going to be a fond memory soon.
The only thing restraining inflation has been the loss of employment, and purchasing power, by millions of Americas. This is reflected in the 28 year low Employment-Population Ratio, from 64.5% in 2000, to 58.2% today. The 9% unemployment rate grossly misrepresents the severity that the dismal economy is having on employment.
Is the picture beginning to become clear as to the enormous mess the economy is in?
The free market and capitalism did not created this mess. It was the Federal Reserve and federal government.
Combine this with public and private debt of $54 trillion, European banks leveraged at the insane ratios of 50 to 1, Greece, Italy, Portugal, Ireland, Spain, and more printing of money and the enormity of the catastrophe awaiting the economy is beginning to dawn on the average citizen.
There are some Keynesians still out there telling the public not to worry. The same misguided fools like Paul Krugman blowing smoke for the uneducated masses to consume.
Austrian economists understand history, money, and simply put the two together. Nothing fancy or special other that rejecting the dogma of the day that is designed more to protect the elites ripping off the peasants than to provide any real understanding of the subject.
Economics in a typical university consist of hero worship of the federal government and Federal Reserve. Often lies are told to students mixed in with the bogus theories about multipliers and other mythological BS theories. It is very rare to find a professor question the dogma of the day. Most fall in line with the propaganda because they want that big fat government paycheck. There is very little academic honesty in the field of economics. Keynesians, Chicago school, and others pursuing fables and myths dominate the profession. Their job is to pass on these myths to the public. They provide cover for the elites. Is it any wonder we have Wall Street protesters blaming capitalism for economic failures?
To get out of this mess and return to prosperity the federal government needs to reduce its consumption, as a percent of the GDP, to a minimum of 18%. Mitt Romney’s 20% proposal will do nothing to help deficits. It would add to the deficit. Since WWII the federal government has collected more than 20% of the GDP in taxes once, in 2000. This means at a 20% “cap” we would have federal budget deficits 98% of the time.
A better percentage for the federal government would be 11%. This would mean the end of all social justice programs and entitlements. These programs could be administered by state and local governments as the founding fathers intended.
The Federal Reserve should be ended.
A return to free banking would be brutal, but swift. Once the transition was complete a return to normalcy could begin. The boom bust cycle we are all familiar with would be moderated by the free market, adjusting interest rates automatically, and not set by some senile 80 year old man living in a fantasy world.
We will go bankrupt. The federal government will fail. Social Security will be gone.
How do we deal with it?
The sooner the better for our children. It is no longer about the adults. We will take care of our grandparents the old fashioned way, by ourselves. We need to force the politicians to go bankrupt and eliminate all federal social programs so our children will live debt free.
Or we can deny reality and print some more money.