The Austrian Perspective on Recoveries, Bubbles, and Monetary Policy >> Welcome to Real Vision. I am having a conversation here with Bob Murphy, who's a Senior Fellow at the Mises Institute. We're going to be talking about Austrian economics. I don't think that we on Real Vision have actually talked about Austrian economics in the depth that hopefully we're going to go into today. Bob, I really appreciate you're talking to us and looking forward to the conversation. >> Glad to be here. Thanks for having me. >> Bob, by the way, just so you know, I have this trusty book here from the Mises Institute that I've read many times, it is Ludwig von Mises, Gottfried Haberler, Murray Rothbard, and then of course, Friedrich von Hayek. I think those are some of the best names to get a sense of the Austrian theory of the trade cycle. You're an expert in Austrian economics. Tell me, if you had to give the two-minute elevator pitch of how to describe what Austrian economics is all about, what would you say? >> By the way, your pronunciation of their names is better than mine, so kudos to you on that. The term Austrian School, so it's a school of thought, just like there's the Keynesian School or the Chicago School, that I'm sure many of your viewers are familiar with those terms. The name derives from the fact that the founders were from Austria. It started in 1871 with Carl Menger who published a work on the principles of economics. Menger is associated with two others and just standard history of economic thought was discovering what's called subjective value of theory or ushering in this revolution, what's called the marginal revolution from the old classical approach of explaining value and price to the new modern approach where utility is subjective, it's in your mind and prices are formed going from subjective mental evaluations through the market process, so that was the foundation of the school. In terms of today though, like to understand quickly what it is, the Austrians have a very individualist focus. In other words, they try to explain everything, like even the business cycle ultimately by reference back to the actions of individual consumers and business people, the marketplace. They tend to be very free market policy oriented but that's the result of their understanding of how the market economy works and so they think the government intervention was going to impede that corrective process. Then as far as why should people study the Austrian school today? What's the relevance? I think the single biggest unique contribution they made that's relevant is their theory of what causes the business cycle. On that point, they're different even from the Chicago School who also tend to be very free market in their policy prescriptions. But the Austrians think it's government intervention in money and banking that sets up the familiar boom bust cycle that characterizes market economies. >> That's a great description. When you mentioned marginal revolution, I think immediately of the blog marginal revolution with Tyler Cowen. Tell us a little bit more about that concept. >> Sure. The reason Tyler and Alex Tabarrok named their blog but it was a bit of a pun because they're saying what they want their blog to do is to do small and incremental improvements to bring change. But of course they're alluding to, yes, this period, this revolution in economic thought. Again, it's associated in the early 1870s, it's Carl Menger, William Stanley Jevons and Leon Walras were the three people that are credited with bringing in this new marginal revolution. The quick version is the old classical economist, people like Adam Smith, David Hume, Karl Marx, you could even sometimes classify them Rome, they knew prices in the marketplace had something to do with human valuation. Like why don't people pay a lot for a stage coach or so? It's because people value it. But there was a certain paradox. There were an awkwardness where things like water had a low market price per unit whereas diamonds had a high price and so why is that? Because diamonds are nice but they're not essential to human survival whereas water is. It would seem like if you were trying to explain market prices or market wealth by reference to human needs, it didn't seem like there was a good fit and so the marginal revolution had the insight to say because in any given market transaction, you're never in a position of buying all the diamonds in the world or all the water in the world. It's just making decisions on the margin. Think of like on a page, the margin is the thing on the edge. That's what that term means. At any given instance, whether you have one gallon of water or more or less, probably the grand scheme doesn't matter much because typically you have plenty of water to satisfy your thirst and washing the car and stuff like that, whereas on the margin, getting a gallon more of diamonds is going to make a huge difference to you. That's why the prices are determined on the margin. That's how it'll explain the fact that something like diamond has a higher market price than water does. That's what the marginal revolution was. It was just instead of explaining things in terms of entire classes, they realized no, in any given transaction there's choices being made on particular finite units of the goods and then once you have that insight these alleged paradox just fall away and you could explain things much more straightforwardly. >> When you say that immediately comes to mind, I think I was telling you right before we came on I was looking through some critiques on econ log about Austrian economics. Bryan Caplan who's a libertarian, he's a professor at George Mason. His name came up and I thought it was interesting, he was talking about this concept of ordinal versus cardinal utility. Basically when you're talking about utility or what Neoclassical economists talk about the utility function for individuals and he has some debate about how do you express that utility. When I want those diamonds versus the water, how does Austrian economics think about how I classify which one is more important than another. >> Right. What happened in the progression of the history of economic thought is, so as of the late 1800s, there's also in conjunction with just this development in terms of economic theory, just to explain consumer behavior and how to market prices get formed, there was also the philosophical current of utilitarianism from Jeremy Bentham. This is true, even in Menger and Bohm-Bawerk, who's like a second-generation Austrian, they did have this notion of what we would call cardinal utility. For people who don't know this term, so cardinal means numbers like 3.2, 6.8, stuff like that, whereas ordinal is like first, second, third. Ordinal numbers are rankings, whereas cardinal is normal arithmetic. Notice, you can't do arithmetic on ordinal numbers. It wouldn't make sense to say what's fifth minus second, that doesn't make sense. It's not a third, that doesn't make any sense. >> Right. >> What happened, just real briefly here, is in economic thought, originally, when people were trying to explain consumer behavior, they were linking it with this utilitarian notion of utils is like as a measurable substance or a psychic intensity. Like someone gets a certain amount of pain and it would make sense to say hitting this guy in the arm costs three times as much pain as just [inaudible] his ear as if it were a measurable thing. Just like temperature or weight is an objective feature of reality that has a certain extensive measurement, and so that's what they thought. The reason consumers spend this much on apples and not as much on oranges is because they get more utils psychically from the one versus the other. Even some of the early Austrians explained it. But by the early 20th century, economists and Austrians were like, I think [inaudible] but they realized, ''We don't need that baggage.'' Because there's a lot of philosophical problems with old school utilitarianism, like how do you compare psychic intensities among different individuals? So economic theory was purged of that notion, and so they realized, ''No, we can do all of consumer theory.'' We can explain when you go in the grocery store why you spend your money in a certain way, and why if prices are lower, you tend to buy more units of the goods. We can do all that stuff without assuming that there's this psychic substance called utility or happiness or whatever, or satisfaction that's actually measurable in terms of concrete or cardinal units, so that was the revolution economic thought. But mathematical economists, and so another characteristic feature of the Austrian school, is they tend to assume mathematical formalism, not because they don't know how to do math which is the common slur, but because they don't think it's appropriate to the study of economics. They think that's just like aping physics and chemists and so on. >> But the more mainstream economists, they did want to be able to use calculus and to have models. Your viewers who have taken a standard economics class, they might have done things like, "Here's your utility function. How do you solve it? How do you find the equilibrium? You take the first derivative and set it to zero and that's what the consumer does." That kind of stuff. >> Right. Yes. >> They wanted to have mathematical models of consumers and firms and so on to be able to "solve the model". Again, this is mainstream economists, not the Austrian School. In their tradition then, the utility function has to be a cardinal thing. What Kaplan was saying is the Austrians recoiling from that say, "We're not like those crazy neoclassicals. We don't believe in cardinal utility. We're old school and no based on sound philosophical foundations, everything can be done orderly." Just so the listeners get example, you could talk about friendship and say, "I have my best friend and my second best friend, my fifth best friend." That language is meaningful but it wouldn't make sense to say, "My best friend has three times as much friendship for me as my third best friend." It's not just that you say, "I don't know, it's like it doesn't even make sense." The Austrian view, we can do economics just by ranking how much you value certain types of consumer goods without assuming there's underlying thing. That's part of the distinction and we can talk more if you want. But Kaplan was trying to quibble and say, "Mainstream economists don't really mean it. That's just like a shorthand." But on the other hand, plenty of mainstream economists say, "The Austrians are being old Fuddy-duddies." Of course we know that a poor man gets more utility from a dollar than a rich man. What's the harm in saying that? We're getting hit from both sides as Austrians and on one hand we're saying, "Come on, nobody means that." Then they all end up saying, "Yes, of course, we mean that. You're idiots for denying it." >> At the risk of going out and turn, because I want to continue to talk about the concepts that you're talking about, I think that's meaningful in terms of, if you think about the 2008 crisis. Because one of the things that people said when the great financial crisis happened is, who could have known that this was going to happen? Obviously, Austrians did predict the crisis in many ways because of the micro structure being imbalanced. But when you use the precision that economics uses, the mathematical precision as an example, dynamic stochastic general equilibrium models, which are the standard that people use, you wouldn't be able to predict that the recession was going to happen. You would have been bowled over by the great financial crisis. Whereas Austrians have a view which is not as precise in terms of these utility functions that was saying that actually in our model things are out of whack. Am I thinking about that correctly? >> Yeah, I think so. The way I would put what you're getting at there is I would say, so mainstream economists, some Austrians say let's stop using that term because we actually are becoming more mainstream. Not silly like that's not always just stipulate from the outset that were obscure or something. But neoclassical, neo-Keynesian type people who are at Harvard and Yale and things like that, it's true if you go read their journal articles. They're really good at math. There's a lot of precision and so on in there. But yet, as everybody knows, as you alluded to, it's not like economists have a good track record the way the people in quantum physics do. The quantum physics is nutty. When you read about it and how they view the world, it's crazy, but the justification is, but experimentally, these models talking about an electron being a particle and a wave at the same time, that stuff. Look at how well we match the predictions in terms of when you run the experiment with a particle accelerator and so on, modern computers and whatever based on our understanding. Whereas economists, it's not at all that, "Yeah, economics sounds crazy, but look at how well we can forecast what's going to happen to GDP next year." They don't have that track record at all. They're terrible at it. We can talk if you want about like, what's the difference between the fields? Yes, Austrians are saying there's something qualitatively different about the social sciences, for example. There's not constants the way there are in the physical science. There's the charge on an electron, the mass of certain protons or what have you. There's things like that in physics that at least we assume are constant and that seems to serve as well. Whereas when it comes to the social sciences, there's so many moving parts. There's really no controlled experiment possible in the social sciences. So that's why I would say it's so open-ended. It gives scope for people with different ideologies can cling to their view no matter what. Keynesians and Austrians still disagree about what happened in the '30s. We still disagree about the Obama stimulus. Keynesians say the Obama stimulus package created or saved X million jobs. Look at the numbers, we're right, and the Austrian say, "No, it destroy jobs." Unemployment went up higher than you wonder would happen without the stimulus package. We're both making true. It's like we need our model to be able to interpret what happened in reality to parse the data. Because of that, you're right. Austrians tend to be more qualitative and yet I would say, even though the Austrians are saying our method is different from the physicist or the chemist, where it's ultimately experimental verification or falsification that's the criterion for success, even so, I would say the Austrians are better at anticipating what's going to happen. For example, I personally in October of 2007 had an article saying the worst recession in 25 years and I had a question about it, but I was using Austrian Business Cycle Theory to say the Fed has blown up a housing bubble and more generally, an asset bubble. The last time that they were this distortionary was in the late '70s, and look how bad that recession in the early '80s was. So I writing 11 months before the 2008 crisis was saying, I think we're in store for something that's going to be as bad as it was 25 years ago. I wasn't giving quarterly estimates of GDP growth because I knew that would be silly, I don't have that precision, but yet qualitatively because my understanding of what causes the business cycle, which I think was correct, that was on my radar, whereas these other economist who on the surface look like they were much better scientists and more empirical, a lot of them had no clue any of this was coming. >> Exactly. Before when you were talking earlier, you mentioned the Chicago School, which I would consider to be a school of thought that is mainstream and actually really influences policymakers today. What's the difference between Austrian economics and the Chicago School? What's your view? >> Okay, sure. Like I say, in terms of man on the street or people who just care about political policy battles, who read National Review and stuff like that, the heritage, but they might think, yeah, the big thing is let's just beat up on those Keynesians. From that level, the Austrians and the Chicago School typically are against stimulus packages and stuff like that. They don't want to raise the minimum wage, things like that. But fundamentally, in terms of the actual economic methodology and things like that, there are some pretty stark differences. One big one is, this issue. The Chicago School famously Milton Friedman, one of its chief proponents in the 20th century, he famously argued that when it comes to economic models, it's fine to make false assumptions as long as he's saying the predictions that model gives you are accurate enough for the issue that's under discussion. The analogy he used was, if you're trying to model an expert billiards player, someone playing pool in a pool hall who is an expert, it's fine to assume that the person knows the laws of physics into doing a momentum and he hits it. Even though you know in reality the pool hustler, he probably hasn't studied Isaac Newton. It's just, he's doing something subconsciously, but they say, "That's a decent model for that type of behavior." The Austrians have a completely different. They think, "No, we're giving correct descriptions of the economy." In other words, we start with the insight that human beings act, meaning they have goals and preferences that they tried to achieve using their reason. That could be wrong. But the point is, we're interpreting it, their actions as purposeful behavior. Then step-by-step, they build up things from there. The authors who were there, it's like you can't say too much with precision but you can say things like, "If the Central Bank or the banking system push interest rates below where they should be, that will cause investments to go in areas where they shouldn't go." We don't know how big of an effect is that, and that would be a judgment call, but we can say with certainty, if you will, it's going to cause a distortion. That's the difference in terms of their method. Then like I say, in terms of specifics, the big one is with the business cycle. Like the Chicago School thinks, what caused the Great Depression was that in the late '20s and early '30s, the Federal Reserve didn't pump it enough money. Whereas the Austrian School has almost the opposite view. They say, "No, the problem was during the mid '20s, the Fed pumped in too much money that caused this unsustainable bubble. That's why the '29 crash was necessary. Then Herbert Hoover and FDR did all sorts of goofy interventions that prolong the agony. That's like a specific area where the Austrians in Chicago School are totally different in their explanation of what happened. >> That's a profound difference and I think that's where I wanted to go next in terms of you mentioned the holy grail here in terms of interest rates and what I would call the micro structure. That is, is instead of thinking about aggregate demand in terms of the way that Keynesians think about it, we can talk about, first of all, there's the concept of natural interest rates, which we'll get to. But you've mentioned interest rates below the level where they should be. I think that this is where the rubber hits the road in terms of thinking about recent events in the United States in particular and across the world in terms of stimulating spending. >> That's what maybe a Keynesian would say, but at the same time, an Austrian might say that you're building the wrong stuff. The lower interest rates is causing the wrong things to happen and you're creating zombie companies. Can you explain that difference between aggregate demand and the micro-structure in terms of capital investment being skewed to different asset types. >> Great question, Ed. Another difference that I didn't even mention till this point, I'm glad you highlighted it is the Austrians, it's ironic because even though the knock against them is they're anti-empirical, and they're simplistic where they're not as sophisticated with math as their neoclassical colleagues. It's in the Austrian model, if you will, of the economy, the way they explain the business cycle in particular, the Austrians have a disaggregated approach. So they'll have multiple sectors. They might do something just for pedagogical purposes, say like dividing the economy up in a multiple stages, like mining, manufacturing, wholesale, retail, and consumption, things like that. Or, starting at the farm and then all the different stages for the wheat's harvested, and then it goes to the baker, and then it goes to the grocery store, things like that. Where you're having a structure of production over time. Then if you had an economy that was originally in equilibrium and that structure where things happen, the coal is mined, and then it gets processed all the way down the line, that takes multiple years perhaps to actually reach the final consumer. In that setting then, what happens if all of a sudden the central bank decides to push down interest rates? >> Right. >> So in a Keynesian framework, at best, usually they'll just have the difference between consumption and investment. So they'll say total output gets allocated between either consumption or investment, and they'll mostly say, we're in a recession. It's because there's a shortfall in demand and total output isn't as high as potential output could be. Let's lower interest rates to stimulate spending. That's the way they look at it, whereas the Austrians, a lower interest rate doesn't merely cause people to spend more, it changes where the spending occurs. In particular, a low interest rates gives more impetus to long-term projects rather than the short-term ones. So people who are familiar with just state at accounting and present discount value calculations like a 30-year project, if you lower interest rates from five percent to two percent, the [inaudible] project will see a much bigger jump in its present value than a two-year project, that's the logic. >> Right, yes. >> So in the Keynesian model, it's just not rich enough to handle it. There aren't 30-year project versus two year project, it's just all what's investment spending this year. It's an aggregate, whereas the Austrian ones, it's more disaggregated. So because you see that distinction, you realize, wait a minute, lower interest rates doesn't just cause more investment spending, it causes more investment spending in particular in longer-term projects. So the Austrian view, when the Fed, for example, in the US context, lowers interest rates, yes, that might cause a boost in investment spending, but it's unsustainable because now entrepreneurs are pumping resources into these long-term projects and there's not enough total savings to carry us to the finish line. So just because the Fed electronically creates money and buys bonds, there isn't actually more factories, there's not more farmland, there's not more people who know Java programming. All it's doing is rearranging resources, and so if you're now sucking them into long-term projects, you're going to hit a wall, a real physical resource constraint that the Fed can't create more genuine real savings just by creating more money. Go ahead. >> I was going to say, for me, the allure of that as someone who was in the junk bond market at one point in time is that I saw with my own eyes that the projects that we were looking to have people fund when lower interest rates were there, people were snapping those projects up, that it did have that skew. It did cause investment to move in one direction or another, and it makes me think about what you were talking about in 2007, which is at the end of a huge boom in housing. How would the Austrians have described, and how did you describe at the time, what was going on when the Greenspan Fed lowered interest rates to one percent and then kept them very low sparring aggregate demand? How did you position that, and what were you thinking? >> Housing is a great example of this idea that even people who aren't in business or who are accountants that know about a present that's good, everybody knows when mortgage rates come down, you can afford more a house. Everybody knows that, for a given monthly payment. So whereas when interest rates come down, it's not like all of a sudden someone's going to buy a computer that's 10 times as higher, it's like a shorter term thing. Interest rates don't affect it as much, whereas something really long-term like housing, there the mortgage rate has a huge impact on what the present market value is of a given structure. So I don't want to overstate. I was slow on the uptake in terms of perceiving that we are in a housing bubble. It was only the summer of 2007 that I realized the problem, but other Austrians saw it much earlier, for example, Mark Thornton has a 2004 piece for the Mises Institute called Housing: Too Good to Be True. There, it's almost eerie how much he anticipated saying housing is overvalued, there's going to be a crash. He even said how the Fannie Mae and Freddie Mac might have to get bailed out by the tax, it was very prescient. Another thing I would encourage your listeners to go and look up is called Ben Bernanke Was Wrong. It's a YouTube compilation just showing at every stage in the crisis, Ben Bernanke was totally off of this. So just to show the distinctions. But yeah, the Austrians were saying low interest rates makes housing more attractive. So there's too many resources flowing into housing. Then of course, there's a self-fulfilling prophecy where as housing starts rising rapidly, other people get into that and then it builds it up even more. So there is an element there, we can say we think it's a bubble. Well, when's it going to pop? When it starts going down, we don't know what's going to make it. But in this case, it was pretty Standard Austrian Business Cycle Theory where the Fed lowered the Fed funds rate. It was like it's six and a half percent when the dotcom bubble burst, Greenspan took it down to one percent by June of 2003, held it there for a year, and then from June of '04 onward, the Fed every time it met would raise to 25 or 50 basis points, they were going for a soft landing. Remember, they were calling Greenspan the maestro. Even though there was the dotcom crash and the September 11th attacks, housing keeps going up amidst the recession. What, the maestro, this guy is great. But then as of 2007 and eight, all of a sudden, the fact that he was pumping up housing, maybe that wasn't such a good idea after all. So that, I think, encapsulates the difference between the Austrians and the Keynesians. The keynesians always are thinking, in the midst of a recession, what do we do to get out of this? How do we boost demand to provide employment? The Austrians are saying, during the boom period, we're sowing the seeds for the next crash. So that's the distinction, that the Austrians are saying when you're in a recession, ironically, you let it just clean itself out because if you "fix the recession by lowering interest rates, you're just pumping us up for another crash down the road," this is why we keep having these cycles. Whereas the Keynesians blame just, "Oh, there was a wealth effect because people panicked." Someone like Paul Krugman explicitly said after the financial crisis, it doesn't matter what caused it, let's fix it first, restore whole employment. Then we can argue about historically what caused it. It doesn't matter. We need to prop up demand right now. So if the Austrians are right, that advice is totally wrong, because what he's saying, his medicine is actually the poison. >> It's good that you've mentioned that because that's where I was going in terms of asset bubbles, because I think that's a great phrase, because that's exactly where we are right now in terms of what you might call mania. I'll give you an example. Just yesterday we saw that Tesla's shares went up to, I think it was like $1,800 a share, at some point they settled in just below 1,500. But at some point I think that Tesla's was worth more than Toyota, Nissan, and Honda combined. It stretches Credila to think that that's the case, but obviously, when you are talking about long lived assets, as you are, the bet on Tesla is in the future, that makes Tesla a good bet when interest rates are low. How do you think about this particular period as an Austrian economist of interest rates where not only are we at the zero lower bound, but we're also engaged in quantitative easing for treasuries and credit easing in terms of buying assets that are non-treasury assets like corporate bonds. >> What I was doing from 2009 through last year, is I was going around when I was giving presentations to people in the financial sector or whatever, I was given the stake I just told you about, the housing crisis. Again, given their framework, it's easy to show how, yeah, the Fed pumped in money, interest rates went down, mortgage rates went down, housing went up. Then once the Fed started raising rates, that's when the housing bubble peaked and turned. So the facts fit that qualitative story I was telling, so I would convince audiences that the Fed had at least, had something to do with the housing boom and bust, then I would show them what Bernanke had done. That hey, if you think keeping interest rates at one percent for a year from June of '03-'04 might have had something to do with the housing bubble, what do you think is going to happen when Bernanke and then again, Yellen, had interest rates at basically zero percent for seven years which is what happened from December of '08 to December of 2015. Clear that and then of course as you know that, it wasn't merely the interest rate if you looked at the size of the Fed's balance sheet, it dwarfed whatever happened under Greenspan, and it was just the reason that they want to get down to zero percent, they can't really push it much lower for various technical reasons. So my point was I was warning people if you think the '08 crash was bad, what we're in store for is going to be much worse and I was saying that for years even as the stock market was booming under Obama. By the way, it's an accident actually if people just chart the S&P 500 index against the Fed's balance sheet, they fit hand and glove from like '09 to basically until Trump gets elected and then the stock market seems to go up even though the Fed wasn't inflating. That wasn't crazy talk for me to say, the stock market under Obama was driven by the Fed not by his great policies that helped fundamentals. To answer your question, the stuff that we saw happen and then the yield curve inverted in this summer of 2019, so I was warning people there was going to be a big crash by this summer, the summer of 2020. Now it did happen, but of course, the coronavirus also hit too. It's like, I don't get to take credit for it, it was, oh, you got lucky, but I say, well, I wasn't wrong. In my view, the distortions that accumulated from 2009 onward are massive, way bigger than what happened during the housing bubble years. We were due for a huge crash, we did see some of it and now we're still lingering but again, it's cloaked under the coronavirus panic. Then what the Fed's doing now even dwarfs what Bernanke did. Both quantitatively and like you said now even qualitatively where they're buying individual corporate bonds. >> Right, yeah. >> So even forget like technical economics, just in terms of political economy and just history and political science, there the temptation of corruption is just astonishing to me. What I think the Fed shares have been doing, at least, Bernanke and Powell, Yellen actually didn't do this, was they're expanding their power to like FDR. Like during the crisis of the Great Depression FDR greatly expanded the powers of the federal government, whether people think that was a good thing or a bad thing he clearly did it, and likewise the Fed's doing stuff now that would've been inconceivable in 2005. >> Yeah, definitely. People are talking about yield curve control coming up next and things of that nature. There are two jumping off points here that I'm thinking about in particular. One is, the potential for the overwhelming wild liquidity to do what it did in 2008. I think we can save that for a second because that's a forward looking statement, but I want to talk about the political economy, because you talked about the political economy. The way that I'm thinking about it is, how can you resist the urge to blow up the Fed's balance sheet, to blow up the asset bubble, when we all know that when you have an asset, let's use housing as an example, that's an asset that you can use to leverage into spending. It boost up the economy over the short-term, over even the medium term, it boots up the economy. If my house price goes up, I'm wealthy. I could even use it as a piggy bank in order to extract that wealth. If my stocks go up, I can use that as collateral for loans and I can have spending associated with that and the economy moves up, it boost forward. If I as the politician want to get reelected, is that not what I want to see? >> Exactly. That's the problem or the perversity of this stuff that suppose the Austrians are right or at least, they're telling an important part of the story of where does the business cycle come from in our time, the reason that it will keep happening even if the Austrians are right is that as you say, if we're in the middle of a bad recession, what's the Austrian solution? Don't do anything, let's just wait and this eventually will fix itself and no politician or federal reserve chairman wants to be seen as doing nothing while people are suffering. So it always seems to be the case and especially when the problem with having the Fed now being able to do it. When the federal government tries to do relief programs, that makes the official federal debt go up and so voters don't like that because they have this idea that, oh, wait a minute, I don't want Uncle Sam to be in debt to people, so they're leery about that. Whereas if the Fed just creates a bunch of money and buys assets and in particularly, as in our time, it doesn't immediately make gasoline cost $10 a gallon, it looks like that's free money. Like there's no downside. So why would the Fed just create more money and buy stuff and probably you say, prop up assets, they might spur more hiring and things like that. It's very pernicious that yes, all the chips are stacked against what I think is the correct discipline long-term solution, which is just to stop these interventions and let the mail investments get washed up. >> It just keeps setting us up for recurring boom bust cycles. But even worse, as we've seen, they are going to keep getting higher and higher in amplitude because the new problem is so much worse than it was the last crash. The Fed has to do even that much more to get traction to solve something. I think that's just going to keep happening until finally the dollar crashes. That's going to be the only thing that will snap us out of this and realize we can't just keep heaven, the Fed create a trillions of dollars to solve a problem limping from crisis to crisis, the only thing that will stop there is if the dollar crashes. >> That's the forward-looking part of this in terms of, right now, we're at a point where there are many people who are saying in the market that we're early cycle. That is, they're looking at the stock market, and as prognosticators are saying, "We think that we actually we're early cycle." Meaning that the recession was really short and it's over now, and now we're moving into a new business cycle. Obviously, if that's the case, what they're saying implicitly is that the Fed's wall of money, the Fed's action has overwhelmed the negative impact of the recession to the point where we're now starting the next boom, which you're saying is going to be worse in terms of mail investment, in terms of the crash that happens subsequently. My question to you is that even an accurate depiction of where we are right now, is it true that we're actually potentially in a new business cycle? That the Fed's wall of money has overwhelmed the negative effects of the recession? >> Yeah, a great question. So I have a financial publication that I do for subscribers, and that's literally what we're covering this particular month's issue is this question of, we know standard Austrian business cycle theory. The Fed blows up a bubble, there is a crash. The Fed comes in with low interest rates and easy money that blows up another bubble. The question is, right now, where are we? Because clearly the Fed pull out all the stops and pumped and a bunch of money and cut interest rates back down to zero. So yes, like investors in particular, do they think the stock market now is going to have another upswing for awhile before there's a huge crack? So the quick answer is, I don't know. Like you say this is the issue with Austrian economics. It doesn't allow for precise quantitative measures as more qualitative to understand processes and to get a sense of different causal factors and other things equal, what does this do? But to then put all those things together to say our net worth, the result, that's more of a judgment call. So I happen to think that right now, we're still working through the mail investments. I could be wrong. So here I'm just saying this is my personal judgment. Where I'm coming from is the last one. The Fed cut interest rates down to zero and was pumping in money with QE and still the recession lingered for awhile, and even the alleged recovery was very lackluster although the stock market was booming. But in terms of the real fundamentals, the labor market took a while to even get back to the total employment at the peak before the OE crash. So I think it's going to be like that this time around that, especially with the coronavirus threats still being there, if they extending unemployment benefits, I think the unemployment rate is going to still remain at high levels for a while even though the stock market might be pumped up. So that's my long way of saying, I think we're still going to be in a bad economy at least for another year. But again, that's just a judgment call. Austrian theory per se doesn't give you that. That's more of trying to figure out where are you in the cycle. >> Some of that has to do with policy constraints or policy initiatives. Meaning that, how far is the Fed willing to go? How far is the federal government willing to go? This past month, June was a month of over $800 billion of deficit spending. So if you continue that over a longer period of time, that's definitely going to overwhelm some of the recessionary impulses, and that combined with Fed [inaudible] could get you to where you want to be. So going back to what you were saying about the great financial crisis, the recession officially ended in March, but we had round QE1, QE2, QE3, operation twist. That tells you that they were still pumping in the money. They were still giving the spending in order to keep the economy going. So you can't really know what's going to happen going forward unless you know what kind of policy response you're going to get. >> Yeah. So let me just clarify because you really made a good point. Because this has been superimposed with the coronavirus stuff. So yeah, certainly unemployment shot way up and then it's coming down and GDP fell off a cliff, and now it's going to recover somewhat. So you're right, the way the National Bureau of Economic Research, the way they classify peak to trough and the cycle, they might officially say we're in a recovery. But I'm saying if fourth quarter 2020 unemployment are at levels that would have been considered a recession had we not had the coronavirus stuff. That's what I'm saying. You get what I mean? >> Yeah, definitely. >> GDP growth could still be lower then than it was in fourth quarter 2019, but yet it might be showing a growth relative to how awful it was second quarter 2020. So even though there was, "Oh see the economy's growing," I want to say yeah, but if it's still less than what it would have been, then we're still lower than the trajectory that was on pace, they ended 2019. So that's what I'm saying when I say, I think the economy is going to be in this route at least for another year, is we're not going to be where you would have thought we would've been at the end of 2019 if you thought it was smooth sailing. >> Right. When you make that analysis, you are pointing out almost implicitly, I think you said this explicitly before that the stock market or asset prices could go up, well, that's occurring. I think this is a big, well, what I would call political economy issue, inequality. That is, is that people who own assets, they're benefiting from the large asset of the Fed while the real economy is stagnant. The numbers that you're going to see coming out in 2021 are going to be below the numbers that you saw at the end of 2019. What does that do to the economy in terms of the cohesion of people feeling like we're all in this together? >> Great question. So it's interesting because as I'm sure your listeners could probably guess, I'm very libertarian in my policy views and I'm against redistribution of wealth and stuff like that. But yet I think if what the Fed does, that they causes way more inequality than if we had, either no Federal Reserve at all or a Fed that was constrained by the gold standard, things like that. So I think you're right, inequality is going to get exacerbated by this. Also too that now, in terms of which businesses are deemed essential or not, I think there was a lot of favoritism there. There was a big company where the CEO knows the governor, so I think there are going to be able to continue, whereas it's the smaller individual mom-and-pop shops, wherever they're going to get hurt more by some of these political lockdowns. So who gets the bailouts? There's all kinds of examples like that where, especially like we're saying, the corruption of the Fed being able to buy individual corporate bonds now. I'm sure that there are going to favoring towards big rich insiders and not some struggling new company issuing bonds. So all that's to say, yeah, I agree with you that people are going to be hurting. Unfortunately, I think what's going to happen is they're going to misunderstand what happened and they're going to blame capitalism or something, even though clearly in my view, interventionism is going to be causing that. But yeah, it's the measures of wealth inequality, and something that I think are going to go way up, going forward for all these reasons. >> You mentioned something about gold there. I want to end the conversation talking about gold and the dollar because earlier you talked about the dollar's collapse being the only way that you're going to end this cycle, this boom bust cycle. I'm thinking about the gold-standard. I'm thinking about Bretton Woods. Talk to me about how you think about the gold anchor, and fiat currency, and the dollar going forward and also going back, if you will. Meaning, we had those standards in the past. Now, we're living in a fiat currency world and potentially, the dollar could take it on the chin as a result of everything that's happening now. >> Yeah. By that, I just want to clarify I'm not predicting an imminent dollar collapse. >> Right. Yeah. >> Because I've been saying that would be the only thing that would. You didn't put words in my mouth, I just want to make sure the listeners don't misunderstand what I was saying. So historically, and people like Ludwig von Mises, one of the important Austrian economist of the 20th Century, the way he said the classical gold standard, the system in place before World War I, he said that was almost comparable to the Bill of Rights. He was saying the point of that, it wasn't a technical economic thing about, "What's the best way to optimize growth?" It was a way to constrain government abuse. That one way the government can lock you up for saying things against the regime, and so the guarantee of freedom of speech in the Bill of Rights, that was to protect the government. The government didn't have the right to do that. They couldn't stop from what you wrote in a paper against them. Likewise, the rationale from a classical liberal perspective of the gold standard was to prevent the government from debasing the currency. They couldn't run the printing press too recklessly because that of their pledge to redeem their paper for a certain weight of gold, they would lose their gold reserves if they printed too much. So that was the function. It was to restrain government so they couldn't rob the people by just printing money and stealing their purchasing power. That was the function of it. Then as we saw, when does the gold-standard go out the window? When there's major wars. Then they went back to it afterwards. So to me, for people who are anti-war, especially like antiwar leftists, they should love the gold standard. They should realize the gold standard is the thing standing in the way between World War, and even opponents of the gold standard would admit that. The would say, "Well, what if there's a crisis? What if we have to go to war? We can't have our hands tied by the stupid pledged to gold." So everybody admits that the gold standard prevents you from going to a world war, so it's ironic to me that pretty like leftists tend to think of the gold standard as this bourgeois institution or something that constraints the government from helping, but again it also constraints the government from doing really horrible things. At this point, it's a hopeless course. I don't agitate for a return to the gold standard because they would just go off again when there is a next crisis, but clearly to me, it would show that these boom bust cycles were exacerbated once the Fed was formed. Think of it this way, when was the worst crisis in US history? The 1930s. The Fed was formed in 1913. So the Fed had been in operation for 17 years to allegedly smooth out the business cycle, and then we got the worst one in history. Clearly, the Fed and then removing the gold standard isn't doing what the proponents of those policies say they are. Last point I'll make about the inequality stuff, the conventional measures by which people try to show that all median workers wages have been stagnant while the top 10 percent have seen rising, those things they lead you to believe it happened in the Reagan years, but if you actually look at the statistics, that turnaround starts in the early '70s, as to when all of a sudden for some reason it seemed like the workers hit a wall and we're not gaining anymore. >> [inaudible] right? >> Right. What happened in the early '70s, Nixon took us off the gold standard officially, so I would say that's not a coincidence. It was going off gold that really marked the turnaround in these standard measures of how are the middle-class or what are the working class keeping up with the capitalist fat cats. >> Interesting. One piece that I want you to address is the panics for the reason that the Fed was formed, 1819, 1837, 1857, 1873, the Long Depression. Do you think that the monetary policy as used with the Central Bank has been helpful in terms of stopping those kinds of things from happening? >> Okay, great. In terms of Standard Austrian Business Cycle Theory, strictly speaking, so Ludwig von Mises was the one who developed that approach in his book in 1912 that came out. The actual theory, it isn't about Central Bank, it's about if the banking system pushes interest rates to artificially low levels that causes non-sustainable boom that then leads to a bust. All those pants you're talking about, we can go through and historically explain them like Robert Rothberg for example, he had a whole book on one of those panics. What's interesting though is that yes, you're right, the ostensible purpose of the Fed was to be a lender of last resort that would smooth out the business cycle. As I've said, the worst business cycle happened right after the Fed was formed, so that's a strike against it. The second worst one, the Great Recession also happened on the Fed's watch. So even after people said, "Hey, thanks to your work, Milton Friedman, we won't let this happen again." There have been people using more modern estimates of industrial output, stuff like that. It does look like just looking at the numbers, business cycles, they were less frequent, but they were more severe after the formation of the Fed. >> I'm thinking of it terms of board looking. So maybe just as we had the boom bust because banks pushed down interest rates below a level that was sustainable, and then we had the Fed come in, and they were supposed to be the lender of last resort, and they modeled it up both in '29, and then again in 2008, and potentially now. Maybe the answer is the Bagehot rule, that the Fed actually is the lender of last resort at a penalty rate as opposed to making the economy awash with liquidity. Doing that, helping to reorient away from the Mao investment, and then moving towards a new economy, and all they're doing is providing liquidity, not providing a backstop for all assets. Do you think that that might be a solution in the future for crises like the ones that we've been having? >> Okay. Just for the benefit of your viewers who might not be familiar. Walter Bagehot, a British writer, in the late 1800s I think is when he was writing. >> That's right, yeah. >> He was making the distinction between a firm being illiquid versus being insolvent. You could be a solvent for like you're not bankrupt and your assets are worth more than your liabilities, but you might have a cash crunch. So you just, "Oh G, I owe people money right now; my workers or my suppliers, and I'm profitable in terms of our sales, it's just the money hasn't come in the door yet, and boom, I can't pay these people." So there the idea was all your badge it was saying yes, the Central Bank's role is to be a lender of last resort to provide unlimited amounts of liquidity, but as you say at a higher or a penalty rate, meaning we don't want firms that are really losing enterprises just limping along and borrowing money to prolong the agony, we only want going operations that are profitable, they just temporarily need some cash, and so they're willing to pay a high price. That maxim was not following the Great Depression, it was not following the oil credit, it's not following nowhere, the Fed is not only just being a lender of last resort, but it's doing it at very low interest rates. So if you're saying, "Would it be better if the Fed provided liquidity, but at a higher rate, like in an above-market penalty rate?" Yes, that would be better, but I would still prefer that there would be no Fed at all, because again in my book, liquidity it has this nice sound or whatever, but ultimately, the Fed's not creating more real resources, and I think if the Fed weren't there, the private lenders would be able to do that, and so there would still be lending and prices would adjust and whatnot. Part of it is because the Fed is sitting there, it distorts everything. Yeah, it's like the worst of both worlds, that the Fed exists and penalizes or retards the development of private sector clearinghouses, and then the Fed refrains from acting, even though everybody thought they were going to rescue people, that might be worse than if there were no Fed at all. That would be worse than if there were no Fed at all. If you're saying given the Fed exists and everybody expects it to do something, what would be a better policy? Yes. If they had higher penalty rates, I would think that would cause less distortion, but again, even there when the Fed provide liquidity, it's creating money out of thin air, and it's allowing firms to go in and buy stuff and get resources. So think of it this way, there's less incentive for firms to be careful and not put themselves in a position where they do need someone to come in and bail them out with an overnight loan of a billion dollars, and so partly why firms act as so recklessly and at such razor-thin margin for error is because they thought the Fed's waiting there, they wouldn't let us fail, and saying, "If the Fed weren't there, maybe these firms would act more responsibly and we wouldn't have the crisis in the first place." >> Bob, I'm going to have to leave it there. I have tons of more questions because we've talked about this. The currency is a release valve, I'm looking at some of these here, natural interest rates, negative interest rates. We can talk about a whole lot more, but I really appreciate you giving us the soup to nuts overview of not just the history, but also how you're thinking about what's happened recently and what's going to happen in the future, maybe we can have another conversation going forward as well. I really appreciate the conversation today. >> Yeah. Thanks Ed for doing it, and you're probably the most informed interviewer I've tasted in a while, so thank you, this is great. >> I appreciate you saying that. Thanks very much again. >> Thank you. >> Hey there. Since you got to the end, I'm guessing you liked the video, and that's probably because we don't just turn on a camera and film, we work really hard on getting the narrative flow just right, and that's why many finance companies are actually now hiring Real Vision to make videos for them. One of our recent client videos just hit 100,000 organic views on YouTube, and there were no kittens in site. 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