All right, everybody, welcome back to Antiwar Radio, ChaosRadioAustin.org, also streaming at Antiwar.com slash radio.
And introducing Robert Higgs, he is Senior Fellow in Political Economy for the Independent Institute and editor of the Institute's quarterly journal, The Independent Review, received his Ph.
D. in Economics from Johns Hopkins University.
He's taught at the University of Washington, Lafayette College, Seattle University, and the University of Economics in Prague.
He's been a visiting scholar at Oxford University, Stanford University, and a fellow for the Hoover Institution and the National Science Foundation.
He is the editor of Independent Institute books, Opposing the Crusader State, The Challenge of Liberty, Arms, Politics, and the Economy, plus a volume, Emergence of the Modern Political Economy.
He's authored the books, Neither Liberty Nor Safety, Depression War and Cold War, The Political Economy of Fear in Czech, Resurgence of the Warfare State Against Leviathan, The Transformation of the American Economy, 1865 through 1914, Competition and Coercion, and Crisis and Leviathan.
Welcome to the show, Bob.
How are you today?
I'm fine, Scott.
How are you today?
I'm doing great.
Thanks very much for joining us on the show.
Really appreciate it.
My pleasure.
Let's get started with the economic crisis that I fear maybe is only just beginning rather than is the kind of thing that, like the politicians say, we can now begin the healing and get back to work and these kinds of things.
I was wondering if you could maybe start off defining this concept that I guess you coined the term regime uncertainty, and what effect do you think that might have in the ability of the American economy to recover from the crisis it's already in?
Well, Scott, I came up with that term in a study of the New Deal, and I arrived at it because I encountered a great deal of evidence that, particularly from 1935 to about 1940, the Roosevelt administration's actions and, in addition, just the character of the people who were closest to the president and advising him at the time, had given investors the willing.
They had become very apprehensive about not simply what the profits might be for firms in the future or what might happen to prices or costs.
Those are the usual kinds of uncertainties that all investors have to worry about to some extent.
But investors in the United States in the late 1930s became worried about the very nature of the economic and political order in this country, and many of them became convinced that the country was going to become some kind of a collectivist arrangement, perhaps even a collectivist dictatorship along the lines of Mussolini's Italy or Hitler's Germany, and as a result of that apprehension and fear, long-term investment remained very, very low in the late 1930s.
There was some recovery of investment in general after 1933, but it was overwhelmingly short-term investment in inventories and equipment rather than the investment in long-term projects such as the construction of new plants.
So people were afraid, overwhelmingly afraid, to commit resources to projects that would not pay off until a long time in the future, because they were worried that before that long-term future arrived, the government might have simply taken over the economy.
Well, how do you show the causation there?
Because of course everybody has a chart this way and the other thing, trying to correlate everything together.
Right.
Well, I brought several different forms of evidence to bear on this idea.
One is that there's simply a great deal of direct testimony from investors and other people at the time who talk about this fear and what it is they're afraid of.
Fortune Magazine did a number of surveys in those days of businessmen, and they asked questions about this, and the answers were astonishing.
At least when I first ran across these surveys years ago, they astonished me, because I didn't expect so many people in business to have such extreme expectations about the future of the economic order in this country.
But there's that kind of direct evidence, and there's also just the evidence of what was going on.
If you just look at the kinds of legislation that was being enacted at the time, the kinds of regulations that were being imposed, and of course a number of new regulatory schemes were put into operation in the 1930s to regulate securities markets, for example, and labor relations and all sorts of other aspects of the economy.
So businessmen were coping with these things.
They were coping with new tax laws that raised taxes on investors and higher-income people, and in one case actually taxed retained earnings, which is the primary financing vehicle for start-up companies.
It was a very harmful measure for recovery of the economy.
But you have all of these things.
You can see they're part of the public record of what the government was doing at the time, plus the direct testimony of the people on the receiving end of these actions.
And then you can look, as I did, at what was happening in the financial markets.
One could always say, well, these investors, they're just fat cats, they're blowhards.
Of course they're going to tell you they're afraid of the Roosevelt administration, because they don't like the administration, and they enjoy bad-mouthing it.
But if you look at people putting their money where their mouth is, if you look at what's going on in the securities market, you see dramatic evidence that corresponds exactly with the period during which this regime uncertainty took hold, which is from about 1935 to about 1941.
And what you see there is that the spread on the yield, the difference between the yield on long-term bonds and bonds with very short maturities, widens tremendously.
It jumps up in 1935 to spreads that are three or four times greater for 20-year bonds than for bonds maturing in a year.
So what you see there is that people are demanding very large risk premiums when they purchase bonds in the open bond market.
So this is not public relations stuff, this is what people are doing when they actually put their own money on the line in the markets.
And it's just astonishing evidence, I believe, of the effects that the Roosevelt administration was having during this so-called second New Deal, when Roosevelt turned very hostile toward investors as a class.
What was the role of the protective tariffs in the Depression?
I guess that's usually the knee-jerk response, is that foreign companies are competing with our companies and our dollars are all sailing away, and so we should raise up protective tariffs to keep their goods out to protect our own guys, especially in bad times, right?
Well, that is generally the case, that the sentiment in favor of protectionism rises during recessions.
What happened in the Great Depression was that tariff increases had been sort of on the table throughout the 1920s, and in fact, tariffs had been raised earlier in the 1920s, and many Republicans, as they had for decades, wanted high tariffs to protect American industry.
That was being debated in 1929, when Hoover became President, and then finally, the Smoot-Hawley Tariff Act was enacted into law in 1930, signed by Hoover, and it raised tariffs to all-time high levels.
And the timing could not have been worse, because the Depression had begun about the middle of 1929, so the economy was faltering already, and raising tariffs really gave it an additional shove down.
And those American tariff increases inspired dozens of other countries to raise their tariffs in retaliation to protect their sellers, and so world trade diminished tremendously in the early 1930s.
Now, what did happen?
One of the few good things, I have to say, about the New Deal was that after Roosevelt took office, that high-tariff sentiment was no longer official government policy, and in fact, legislation was enacted that gave the President some unilateral authority to negotiate bilateral tariff reductions, and that was used by Roosevelt, and tariffs were generally brought down after he became President.
So in that respect, I'd have to give Roosevelt positive credit.
It's one of the few bright spots in the New Deal's economic policy.
Well, now, I guess we're sort of working backwards here, or starting back in history and then working backwards even further, and I'm worried about being redundant on just the Fed caused the bubble, because the Fed had been around long before, 16 years before the bubble popped.
It wasn't part of the New Deal.
It had caused the bubble.
The bubble popped, and then that kind of thing.
I don't just want to go over that, but I kind of want to see if I can fill in a little bit of detail about where I'm confused along the story here.
For example, the bubble that popped in, I guess, the World War I bubble that popped in, what, 1919 or 1920, and there was a recession then, and I guess I've heard Thomas Woods and other Austrians say that one was over very quickly because the Fed didn't do anything, but if they had inflated to create the bubble for the war, and then that recession was over real quick because they hadn't done anything, does that mean that they basically did a green span and continued to inflate, and instead of propping up the war bubble, they then propped up the other bubble that became the Roaring Twenties?
Well, the Fed did, in a sense, finally raise interest rates in 1920 to a high level and brought the growth of the money stock, which had doubled between 1915 and 1920, to an end of that growth, and in fact, money declined a little bit in 1921.
So generally, consider that the Fed's change in policy from the very expansionary monetary policy of the war period to contractionary policy in 1920 brought on what you're calling the bursting of the bubble.
At the same time, when a recession did begin in 1920 and extended for about a year into 1921, the Fed did not then turn around and try to reflate against that.
It accepted what turned out to be a very large reduction in prices, 30-40% fall in prices between 1920 and 1921, and wages fell, real national product fell a little bit as well, and it was a serious recession.
Unemployment got up to nearly 12%.
But because the Fed didn't, as it were, change course quickly in response to that recession, the economy's natural adjustments took place quickly, and especially because wages fell a lot.
That kept unemployment from getting as high as it would have otherwise become.
So you can give the Fed credit, as it were, for a while there of keeping its hands off and attempt to fine-tune things and letting the economy adjust on its own, and that adjustment was very quick.
Within two years, the unemployment rate was down below 3%, between 2% and 3%, one of the lowest ever recorded in our history, even though neither the Fed nor the federal government took any special actions to bring about that recovery.
After that, the Fed pursued a kind of off-and-on policy of expanding the money stock for the rest of the decade, and in a couple of periods, created quite easy money as a way of helping the British bring the pound sterling back onto the gold standard.
The British were having a lot of trouble.
They went back on the gold standard at an exchange rate between gold and the pound that was too high, and as a result, money tended to leave Britain, the economy was not performing well, and people were moving money to the United States.
So in an attempt to keep that from happening, which put pressure on the pound, the Fed authorities, particularly in the New York Federal Reserve Bank, cooperated with the Bank of England in a plan, I almost call it a scheme, to create artificially easy money in the United States, so interest rates would be lower here, and therefore American investment would be less attractive to people in England.
So that was a policy that helped to bring about quicker monetary growth in the United States in the 1920s than otherwise would have taken place.
Well, and that was because Benjamin Strong, who was the chair of the New York Fed, or was it of the Federal Open Market Committee, or I don't know exactly the structure then, but he was basically the boss, and he was the student of Montague Norman, who ran the Bank of England, right?
Well, they were the two schemers on this thing, and they were very close friends, and basically saw eye-to-eye on monetary policy and on the desirability of U.S.
-British monetary cooperation.
So the two of them are the main men in this story.
At the time, we didn't have an open market committee as we do now to manage Fed securities purchases, and really each individual bank made its own rules for policy, but the New York Fed was so much more important as a player in international finance than any of the other Federal Reserve banks that its actions really dominated.
And to some extent, Benjamin Strong was such a compelling figure among central bankers that they tended to follow his lead anyhow, so that even though they had autonomy and discretion to adopt different policies, if they wanted to, they tended to go along with Strong.
Okay, now here's something else I'm confused about.
Basically, my understanding is that the New Deal, all in all, besides the liberalization of trade policy that you mentioned earlier, for the most part, did nothing really to solve the problem of the depression that the Fed bubble had caused when it popped, and that the myth, they say, the myth is that World War II brought us out of the Depression, when in fact it didn't.
But then here's the thing, though.
The Depression was over at the end of the war.
You're the author of the book, Depression, War, and Cold War, and so obviously, really when I talk with Tom Woods or any of these other guys, you're the guy that they cite as explaining how it was exactly that the war in fact destroyed wealth, that the recovery came after the war ended.
But here's where I'm confused, Robert Higgs, and that is that I guess I could see where the New Deal controls kind of became World War II controls, and then many of them were repealed by the end of 1946, and yet by the end of World War II, it was the biggest government ever, and much of the New Deal remained.
And that was the year of the big recovery, I understand.
But then it also seems that the fear at the time was that if they took down the military state that they had built for World War II, that that would be really bad for the economy, so they needed an excuse to keep all the arms manufacturers going, because that was the strength of the economy, so that was why they created the excuse of the Soviet threat was going to take over the world and all that, scare the hell out of them, Harry, and all that, in order to justify the big post-World War II arms buildup, which was like the arms thing from World War II and continued all along.
It seems like this would have completely buried the economy, and yet this is the era of leave it to Beaver and economic prosperity for all and things like this.
So obviously I'm caught in a riddle here, and I need some help getting out of it.
Well, you've got events here that took place over a number of years, and they need to be kept in place to make sense of what happened.
What happened, first of all, was that starting in 1940, Roosevelt became really virtually obsessed with foreign affairs.
The New Deal had been pretty much stymied in 1938-39.
Very little was getting added to the set of policies that had been enacted previously, and the President had become more and more concerned about what was going on in the world at large, rather than simply in the U.S. economy.
So particularly after the war began in September 1939, Roosevelt clearly wanted to do everything he could to bring the United States into that war on the British side.
The correspondence that had been published subsequently between Churchill and Roosevelt was immensely enlightening.
I think many, many people would be astonished if they saw the extent of the conspiring between Roosevelt and Churchill that was going on as soon as the war began.
But in all events, Roosevelt was committed to building up the military capacity of the United States, because our armed forces at that time only had about 200,000 officers and men.
They were of no consequence relative to the belligerents already engaged in the war.
So the United States and Roosevelt needed desperately to build up the armed forces, and that meant building up the munitions industries to supply and equip these men for effective fighting.
And he ran into an immediate roadblock.
Even when Congress appropriated quite a lot of money in 1940 to spend for munitions, a great many American industrialists wanted nothing to do with this.
They didn't want to take these contracts.
And it became quite clear that this was simply an aspect of the regime uncertainty that had developed from 1935 onward.
These people did not trust the administration.
They didn't think they could do business with it.
They thought they would be sabotaged or undercut or used or abused.
And so a great many American business people simply folded their arms and said, you know, let somebody else do it.
I'm not going to throw good money after bad.
And this presented a huge challenge to the administration.
How were they going to gain the cooperation of the masters of industry?
And they had to have that cooperation, Scott, because politicians and lawyers and economists don't know how to run factories to produce anything, whether it's battleships, tanks, or toothbrushes.
So they needed the cooperation of the people who were managing industry.
And in order to get it, they began to placate these guys.
They began to basically put them in charge.
Roosevelt brought in, in the middle of 1940, Henry Stimson, a lion of the Northeastern establishment, to be Secretary of War.
And in turn, he and Knox, who was brought in to be Secretary of the Navy, brought in Florestal and Robert Patterson to be their key guys running industry.
And in turn, those guys recruited thousands, literally thousands, of business people to come in and occupy the munitions bureaucracy to cooperate with and join forces with people still in industry to build up the munitions capability of the country.
So at that point, yes, you've got a wartime command economy, a tremendous amount of controls during the war, but it's being run by people who are anything but hostile to business.
So you've had a complete transformation of the situation that existed in the late 1930s when the government was being run, basically, by people like William O. Douglas, who hated business, hated capitalism, and these ardent new dealers have been, to a very large degree, pushed out to the peripheries of the government or excluded completely.
They've been removed from positions.
And so during the war, you had this kind of regime, this wartime, businessman-run military economy.
And after five years of this, people in industry were very comfortable with the government.
In fact, military contractors made very nice rates of return, on average, during World War II.
So they had no complaints, really.
And at the end of the war, there was an effort to quickly get rid of the strictly wartime controls.
As you say, the government was still big.
The New Deal was not all tossed out the window by any means.
So it was bigger than ever, but when the war ended, Roosevelt was dead.
The ardent New Dealers were no longer running the administration, and business people felt at that point that even though the government was big, it was a government they could do business with.
So that regime uncertainty was very largely dissipated as a result of the way the war economy was run.
Now, notice, this is distinct from saying the war created prosperity.
That's a mistake.
It wasn't the war itself that created prosperity.
The prosperity was created in 1946-47 by the fact that long-term investors could finally feel sufficiently secure to come out and commit their money to new long-term projects.
And there was just a huge surge of investment in 1946-47 during this reconversion period.
That brought about recovery, finally, after 16 years of depression and then wartime privation.
So we finally had a prosperous economy because this care that Roosevelt had put into the business community in the late 1930s had been washed away.
I see.
And then so what about the fear that without the wartime economy staying permanently, that they would have to deal, I don't know, it would be bad for the economy and Truman wouldn't be able to get re-elected or something.
So they kept it going.
It seems like that would have, particularly not even, well, I guess it's less expensive than actually having a nuclear war with Russia or something like that, but it seems like just trillions of dollars dumped into do-nothing nuclear missiles, as Mr. Burns calls them on The Simpsons, and a bunch of tanks and planes flying around all the time in the giant military state that was built up in the Cold War, would have been worse than the New Deal for the rest of the economy, never mind the arms manufacturers.
Well, yes and no.
The military economy was drastically cut back in late 1945, 1946, into 1947.
So there was a huge reduction in that.
But even after that reduction, you see that some of these military contractors survive, and the amount of national income that's going into arms is, after the war, about three times what it was before the war.
So there's been some ratchet effect there on the military-industrial complex.
But it's still a very small operation in 1948-1949.
Now, there were people in the government who very much, you know, the Acheson-Nietzsche people, they wanted very much to build up the armed forces for containment and for confronting the Soviet Union.
But they were having very little success persuading Congress to go along with appropriating huge amounts of money for that purpose.
And in that sense, the Korean War was what saved them.
In fact, that's what Acheson explicitly said.
Korea saved us, by which he meant Korea was the pretext the administration used to enormously increase the amount of money being spent on the military.
And if you look at that increase between 1950 and 1953, it looks as if it's the Korean War.
But if you dig into it and see what it's used for, most of it had nothing to do with Korea.
It had more to do with building up U.S. forces in general, and in particular, building up U.S. forces in Europe.
So this was a coup for the people that wanted to up the ante in the Cold War.
And from that time on, they were able to sustain that big jump.
It would come and go, depending on the kind of hot war that was going on at the time.
But nevertheless, that jump up remained almost a plateau for decades.
And even though it falls, if you compare it with national product, over time, in real terms, it doesn't fall.
And in fact, now, of course, after the past decade, it's risen to all-time highs in real terms.
So the military economy was able to entrench itself, not so much because of how it came out of World War II directly, although some of the institutional changes were critical there, but more because of the way the administration under Truman exploited the Korean War.
And so what about, I guess, the rest of the economy?
Because I guess if you cross out the part about hide under your desk because you might get attacked with nuclear bombs any minute now, the rest of the idea of the 50s was that it was just widespread prosperity, and yet it seemed like the economy was carrying a much heavier burden.
Well, it was carrying a heavier burden than before World War II, but the burden during the Cold War relative to the economy was much, much lighter than during World War II.
During World War II, military spending accounted for about 40% of GDP.
During the height of the Cold War in the 1950s, it never got above 13%.
So you see the orders of magnitude there are quite different.
And then after that, except during the hot war buildup or the Reagan buildup, the Bush buildup, during these transitory buildups, military spending rises as a fraction of GDP.
On trend, it's falling so that even now it's only about 4% compared to 13% in 1953.
So the economy is growing sort of around this big military-industrial apparatus and making it relatively smaller over time.
Now, that's part of the reason why the economy could still perform pretty well despite this big military burden.
But another part is that actually in the 1950s, the economy was not very dynamic.
And in fact, that became a big campaign issue in the presidential election of 1960.
Kennedy promised people he would get the economy moving again because the rate of growth had been quite slow in the 1950s.
This is only part one of this interview.
I can tell already.
Okay, thank you very much for your time on the show today, Bob.
Okay.
I'm Scott Horton.
This is Anti-War Radio.
And I guess we'll call this part two of our interview of the great Robert Higgs from the Independent Institute.
He's the author of Crisis and Leviathan, Against Leviathan, Neither Liberty Nor Safety, Depression, War, and Cold War, and many other books on top of that as well.
He's the editor of the Independent Review.
The website there is independent.org.
And in the first part of this interview, we've discussed so far the crash of 1921, the creation of the bubble during the roaring 20s, regime uncertainty during the 30s, World War II as stimulus or lack thereof, the relationship between big business and war, and the end of regime uncertainty in the 30s with the onset of World War II.
And then we began talking about the Cold War buildup, or I guess we really discussed the Cold War buildup and how the American economy was strong enough that all this militarism wasn't enough to weigh it quite down.
So all that being said, welcome back to the show, Bob.
How are you?
I'm fine, Scott.
Well, it's great to have you back on the show here to finish up talking about some of these topics here.
And I guess where I want to start before we get into the current economic crisis, I want to ask you whether you think the empire is a profitable enterprise from the point of view of the country as a whole.
I mean, I guess like Andrew Bacevich says, it'd be pretty hard to deny that stealing Mexico was a profitable venture in the long run.
But at what point, I guess, do you think that Americans started spending more on empire than they were taking in?
Or how much have the American people really benefited from our government's intervention in other people's countries?
Well, I think that from the time of the Spanish-American War to the present, Scott, the American people at large have suffered from the operation of the U.S. empire.
And they may have suffered earlier as well.
I'm not sure that if we think about the conquest of Mexico, it would necessarily follow that that was a good deal for the American people either.
But that's a different question.
And I am certainly willing to maintain that for the past century and more, but the maintenance of these American territories and the projection of force and influence around the world have not been for the better for the American people at large.
They've led to a variety of extremely harmful events and developments.
Certainly the U.S. engagement in World War I would have to be considered one of the most devastating, not only for this country but for the entire world.
But that's also a big question.
But I am quite convinced that even though you can identify specific beneficiaries, either in the state itself or in interest groups or industries or sectors that are cozy with the state and connected to it as the suppliers or beneficiaries of its protection or privilege in some way, that once you take away this small minority of Americans, everybody else is a net loser.
Well, what about the idea that I guess basically whether the proponents of empire or its opponents, usually the case comes down to cheap labor, right?
Exporting the manufacturer of finished goods to poorer countries so that they don't have to pay as much.
And then we all ultimately as consumers save money on tube socks and sweatshirts and lawnmowers and everything else.
There have been ideas floating around for over a century to the effect that the American industry requires foreign markets that won't exist unless we have the military out there beating people into line or requires access to raw materials.
And of course that still plays a role today specifically with regard to oil.
But these are all fallacious arguments.
These are just variants of mercantilist thinking.
They've always been fallacies.
They will always be fallacies.
They have a kind of surface plausibility that makes them somewhat compelling to people who don't know much economics or who don't care.
Even people who do sometimes know economics are willing to mouth these ideas for their own purposes.
But there's no sound economics in those ideas.
We all benefit from the maintenance of the freest possible trade all over the world.
And, in fact, we Americans would benefit from simply declaring unilateral elimination of all protection and open the doors to anyone who wants to sell us goods on any terms we're willing to accept.
So we don't need protection.
We don't need protection that's bulked up by military force.
These are all bogus ideas.
Well, is it they're bogus because on the balance sheet it'll just never pay off?
I mean, well, let me try to take a hypothetical.
In 1954, and I guess if you measure the cost in lives in Guatemala in the Civil War that followed, obviously you're dealing with pricelessness.
But in terms of American dollars spent for the reward of overthrowing the government there and protecting United Fruit Company's interest there, did the American people – was it – it couldn't possibly – you're saying just as a matter of fact, it could not be that the American people as a whole saved money on bananas to the point that they saved more than they spent on the intervention?
Or am I measuring it wrong?
I don't think they could because they didn't need the intervention to buy the bananas.
And in fact, the bananas would almost certainly have been available to them on just as good terms had the U.S. never overthrown the Arbenz regime in Guatemala.
So I just don't see that there was any real benefit at all other than keeping United Fruit from having some of its properties taken over by the government of Guatemala.
So the company got some benefit out of it, and that's it.
The nation at large got no benefit out of it.
In fact, if you look at the repercussions of that action in terms of its importance in creating hostility to the United States and to the American people throughout Latin America, you might well argue that indirectly it caused various harms to us by creating bad feeling and therefore discouraging, say, other Latin American regimes from engaging in open trade with us or allowing our free investments to come into their countries.
So there are many indirect effects of U.S. imperialism that most people never even try to take into account.
It's hard to take them into account because many of them are indirect.
They're subtle effects, and they require a lot of historical research to even begin to track down, but that doesn't mean they don't exist.
So it's by no means a clear case that even what looks like a good deal, like overthrowing the government of Guatemala, which you'd have to say probably was pretty cheap at the margin, was a good deal for the American people.
Yeah, there are always many more costs to take into account, the blowback effects and all that.
Well, okay, now let me ask you what you said about we ought to just unilaterally declare free trade with all countries in the world, which I guess what you're saying is, if they all kept protective tariffs high and didn't want to allow American goods in, we shouldn't mind at all.
We should go ahead and still have no tariffs on any of their goods.
That's right.
Well, most people, I think, would say no.
Protection hurts the protected country.
I'm sorry?
Protection is something that hurts the protected country.
It's often viewed as somehow hurting the other countries who want to sell to you, but this is like shooting yourself in order to hurt somebody abroad.
So there wouldn't be a worry at all about a trade deficit and all that stuff?
No, there's no problem with trade deficits.
These are bogus concerns.
If you didn't have a balance of payments, if you didn't have people collecting information on imports and exports and capital flows and all this, just suppose the statistics disappeared and nobody knew whether there was a positive or negative balance of trade or how the balance of payments was being brought into equality, which it always must be by definition.
If nobody knew that, well, who would be the worst?
And the answer is nobody.
The only purpose served by collecting that particular information is to give support, which is really serious support, it's apparent support, for protectionist actions and for other government intervention in international trade and finance.
And we would be massively better off if we didn't have this kind of information available to be misused.
That's interesting.
Usually the more information the better, I guess.
What we need is those statistics plus your argument against them, right?
Well, certainly you can always argue that from the standpoint of simply understanding the world better, more information is better than less.
But in this case, the harm that's brought about by the misuse of these particular statistics is so overwhelming that I have no doubt that on balance it's a bad thing to have this information.
And by the way, this information is really horrible.
People talk about what's happened from month to month to the balance of trade, and they talk about small changes from year to year, when the margin of error in this information is gigantic.
There was a wonderful book written years ago by Morgenstern, one of those Austrians that came over to this country, spent most of his career here.
But Morgenstern has a wonderful little book called On the Accuracy of Economic Observations, and some of his best examples have to do with international trade and finance data.
They're really horrible, and you'd never know it from reading the newspapers or listening to the news broadcast on television, because the journalists seem to have no idea that these data are not as precise as they're assumed to be.
I never could figure out how anybody was supposed to be able to do mathematical equations and figure out how the economy is going to do this or that, because it's just too many people making different decisions for who knows what reasons.
They might make completely uneconomic decisions, and how is a group of bureaucrats supposed to predict it or even really properly measure it?
That's an even different issue of whether we can model the economy's operation with mathematical models or not.
In the case I'm talking about, it's even more elementary than that.
It's whether we can even measure the things we purport to measure.
The answer is we can't with any kind of reasonable accuracy.
What's our problem now?
I guess I read this article about how they hire physicists to come up with all the mathematical models for how they ought to invest on the highest levels of Wall Street.
Is that what got us in our current mess?
It contributed.
Wall Street institutions did, in fact, hire some MIT math whizzes to build financial models to help them assess the risks associated with various financial derivatives and other securities that were created in the past decade.
From these models, the banks and the other dealers in these derivatives assured themselves that they had covered all the angles.
They had figured out where their risk exposure was, and they had hedged against everything properly.
Of course, now we know that this was a fool's paradise, that these models were not adequate for the job.
One of the reasons they were not adequate for the job is that, in many cases, they were feeding in artificially created values as opposed to values determined in actual markets by actual traders.
When it came to the crunch, they found, for example, that some of these securities had no value at all in the market because nobody wanted to buy them.
Of course, that condition generally didn't last.
In many cases, these frozen markets thawed pretty quickly, and they would thaw probably totally if people weren't waiting for a better deal from a government bailout.
Nonetheless, the financial modelers were certainly contributors to building up the huge house of cards that's collapsed in the past year.
Could it be argued, I hear the Democrats say this, I've got to say to a certain degree it rings true, that the Bush Justice Department and the Bush Administration, SEC, just refused to investigate or prosecute anybody but a bunch of Martha Stewart and athletes using steroids and a bunch of low-level nobodies, but that they basically let these guys get away with blue-bloody murder?
Really, what we need is just to have Democrats, good government Democrats, who know how to run an SEC to prevent birdie-made-offs and bad decisions like this.
I don't agree with that view at all, Scott.
I think what has happened in the last couple of years was not caused by a lack of more thorough regulation or oversight by the SEC.
It was caused by a variety of government policies that created the conditions that brought the bubble about.
This involves all sorts of things, subsidizing home ownership and subsidizing finance for home mortgages and bulking up the money stock through Federal Reserve policy and bludgeoning banks and other lenders to lend to people who don't meet traditional qualifications to get a loan and so on and so on.
Things you could blame regulators for or government functionaries of some kind could be blamed for, but a lot of these things, like a Bernie Madoff-type operation, that's just simple fraud.
SEC is not really there to prevent fraud.
That's what the whole justice system is supposed to be doing.
It's true that a number of people apparently made reports to the SEC informing them that Madoff was engaged in hanky-panky and the SEC didn't follow up on it, but there are other people who are at fault for that as well.
That should have been something that various prosecutors were all over.
You shouldn't have to wait for the SEC to ferret out fraud.
They basically make it their business to just require all kinds of reports, and companies spend a huge amount of money and time and effort to prepare these reports and ship them off to the SEC, and then they're made public, and supposedly this publicity is what keeps the markets honest.
But in the case of the debacle of the past decade, it wasn't so much dishonesty that created the problem, it was lack of understanding or transparency as to what people were dealing with.
A lot of these derivative securities were being bought by people with their eyes open.
They weren't being defrauded by anybody, they just didn't know what the hell they were doing.
They didn't really understand.
Now I think there was a real flip-up that should never have been involved along the way with the ratings agency, because the government has given a privileged status to three of these ratings agencies, and people put a lot of weight on the risk rating of securities when they trade in them.
And if Moody's says it's a triple A, then you think, well, this is a low-risk promise I'm buying.
If it says it's a triple B, you think, oh well, this is iffy, I'm taking my chances.
But the fact that those ratings agencies also got into the consulting business with the same people whose securities they were rating, and obviously began to slack off in doing their job and failing to see that there was risk in securities they were giving the highest rating to, they can be blamed and should be blamed, but again, it's more just doing a bad job, which they can get away with because the government has given them protection from competition, more than it is fraud.
Well, what does that mean?
There's only a few people who are allowed to be ratings agencies?
That's right.
Just three, really.
But these securities rating companies do have a privileged status given to them by the government.
Well, what role does all the spending on the war on terrorism, the occupations of Iraq and Afghanistan, have to do with the bubble?
Anything?
Well, it has something to do with it because it's certainly been a major factor in the high level of government spending in the past eight years, and that government spending, of course, has been largely paid for with borrowed money, so it meant that the government was, because it was running large deficits, putting pressure on the Fed to create easy money conditions so it could sell those bonds on better terms.
And of course, when the Fed operates that way to accommodate the federal government's deficit finance, it also has other effects.
That easy money that it brings about results in misallocation of resources over a very wide front, and that was part of the reason why so many resources went into building houses and condos and apartments and commercial real estate developments and so forth.
And all of that was part of the boom and bubble in real estate and therefore in real estate finance.
So it's not so much that war stimulates the economy as much as the Fed stimulates the economy to help pay for the war.
Yeah, that's more like it.
And this goes back to what we talked about in the last interview about the military industrial complex and the arms manufacturers.
I guess you said all the regime uncertainty from the early New Deal kind of went away because big businessmen in this country favored a military state, and they were more than happy to do business with the government if the business was making planes and tanks and rifles and the weapons of war.
Sure, that was stability.
That guaranteed regime certainty.
And that's the story of the military industrial complex, right?
If they control the policy, then they know which weapons to make and sell to the government.
And it's been like that this whole time.
There have certainly been influential parties in the military industrial complex.
The big contracting companies have been major players.
And by the way, they're not simply major players in drumming up markets for the products they sell or would like to sell after developing them.
But some of these big companies have been major players actually in crafting military strategy on a global basis.
I remember years ago when I was first starting out as a professor in the late 60s, one of my students was working for Boeing.
And it was odd because the group he was working in didn't have anything to do with making airplanes.
This group was entirely devoted to geopolitical strategizing.
And besides having a bunch of computer whizzes and mathematical geniuses, it had a bunch of former admirals and generals in the group.
And so these guys would basically scheme what kind of foreign policy they wanted for the empire.
And then this would presumably fit in somehow with the fact that Boeing would supply the airplanes and rockets and communications equipment and so forth that would serve as the tools for implementing these imperial plans.
But most people, I think, have no awareness that the big contractors are not just lobbying to sell weapons, but they're also lobbying for strategy.
Well, I don't know if you saw this, but Pat Buchanan wrote an article that said that basically that era is completely coming to an end now, that this financial collapse is so severe that not only will the American empire be coming home from Iraq and Afghanistan, but from all of Asia and Europe and everywhere else as well.
Is this that severe of a contraction?
Yeah, it's conceivable, of course.
Many things are conceivable.
The whole system could fly apart.
I don't think it will, and nor do I think the empire is going to fold up.
I think Pat's engaged in some wishful thinking, and a lot of people, I think, have jumped to conclusions.
We just don't know how bad this economic problem is going to become.
I think if the government continues to deal with it as it has in the past six months, it could become very bad indeed because these interventions are driving a worsening of the economic situation.
But we can't yet say that we're looking at another Great Depression, or certainly can't say that we're looking at the end of the U.S. empire.
Well, in terms of those interventions and making it worse, if I understand the argument correctly, it's that if we allow just the recession to take its natural course and for all the bad debt to be liquidated, that there's so much of it that that would precipitate a complete unraveling of the financial system altogether, and then you wouldn't just have people who are upside down in their mortgages and that kind of thing being bankrupt.
You'd have good businesses across the country, a breakdown in the division of labor, that kind of thing, with basically all the banks failing across the board, wiping out savings and that sort of deal.
They have to keep injecting new liquid and whatever in this way and that in order to prevent that unraveling from happening.
If I understand the administration and people arguing on their behalf, their motivation, that's what they say is going on, right?
Yes, they're making claims very much like what you just described.
I think either, one, they don't know what they're talking about, or two, they're deliberately attempting to paint a doomsday scenario to justify their policies.
I don't think there's any good economic reason to believe that if they just stood aside, if they said, well, we're not going to do any more.
We're going to revert to the Grover Cleveland strategy here and let the economy shake itself out, and if businesses can't survive on their own, they'll have to go bankrupt and deal with it.
If they did that, I don't see that the whole world would go to hell and never get out of the hole.
Obviously, some businesses would fail.
Some banks would fail.
But people need to remember, and they don't seem to understand this, that when businesses fail, any good assets that they possess are still there.
If you go bankrupt and you have some valuable assets, those get redistributed to creditors and life goes on.
Some new owner acquires those assets and manages them, presumably better than they were being managed by the company that went bankrupt.
And that's a good deal, to reallocate resources from the hands of incompetent and irresponsible managers into more promising hands.
It doesn't mean that everything grinds to a halt.
Certainly not every bank and not every lending institution in the United States has got itself so burdened down with worthless assets that it has no potential for continued operation.
And what it means is if Citibank fails, if Bank of America fails, that's not the end of the world.
Other lenders step in.
New banks are created.
New institutions are created to fill the gap.
Well, but I mean, the FDIC only has so much money to bail out people who have their life savings in those banks, too, right?
Well, it's not the – well, the FDIC, yes, but certainly it has limited resources.
Now, its resources can be replenished, basically.
I mean, they can make up new arrangements whereby, in effect, the Fed bails out people indefinitely by creating the money from nothing.
Because that's what the Fed does.
But when you go far enough, and I think they've probably already gone very far indeed along those lines, all you do is destroy the dollar as a medium of exchange.
You create so much inflation that people flee from the dollar and it becomes useless.
Now, I know that they have to be thinking about this at the Fed, because they've created so many bank reserves, and the banks are holding such a gigantic volume of excess reserves on their books right now, that the managers at the Fed have to be losing sleep over what's going to happen if the banks suddenly start lending this money.
Because the result will be a huge increase in the money supply of the country, and an abrupt increase in money is going to certainly generate an abrupt increase in the price level.
And we're going to have rip-roaring inflation if the banks suddenly cut loose.
Now, the Fed's obviously convinced itself that they will be able to handle the situation when the banks decide to lend again, rather than sitting on these reserves.
But I'm not at all confident that they will be able to do so.
Well, and that is what Ben Bernanke said at a press conference last week, is that he's not worried about price inflation.
In fact, it was a question from a reporter he was answering, I believe.
And he said he wasn't worried about that.
It's true that they had increased the supply of money, but it was just sitting in the vaults.
And when they do start loaning it out, they'll just tinker with the federal funds rate and raise that a little bit, and it'll all balance out.
They know what they're doing.
Well, you know, if you look at what they've done in the last year or so, it's hard to credit them, to think, yes, they've got a well-established record for competence.
I think they've got a well-established record for incompetence, and I don't see any reason to think they'll get better now.
Help me understand this, because I'm still confused about why there would be – there's massive inflation of the currency, and it builds up a bubble in the dot-coms.
And then they keep the printing presses going, and that creates a big bubble in housing and in a few other sectors.
But it didn't seem to create widespread price inflation across the board over the last time.
Now they're trying to reinflate the bubble, and you're saying that the fear is that rather than there would be inflated prices in one specific sector or another, we're just going to have inflated prices all the way across the board.
So why does it work one way instead of the other?
Well, the difference this time is the gigantic volume of reserves the Fed has created.
This didn't happen before.
They had an easy money policy from 2002 up until 2005 or so.
And so they were keeping interest rates below where they otherwise would have been, and one consequence of their pursuing that policy was that the money stock was rising fairly briskly.
But by briskly, I mean 6-7% a year.
What we could see now if the banks suddenly started lending some of this $700-$800 billion in excess reserves that they're holding, we could see inflation of hundreds of percent a year very easily with that amount of reserves suddenly being lent and put into the banking system where it creates a multiplied effect on the money stock.
So the magnitudes are different.
That's why I'm raising this possibility now where if we look back, you're right.
We didn't have a rapid rate of general price inflation in the earlier part of this decade.
Well, I don't have any money to invest, but I guess there's got to be people in the audience who are wondering, what are they supposed to do if the dollar becomes worthless?
And I guess really a better question before that is, is it assured?
At this point, they've created so much new money.
If the banks start loaning this money out that we're doomed kind of thing, for sure the dollar's going to fall.
And if at this point that's already 90% certainty or something, then what do people do with what little wealth they may have left at this point?
Well, I don't think it's assured at all.
I don't want to give the impression that I'm here forecasting that we're going to have hyperinflation pretty soon.
What I'm saying is that the potential exists, and I'm not confident about the Fed's ability to manage that potential if it starts to be realized.
Maybe I'm wrong, or maybe they'll be more competent than I expect them to be.
And they will, in fact, begin to take countermeasures if the banks start to lend and the price level starts to rise quickly.
But I think the potential risk now is very different than it was earlier in the decade.
Again, because of the great magnitude of what they've already done to lend huge amounts, hundreds and hundreds of billions of dollars, what they'll obviously try to do is countermeasures to start reducing that volume of loans.
As those loans are repaid, many of them are short-term loans, as they're repaid, they just won't renew them.
And they will therefore contract the volume of their credit outstanding, and that would be a countermeasure.
Or they could sell U.S. government securities they still hold, although they don't hold nearly as many as they did.
They've lent a lot of them out.
But again, most of them are lent for fairly short terms, and they could recover them.
So there are measures the Fed can take.
They believe these measures are adequate to allow them to maintain control of the money stock and keep inflation from running away.
I'm just not totally convinced that they're capable of managing this situation.
Well, there's talk in some quarters now.
In fact, Alan Greenspan, the former chairman of the Fed, is saying that it looks like they're going to have to temporarily nationalize the banks in order to get them through this crisis.
What will that really mean to the average person in America to have the banks nationalized?
Well, in the short term, it probably wouldn't mean very much.
Nationalization basically means that all these banks just become subject to some kind of overriding dictation by probably the Treasury is what it would be.
And they go on operating.
They accept deposits.
They clear checks.
They make loans.
They do the same kinds of things they've been doing.
But what it means is that instead of the board of directors and the managers deciding about general strategies for operating the bank's business, they have to do what they're told by their superior in the Treasury, who's now the agent of the owner, the U.S. government.
And we've done this before with other institutions.
The government nationalized the railroads during World War I, for example, for about three years.
And it just means that we have government officials at the top of the pyramid of control over these institutions.
But the difference comes not so much in what you'd see in the short term as in what you'd tend to see in the longer term, because to the extent that the government retains this authority or doesn't return the banks, privatize them again, we've got basically a state financial system.
The state has taken over the most commanding of commanding heights.
And at that point, we're in deep trouble, because that means that capital is going to be allocated in the economy no longer by economic rationality, by calculations of where capital can be used most profitably, but it's going to be allocated according to political priority.
There's no point dancing around this.
The government cannot act like a business.
It doesn't have the incentives, constraints, or interest of a business.
And so all it's going to do is what any government does.
If we look at governments where everything was nationalized, we see utter economic ruin.
We see the USSR or Maoist China.
And if we have the government running all the banks in this country for very long, we'll move in that direction.
Well, I'm always worried when I hear a politician use the word temporary.
But on the other hand, they're saying, well, you know, Sweden did this temporarily, and these and those other countries did this temporarily to get them through a crisis, and so it makes sense, and it really will be temporary.
That's what they're saying.
What do you think?
I think that yes, Sweden apparently pulled this off fairly successfully in the early 90s, but this is not Sweden.
It's a much bigger deal with much more influence and consequence on a global basis, and policymaking is different here than in Sweden.
Sweden's a small country.
You don't have so many interest groups pulling and hauling, and I can just see that the Swedes may just happen to blunder into doing something intelligently, whereas in this country it's almost impossible to ever do anything intelligent in the government.
So I don't take a lot of comfort from the precedent that the Swedes had a temporary nationalization.
I think it's extremely dangerous for the government to take any major action on the expectation that it'll be temporary.
If there's one thing we know about temporary government programs and operations, it's that they tend to last forever.
The ratchet effect.
That's right.
Crisis and Leviathan.
Go out and buy it now.
So let me ask you this.
It's pretty obvious that capitalism is taking a really bad rap for the behavior of the businessmen on Wall Street and their cronies in Washington, D.C. and the mess that they've gotten us in, and now you've basically been arguing a laissez-faire approach to all these problems.
Are you sure that the problem isn't you, that you have some kind of misplaced faith in some kind of mystical force called the market to solve these things?
Because it seems like you have so many criminals.
You talk about the guys on Wall Street who figured out all these fancy derivatives and weird mechanisms to funnel all this money to themselves at all the rest of our expense.
Are these men to be trusted with our economy any better than politicians?
Why should capitalism itself be better than government management of it?
Well, it's better on a lot of different grounds, Scott.
It's better, first of all, because if it really is capitalism, it doesn't involve having a gun put to people's heads, literally.
Everything the state does is done with the threat of violence in the background.
If you don't obey the government's dictates and rules, they may kill you when push comes to shove.
Walmart can't kill you.
Citibank can't kill you.
The only time these institutions, even big ones in the market, become dangerous is when they stop being free market institutions and get tangled up with government.
That's when we get in trouble.
The idea, for example, that the current financial debacle shows a failure or a breakdown of capitalism is ludicrous.
The idea that we had anything within a thousand miles of free market capitalism in the financial sector during the past decade is enough to make you fall on the floor and roll around laughing.
We had nothing vaguely like that.
We had certain room for maneuver by people in these markets.
They took it.
Some of them made big mistakes while moving around in that room they were given.
I'm not saying people don't make mistakes in the market, but if it's really a market, they get market feedback, which means if they do things that cause bad economic performance, that don't generate profit, there's immediate feedback that they stop doing those things.
The difference is once we have government engaged, the feedback is totally different.
The government, because it can use the gun to get resources, because it can use the gun to dictate what people do, is in a position wholly different from any truly private market firm.
If we have, for example, the U.S. government nationalizing these banks, they're going to be operated completely differently from a true private free market bank's operation.
The tendency that we have in politics in this country, on the part of Democrats in particular, to blame laissez-faire or blame the market whenever something goes wrong, I don't know why this flies anymore, frankly.
We haven't had anything like free market capitalism in this country since the 20th, maybe not since the 19th century.
So you can't blame something that hasn't existed in many, many years for what's happened recently.
Well, I guess it's just hard to argue in a crisis like this that the part of the system that is still capitalism is what works, and the part of it that's government is what's at fault.
It sounds like it's just an ideological bent rather than a sound conclusion.
Well, it may sound that way until you've learned some economics and some history.
And so I would just say, if somebody thinks I'm spouting ideology and that's all there is to it, I would say I didn't start out with the views I now hold, but I've spent nearly 50 years now studying and researching and writing about these things, and I've come to my current views as a result of that.
I don't have any personal stake in any of this.
I don't run a bank.
I don't work for any political party.
I could care less in that sense, but I do care about honesty and truth, and that's the only stake I've had in these things, and that's the only stake I have today.
Everybody, that's Robert Higgs.
He is senior fellow in political economy at the Independent Institute, the author of Crisis and Leviathan, Against Leviathan, Neither Liberty Nor Safety, Depression War and Cold War.
And you can also, by the way, read him almost daily at the blog at independent.org.
Thanks very much for your time on the show today, Bob.
You're welcome, Scott.
