10/20/08 – Robert Murphy – The Scott Horton Show

Alright folks, welcome back to Anti-War Radio.
It's Chaos 92.7 in Austin, Texas.
I'm Scott Wharton and our guest today is Robert Murphy.
He runs the blog Free Advice and a website called Consulting by RPM.com.
He's also a scholar at the Ludwig von Mises Institute, those Austrian economists.
Welcome back to the show, Bob.
Thanks for having me, Scott.
Hey, I really appreciate you coming on the show on short notice for us today.
Sure thing.
Hey listen, so I want to learn more about this financial crisis type thing.
And let's see, I guess where I want to start is I was wondering if you could explain to me about what I'm coming to understand is the fraud of what they call the credit default swaps, which really aren't credit default swaps, they're insurance policies.
And apparently there's been tens of trillions of dollars of speculation in these insurance policies made to cover these mortgages.
And I just wonder if you could help kind of explain what that is and then also if you could help answer whether the payback for all that speculation has already come or is still waiting to come due.
Okay, sure.
So a credit default swap, first of all, the reason it has that name is there's other contracts in financial markets that are called swaps.
And in those contexts, the term is intuitive that like if you have a fixed interest rate, and then you want to swap and get a variable interest rate, then you find someone else who has the thing you want.
And then that person, you know, he wants what you have and you swap and there's a contract.
And so it makes sense that you're swapping cash flows.
The reason they use that strange term for what really is a credit default swap, which is really just an insurance contract, and I'll explain in a second exactly what it is, but I just want to explain to people the reason it has this odd name of a swap, my understanding is it's just a regulatory trick they're trying to avoid.
They can't call an insurance contract because then they would be regulated under the insurance laws.
And so by structuring it, no, this is just a swap just like other, you know, commodity swaps and interest rate swaps, then they avoid punitive regulation.
But for whatever reason, that's what they call it.
And now the question is, what is this thing?
Well, a credit default swap is a different entity that's just making a side bet.
So let's say you have bonds issued by some major corporation and you're worried about, well, gee, what if that corporation defaults on these bonds and then I'd lose all my money that I lent to them?
You go to some other company and you say, I want to buy a credit default swap on General Motors.
So in case GM defaults on its bonds, I'm not left holding the bag.
And so this other corporation says, okay, well, we'll write this contract with you called a credit default swap, and if GM defaults on its bonds, then we pay you.
And then in exchange for that, I pay this other company premiums.
So it's really just an insurance contract on the event.
You know, it's not I'm buying insurance when my house burns down.
It's I'm buying insurance in case this company that I have a bunch of bonds from in case they default.
So what's the big scandal?
Okay.
I'm sorry?
So what's the big scandal?
The problem is, or the alleged problem is, this is how, or this is the mechanism through which the subprime mess and then all the real estate stuff in general is supposedly going to infect the whole world financial system because what's happening here, and this is what the problem with AIG, that American insurance company was, if you recall a few weeks back, that was the big deal.
The reason AIG was in trouble was not that they bought a bunch of mortgage-backed securities.
It was that they had written a bunch of credit default swaps on companies that now were holding all these bad securities.
Right.
So the issue is here, companies are now in trouble not merely if they bought a bunch of bad mortgage securities, but if they had issued a bunch of credit default swaps, insuring the companies that now are in trouble of going bankrupt or at least defaulting on their bonds.
That's what the issue is, is why a lot of firms now are vulnerable, that at first glance you would think, well, gee, they would have nothing to do with the real estate sector, so why should they be in trouble?
It's because, well, if they were insuring the companies that are now in trouble, then they're in trouble.
And the issue in terms of people who blame everything on the free market, the issue is the credit default swap market was fairly unregulated compared to some other markets.
And so, of course, there's trillions of dollars of policies being issued.
And just to clarify, when you see these astronomical numbers, what that's referring to is what's called the notional value of the contract.
So if you ask the question, well, gee, how much fire insurance is being offered in the United States right now, that would be a huge number, too.
It doesn't mean that's how much fire insurance companies are going to pay out.
It just means if you added up the value of the property that technically they're underwriting, it would be an astronomical number.
So that's where those huge numbers are coming from, is they're saying, you know, if every single credit default swap got triggered tomorrow, what would the payout be?
And yet that would be many trillions of dollars.
Well, okay, so if the liberal type who said this is all the problem of the free market said that, wow, you know, all these things sound like Ponzi schemes.
They sound like the kind of thing where whether you're a bank or any of these insurance companies that you have far more in liabilities than assets at any given time.
Is that not the result of criminal greed, private property ownership, and free markets, Bob?
Well, it is an interesting question, and you're right.
So there is an element of truth, and I can understand why people who think the government has to keep markets safe would have this reaction, because there is an element of truth.
Like I said, they did structure these things to evade the regulatory laws that apply to the insurance proper industry.
And so it is true that, you know, if there were a bunch of fires, strictly speaking, you know, that shouldn't make all the fire insurance companies be insolvent because they're supposed to set aside enough money to handle that.
But even there, as I'm saying that, I'm realizing that's not true.
I mean, if fires burned down 80 percent of all the buildings in the United States tomorrow, then surely the fire insurance industry would all be bankrupt.
I mean, they couldn't possibly pay all that off.
So, I mean, the regulatory requirements, I mean, they must be assuming some sort of underlying probability of these events happening.
And that's what really is the problem here, that it's while the Wall Street banks held onto these things, it's while the ratings agencies gave, you know, very high ratings to these things.
What happened is that the intellectual mistake, and this isn't the fault of the government per se, but what happened is they had these mathematical models that looked at the real estate markets.
And they said, okay, what's the probability of the San Francisco real estate market tanking and the Miami market tanking and the Chicago market tanking all at the same time?
And they said, well, gee, the chance of that happening is incredibly low because that hasn't happened in the last 50 years.
And so that's why they thought with these mortgage-backed securities, where if you're taking little pieces of mortgages from all over the country and then bundling them into one pool, one common pool where all the monthly mortgage payments flow, they thought that's a very safe asset because you're diversifying the risk across the entire U.S. real estate market.
And that thing has never gone up and down all at the same time, except it happened now because the Fed pushed the market way up, and then the market came crashing down all at the same time.
So my point is, even if they had regulated these things according to standard insurance models and so forth, the regulators didn't know that there was going to be this coordinated simultaneous fall of multi-billion dollars in the real estate markets all across the country at the same time.
So yeah, if the liberal critic wants to say government officials, if they had a crystal ball five years ago, could have prevented all this, I guess that's true.
But I mean, I just ran across a thing the other day where in 2004, two Fed economists published a paper saying there wasn't a bubble in housing prices, that the fundamentals justified the rise in home prices.
So I mean, to assume that politicians are going to know more and try to be safer with investment from the people who are actually going to suffer the losses, I think is very naive.
Well now, you guys at the Mises Institute predicted all this years back, right?
Right, and not me personally, I was dabbling in other things, but yes, the Austrian theory of the business cycle explains what happened, and yet people like Mark Thornton, who got the URL to prove it, they wrote things back in 2004, I think, showing that yes, this is a credit-induced boom, and we're going to expect housing prices to come down in the future, that this is unsustainable.
Yeah, there's one by Ron Paul from 2003 called The American Dream with No Money Down.
Yeah, right, exactly.
So it's – I mean, you're right, with each of the specific components of what fueled the housing boom, certainly libertarian economists, particularly ones associated with the Mises Institute, explain the problems of that piece of the puzzle.
So I think very few people saw the absolute catastrophe this was going to be, but when Fannie and Freddie – I mean, I myself have written on this in my book, The Politically Incorrect Guide to Capitalism.
I have a little thing where I made fun of the Wikipedia article explaining how Freddie and Fannie work.
There's a little part in there where it says something like, this arrangement is seemingly benefits all parties involved.
And then I put my little joke that except for the taxpayer, if they default on these things, then the taxpayer's going to eat the loss.
All libertarians could explain to you the problems of these different components, and then it just so happened that they all came together in the last few years to promote.
So in other words, the Fed provided all the cheap credit, and then it was the things like the Community Reinvestment Act and Freddie and Fannie and so forth that channeled that cheap money into the housing sector.
Well, you know, it seems like – and my level of expertise on these issues is really short, but I tend to just by default blame the Federal Reserve for whatever economic problems exist.
Their pretended good policies, their best efforts, and the backlash from them.
But it seems like a lot of the debate around what's happening now is centered around the symptoms and not the cause.
Well, for example, I read this great – it was really funny actually, this exchange between Matt Taibbi from Rolling Stone and I forget the guy's name from the National Review, the conservative magazine.
And the guy from the National Review immediately started blaming poor black people for taking out loans they couldn't pay back.
And Matt Taibbi just jumped all over them and said, oh yeah, of course, it's the weakest among us who are responsible for all this.
It wasn't a bunch of billionaires trading in these ridiculous insurance policies to the tunes of trillions of dollars in the inflated market and the most powerful people screwing us.
Oh no, it's that poor black guy's fault for taking out a loan that now that the value of his house has dropped, he's upside down in it and can't pay it anymore.
There's a danger whenever something like this happens that every special group with their own ideologies just takes their principles and applies it without really making sure that it fits up with the facts.
And yeah, it's true that with the Community Reinvestment Act and things like that, that there was pressure put on banks for them to lend to groups that traditionally would have been denied mortgages.
But the question is, I mean, that alone wasn't enough to generate what happened.
The question is, why did all these Wall Street banks take these mortgages that were of dubious value and then package them into securities and sell them off to other people?
And how come the ratings agencies signed off on them?
And that's really – if it had just been poor black homeowners getting mortgages they shouldn't have, then that would explain why a bunch of banks failed.
Banks that granted mortgages, but it wouldn't explain the financial crisis per se.
And as you say, and I'm sure Toby said that, was somebody sticking a gun to these banks' heads?
Well, in a sense, in some cases they actually were.
I mean, there were lawsuits brought against particular banks for not having so-called discriminatory lending practices.
But yeah, I mean, what happened the last few years?
There were several different things that all had to happen at the same time.
I would use the phrase the perfect storm because I'm sick of that phrase, so I won't use it.
That's funny.
Yeah, that's what everybody keeps calling it.
And now one thing that Taibbi brought up in his argument was he said this is all Phil Graham's fault because of the thing he passed back in 1991 or whatever it was.
And the National Review guy had no idea what he was talking about.
All he knew was his acorn talking points or whatever.
But I don't know what he was talking about either.
It seemed to be, Taibbi, I think he said that Phil Graham, senator from Texas, the man who beat Ron Paul in the primaries for U.S. Senate back in 84 or whatever, curse him, that supposedly he was the guy who added an amendment to some bill back in the early 90s that basically created this credit default swap market.
In a sense, kind of, and I'm not sure of the context, but it sounded like sort of legalized and created this fraud by an act of Congress.
Yeah, there are various deregulatory measures.
And, yeah, so the question is, and this is, again, what I'm, when people are trying to say, well, is it the free market's fault, is it deregulation?
It's that, look, you can go one of two routes with it.
You can say the government is going to hold firms' hands and make sure they do things properly and then bail them out if they screw up.
And, of course, if you have those bailouts there, the possibility that these firms have to be regulated in terms of the risk they take.
Or you can just say, no, instead of trying to trust the politicians to fine-tune things and get it all right and to see bubbles as they're forming and to pop them before they get too big and so forth, and to ensure financial integrity, instead of entrusting politicians to do that, why don't we just say firms can do whatever the heck they want, but if you screw up, then you eat the loss?
And so I think the strict libertarian position and the one I personally believe in is the second I described.
So it's true, in our mixed economy, if you've got corrupt business people who are going to lobby Washington and get paid billions of dollars if they screw up, then maybe you do need the government to come in and try to regulate things and make sure the most outrageous abuses don't occur.
So it is a tricky thing here where if the government comes in and allows certain practices and the business people know that if they blow up in their face they're going to get bailed out, then yeah, I can understand, especially if you are someone coming from the left, that that looks very suspicious, especially because it's going to be so-called free marketeers who are ushering in that deregulation.
But again, my point is we certainly did not have a free market in the last ten years, and so this is hardly the fault of the free market.
You know, it's funny because before all this mess, I've always used the S&L crisis of the 80s as my example.
They always blame deregulation whenever there's a financial crisis and then add more regulations and more regulations when we've had this so-called mixed economy for going on 100 years now here, well, really the whole time, but especially since the creation of the Federal Reserve back in 1913 and that kind of thing.
And I always said they never repeal the regulations that say we have to bail them out.
They only repeal the regulations that say you can only commit so much fraud.
You can loan out these many dollars per how many you have in the account, and they loosen those regulations and let them commit more and more fraud, but they never get rid of the part that says we have to bail them out.
Look at Neil Bush.
I mean, that was back in the day he got billions for that bank that he destroyed, right?
I'm not familiar with that particular case, but I'm definitely agreeing with what you're saying.
I mean, it's like to give an analogy for people.
If the post office said, hey, can we charge $10 for a stamp?
And then the Bush administration said, well, sure, we're against price control.
You can charge whatever you want.
I mean, in a sense, you could say, well, that's deregulation, and obviously that would be harming poor people, but that wouldn't be the free market because the post office enjoys a legal monopoly.
Right.
And so it's a similar thing here.
I mean, the whole banking and financial sector is heavily regulated, and the member banks who are connected to the Federal Reserve.
I mean, if you, Scott, wanted to start your bank tomorrow and say, I'd like to have access to those Federal Reserve handouts, you wouldn't be able to do it.
So it's certainly not the free market.
And actually, Anthony Gregory has a wonderful piece at lourockwell.com, so it's running on Monday in case your listeners hear this later in the week.
But I would point them to it.
He's got a great passage where he says, you know, what did we learn in school?
We learned that there used to be laissez-faire in the United States, and then that led to huge leverage bets during the 1920s and the Great Depression.
And so then we had the New Deal and the SEC and all these other things in place to prevent that, and that's why we have these things.
So now we don't have to worry about a depression anymore because we got rid of that horrible laissez-faire policy that they had back in the 1920s.
And then now what just happened, even with all these alleged safeguards, oh, man, the free market just gave us another depression, so that's why we need more government regulation.
So it's like whenever bad things happen, it's always the free market's fault, whereas back in 2002, let's say, if I had said, how about we abolish the SEC?
They would say, well, no, because if we abolish the SEC, we'd have another depression because of the free market.
So the point is just whenever things are good, it's because the government's protecting us.
And then when things go bad, it's not because the protection really wasn't very good.
It's because, oh, that free market snuck in again.
Right.
Those damn greedy capitalists, they're evil.
And this is the thing, too.
This is what I like about you Mises Institute types and the whole Austrian school thing, is it's a love of capitalism that I think necessitates and it's revealed in y'all's writings all the time.
I don't know about yours particularly, but I'm sure yours, too.
Well, yeah, hell, I read your book, The Politically Incorrect Guide to Capitalism.
It's there all throughout is this disdain for actual capitalists who will stop at nothing to just buy off some congressmen, buy off some regulators, use regulators against their competition, cash billion dollar welfare checks.
I mean, American capitalists are the biggest commies of all, it seems like.
Yeah, I mean, this this last crisis really should solidify in a lot of people's minds that I am just appalled by how many so-called free market analysts are endorsing the bailout when it doesn't even make sense in economic terms.
I mean, there are plenty of fairly neutral mainstream economists who are coming forth and saying, you know, what would you?
Paulson said he's going to do this, but that doesn't really make sense.
I think instead they should do such and such.
And for example, this latest shenanigans, they just gave $125 billion to healthy banks.
$125 billion to healthy banks.
You remember just a year ago, $125 billion was a huge number.
Now it's not because these other numbers are thrown around.
And then the point was, wait a minute, I thought we were trying to rescue the financial system.
Why are you giving money to the biggest, healthiest banks?
And the official reason was, oh, because we don't want there to be a stigma for the unhealthy banks when they take our money.
And, you know, as someone pointed out, that's like giving Bill Gates a check to make sure people don't feel bad for taking welfare.
That's craziness.
Well, and, you know, really, the congressman, because and I think this is something you alluded to earlier, the idea that people who aren't the ones paying the penalty when they're wrong, the idea that they would have a better grasp on what's going on than people whose own assets are at stake.
You know, the gulf there is legendary.
I mean, this is what prices are all about, right?
I mean, this is what this is why government doesn't work, is because they have unlimited access to our taxes and to the pruning press, and it's not their money.
So they'll do ridiculous things like in the bailout bill.
I know they gave a giant welfare check to Starkist Tuna for their tuna fishery off the coast of Pango Pango somewhere or something.
Right, exactly.
So to go back to what you were saying before, those credit default swap markets, again, it's understandable why someone who believes in the potency of government regulation and the need for it to say, oh, this market was unregulated is crazy.
But, again, really, you've got to say, well, the firms writing these contracts, obviously they're the ones that are really regretting having done that right now.
I mean, they're going to lose a lot of money.
And it's true that they can get a bailout.
They can sort of cover their losses.
But on the face of it, they're going to have to pay out billions of dollars if these other companies go belly up.
And so the question, like you just said, though, is, is it really the case that politicians are going to come in and say, no, no, no, let us advise you on how best to protect your wealth?
I mean, that doesn't make any sense.
Would you want the government telling you how to invest your retirement portfolio?
You know, the idea that people in Washington are going to care more about your nest egg than you are is crazy.
And so by the same token, the idea that the government's going to have shareholders and investors protect their wealth better than they would on their own is crazy.
And, again, people say, well, okay, but then what just happened?
And that's because this was not a free market.
These companies knew that they were too big to fail.
And so it's not surprising that then they took too aggressive risks, and then it blew up in their faces, and now they're running to Washington to get a handout.
Yeah, Goldman Sachs has their guy as the secretary of treasury right now.
Exactly.
I mean, this stuff, if I were going to write a novel or something, I wouldn't have dared to put in these things because it's just so ridiculous.
Like all the stuff, you know.
And Neal Cash Carey, the guy that was tasked to actually run the distribution of this $700 billion, he also was a former, I think, vice president at Goldman Sachs.
I mean, you'd think Paulson would have picked somebody from a different company just for appearances, but no, he didn't.
Yeah, well, and the guy's name is Cash Carey.
Right.
I heard someone say, like, what is this, a villain from a James Bond movie?
Exactly.
Well, and, you know, what's funny as hell about that is I read a profile of him in the New York Times, which assured us that he's really smart and that, you know, he's one of these really brilliant engineer guys.
And so don't worry about it, Bob.
He knows what to do, man.
He'll figure it out.
He's really, really bright.
Yeah, and, again, just what happened with all this is there were a bunch of bright people, you know, the smartest guys in the room mentality, and that's part of what fueled this is they, you know, they had these miles that the field was called financial engineering, and it's true.
If you plugged in the probabilities of, you know, they made some assumptions about real estate markets and how their prices change over time, and they thought, gee, if we just put in enough different independent variables from, you know, 1,000 different markets across the country, the chance of the overall thing, you know, going down by 50% is virtually zero.
And so that's why they thought these things were really safe.
And, of course, they made some assumptions in the beginning, and those assumptions were wrong.
And in a free market, you know, people can make mistakes in the free market.
There can be fads, and people can get swept up by new things.
But the way you deal with that is you say, okay, if you are wrong, and you put all your eggs in one basket and you lose it, then you go out of business.
And the other firms who didn't go down that path, who were more conservative during the housing boom, and they didn't have, you know, 50% returns year after year because they were saying, you know what, I'm not going to go into these financial derivatives, these exotic things.
Those companies then would be left standing, and they could gain market share.
But that's not going to happen now because all the companies that followed these new fads and wasted all this money, they're going to get bailed out because, oh, they're too big to fail.
And so there's no lesson being learned, and so then the free market doesn't work as well if the companies that screw up aren't allowed to just go out of business.
Right.
Okay.
But now I want to try to make the case the best I can, which is probably not going to be very good since I don't even think there should be a government at all.
But anyway, I want to try to make my best case for the bailout.
And it's basically stealing from what you taught me about how, look, you could have perfectly good companies that have every reason to believe that they're going to continue being profitable and continue exchanging goods and services with customers for a long time to come.
And yet, if you have a complete breakdown in the banking system where all these major banks are so overextended and all the banks are afraid to loan money to each other, and everybody's got these incredible reserve ratios where they have all these bad loans out with barely anything left, what you told me is you could have perfectly good firms who end up getting completely screwed by the breakdown in the banking system.
They can't make their payroll.
They can't make the light bill for this week.
That's it.
Their employees are gone.
And you're hitting the unemployment rolls, hitting the bread lines, and we have major problems there.
So we have to keep some liquid, even though you're right, Bob, you know, damn it, these capitalists and their co-conspirators in government have created such a disaster.
But, boy, we can't let it bring down the whole country.
We have to create some sort of softer landing for this crisis, rather than just letting it collapse all the way through the floor and putting millions out of work.
Right.
And that is what a lot of people are saying.
I complained before about the free market types who are on board with this stuff, and they do start their articles or op-eds with caveats about, you know, in a perfect world this wouldn't be necessary, and I hate to endorse something that's so socialistic, but it's a regrettable necessity in these cases.
And they make the case that you just did that we have to do this or else the whole world ends, basically.
And the answer to that is that it's, you know, and I've done some, you know, I've been reading a lot on this and I've actually talked to some small business owners in my community, and people have looked, and this notion that there's a credit freeze, it's actually a little bit of a, I don't know, of a hysterical notion that really what's going on is just the credit market for certain firms is frozen.
But, for example, I mean, I keep getting credit card offers in the mail, and I read work of other economists, and they went around to some car dealerships and said, are you still advancing credit for your customers?
And they said, well, yeah, they have a job.
And, you know, so, and the guy who lives next door to me runs a fairly successful business, and I asked him, I said, you know, is it true that some small businesses pay their employees using credit?
And he said, no, if you're having to borrow money just to make your payroll, then you're probably about to go bankrupt anyway.
All right, so a lot of these things really are just blown out of proportion, and really I think the situation is they've raised the standards.
So people can still get credit as long as their balance sheet looks good, and, you know, the banks check them out, or if you're an individual, if you have a job and you've been making, you know, you have a good credit history, you can still get credit.
So what's really happening is people are having the free credit of the mid-2000s where you didn't even need to prove you had a job, and you could all of a sudden get a $600,000 mortgage or whatever these outrageous cases are.
That kind of stuff is coming to a stop.
But that's not because of the bailout?
It should come to a stop.
But that's not because of the bailout that credit markets are okay because the government intervened and saved us?
John McCain suspended his campaign and all that great stuff?
Right, exactly.
So it is true that the standard indicators that people were pointing to, those things have gotten better in the last few days.
So the companies that were really in trouble, you know, these major banks that weren't lending to each other because they didn't know who was holding the mortgage-backed securities, that has loosened up a little bit because of the bailout.
But what I'm saying is those banks should have been frozen up because they really did make a lot of bad mistakes, and, yeah, you shouldn't lend to them if there's a chance they're going to go bankrupt tomorrow.
But even before the bailout was passed several weeks ago, you know, these hysterical warnings about small businesses aren't going to be able to make their payroll, I don't think that was true.
Like I said, I actually talked to some small business owners, and they were saying, no, that's crazy.
If you really need to borrow money, you could go to the bank and show them your balance sheet.
Because, again, the thing with the credit, you know, just think about why was the credit freeze happening.
It was because banks were afraid that, oh, gee, if I lend this bank money, maybe they're sitting on a bunch of these toxic mortgage-backed assets, and they're going to go belly up tomorrow.
So as long as you're not, you know, if you're talking about somebody who's running a laundromat, you're not worried that that guy is sitting on mortgage-backed securities, and you can look at his balance sheet to see if he is.
So what was really freezing up were these credit markets between these huge banks that had made a bunch of bad bets, or some of them had, and the banks weren't sure which people had made bad bets and which weren't.
And that would have just played out.
And I said this the last time I was on your show, I think.
And why that was happening was because of the promise of a bailout.
So these banks had no incentive to be forthcoming about what they were holding on their balance sheet, because they were just hoping that the government was going to take it off their hands.
So to answer your question, no, I mean, I don't think it was ever the case that the entire financial system was really at risk.
I mean, I suppose you could say there could have been massive bank runs, and that's really the only thing.
And even there, that's not the fault of the free market, because of our fractional reserve system.
You could say, hey, that's the way it is right now, and we've got to deal with that reality.
Even there, though, with all the FDIC and everything, I don't think there was ever a chance that everyone was going to start running to the bank and taking their money out.
And so I think it was a bit of a false threat, which this administration hasn't been afraid to do before, to scare people with things that really aren't a plausible scenario in order to justify something that actually ends up being worse than what they were warning about.
Right.
Well, and I guess in the same sense that people ask, well, if Saddam Hussein had nuclear weapons, would you have supported the war then?
Let me ask you, is there such a thing?
Could the government destroy the economy bad enough that you would support some kind of bailout to keep banks open and keep businesses going, or they could basically never do enough to really destroy the economy that much, or what?
Well, I mean, there's two things.
So the one issue is a moral, principled one, sort of like if you could shoot one innocent person to save ten, would you do it, and how do you answer that question?
So let's put the morality of it aside and just say in terms of practicality, I mean, what you're saying, you're asking me, is if the government had conducted such horrible policies that it all of a sudden looked like things were going to end, and then could the government fix things by stealing some money from taxpayers and giving it to the people who had made reckless bets, and could that actually fix things?
No, I mean, I suppose there's some scenario you could come up with, but if the people in charge dug us into a hole, I wouldn't expect them to save us all of a sudden.
And so I really think the issue, I mean, like you said, you may be nailed to a foreign policy if you're against the Iraq war, for example, and you say, yeah, we should have never gone in there, but now that we're in there, things are really bad, and maybe now we've got to stay there another two years and do things perfectly right before we pull out, and what are the chances that that's going to happen?
That's why most people say, no, let's just get out right now, if you were against it in the first place.
There's a similar thing here.
If you think the financial crisis was caused by horrible government policies and corruption, then to say, okay, now let's suppose all these people in Washington right now are going to have a change of heart and do things for the common good, can you support them then?
Well, I don't trust them to do that.
U.S. out of the economy.
I'm sorry?
I was just chanting, U.S. out of the economy.
Right.
So, I mean, really, the things that Paul Flynn has been saying, I mean, his official rationale just keeps changing from week to week.
I mean, it's hilarious.
You can go back when he let Lehman Brothers fail, and just his rhetoric from that point about how, you know, we can't just have a bunch of bailouts here.
You know, draw a line in the sand.
This is a free market economy.
You know, and it was all out the window.
And then, you know, he wanted to buy up the mortgage-backed securities, and he and President Bush were going on TV saying, you know, we have to give this time to work and everything, and then the very next day he said, okay, now we're going to start buying shares in all these companies because, obviously, our other plan hasn't worked.
But the day before he just said you need to give this time to work.
You know, I mean, just the rhetoric keeps changing, and the only thing that's constant is the government keeps getting more and more power over the financial sector.
That's the one constant through all of it.
Oh, that's amazing.
Well, and that goes to the perennial question when it comes to these things, whether we're dealing with stupidity or the plan, and I guess that's always the question when it comes to our foreign wars too.
But, you know, somebody created this central bank for a reason in the first place.
Was it to make it this way, or was it really to prevent it from being this way like they teach us in school?
Well, certainly if you go and read Rothbard's case against the Fed, he's very suspicious and goes through and looks at the people involved and does not find that they were doing it for the common wheel.
And I would say, like, because you're right, some people say to me, oh, so Paulson had this plan two years ago.
And, no, it's not necessarily that this was a giant conspiracy, but what's happened is the people in charge will take the situation as it unfolds and spin it to their advantage.
And so, I mean, again, I think you have to be incredibly naive to think that Paulson is not using this to benefit Goldman Sachs.
I mean, it's no coincidence that Goldman Sachs now is one of the remaining investment banks when a bunch of its competitors have either gone bankrupt or been gobbled up.
So, yeah, the people in charge, they can't run the entire world down to the last little detail because there's billions of people and they're all trying to do different things.
You can't control everybody and what they do, but they can certainly try to weave things and direct things so that they always end up to their advantage.
Well, and, you know, Ron Paul talks a lot about the ignorance of not just, you know, Congress as a whole, but even the leaders most involved in these issues and, frankly, the economic ignorance of people like Paulson and Bernanke that they really don't understand.
I mean, Bernanke, I think Ron Paul's criticized Bernanke as supposedly being some kind of expert on the Great Depression, and yet he understands it all wrong, and so the lessons that he takes from it and tries to apply to our situation now are therefore all wrong.
Right, and I should clarify, I am open to the possibility that Bernanke himself is a pure, well, not pure, but an academic, and that he has just been mistaken on this and was doing what he thought he needed to do.
I mean, if you think about it, you know, his dissertation, but a lot of his work was on the Depression, and so I kind of think that maybe he thought, like, oh, this all makes sense, but I'm in charge just when the next Depression's about to hit, and so I need to fix it.
And then you're right, and Ron Paul is right that I disagree with what Bernanke's, you know, diagnosis of what happened in the 30s was, and so it's not surprising then that he's going to do the wrong thing now.
But in contrast, I do not trust Paulson.
I mean, just reading his changing statements from week to week, I think he is using this just to funnel money to his friends, whereas Bernanke, I'm open to the idea that it's just an intellectual error.
Well, and you know, that's interesting, because that's like premise number one of Ludwig von Mises, right?
It's that everybody's an individual, and man acts.
And so there you go, the difference between those two partners in crime right there.
Now, let me ask you about this, because, for example, well, and you've covered how basically it's a lot of propaganda about how doomed small business would be and that kind of thing, and clearly this is not the same economy from the days of the Great Depression.
Some say it's much worse in terms of the amount of debt we carry.
On the other hand, it's obviously a much wealthier country than it was back then.
But something I never hear addressed, or almost never hear addressed by the Austrians, and this includes Dr. Paul when he goes on TV and talks about we just have to let there be a recession.
That's the fever to get rid of the flu, and then we'll be all right again, but we've got to let it happen.
Unemployment.
This is the big story of the Great Depression, is that there was 25% unemployment, and that if it had gone on like that, we'd have either had a communist revolution or a fascist coup d'etat in this country.
That Franklin Roosevelt saved capitalism basically by putting off a revolution, which could have come from the masses of people who were thrown out of work and were literally starving.
And what would be the situation?
We don't need to necessarily rehearse all the bad employment policies during the New Deal and what have you, but if you could address what you think it would mean to take a completely hands-off approach and let there go ahead and be a bad recession rather than trying to continue to inflate like they're doing now.
How high of unemployment could we see, and how dangerous is that to having peace and continuity around here?
Okay, well, sure.
Historically, a recession, they called them depressions with a small d, and then they stopped calling them that after the Great one because they had been made impossible because of the New Deal, so that's why they stopped using that word.
But historically, there were severe depressions in United States history, but they were all over fairly quickly.
So after about 18 months, things were back to normal.
And it wasn't until the Great Depression that you had this decade-long double-digit unemployment, and not coincidentally, that was also the first time that the federal government really rolled up its sleeves and said, you know what, we're going to fight this thing.
And so free market economists will say that's not a coincidence that the government under Herbert Hoover and then even more so under Franklin Roosevelt, the federal government told big businesses, don't cut your wages, keep wages the same, because they believed in an under-consumptionist theory of recession.
They thought the reason recessions happen is that workers get laid off, they spend less money, then businesses have less money, and it's a vicious cycle.
And so Hoover and then FDR were telling big business to keep your wages up, and that's what caused the massive unemployment.
So it's true, what Ron Paul talks about, and the Austrians more generally, if you have this unsustainable boom period like we had during the early 2000s in the United States, there needs to be a recession that too many resources went into housing in our case, and then that needs to get flushed out of the system.
People need to get rearranged.
There were too many people in building in the related sectors, and so those workers need to get shuffled around.
And so if the government tries to prevent that reaction, it's just going to prolong the underlying problem, and it's better just to rip the band-aid off quickly, as it were.
So there doesn't need to answer your question.
If the government just last year had just said, you know, we're not bailing on anybody, we're just going to sit back, and if you screwed up, then you're going to fail, there would have been a recession back then, but it would have been fairly brief.
It might have been severe, but it would have been brief, and then things would have gone back onto normal.
And so the problem is when the government tries to just freeze everything and say, no, no, we're not going to allow a reaction, and we're just going to keep the production structure the way it is and just pretend that this imbalance doesn't exist and let's hope it goes away.
If we print some more money, maybe that will fix things.
And that's really all you're doing is sowing the seeds for a deeper crisis down the road.
Because remember, what happened, the reason we had the housing boom was because the dot-com crash, and Alan Greenspan took rates down to 1% to try to give us a soft landing back then.
And so if we try to get a soft landing now, all we're going to do is sow the seeds, so five years from now, there's going to be an even bigger problem that's going to make this one look like child's play.
Just like right now, the dot-com crash seems like nothing.
But at the time, it was a big deal, and that's why Greenspan brought the rates down to try to give us a soft landing.
Well, I mean, the stock market's crashed.
Well, I mean, I guess there was a crash then, the NASDAQ got obliterated and all that kind of thing, but they say that the stock market at one point at least was down to, had lost 40% of its value, was down 5,000 points, that kind of thing.
Are they going to be able to inflate another bubble?
Is the market saying, no, this isn't going to work?
And if there is going to be another bubble, in what, so I can make some money for a change?
Well, they were saying for a while the bubble was commodities, right, that if you look at what happened to oil, I mean, most of its price rise was from last September through this summer, in July is when it peaked.
And so a lot of people were saying, you know, that's not a coincidence that the Fed started cutting rates back last September 07, and then all of a sudden oil and other commodities shot up, and so they were saying people were rushing into commodities, and that's where the new bubble was, but now obviously even commodities are down.
I think right now everyone is so spooked that they're not going to just start piling money into something that's part of the problem, and why the traditional measures aren't working is that no matter how much money the Fed is shoveling into the banking system, they're not making as many new loans because they're all just panicked.
You know, they're in defense mode.
But I think ironically what's going to happen is once people start calming down and things get back to normal, then all this huge glut of new money that they just created is going to start filtering through, and then that's going to create another asset bubble.
So, no, I can't tell you where it's going to be.
Just like it was the Internet stocks, the NASDAQ in the late 1990s, and then it turned into housing, and then now who knows what the next one is going to be.
So it's always going to be something.
That money has to go somewhere, and there's always going to be reasons to justify why, oh, this isn't a bubble, this time it's different.
You always have people explaining during each bubble why it's not really a bubble.
But the point is the Fed is doing everything it can to prop the economy back up, and if they continue down this path, I think people will, you know, this immediate crisis mentality will pass, and then people will start investing again, and we'll get another bubble.
And I think five years from now the crisis is going to be worse than it was this time around.
Well, what if they had, after the dot-com crash, if they had inflated a bubble in housing, and then, you know, September 11th aside and that kind of thing, what if Greenspan and Bernanke had actually been responsible and tried to go ahead and give us a soft landing, then, you know, say, I don't know, in 2004, 2005, 2006, and start trying to crank interest rates back up slowly and be much more responsible rather than letting it get to the edge of the cliff?
Would that have been effective?
Would it even be worth a try, or you really can't do that?
Once you start inflating the bubble, you're basically stuck that way.
You can't do it, and that's what's really interesting, is Greenspan did exactly what you just said.
If you go look at, or after we get off, I'll send you the link.
If you look at the federal funds rate, the history of it, Greenspan cut the rates sharply and then held them at 1% from 2003 to 2004, but then after then he started heightening them, and it looked like just textbook.
Like every policy meeting they would raise the 25 basis points, and they may not have gotten to that precision, but if you look at the rate, they came way down after the dot-com crash.
They were held at 1% for a year, and then they go up, it looks like a little staircase.
And so in terms of, I mean, Greenspan was trying to do exactly what you said, and then the same thing with Bernanke.
If you look at the money supply figures, once Bernanke took over, he actually brought it way down, and that's why some people were warning about deflation.
It's only recently that he's been pumping in tons of money.
So that's why I was saying that actually I think Bernanke was an academic, and he got thrown in the job, and he said, well, this is what the textbook says you're supposed to do.
And it wasn't working because the textbooks are wrong, their whole model is wrong, and once you inflate the asset bubble, I mean, because it's not just a matter of financial numbers.
There really were real resources going into housing.
Too many homes were built, and too many big McMansions were built, and no matter what Greenspan does with money supply figures, that's not going to undo that reality, and so that's why the Austrians say there is a physical component to what happened during a boom period.
Americans really did consume too much.
They bought too many cars, and they ate too much food, and bought too many TVs that were imported from China, and you can't just undo that by doing something with the money supply, and so that's why this notion of a soft landing is not really possible.
Well, so tell me this.
We're already over time and off the air and just recording the tail end of this interview anyway.
If you still have time, I don't want to put you on the spot.
Yeah, I've got time.
Okay.
Well, tell me this then, Bob.
What direction are we headed now?
What's going to happen from here?
Are they going to inflate another bubble and things are going to seem okay for a little while, or we're headed for a catastrophe?
I mean, it's hard to tell.
Like you said, there's a lot of hype, but from my point of view, I don't really know how to separate the wheat from the chaff at all.
I mean, the TV says we're headed toward a new dark age, man.
This is the end of everything.
I don't know how much likelihood to a sign of this, but it is possible things could get awful, because what really scares me is let's say Obama wins, and not that McKean would be much better, but let's say Obama wins and he gets in there, and then because of all the money they just flooded into the system, things do thaw out, people relax a little bit, they start investing, and let's say we have 10% inflation by next March.
Okay, 10% price inflation, the way the government reports those figures, which is entirely possible.
Well, what's Obama going to do?
Is he going to say, you know what, I think we should go back on a gold standard and we should have free and open markets?
No, he's going to start putting on price controls, and then there's going to be shortages.
You're not going to be able to, you know, just like we had with gasoline in the 70s, and even, you know, we had it here in Nashville that there was actually, I had to wait in line for gas a couple weeks ago because of the hurricanes, and there were, you know, anti-gouging laws here, and so gas stations were afraid to raise their prices.
So I actually saw lines out the road, you know, on the road at gas stations, and that's going to be for everything if the next administration tries to protect people from these evil gougers.
And so that's the thing that really scares me is not so much just the Fed, but the Fed's going to do its inflation, and then the federal government's going to try to protect us from the harmful effects of it.
And then those two things put together is what really could bring another depression.
Right, okay, so let me try to restate that in my kindergarten understanding here.
First of all, the government is printing all this money.
That's the inflation.
It's not the rise in the prices at the local gas station.
The rise in the prices at the local gas station is the guy that runs that local gas station trying to make his tiny percentage on the margin cut for himself and get the gas to you as best he can.
And as the value of the money goes down, it takes more and more dollars.
And, of course, there's manipulation of the market price of gas besides that, you know, all things being equal.
But what you're telling me from your experience just the other day, just a few weeks ago, with price controls at the gas station or anti-gouging laws, what that means is the local gas station attendant is afraid to raise his prices because he'll get in trouble with the government.
But because he can't raise his prices, he can't afford to buy the gas to get in the ground to dump from the pump into your truck.
And so that's why you have long lines and shortages.
It's not that America's out of gasoline.
It's not that 18-wheelers can't get through the roadways.
It's because he needs to be able to raise the price to get them all the way out to where he needs to kick that supply down to us retail customers.
Do I get it right?
Is that it?
Right.
That's exactly right.
So specifically what happened here was every other gas station was just closed because they said, you know what, if we're not allowed to raise our prices because our wholesale price just went up 30 cents because of the hurricane hitting the refineries, then we're just going to shut down until conditions return to normal.
So a bunch of gas stations just shut down, and then the other one said, well, if we have just customers lined up and we're turning the gas over that fast, actually we can afford to have a much lower profit margin.
And so that's why it made sense for a few to remain open.
But, again, so the government changed the reality and the only way it was profitable to sell gasoline is if you had a line of 10 cars the entire day you were open, and then half the gas stations chose to remain open under those conditions.
And so how would that work, say, if they put price controls on bread and milk and diapers and absolute necessities for people's families?
That would probably be the first step, right, if inflation gets out of control.
Right, yeah.
So let's just assume that all of a sudden a gallon of milk is supposed to be $10 next year.
I mean, I'm exaggerating a little bit, but, yeah, you could imagine the government coming in, or maybe it would be local jurisdictions doing it.
I don't know how it would play out.
And, yeah, they would pass regulations limiting it to reasonable price increases or things like that.
And you're right.
They would put it on the most crucial elements, thinking those are the important things.
And so your milk and bread and eggs and so forth.
Yeah, grocery stores, if they know, well, gee, I have to pay my wholesale.
It's now more than what the government's allowing me to legally charge my customers.
I'll just stop stocking the shelves with bread.
And then all of a sudden the bread would disappear from the shelves and milk would disappear from the dairy counter.
And then the next round of intervention, the government would probably then say, okay, we'll forget that.
We'll just give everyone ration cards like they did during World War II.
And now we won't even have it to be a market system anymore.
And we'll just order people, you know, every grocery store, if you want to remain open, you have to have this many loaves of bread per day and this many gallons of milk that you sell.
And so my point is they're not going to stop and realize it's their interventions that are causing it.
They're going to keep blaming greedy people in the private sector, and they're just going to keep laying on more and more regulations.
And that's really what scares me is the inflation could fuel these other reactions.
And that's exactly what happened in the Depression.
Okay, Bob, but Barack Obama, who is apparently likely to be elected president here in a few weeks, has, as he invoked just the other day as one of his economic advisors, Paul Volcker, who is the chairman of the Fed, I think appointed by Carter, but then kept basically through the early Reagan years and the war against inflation.
And so if they did that, say, for example, he, you know, used Volcker as his, made Volcker his treasury secretary or put him back in charge of the Fed or something like that, and they decided to have a war on inflation, crank the interest rates up to 25 percent or something, basically make it impossible for people to take out new loans, and that, you know, kind of strangle the economy in order to put a check on the inflation rather than go in the price controls route.
That would be then the opposite of creating the next new bubble, right?
That would be saying, no, we can't create the next new bubble.
We've got to lick this inflation first, then we'll create the next new bubble.
Yeah, I think you said it well.
Basically what I try to do is I say it as best I understand, and then you get to make it right.
Yeah, I mean, and it's interesting.
I mean, the problem, so what you said was perfectly fine, and what's the tricky thing there is that the way our system works is that if the government wants to restrain the supply of money injections, then that makes the interest rate go up.
So, you know, in other words, if the government just had a printing press, and inflation was the result of the government just printing up a new $100 bill and then saying, hey, we want some more aircraft carriers, let's print up another $200 billion to give the company to do it, then the inflation wouldn't have anything necessarily to do with interest rates that, you know, if there's high price inflation, then the interest rate would be higher to cover that.
But the reason the system now is set up is that that new money has to enter through the banking system, and so that's why if you want to be a hard guy on inflation, that makes interest rates go way up, at least in the short run.
And so it's, again, another perversity of our system that, as you say, if the government wants to amend its ways and get responsible about not printing up a bunch of new money, then in the short run that's going to hurt people who want to borrow money to buy a house.
Well, and also it's sort of kind of, it seems like demand-side economics for the rich people.
Like in the 1980s, it was an era of mergers and consolidation, so all the so-called trickle-down economics, it didn't really trickle down.
The investment didn't really go into new supply.
Rich people just bought each other a lot of diamonds and Porsches and stuff.
They were making a killing off all those interest rates, but they weren't investing in new factories and such, right?
Do I understand that era right?
If you're talking about the immediate, you know, the very early 80s with the high interest rates, it could be true there.
I would need to go review the actual, I mean, I think it is true that with the Reagan tax cuts, that that really did spur output however you want to measure that.
But it's hard with all this stuff to, you know, all the statistics are difficult to back out exactly what the heck happened.
But certainly, you can always be sure that politically connected rich people are going to benefit whatever way the policies change.
They're going to tweak the policies to make sure their rich friends do okay.
Yeah, all right.
Now, I'll let you go after one more question, and I really, really appreciate your time today.
Tell me about, because again, I got the junior high school understanding of what's going on here, but I'm trying my best.
And I think the way I see it is that from the Austrian perspective, the Chicago school of supply side, that basically that's only right Keynesianism, right?
That it was John Maynard Keynes who came up with government intervention can either be demand side economics or it can be supply side economics.
But that's only right and left socialism under the entire Keynesian framework, right, which the Austrians reject entirely and the Chicago school embraced one side of it.
Do I understand that correctly?
That's kind of right.
I mean, so the problem with conventional supply siders is you're right.
They just focus on we need to cut taxes and we need to ease regulations, and that will boost the supply of goods and services.
And that's the way you give a shot in the arm of the economy.
But they're pretty, you know, their view is on money.
They just think, oh, as long as there's not price inflation, then the Fed's doing a good job, or as long as price inflation is not too high.
And so what the Austrians point out is they completely misunderstand how business cycles happen.
That, for example, supply side economists think that the Great Depression was because the Fed overreacted and reduced the money supply in the early 30s.
They don't look at the artificially low interest rates of the 1920s and how the Fed was just pumping in fiat money into the credit system and causing a bubble.
Supply side economists look at the 1920s and there are fairly stable prices, and they say the Fed did a beautiful job in the 20s, and then it just screwed up in the 30s.
When Austrians say no, it's, you know.
So the inconsistency, as you say, is supply siders talk a good game about being free market and how you let the prices determine things and not central planning, and yet they'll say the Fed really ought to raise rates next quarter because of something.
So they're central planners when it comes to the interest rate.
They think that's the one price in a market economy that the government ought to be setting, and that's kind of inconsistent.
Yeah, well, would they, what, make the case that if the market set interest rates that fractional banking would be even worse, if it was just a free market and currencies and stuff, that people would be more reckless?
What's the necessity for having the government set that one price, if nothing else, the price of money?
I think the argument probably varies depending on which particular supply side economist you talk to, but I think a standard view is, let's say you're on a gold standard.
If the demand for money increases for some reason, whether because of commerce or just because people get more fearful for the future, under a gold standard, then you've got to go and dig up more gold, and that takes real resources.
Workers and tractors and whatever have to be devoted to digging up more physical gold, whereas if you have a Fed and there's an increase in the demand for money, you can just print more dollars, and that doesn't cost anything, and so it's more efficient.
So I think that's the idea, and just in general, it's better to have these wise overseers to make sure that things don't get off kilter.
But again, even as I'm saying that, it doesn't make any sense, because in a while they think they should just be straight up Keynesians, and that's the whole Keynesian approach, as you said before.
All right.
Very interesting stuff.
I swear to God, one day I'm going to get around to reading Human Action and figure these things out.
But in the meantime, I really appreciate you, Bob.
Oh, sure thing.
Thanks for having me, Scott.
All right, everybody, that's Robert P. Murphy.
He's the author of The Politically Incorrect Guide to Capitalism, and his website is consultingbyrpm.com.
You can always find him also at the Mises Institute, mises.org.
All right.
You still there, Bob?
Yep.
Hey, man, that was really great.
I really appreciate you.