Robert Murphy, an author, scholar, and professor, discusses the core premises of Austrian economics; the artificial business cycle of booms and busts; fractional reserve banking and the Federal Reserve System; and lending policy and business decisions.
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Okay.
Yeah.
And I said Twitter, right?
Scott Horton Show.
Okay.
On the line, it's my good friend, Bob Murphy.
Hi, Bob.
How are you?
Hey, Scott.
Doing well.
Good.
Good to talk to you again.
You guys probably know Bob.
He's a senior fellow, I guess probably they call them at the Ludwig von Mises Institute for Austrian school economics.
And he wrote the politically incorrect guide to capitalism.
Oh, it's so good.
It's so much better than you even know it's going to be.
It's really, really good.
And also the politically incorrect guide to the great depression and the new deal, man.
Have you guys not read both of those?
You have a problem with your brain.
By definition, you need to read them.
Thank you.
All right.
Welcome back to the show, Bob.
How are you?
I'm doing great.
Glad to be here.
I'm so happy to talk to you again.
I already asked you that, but I'm asking it again, just because I like hearing you say, and also I kind of forgot, but listen, there's this thing for me to read, you know, reinforce it for myself.
You know, positive thinking.
That's right.
We're doing good here.
Doing good.
Fake it till you make it.
That's right.
Just smile at yourself in the mirror until it feels real.
It is kind of funny, right?
Okay.
Hey, listen, there's a thing, theory and practice.
It's the Austrian explanation.
That's the way I like to say it.
The Austrian explanation of the boom-bust cycle, otherwise known as the business cycle.
The phenomenon that we've all known our whole lives.
Sometimes the economy's good, and then sometimes the economy sucks.
And then sometimes it's good again, and sometimes it sucks.
And we're all just sitting around going, man, why isn't anybody spending any money right now?
Everything sucks.
And then, okay, it seems like it's okay, and then yeah, and then all of a sudden the rug gets pulled out from under everyone again.
And I got to tell you, I know I'm quoting and paraphrasing somebody else.
Not one man in 10,000 understands what's going on here.
So can you tell us, first of all, just real quick, what is the Austrian school of economics explanation of why the boom and bust all the time?
Sure thing.
So yes, the Austrian school of economics, the name derives from the founders happen to be from Austria, go figure.
And I think in our time, in terms of getting across to the average person who understandably says, you know, why are some of you guys who are into free markets, if you talk about the Austrian school, is that the same thing as what Milton Friedman did, or what's the difference?
I think the single most important difference between the Austrian school and let's say the Chicago school is what you just talked about, Scott, their theory of the business cycle.
So this was developed by Ludwig von Mises, elaborated upon by Friedrich Hayek, who I'm sure lots of your listeners have heard of.
And in a nutshell, what Mises argued is that the ups and downs we see in the market economy, where there's booms, where it seems like everybody's prospering and workers can all get jobs real easily, wages are rising, businesses are expanding, and then for some reason, it all crashes.
And then it's just awful for a while, where nobody can get work, businesses are laying people off, people are, you know, sectors are shrinking.
And so, you know, what is that?
And Mises said, that's not normal.
That's not just, oh, that's capitalism for you.
Mises said that that's because of the banking system, that it can expand credit that pushes down interest rates artificially low, and that gives a false signal to the private sector to expand, to start new projects.
To start hiring and so on.
But they shouldn't be doing that.
There's not enough real savings in the economy for all those new projects to cross the finish line.
And so something has to give.
And normally what happens in a typical business cycle is that during the boom, which is illusory, it's not really, there really isn't that genuine prosperity, it just feels like it, that eventually prices start rising, the banks chicken out, they pull back on credit, that makes interest rates spike.
And then, you know, that's the immediate cause of the crash.
And then resources have to get shifted around to where they really should be in light of the mistakes that were made during the boom.
And so that's what Mises says causes this.
And in the modern, in the modern institutional framework, it's the central banks of the world that run this show.
They really drive that outcome.
Okay.
But now, so I went to government school for a while, junior college too.
And so my, my first objection, I think that just comes to mind is, but yeah, man, I mean, but don't they have to expand credit?
We have a growing economy, new immigrants and babies being born all the time, growing population on the planet Earth, resources being pulled out of the ground and, and new advanced technologies and, and improvements in productivity.
So don't we need a lot more money to pass around in the economy in order to be the grease for all of this new stuff, this new wealth that, which is the point of all of this, right?
Why am I confused when I say that to you?
Well, you're not confused.
Um, this, well, at least because of that point, you might be confused on other stuff.
I don't know, but yeah, that one, I'm clearly confused on lots of things, but on this though, right, right.
Let's, let's, let's keep it limited here.
Um, so I don't, I'll give you a dance and you can tell me if you, how deep you want to get in the weeds on this stuff.
So you're right.
There is the issue of what's the correct amount of money that the economy should have.
And so you can have an, even like a total free market where the government never got involved in money and banking.
I think the precious metals would still be the basic unit of the money.
So let's just, I'll walk through that real quickly.
Let's say it was gold, right?
So people are using gold as the money.
Um, you know, there's no such thing as dollars and euros and stuff like that.
Everyone's using gold.
So there, yeah, babies are being born.
More people are coming online.
What happens?
Well, as people want to hold more gold coins, cause there's populations growing, people are getting wealthier too.
That would make prices in terms of golds, uh, tend to fall, right?
As, as the demand for, to hold gold goes up.
And so, um, that makes gold more valuable.
So the people who own gold mines, they would put more resources into digging up more gold and the, you know, they'd ship it to the mints and they would stamp more coins and so on.
So even during the classical gold standard period, when all the major powers had their currencies tied to gold and everyone really thought of gold as the actual money, um, it's not that the supply of gold was constant, that no, they're the money stock even consisting of gold coins was, was rising over time.
All right.
So that's fine.
That's not what causes the business cycle in the Austrian tradition.
It's when the banks, whatever the stock of money is, the banks on top of that, if they engage in what's called fractional reserve banking, have the ability to leverage that, to multiply it.
So even if there's still just whatever, a million gold coins period in the economy, the banks then can lend on top of that.
So you go and you put your gold coins in deposit at the bank, let's say you deposit a hundred of them.
So the bank now in your checking account says, Oh, you Scott Horton have a hundred ounces of gold in your checking account.
The bank then can go and make loans to other people, maybe lend 90 of those coins out to somebody else who's going to go buy something with it.
So now that person has 90 ounces of gold coin, but you still think you have that original hundred.
You look at your, you know, you go to the ATM, your balance is still listed as a hundred ounces of gold.
So there the bank in a sense created, if you will, 90 more ounces of gold in the economy, even though nobody mined that and turned them into physical coins.
So that's the sense in which the bank's lending policies can expand or contract credit.
And so in the Austrian tradition, and Austrians disagree about what's, you know, can banks do it within limits and it's okay and it won't screw things up or can't, you know, so they, they do argue about that.
I don't want to give this false sense of consensus, but, but the point is they all agree at some point if the bank's engaging that too much and flood the market with this new credit that really isn't based on anybody saving anything, but just by the banks deciding to lend more and to have a lower fraction of reserves in the vault, you know, gold coins or a hundred dollar bills in our, in our day, backing up those customer checking accounts.
Well then that screws things up.
You know, it's, it's, it should be common sense or intuitive that if the banking system just by getting more aggressive can all of a sudden make people have more money collectively, even though people haven't really been saving more that, you know, that, that does seem like something's weird there.
Like the banks haven't created more tractors or drill presses or farmland just by changing their lending policy.
And yet it's as if now entrepreneurs have access to more resources to fuel their investments.
Which is why you're saying is what makes them sort of by definition bad ones, or at least some certain percentage of them will be bad bets because they're based on credit.
That's based on wealth that doesn't really exist.
Yeah.
So here, I think to understand how things get screwed up, like Hayek suggests first, just to have the big picture of how does the economy expand when it's sustainable, when things go right.
And so in a normal healthy economy, households save some of their income and the, and then that they either give it to institutions like banks or whatever, or they just directly lend it out to through investment projects or what have you.
But the idea is the economy can produce so much stuff per year and it can either gear it towards consumption like TVs and restaurant meals and things like that, fancy sports cars, or it can devote some of its output towards long-term investment goods or what's called capital goods, things like 18 wheelers or factories, or if they start laying the foundation for a new university, things like that, that don't directly provide happiness to people, but that are the tools or the means by which down the road they'll make us more productive.
And so in the Austrian, so that's sustainable as long as the correct mix is there and the entrepreneurs are directing resources between consumption and investment in the way that matches up with everybody's actual preferences, then that's fine.
And the economy grows over time that if, you know, each year you're not just making pizzas and sports cars, but you're also making more drill presses and fancy laboratory equipment or whatever.
That means the workers down the road are going to have more tools and stuff to work with.
So that's how the, you know, your standard of living rises over time.
That's not magical.
It's sustainable.
That's fine.
People do feel wealthier over time because they really are.
But if, if the economy tries to do both at the same time, but they try to make more hammers and drill presses and fancy laboratory equipment, but they don't cut back on making pizzas and sports cars and you try to have both at the same time, that doesn't work.
And that's kind of what the Austrian story centers on is that how is it that the commercial banks with their lending policies cause entrepreneurs to try to do both at the same time and it screws it up.
And that's what can cause a few years where everybody feels rich, like, oh yeah, we're getting pizzas and sports cars and all these other businesses are hiring to make more hammers or whatever.
But yet that's physically impossible that you can't, you can't do both at the same time.
And so that's what sows the seeds of the eventual crash.
So then in other words, without a central bank to be the backstop for the banks themselves, they would have to cut back before it gets this bad.
This is what Ron Paul is always saying is that it's always a bailout all day, every day.
Yes, I'm against this one, but the Federal Reserve itself as the lender of last resort at closing time every day is the subsidy for banks to act recklessly and get this far out of proportion.
You're saying in a free market, they would have to already cut back long before they do in our current situation, the way we have with the Federal Reserve.
Yeah, and this is a great point to stress, because I really think it just illustrates beautifully how the conventional history that we learn in the regular school system is backwards.
And so you're right.
Let me just clarify, though, that Mises originally developed his theory of the business cycle even when central banks were a relatively new phenomenon.
So Mises applied his theories and situations.
I mean, the U.S. didn't have a central bank when Mises first developed his theory, because it was before the Fed was formed and after, I guess, Jackson closed the second bank of the U.S.
Right.
Lord knows there were panics before then.
That's why we have the Federal Reserve, Bob, right?
Right.
So and this helps to address, you know, because an obvious objection is, wait a minute, where I'm coming from is sometimes Austrians, when they're trying to get the point across quickly and glibly to the public, will say, oh, yeah, the Fed causes the business cycle, and that's why I'm against the Fed.
And then some guy will say, well, wait a minute, there were panics, you know, in the 1800s before the Fed.
So we talk.
So my point is that the true theory is that the commercial banking system, if they flood the market with credit that isn't backed up by genuine savings, that makes the interest rate lower than it really should be.
That's the issue.
However, you're right, Scott, that without a central bank there, there are strict limits on what the commercial banks can do, because if any one bank expands rapidly and the other ones are more conservative, that aggressive bank quickly through clearinghouse operations is going to lose all of its reserves to the more conservative banks.
What does that mean?
OK, so what we'll keep it in terms of dollars, because I know it's hard for people to think in terms of gold coins.
So I'll just change one thing.
So we have a we have the present system right now where we use dollar bills, green pieces of paper, and that's the money.
But then banks are allowed to make loans to people and they can make more loans than they have actual money in the vault to back them up.
And so the banks are kind of gambling, saying, well, as long as not everybody shows up on the same day to take out their money, we'll be fine.
Even though we only have, let's say, like 10 percent of the currency in the vault to back up what everybody thinks they have on deposit with us, on a typical day, people aren't going to go withdraw everything.
So we'll be fine.
We'll have enough cash in there to meet standard withdrawal requests, and that's how we can skate back.
So in that environment, if all the banks are holding 10 percent and now one bank says, you know, that's stupid.
Why don't we just hold 2 percent of reserves?
We can make more loans.
We'll lend out another 8 percent of this money that's just sitting in the vault doing nothing.
And so what I'm saying is the customers of that bank now have more money than the other customers in the community.
So they're going to be spending more.
And so at the end of whatever it is, every week or every month or whatever, the banks all settle up with each other and say, OK, our customers collectively wrote checks or swiped their debit card and spent a billion dollars, you know, vis-a-vis your customers who are merchants or whatever.
And then that bank says, OK, and ours only spent $850 million vis-a-vis your customers.
So you owe us $150 million on net.
And so then the first bank would have to actually, you know, send an armored car carrying $150 million of actual $100 bills to the other bank.
OK, so, you know, in other words, day-to-day commerce, things can happen and you can have debits or credits build up.
But at some point, the commercial banks settle up with each other, then that's going to let their neighbor bank accrue this huge debt to it.
They'll just say, no, just pay us off.
So my point is, if one of the banks expands too rapidly relative to everybody else, it quickly runs out of green pieces of paper in its vault just through normal banking operations.
So that's a check.
So all that could really happen is all the banks could expand in unison.
But even there, if it's a free market and going into banking is just like opening up a pizza shop, well, then somebody could start a new bank that has a higher reserve ratio.
And then ultimately, that newcomer would collect all the actual green pieces of paper and all the other banks would eventually run out.
So those are the checks under what's called free banking to this process of credit expansion.
So just forces of competition, whatever, I think, would push that fraction of how much of the total customer deposits do the banks need to keep as green pieces of paper in the vault.
They couldn't get too reckless with that because of competition.
So now in that environment, think of what a central bank does.
Even by its own description, what does a central bank do?
It regulates the banking sector.
So right there, there's no longer free entry.
It's hard to open up a new bank.
It's way harder to open up a bank than it is to open up a pizza shop.
So that right there allows for collusion and a cartel among the existing incumbents because it's hard to enter the sector.
And then on top of that, what does it do?
Its most famous function, which you talked about, Scott, was to be a lender of last resort.
So there, if one of the banks expands too rapidly and gets into trouble, the central bank is there to bail them out.
So the normal market checks on reckless behavior that fuel the business cycle, the central bank's main functions are designed explicitly to beat down those limitations, to allow inflation to happen and the normal checks to it get smacked down.
So that's why it's, for example, the United States, to me, it's no coincidence that the worst depression happened after the Federal Reserve was formed, right?
So the normal story that the Fed was there to stabilize the business cycle, that's kind of weird.
But the Great Depression happened in 1914 and then, you know, the Great Depression happens in the 1930s.
All right.
So well, let's talk about real life in my lifetime.
And I realize that now we're living in the future and I'm old, I'm 40, which is a lot older than a young person, which I thought I was.
But anyway, so what that means, though, is that I remember the early 80s and watching HeHaw and during HeHaw, they had commercials for Ford trucks and you could get one with just 28 percent financing or whatever it was, some insane high interest rate.
I remember that.
And that was a time of bust in the very early Reagan years.
But then that kind of turned around and I guess they loosened up the monetary policy and all of a sudden it was the era of good feelings again by 1984 and Reagan got reelected.
But then there was a giant bust in the stock market.
I don't know if the whole economy crashed, really, but certainly there was a crash in the oil market and in the stock market in the late 80s.
And then it seems like there was a kind of a mini boom, but then another bust again after the first Gulf War, which helped defeat George Bush, Sr.
And then, of course, everybody, even little kids, probably remember the NASDAQ and Dow destruction at the end of the millennium there in 99 and 2000 with the giant dot-com bust, as they call it.
Then they still kept going.
And the only reason I'm good on any of this stuff is because from 97 on, 20 years now, I've been paying close attention to Dr. Paul.
And he was saying on the House floor, see what's going on is now that the dot-coms have busted, they're still just going to continue inflating and inflating and inflating and they're putting all the money in housing, which is going to make everybody feel real happy for a little while until reality comes to kids.
And this is him talking in the year 2000, right?
And then this is exactly what happened.
We saw the peak in, what, 06, 07, and then it all fell apart completely in 2008.
And then, so this is what we've been living through.
And now I know that, well, you can address any and all of that that you feel like needs clarification or endorsement or whatever you think about any of those things you want to say.
But also, so what I'm really wondering now is, where are we in this cycle now?
I know when they say quantitative easing, that really means the Federal Reserve creating new money to buy up old bad debt, right?
And that they've expanded the money supply.
But you know what?
I was also reading, I know I'm packing a lot into this question, but you're really smart.
I was also reading about how, well, of course, they've stopped all that QE and all of this, and that the money supply has actually really been tightening lately, and there's a lot of deflation, which makes me think, uh-oh, now we're getting ready for the bust again.
Ah, but on the other hand, them Reagan years that I remember, especially because I read about them later, you had this conflict, even while the Federal Reserve was jacking up the interest rates on Ford trucks, like I was saying, so high, in order to force that recession.
Ronald Reagan came in, Mr. pseudo-free market capitalist, started cutting a bunch of regulations and cutting a bunch of taxes, and encouraging more expansion of the money supply, and more growth in the economy.
And so there was that conflict there.
And I'm seeing that, since the economy didn't crash on Obama's watch, the way it did on Bush's, as Obama deserved to happen, now it's the Republicans come in, cutting taxes and cutting regulations.
So it seems like the monetary policy people are contracting the money supply, they're ready to go ahead and induce the next bust, before, I don't know what gets out of hand that they're worried about too much, because I don't understand well enough, but the Republicans' fiscal policy is stimulative, and they say they want to spend another trillion dollars on infrastructure and all these things.
So I wonder, what's your guess then, for the timing of the next bust?
Is it now, or is it in another eight years, or what in the hell?
That was a long question.
I know.
What do you think of it?
Other than how long it was?
Yeah.
Okay.
I'm pretty much right about the way I remember the economy going in my lifetime, though, right?
Oh, yeah.
Yeah.
So one thing, by the way, I don't want to get a bunch of nitpickers, the Federal Reserve Act was actually in late 1913, but it was like December, like right, it was like Christmas Eve, or the day before Christmas Eve, something like that.
I know.
They really just snuck that in.
So I'm saying- It actually came into operation in 14.
You're absolutely correct.
It was also there, and partly, I don't think that's a coincidence that World War I would not have been possible, as destructive as it was, without all the major powers having their central banks, and many of them going off the gold standard.
So it's not a coincidence that people like Ron Paul, who are staunchly for hard money and are anti-war, those two positions, as Dr. Paul says, go hand in hand, that if you don't like war, then you really should be against the central bank, because that's the mechanism by which they can finance this thing.
So yeah, as far as what you said, what happened is, in the early 70s, Richard Nixon finally kills the last vestiges of the gold standard, so now the U.S. and the world are totally on fiat money systems, and that's, again, no coincidence that the 70s is when the U.S. had a really bad bout of price inflation, you know, when the average person really was getting hit hard and like, wow, what's going on with prices?
And so then they realized that, OK, this isn't good for anybody, what's the point of having this monopoly on the printing press of the dollar if its value is falling too rapidly?
So they bring in Paul Volcker, and then late 70s, early 80s, the specific mechanism, people say, oh, he jacked up interest rates, but the Fed's not magic, they can't just control what interest rates are.
The mechanism is that they stopped pumping in as much money as they had been doing earlier, and so then that's why interest rates zoomed up, because they kind of slammed the brakes on the monetary inflation, and that's what caused the crash.
So that's a standard application of the Austrian theory, where they sort of had this false boom in the 70s that was fueled by monetary inflation, and they came and slammed on the brakes, and that caused a really bad crash.
You're right, Scott, that Reagan had his expansionary fiscal policies at the time, but I would just clarify that it's, you kind of, to get the boom-bust cycle, you really need, I think, the central bank to be participating.
So coming up to modern times here, just the most recent thing you said- Well, the point on the Reagan thing is, though, right, is that once the Fed eased up, then the effect of Reagan's fiscal policies really, that's what created the next boom.
It already got a revving jumpstart there.
Right, yeah.
That it's, exactly, that the Fed did tighten, then once it got price inflation expectations under control, then yeah, it loosened up the monetary spigots, and that fueled.
So I do think some of the prosperity of the 80s was genuine in the sense that those marginal tax rates that were prevailing in the 1970s, I mean, that was crazy.
So I think that did help and lap incentives, right, and get people to have the incentive to go and produce more income when the government wasn't taking seven out of every $10 you made on the margin.
But you're right, it was fueled by unsustainable monetary policy, and that's why you did have the crash in 87, which was the worst percentage drop in the stock market, I think, to this day.
But it didn't spill over in the real economy, as they say.
So as far as up to more recent times, you're right, I've been very concerned that what Bernanke did with his rounds of QE since the financial crisis, you remember that hit in the fall of 2008, has been very reckless.
It's unprecedented.
The amount of money that Bernanke pumped into the financial sector dwarfs what had happened earlier up to that point in history.
Bernanke pumped in more than the Fed had done in its entire history up to that point.
But then when they bring in Yellen, I think they're trying to move towards a normalizing stance in policy.
And so, for example, since the fall of 2014, the Fed has just been rolling over its assets as they mature.
So before then, yeah, they were buying massive quantities of mortgage-backed securities and treasuries to help, I think, ease the government situation, because it was running huge deficits, and to bail out all the investment banks that made bad bets on the mortgage market, real estate market.
But then since, like I say, the late 2014, the Fed has not been pumping more money, and they've just been sitting pat, rolling over their portfolio, and keeping its total size the same.
So that's why the dollar actually has been strengthening since then against other currencies, because the Fed has been tightening in that sense, and they've been raising interest rates too.
So that's kind of the situation the Fed is in, where they're trying, I think, to go back to a more normal monetary policy, because they realize, we can't just keep doing QE forever, because then the dollar's just going to crash, and no one's going to accept this thing anymore if they think that's our policy.
So one other thing about Obama, it's true that you didn't have the feeling of a crash under him, but it's almost because it was so bad.
The recovery under Obama, here's one factoid about it, year-over-year real GDP growth, to the extent that you believe those numbers they put out, never broke 3%.
So to have the worst recession or depression, with a small d, since the great one of the 30s, and then to not even have a single year where the economy broke 3% growth, is unimpressive.
That goes back to the last time that has been true, where you've had a four-year stretch of not having that happen, is the Hoover administration.
Okay, but Bob, why is the stock market doing so well, then?
When the stock market prices, that's a measure of how much these companies are worth, right?
Right, so I think that the U.S. stock market, I don't follow the other ones as closely, so I don't want to speak about them, but for sure, I think the U.S. stock market has been overvalued because of all the stuff the Fed's been doing.
So my favorite thing to do to try to get people to see some empirical evidence for that claim is if you just go to FRED, the St. Louis Fed's charting program online, and you just plot the S&P 500 index against either the Fed's total assets or what's called the Fed's monetary basals, or two different measures of trying to gauge the size of monetary policy, they fit together hand in glove for most of the 2009 to 2015 period, and it's only recently where the measures of monetary expansion are dipping, because like I said, the Fed's tightening, but the stock market keeps going up.
So anyway, Scott, I think that's just an example that, yes, the Fed can create periods of apparent prosperity that are artificial that are then just setting us up for a crash.
Just like in the mid-2000s, people were saying, well, what are you worried about?
Things are doing pretty well here.
The housing market's booming, and somebody who followed the Austrians would say, well, yeah, but interest rates are artificially low, and that's goosing the housing market, and this is going to come crashing down.
I mean, one way to think of it, Scott, when interest rates are low, that means you discount future cash flows less heavily.
So if interest rates are low, then something like a stock should go up in price.
And so if interest rates really were supposed to be as low as they've been over the last several years, it would make sense for the value of things like companies to go up, because the discount you're applying to their future dividend flows is lower.
But the point is, what if those interest rates are just artificially low?
Then that could be a problem.
Right.
Hey, Al Scott here.
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Okay, so then when's the next pop?
And what should we all put shorts on?
Because I saw a movie that said that's how we all make a bunch of money is betting on these stupid companies that are making all these stupid bad bets because they believe in this bubble nonsense because they never read No Mises.
That's one thing I do.
You're talking about the big short, right?
Yeah, there's a few of them, actually.
In fact, I forgot if I ever asked you about this, but there's one that's got to help me narrated by Matt Damon called Inside Job that I thought was 100% actually absolutely perfect other than what was left out, which was who said these banks could create all this money and that in the entire mention of the Federal Reserve is not even in there at all.
But all the rest of it seemed legit.
I don't know.
Yeah, I don't think I've seen that one.
But yeah, my reaction to the big short is just like what you said about this Matt Damon documentary that I had no problem with what they said, even depicting the people on Wall Street as a bunch of conniving liars and so on.
I got no problem with that.
It's just that, yeah, the stuff they left out that they made it look like, oh, it was just greed that did this and more government regulation and oversight would have stopped it.
I mean, like in 1994, people on Wall Street weren't greedy and then all of a sudden they became greedy between 2001 and 2008 and then they stopped.
That's interesting.
So I realize somebody who pushes that view could give me a more nuanced answer, but my point is to explain the boom and bust just by greed, that's like when there's a plane crash saying, oh, it's because of gravity.
I mean, yeah, gravity is involved, but to understand how come some planes crash and some don't, how do we stop it?
You need to know more than just gravity.
So greed is an ever-present thing there in terms of people on Wall Street and the questions, why are these cycles of boom and bust in there, I think you need to bring in the central bank policy.
Right.
Yeah, same thing with bad weather and new inventions and changes in taste.
Everybody says, yeah, well, the buggy whip factories all went out of business and then one time they had a deep freeze in Florida of all places and all the damn oranges died and so that completely ruined the citrus market that year and this, that, and the other thing, who knows what, all these other things happen, but that's not what you're addressing.
You're addressing when the whole dang system goes up and down like this.
Right.
The way Murray Rothbard, I don't know if he coined the phrase in this context, but he would always focus on the, what he called the cluster of errors.
So yeah, entrepreneurs make mistakes all the time and, you know, in a given shopping mall or something, one of the stores might go out of business and have to have a liquidation sale because they just thought, you know, we just thought the public was going to really like orange Julius drinks and apparently they don't.
We were wrong.
You know, we, we shouldn't open this location and they shut down.
That's fine.
That's how markets work.
There's profit and loss and the people who make the right guesses expand and earn profits.
The people who screw up, they suffer losses and go out of business if they're, if they're too far out of the, you know, the correct cycle.
But why is it that so many entrepreneurs during the bust phase of the business cycle slapped their heads and say, oh man, we were way too optimistic.
It just, you know, the, why should it be grouped together like that?
And that's the thing that Rothbard said, you need the Austrian theory to explain.
So you asked me before about the timing and whatever it's.
So I've, I've just as a full disclosure, I have thought the U S markets were in bubble territory for a long time, but now while the fed kept pumping up, you know, pumping more money in, it made sense that it hadn't come crashing down yet.
Cause I could say, well, they're still inflating the bubble.
So now it's a bit more difficult to say, well, since the fall of 2014, the fed really has shifted its stance and now it's more of a holding pattern or even slightly tightening relative to what it was doing before.
So, you know, it, I have been on alert since then really thinking, Jesus, think a crack, you know, anything could spark this.
Some of us thought that Donald Trump would, would set it off just because it would spook markets.
And then ironically it went the other way, presumably because people thought, well, you know, this guy actually has a lot of pro growth policies and then as they, you know, learn more about it and finagle with their, their expectations and so on.
So I mean, it's, it wouldn't surprise me if there's a crash at any time at this point.
But again, I thought we've been poised for one for a good year and a half at this point.
So well now, so does a big, you know, tax cutting and stimulus program and all of that counteracted enough to delay it really?
Or like you're saying now the Federal Reserve would have to still be inflating themselves.
And I mean, they're raising the, the, the federal funds rate, right?
Right.
Yeah.
Yeah.
They've, they've raised it a few times.
Um, so it's, I mean with a lot of this stuff, it's, it's kind of like, oh yeah, it'll, this illusion will continue until it stops and it's not really helpful in terms of predictions.
Right.
So it's, we are clearly in a tightening phase, you know, the standard textbook theory is during the boom, the feds pumping in extra money and keeping interest rates artificially low that at some point they chicken out, slow the rate of monetary inflation, let interest rates start rising.
So that's where we are right now in that phase of it.
So you would think that a crash is imminent if you buy into this whole theory.
I will say though, that, um, like looking back at the, at the most recent cycle, the boom bust in the housing market there, uh, the fed pushed interest rates down, you know, the federal funds rate, the thing that the fed targets pushed it down to 1%, I think by June of 2003, held it there for a year, then started raising in June of 04.
So if you think back, you know, to the timeline, it really was that early on, huh?
Yeah.
Yeah.
And they tried to do a quote soft landing.
It's not like they jacked rates up.
It was like every time the fed met, they would raise it by 25 basis points.
It sounds like it almost was a soft landing, but then it went into the water anyway, right?
Right.
Exactly.
Like it was soft from 04 through 08, but then nope, off the end of the clip.
So if you, yeah, I mean, if you look at various measures of home prices, I think you could say the housing bubble turned around probably like an 07 and it's just a crisis didn't really strike until the fall of 08.
But so my point is that there, there was a solid two and a half, three years of tightening before the housing market really, you know, its momentum turned around and the thing started shrinking again.
So, you know, is it going to take that long this time?
I don't know.
Even if you did say that, that means, okay, well, it's still kind of due then because in a sense they stopped pushing money in and either stayed pat or started tightening in the fall of 2014.
So, you know, it's, I am just saying that sometimes these things do take longer and like that.
I like them in the movie, The Big Short, how, you know, it was showing the, you know, with the Christian Bales character, I forget what his name is, that he was sitting there agonizing and like laying on the floor and like, no, I think I'm right.
And everybody else was saying he was crazy and he was right.
It's just, you know, he, he realized the situation and it took a while for everyone else to catch on.
So that, that's kind of the thing with this stuff is, you know, ironically, the more ahead of the crowd you are, the longer people think you're a nut job.
And so it's, uh, so anyway, it's, but it's the stuff that, let me just give you some other examples.
They really have painted themselves into a corner that right now, part of what the Fed did to try to contain the effects of all that pump and all that money is because normally, you know, commercial banks would take all that new money and go lend it out and that would cause a multiplier effect.
The Fed in October of 2008 started what was then a new policy of paying interest to commercial banks to keep their money parked at the Fed because the Fed was trying to like decouple its two operations.
Like it wanted to buy mortgage backed securities and treasuries for, you know, specific things to those sectors, like to rescue the housing market, but it didn't want interest rates to reflect how much money it was either pumping in or pulling out.
And so the way that it's gotten around that, and now recently when the Fed's raising interest rates, some of your listeners might've been confused, like, wait a minute, I thought you said the Fed's just like rolling over assets, wouldn't it have to be selling assets off to raise rates?
Well, no, because what they're doing right now is when they want to raise rates, they just bump up how much they pay the banks to not make loans to their customers to say, no, keep your money parked with us, the Fed don't lend that out to your customers.
So if the Fed wants rates to go up to 2%, then they'll just tell banks, you know what, if you keep your money with us, we'll, you know, we'll, we'll pay you 2%.
So then the banks, you know, the very minimum they would charge anybody else is 2% because they can get a guaranteed 2% from the Fed.
But wait, so you're talking about a Guinness Book of World Records level amount of welfare, but it's only for the banks and they pay them to not lend it to anybody else.
And thank God, because if they did, then it would be even worse.
It would, yeah, it would, economists are debating about how big of an effect did this policy change have in the grand scheme?
Because like in December of 2008, the commercial banks were all freaking out.
They weren't going to be, you know, they weren't making loans to people except that were totally credit worthy and, you know, their best customers ever, that kind of stuff.
So I'm not saying that this one little policy shift totally changed the posture of the commercial banks, but yes, you're exactly right.
This is a clever mechanism by which the Fed right now is shoveling tens of billions of dollars annually into the pockets of the commercial banks.
So if they had tried to do this under normal circumstances, people would have put you on your mind.
We're not going to do that.
But yet now through this, like, you know, this sort of antiseptic sleep inducing phrase, interest on reserves, that's what it, that's what's going on.
And so how effective is that then?
Does that mean that actually the bubble isn't nearly as bad because they've made sure that pretty much just the banks get all the new money, but that it's enough to, in other words, bail them out for all of their bad bets from the last time around.
But hey, don't loan it out because that would create, they almost even sounds like they recognize what you're saying.
That would cause the same problem again, too much.
So does that mean that they've avoided creating too big of a bubble this time, Bob?
Well, I, I don't think so.
I think they have bought themselves more wiggle room by this, you know, new policy tool.
Okay.
But it's not magic.
They, what the problem is going to be is, so what's, what's happening is people get the big picture.
The Fed right now is sitting on something like $4.4 trillion worth of assets, mostly treasury bonds that, you know, Uncle Sam has issued and mortgage backed security.
So it's like the Fed is a big hedge fund, if you want to think of it like that, and their assets are all these, these bonds.
And so they earn interest on that in terms of the accounting, you know, if you just treat the Fed like a normal company or something, you could say, well, they have whatever it is, $4.4 trillion worth of bonds.
They yield a certain amount.
So the Fed earns income every year and, you know, they pay their expenses, you know, they got a bunch of staff economists, they got to pay their electric bill and whatever.
And then they remit whatever's left over to the treasury.
Okay.
And so one of the big expenses now that the Fed has is paying this interest to the commercial bankers.
So as they raise interest rates, like if they, if they right now interest rates are like, I think 75 basis points, something like that, you know, they give a range, if they raise interest rates, you know, up to 2% now, that means they're going to have to more than double the amount they're paying to the commercial banks, right?
Just because you're doubling the percentage applied to whatever the total amount of reserves is.
And so that means the amount they're paying to those banks will have to double.
So at some point, if interest rates keep rising and the Fed sticks to this model, the interest that the Fed's earning on its assets is not going to be high enough to pay the commercial bankers.
You know, at that point, the Fed would be losing money.
It would, you know, it would, it's operating expenses would be higher than its operating income, if you want to think of it like that.
So right now they have wiggle room because what happened, the Fed created trillions of dollars and bought trillions of dollars worth of assets that generate an income.
So it's, you know, that makes you a popular guy in the room.
You can throw money around, you can shovel tens of billions to your banker friends.
If you have that legal ability to create money like that, go buy assets with it.
But even there, given that they're not buying anymore, there's only so much income the Fed's earning.
And so number one, every dollar they give to the commercial banks and those subsidies is less going to the treasury.
So really, in a sense, the taxpayers are footing that bill because now the deficit's going to be higher than otherwise it would be because the treasury is getting less revenue from the Fed.
But number two, and perhaps more important, is that there's a limit to that process.
Like I say, once the interest rate that the Fed wants to be the target gets to be, basically once it gets to be higher than, well, it depends on the amount of reserves relative to the Fed's balance sheet.
But you can see at some point the Fed's not making enough.
And that's really where the crunch would hit.
So yeah, I think they bought themselves more wiggle room with this.
But still, once interest rates return to normal, they can't keep doing this.
Well, you know, it's always seemed to me, one of those kind of practical jokes of history there that the crash of 08 happened just before the election, right?
The end of September in 2008, when it was already McCain was the Republican, where if it had to happen anyway, if it had happened exactly one year earlier, it would have been right on.
I mean, Ron Paul was already doing great.
You know, the real revolution started when he beat Giuliani that night on the cause of terrorism against the United States.
But then I believe it was just the very beginning in November, and they were doing it anyway, that they had set up for this big money bomb where he made $6 million and made all those headlines.
Who is this guy?
And all this stuff.
It was right, Ron Mentum, like crazy, right then.
Just getting going.
And then if the economy had a crash then, and we'd have had Professor Paul up there to explain all this stuff you've been teaching us, where the rest of these guys, McCain and the rest of these guys are nothing but a bunch of sputtering nincompoops, and he could have just sat there and explained everything about how the intervention in the economy had created this situation.
And all we need to do is stop the intervention and, you know, the central banking and the Fed and all of that.
It was just almost exactly one year too late, because I think he could have won and been the president if that had been the situation.
But at the time, no one was hearing it.
And he would say, listen, the economy is on very shaky ground.
Believe me, you need to look out and be careful, invest in metals.
I don't know if he would say that, but he certainly was, you know, and people just couldn't hear it because it seems like it's not happening yet, Ron, whatever your problem is.
But just think of how different things could have been if only Bernanke had pricked that bubble a little bit sooner, you know?
Yeah, that is interesting.
I hadn't thought of that.
You're right, that there wasn't enough time for him to capitalize on- Yeah, I mean, the nomination was already wrapped up by then.
Yeah, he had correctly diagnosed the situation.
I don't know that it would have made him win the nomination, but that definitely would have been an interesting alternate course of history to see how that played out.
I mean, because the economy just wasn't the centerpiece of the election, but boy, it sure would have been, you know?
And that's the thing that John McCain knows the least about, and he doesn't know nothing about nothing.
And yeah, it arguably helped Obama because then it was perceived that, oh yeah, the Republicans deregulation, look what happened.
And so that's why we need to have Obama come in and fix things.
But yeah, if it had been Obama versus Ron Paul, it would have been a lot different.
And it definitely would have set the whole example, too, where Ron is attacking the Republicans from a free market perspective, from getting into this mess.
So you can't blame it on him and the free market, which is what they tried to do after Obama won, right?
Was pretend that George Bush was Ron Paul, and that because George Bush was Ron Paul, that's what got us into this mess, when that narrative wouldn't have been allowed to take hold at all, that it was the free market's fault.
Because we'd have just had a year of the most free market guy in all of media history anyway, the most famous and most free market guy of all, explaining and attacking the Republicans from that point of view, for that consistent and obviously correct, and we all know Ron Paul knows his stuff as well as you, kind of thing.
You know, he's a real economist.
He talks about Austrian economists like he's not one of them, but yeah.
Anyway, I like pretending about how stuff didn't have to be this way, Bob.
That's all.
Yeah, well, I like your point, and I think it's good to emphasize that, because it is unfortunate that you get a lot of Republican politicians draping themselves in the mantle of free markets and go ahead and laissez-faire, when that's not what they implement.
So it discredits laissez-faire, free market economics, when stuff blows up.
So one way to put it is, I think the safest, most stable system, given that there's always these greedy people on Wall Street and they're doing shenanigans or whatever, is to say, let them do what they want.
If you're going to have a government with contract enforcement, okay, treat the banking sector like you treat everything else.
If they have contracts with customers and they break them, then okay, then they should be penalized just like anybody else who breaks a contract.
But other than that, just let market forces, quote, regulate the thing with the government.
But then if they screw up and they blow up, you just let them go down.
It's a profit and loss system, and that's ultimately how you're going to discipline them.
Whereas what we have now is the worst of both worlds, where you've got the central bank there waiting to bail them out, you've got FDIC there assuring everybody, hey, don't worry where you put your money, we're guaranteeing your checking account, so don't even bother doing research, just go ahead and do whatever place gives you the nicest toaster or something or free checking or whatever gives you the nicest checks, go ahead and put your money with that group because we'll bail you out, we'll guarantee your checking account, those sorts of things.
And then there's not strict regulations that the regulators are always behind the curve and they're in bed with, and it's often the same people and revolving door kind of lobbyist thing where the regulators are people who used to work with the regulated in that environment where the government's going to bail you out when you screw up, but then when times are good, go ahead and do whatever you want.
So it's a mix of lackluster regulation with bailouts tied to it.
That's the worst of both worlds.
So like I say, I think it's naive to assume, oh, just another burst of regulation would fix this and restore honesty, but what we have now is particularly crazy where you're going to sort of deregulate and have a free market, but yet the Fed's there waiting to bail everybody out.
That's not a free market.
You're just asking for these kind of boom bust disasters.
Hey, Bob, am I right?
You're a Texan now?
I forgot to say at the introduction.
Yep.
I'm at the Free Market Institute at Texas Tech University.
Cool.
So that means like if somebody was young and a student and they wanted to learn economics from you, then they could go there.
Yeah.
By all means, especially if people who are undergrads right now and considering graduate education in economics, like Austrian economics and applied libertarianism, that kind of stuff.
Yep.
Let's check out the Free Market Institute.
We have seven or eight faculty right now and got a host of grad students.
We have funding.
So yeah, check it out.
That's great.
And that's just what?
Freemarketinstitute.org?
Yeah.
Well, it's if you just Google Free Market Institute, Texas Tech, you'll find it.
The URL is cumbersome.
The other thing, Scott, while we're talking about this is that you're coming on the cruise with Tom Woods and me.
Yeah.
That's true.
So yeah, I encourage people to check that out, ContraCruise.com, where Scott and a bunch of other special guests are going to be on this one-week cruise that Tom Woods and I put on in conjunction with our podcast about Paul Krugman.
So ContraCruise.com.
Check it out.
It's going to be great.
We're going to go swimming.
In October.
Yeah.
Yeah, man, that's great.
I can't tell you how much I appreciate you guys inviting me along on this thing, dude.
I'm really looking forward to it.
We've got a lot of people telling us that they're booking because they're going to get to hang out with you.
So make sure you're real snappy and you know a lot of anti-war trivia because they're going to be expecting it.
Yeah.
That'll be easy enough.
If that's all I got to do, hell.
That and swim.
Okay.
Hey, listen.
I'm going to even get you on the show.
I'm going to get you on the show.
I'm going to get you on the show.
I'm going to get you on the show.
I'm going to get you on the show.
I'm going to get you on the show.
I'll let you go, dude.
I know you have very important things to do, unlike just to chat with me all afternoon.
But I really do appreciate you coming on my show, Bob.
It's been way too long since we've spoken.
Thanks for having me, Scott.
And I keep up the good work.
We especially appreciate you coming on the show.
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