WEBVTT NOTE The Myth of Neutral Interest Rate Policy 1 00:00:00.000 --> 00:00:04.000 We hear all the time about the issue of the so-called neutral interest rates 2 00:00:04.000 --> 00:00:08.760 and the central bank is aiming at the so-called neutral interest rate. 3 00:00:08.760 --> 00:00:11.360 And I was pondering all the time what it's all about. 4 00:00:11.360 --> 00:00:18.680 Now, the conventional wisdom suggests that if the central bank will bring the so-called federal funds rate 5 00:00:18.680 --> 00:00:21.960 towards this particular rate, we'll have a heaven on earth. 6 00:00:21.960 --> 00:00:27.240 We'll have proper stability, everything will be fine, and there won't be any disruptions. 7 00:00:27.240 --> 00:00:39.240 So in other words, according to the mainstream thinking, the so-called neutral interest rate represents an environment where prices do not move at all, stable stability, so to speak. 8 00:00:39.240 --> 00:00:46.920 And according to mainstream thinking, price stability is the key for having a proper, balanced type of economy. 9 00:00:46.920 --> 00:00:55.040 So if one looks a little bit into this idea, it's not actually modern at all, and in fact, it's got a long history. 10 00:00:55.040 --> 00:01:25.040 And you would be surprised the history begins in 18th century by writings of then economist Henry Thornton who actually was the first so-called central banking type of economist and the idea of the neutral interest rates was further articulated by famous Swedish economist Knut Wichsel and it won't be exaggeration on my behalf to suggest that writings of Knut Wichsel are the foundation 11 00:01:25.040 --> 00:01:30.040 Congratulations today for the modus operandi of all the central banks worldwide today. 12 00:01:30.040 --> 00:01:40.040 Now, so if I'm correct in what I'm suggesting, I believe it will be a good idea to have a look what actually Mr. Wixel are saying. 13 00:01:40.040 --> 00:01:47.040 And you will be surprised to see there's a lot of similarities of what Mr. Greenspan is talking, all the central banks in the world likewise. 14 00:01:47.040 --> 00:02:07.640 The key aspect in Wixellian framework is that the fluctuation in prices are driven by the fact that as today modern economists are saying that money market interest rates are fluctuating along the so-called natural interest rate. 15 00:02:07.640 --> 00:02:19.640 According to Wixil, if money market trades moves above the natural interest rate, then it sets in motion downward pressure on prices, so-called price deflation, which is bad news, of course. 16 00:02:19.640 --> 00:02:30.640 And if money market trades interest rate, which is set in financial markets, is set below the natural interest rate, this sets in motion upward pressure on prices, which is, again, bad news. 17 00:02:30.640 --> 00:02:43.640 And therefore, the ideal setup according to Wixle is to have alignment between the money market trade, or if you want a new language, the federal funds rate, with the natural interest rate. 18 00:02:43.640 --> 00:02:52.640 Now, whenever money market interest rate will be in line with natural interest rate, this money market trade also can be labeled as neutral rate, the neutral rate. 19 00:02:52.640 --> 00:02:59.640 Now, having said this, we have to ask ourselves, what does it mean the natural interest rate? 20 00:02:59.640 --> 00:03:01.640 What actually Wixel meant by that? 21 00:03:01.640 --> 00:03:06.640 And in fact, also, Austrian using this term extensively, the natural interest rate. 22 00:03:06.640 --> 00:03:09.640 And it's not always been clarified exactly what does it mean. 23 00:03:09.640 --> 00:03:19.640 And according to Wixel, natural interest rate is that rate where real supply and real demand for capital are in equilibrium. 24 00:03:19.640 --> 00:03:26.640 In other words, if you remember the so-called first year of economics, we're talking about supply-demand curves, 25 00:03:26.640 --> 00:03:30.640 it's a situation where the supply of real capital and demand for real capital intersect, 26 00:03:30.640 --> 00:03:35.640 and you have the happy outcome, the equilibrium interest rate, 27 00:03:35.640 --> 00:03:44.640 and this equilibrium interest rate in the real world of capital is what Wixel meant by the natural interest rate. 28 00:03:44.640 --> 00:03:47.640 Now, how important all that? 29 00:03:47.640 --> 00:03:52.280 First of all, if one looks at the whole framework of Wixil 30 00:03:52.280 --> 00:03:56.520 and how he established the real interest rates, 31 00:03:56.520 --> 00:03:59.080 and he was talking about money market interest rates, 32 00:03:59.080 --> 00:04:00.680 but one observes immediately 33 00:04:00.680 --> 00:04:03.000 that there is some kind of a dichotomy. 34 00:04:03.000 --> 00:04:05.960 Those two are kept in separate compartments. 35 00:04:05.960 --> 00:04:08.720 In other words, the interest rate in the real world 36 00:04:08.720 --> 00:04:10.600 is set by real factors, 37 00:04:10.600 --> 00:04:15.120 interest rates in financial world set by monetary factors, 38 00:04:15.120 --> 00:04:17.120 and they got nothing to do with each other. 39 00:04:17.120 --> 00:04:24.760 In other words, changes in money supply got nothing to do with what will determine the real interest rates and likewise. 40 00:04:24.760 --> 00:04:32.120 So in other words, what we're seeing here is so-called neutrality of money as far as interest rate determination is concerned. 41 00:04:32.120 --> 00:04:39.120 And again, we have to actually ask the question whether it's logical at all, right? 42 00:04:39.120 --> 00:04:47.160 But before we discuss all that, we need to ask ourselves what is all to do with the modus operandi 43 00:04:47.160 --> 00:04:52.680 and how one really applies a weak selling framework in the modern world. 44 00:04:52.680 --> 00:05:02.240 So as you remember, I suggested that Wixel was arguing that if interest rates in the financial markets are moving along the so-called neutral rate, 45 00:05:02.240 --> 00:05:07.280 this creates disruption as far as the fluctuations in the so-called price level. 46 00:05:07.280 --> 00:05:16.880 So, when Wixol was asked, and let us say we would like to implement your framework, how actually, practically it can be done, 47 00:05:16.880 --> 00:05:23.780 Wixol argued that, well, in reality, we have difficulties to ascertain what natural interest rate is, 48 00:05:23.780 --> 00:05:27.580 because we don't observe such a thing, we've never seen such an animal, 49 00:05:27.580 --> 00:05:32.480 therefore, we have difficulties really to practically implement such a thing. 50 00:05:32.480 --> 00:05:35.880 But nevertheless, he said, don't give up, I have an idea for you. 51 00:05:35.880 --> 00:05:49.880 And the idea is that, well, if you are starting to observe that prices are going up, then it means basically that money market interest rates are below the natural rate, and therefore what you have to do as a central banker, push the interest rate up. 52 00:05:49.880 --> 00:05:57.880 And if you observe that prices are falling down, therefore what you have to do, you can push interest rates down, and everything hunky-dory will be alright. 53 00:05:57.880 --> 00:06:23.880 If you look at this framework, it's very practical in the sense that most central bankers are applying this particular procedure today to the extent that they perhaps don't really follow absolute levels of price levels but what they're paying attention to are the rate of changes in the various price indices and that's really the modus operandi of this so-called modern banking. 54 00:06:23.880 --> 00:06:35.380 Now, Wixel himself has suggested basically that we are not in a position to know what natural interest rates are and where they are at all. 55 00:06:35.380 --> 00:06:44.380 Nevertheless, modern economists today believe that they can discover what natural interest rate is and they're using various sophisticated methods. 56 00:06:44.380 --> 00:06:49.880 In fact, some of them starting with very simple ones like long-term average of real interest rate. 57 00:06:49.880 --> 00:07:01.880 Now, they will take the federal funds rate divided by consumer price index, or let's say the federal funds rate minus the percent of changes in the price index, and they'll get the so-called real federal funds rate. 58 00:07:01.880 --> 00:07:07.880 They'll take an average of the last 24 years or 50 years or whatever, and they'll tell you this is the natural interest rate. 59 00:07:07.880 --> 00:07:18.880 Incidentally, this is one of the inputs of the famous Taylor Rule, which is named under the current Undersecretary of Treasury, John Taylor, right? 60 00:07:18.880 --> 00:07:23.880 And one of the inputs there is the long average of the real federal funds rate. 61 00:07:23.880 --> 00:07:33.880 Some other more sophisticated guys are saying, well, this is nonsense to talk about one real interest rate or so-called natural interest rate will be just one number. 62 00:07:33.880 --> 00:07:41.480 We have to be more realistic because supply-demand curves shift over time and therefore the natural interest rate must move also. 63 00:07:41.480 --> 00:07:46.580 But how do you know what it is? Because we never observe, we don't have data for it. How do you find it? 64 00:07:46.580 --> 00:07:55.080 So we use various atomic type of methods, very sophisticated methods that even most sophisticated mathematicians don't use it, right? 65 00:07:55.080 --> 00:08:02.280 So they apply all this very alarming type of mathematics, one of them like Kalman filter. I don't want to discuss it right now here. 66 00:08:02.280 --> 00:08:09.780 And nevertheless, they pretend that they can find the movement or the time series of the natural interest rates. 67 00:08:09.780 --> 00:08:17.280 Well, having said all that, I would now argue that what they're trying to do is mission impossible. 68 00:08:17.280 --> 00:08:19.780 In fact, it's exercising futility. 69 00:08:19.780 --> 00:08:30.780 So first of all, in contrast to the Wicksallian idea that the interest rate is basically intersection between supply and demand curves 70 00:08:30.780 --> 00:08:36.180 of real capital, real saving and real capital, supply of capital and demand for capital, 71 00:08:36.180 --> 00:08:40.980 we need to present slightly different definition perhaps, 72 00:08:40.980 --> 00:08:44.480 what do we mean by interest rate as such, where it emanates. 73 00:08:44.480 --> 00:08:48.880 Now my simple explanation without going immediately to time preference 74 00:08:48.880 --> 00:08:51.380 is to start with the issue of cost. 75 00:08:51.380 --> 00:08:55.580 I'm arguing, and it's also argued by Mises in various writings, 76 00:08:55.580 --> 00:08:58.680 that saving incurs cost basically. 77 00:08:58.680 --> 00:09:04.680 The moment you save, you deny yourself various goods and services that are required to maintain your life and well-being. 78 00:09:04.680 --> 00:09:10.680 So if you are very poor and you are deciding to save, you threaten your life. You can dive in immediately, right? 79 00:09:10.680 --> 00:09:13.680 So therefore, the cost will be enormous for you. 80 00:09:13.680 --> 00:09:18.680 Now if you are wealthier, obviously the opportunity cost of saving will be a little bit lower. 81 00:09:18.680 --> 00:09:23.680 And as wealth expands, the opportunity cost of saving is much lower. 82 00:09:23.680 --> 00:09:26.680 Now therefore, from here we can deduce one important point. 83 00:09:26.680 --> 00:09:31.960 Number one, that if you take a particular dollar, which we'll call present dollar, it's all in type benefit. 84 00:09:31.960 --> 00:09:39.200 There's everything beneficial here because you can buy goods and services with the dollar, which will maintain your life and well-being. 85 00:09:39.200 --> 00:09:46.120 If, however, you contrast it against safe dollar, which means future dollar, it actually incurs already cost. 86 00:09:46.120 --> 00:09:54.800 And therefore, from here, we can say that as a normal individual, you would assign a premium, a premium to present dollar, 87 00:09:54.800 --> 00:10:10.800 Visa the Future Dollar and this premium is really what interest rate is all about or phenomenon of interest is all about or the foundation for interest rate and from here you also can deduce that the moment you assign a premium to a present dollar 88 00:10:10.800 --> 00:10:17.800 Visa future dollar that you also assign what Austrian economists call the positive time preference, positive time preference. 89 00:10:17.800 --> 00:10:22.800 In other words, we are in the world of time preference story as far as determination of interest rates. 90 00:10:22.800 --> 00:10:24.800 Now, let's ask us the following question. 91 00:10:24.800 --> 00:10:30.800 Wixel and other modern economies argue that they can tell you what real interest rates are. 92 00:10:30.800 --> 00:10:38.800 In fact, Wixel was suggesting that by intersection of real capital or real goods with demand supply, 93 00:10:38.800 --> 00:10:40.800 it can tell you what interest rates are. 94 00:10:40.800 --> 00:10:42.800 Well, I tried to do it and I couldn't establish. 95 00:10:42.800 --> 00:10:50.800 For instance, if you take one present apple and land it against two future potatoes, I would like to ask you what will be the interest rate here? 96 00:10:50.800 --> 00:10:57.800 I haven't got a clue because it's not possible to tell you what the percentage is. Why? Because we have a calculation problem, right? 97 00:10:57.800 --> 00:11:09.800 We're measuring two non-homogenous entities. Likewise, if I'm lending you one shirt for three future potatoes, I don't really know what interest rate here at all, right? 98 00:11:09.800 --> 00:11:17.800 So therefore, Wixil, neither Wixil, neither any economies in the world, cannot establish real interest rate just by itself. It's just mission impossible. 99 00:11:17.800 --> 00:11:25.800 Yet everybody says you can establish real interest rate. So in order to find out what interest rate is and how it's established in the market, 100 00:11:25.800 --> 00:11:31.800 you have to introduce, first of all you have to deal with markets, with the world of money, because in the market they have money. 101 00:11:31.800 --> 00:11:37.800 You don't really talk about markets without money. We don't deal with fiction of so-called barter because it doesn't exist 102 00:11:37.800 --> 00:11:41.300 doesn't exist and cannot exist by itself this way. 103 00:11:41.300 --> 00:11:44.560 So therefore, we have to introduce money economy 104 00:11:44.560 --> 00:11:46.860 and how money economy works, very simple. 105 00:11:46.860 --> 00:11:48.560 Let's take Mr. Baker here 106 00:11:48.560 --> 00:11:50.900 and Baker has produced 10 loaves of bread 107 00:11:50.900 --> 00:11:54.120 and what he did, he had a demand for money. 108 00:11:54.120 --> 00:11:57.160 He has exchanged 10 loaves of bread for $10, right? 109 00:11:57.160 --> 00:11:59.880 Basically, so now he has a demand for dollar 110 00:11:59.880 --> 00:12:01.400 and there was given supply of dollars 111 00:12:01.400 --> 00:12:04.320 and he exercised the demand by producing something useful, 112 00:12:04.320 --> 00:12:06.120 right, 10 loaves of bread. 113 00:12:06.120 --> 00:12:15.120 Now, we also know, we have the privilege, as Murray Rothbard writes in his famous book, Man Economy and State, that we have the privilege also to see his time preferences. 114 00:12:15.120 --> 00:12:19.120 You know, although we don't really know, but let us pretend we do know. 115 00:12:19.120 --> 00:12:27.120 And we know that Mr. Baker is happy to lend $10, but his minimum requirement, he wants 5% minimum return. 116 00:12:27.120 --> 00:12:28.120 That is his minimum requirement. 117 00:12:28.120 --> 00:12:35.120 So therefore, he will be a happy lender if you offer him a return back for $10, $10.50. 118 00:12:35.120 --> 00:12:41.880 Now, likewise, we found that there is a shoemaker who is happy to borrow $10 and is happy even to pay a 15%. 119 00:12:41.880 --> 00:12:50.560 That's really his so-called time preference schedule, if you want, or his particular setup, if you want, 120 00:12:50.560 --> 00:12:55.520 which is related to his particular cost structure that he under way operates, opportunity cost. 121 00:12:55.520 --> 00:13:02.440 Therefore, we can say that the shoemaker is willing to repay for $10 borrowed today, $11.50. 122 00:13:02.440 --> 00:13:09.440 Obviously, there will be some kind of a bargain between these two guys, and let us say they have settled on 10% interest rate, and they're both happy now. 123 00:13:09.440 --> 00:13:24.440 So what happened? Baker lands $10 present dollars, gets in return $11, interest rate of 10%, Shoemaker borrows $10, and repays in the few, one year's time $11, and both very happy, right? 124 00:13:24.440 --> 00:13:29.440 And why they're happy? Because that's exactly what they wanted. Nobody really coerced them. 125 00:13:29.440 --> 00:13:34.940 That was a very nice trade and everything came to a nice conclusion, right? 126 00:13:34.940 --> 00:13:36.800 Now, what do we see here? 127 00:13:36.800 --> 00:13:40.480 Now, two things happens here when you observe interest rate determination. 128 00:13:40.480 --> 00:13:41.120 Two things. 129 00:13:41.120 --> 00:13:43.680 Number one, we have demand supply of money. 130 00:13:43.680 --> 00:13:49.360 That's an ingredient part of interest rate determination in the world that we live, 131 00:13:49.360 --> 00:13:51.400 because we live through financial market. 132 00:13:51.400 --> 00:13:54.600 And we had another real part here, time preference. 133 00:13:54.600 --> 00:13:58.240 However, pay attention that you cannot have interest rate, 134 00:13:58.240 --> 00:14:06.240 interest rate by itself just in the world of money in other words demand supply of money apart from time preference will be nonsense right because you have to have something real 135 00:14:06.240 --> 00:14:23.240 human beings have to participate here and you cannot also have interest rate determination but pure real factors by itself without money therefore interest rate that we have is that's the only interest we have one interest rate which is driven by two factors monetary factors and real factors 136 00:14:23.240 --> 00:14:44.240 and those factors are intertwined, as Murray Rothbard always liked to say, and therefore money cannot be neutral here, there's no neutrality, it's all intermeshed, and no way you can try to separate such entity called real interest rate, or interest rate which is driven by pure time preference by itself, because such a thing never realized, it can never be realized. 137 00:14:44.240 --> 00:14:51.240 If such a thing as real interest rate cannot be realized by itself, obviously it's nonsensical to talk about such an entity. 138 00:14:51.240 --> 00:14:57.240 Also, I believe it's nonsensical to talk about natural interest rate because such an entity does not exist. 139 00:14:57.240 --> 00:15:04.240 And it's nonsensical to try really to target towards something which never realizes in the real world that we operate, right? 140 00:15:04.240 --> 00:15:12.240 It could be some kind of a fiction if you want for classroom or for university, but not in the world we really operate because we have to do real things here. 141 00:15:12.240 --> 00:15:19.240 And yet, if somebody believes that this is the case, like the Central Bank of the United States of America or any other central bank, 142 00:15:19.240 --> 00:15:27.740 and they're trying to target towards something which does not exist and they don't have any clue where it is, obviously, they can create a lot of problems. 143 00:15:27.740 --> 00:15:36.240 When Greenspan was asked, what is the natural interest rate, they've always been asked such a question, he said, when we'll reach it, I'll know, right? I'll tell you, right? 144 00:15:36.240 --> 00:16:06.240 You know, what the hell is talking about? Nobody knows where it is, right, and it cannot be even known, right, because as I said, from my point of view, it cannot really separate such a thing, the moment you can separate such a thing, we don't really deal in the world of human beings, right, we don't deal in the world of markets, we do some kind of a mumbo jumbo, but we don't deal really with the world of the way markets really operate. So, having said all that, let us say that by some chance, econometricians, the Federal Reserve, 145 00:16:06.240 --> 00:16:12.240 The Federal Reserve board, smart guys with a lot of mathematical knowledge, came to Mr. Greenspan and told him, 146 00:16:12.240 --> 00:16:18.240 listen, I'll give you the natural interest rate and you have to aim towards this natural interest rate. 147 00:16:18.240 --> 00:16:25.240 So I'm saying even if you give them the natural interest rate and it will bring the federal funds rate towards this natural interest rate, 148 00:16:25.240 --> 00:16:29.240 it still has to maintain this target. And how do they maintain the target? 149 00:16:29.240 --> 00:16:40.240 The smart guys of the Fed told Mr. Greenspan that the Federal funds rate are above the natural interest rate. 150 00:16:40.240 --> 00:16:44.240 So according to the Excellent Framework, what you have to do, you have to push now money, right, to pump money, 151 00:16:44.240 --> 00:16:52.240 to bring the Federal funds rate towards the natural interest rate, which is now below the Federal funds rate, 152 00:16:52.240 --> 00:16:55.240 according to the wise guys of the Fed. 153 00:16:55.240 --> 00:16:59.740 So what the FED does? FED first of all sets the target and then it has to pump money. 154 00:16:59.740 --> 00:17:03.740 It pumps money, right? Otherwise it cannot adhere to this target. 155 00:17:03.740 --> 00:17:10.740 But when money is pumped, and as Professor Hoppe said, there are always first receivers and last receivers, right? 156 00:17:10.740 --> 00:17:16.740 Money never been injected to everybody. Nobody gets it instantaneously. There is always somebody who benefits first. 157 00:17:16.740 --> 00:17:21.740 And according to this story, first receivers are getting money and they are really wealthy. 158 00:17:21.740 --> 00:17:26.740 Because they got more money now, they are happy and their purchasing power has risen, they are really wealthy. 159 00:17:26.740 --> 00:17:32.740 Now, recall what I suggested, that whenever your wealth expands, your time preference actually will be lowered 160 00:17:32.740 --> 00:17:39.740 because now your opportunity cost of saving has been reduced right now because you are wealthy because you got now more money, right? 161 00:17:39.740 --> 00:17:42.740 And what happens? The time preference is lowered. 162 00:17:42.740 --> 00:17:50.740 Of those first receivers and interest rates, so-called time preference rate is supporting now the act of the Federal Reserve. 163 00:17:50.740 --> 00:17:56.740 and the Federal Reserve. Now, if time preference will not be supporting the act of the central bank, 164 00:17:56.740 --> 00:18:04.740 the central bank would not be able to maintain even for five seconds the reduction or lowering of the federal funds rate 165 00:18:04.740 --> 00:18:10.740 because, after all, time preference, the behavior of people is the ultimate driver. 166 00:18:10.740 --> 00:18:18.740 So, after a while, however, the money started to filter through, and I will skip here, 167 00:18:18.740 --> 00:18:23.140 and it's starting to filter through and prices are starting to go up. 168 00:18:23.140 --> 00:18:28.540 Obviously, the last receivers of money, or no receivers at all, there are plenty of them, right? 169 00:18:28.540 --> 00:18:34.340 They're suffering because their purchasing power is falling and what happened, they become poorer now. 170 00:18:34.340 --> 00:18:40.140 And since they become poorer, obviously, the opportunity cost to save for them, the cost of saving is much higher. 171 00:18:40.140 --> 00:18:43.140 Therefore, they're starting to push interest rate up. 172 00:18:43.140 --> 00:18:50.640 So what happens? If Central Bank will stop the game, will not push more money, obviously the rates will go up and that's it. 173 00:18:50.640 --> 00:19:00.940 But Central Bank, because the bright economists told them, must push federal funds rate down in order to meet the target of the natural rate, will continue to push more money. 174 00:19:00.940 --> 00:19:07.640 And this is the game we'll have now. We'll have a tug-of-war now between the last recipients and first recipients. 175 00:19:07.640 --> 00:19:13.800 Observe the following thing. When first recipients get the money first, they're actually enriched. 176 00:19:13.800 --> 00:19:18.520 In other words, there is a transfer of wealth from last recipients to first recipients. 177 00:19:18.520 --> 00:19:24.360 Because when I said they got wealthy, it doesn't mean there was an increase in wealth. 178 00:19:24.360 --> 00:19:32.600 What we have got now, wealth redistribution from some part of the population to another part of the population. 179 00:19:32.600 --> 00:19:38.120 Obviously, such an activity, such a type of outcome cannot be called neutral. 180 00:19:38.120 --> 00:19:43.080 Recall, Greenspan and all the other guys are saying we're dealing with neutral case. 181 00:19:43.080 --> 00:19:47.320 It's like Murray Rothbard was cracking a joke and saying, can you have a neutral tax? 182 00:19:47.320 --> 00:19:50.280 Is it possible? Obviously, he concluded it's mission impossible, right? 183 00:19:50.280 --> 00:19:55.160 There's no such thing as neutral tax, yet most economies are talking about neutral tax, right? 184 00:19:55.160 --> 00:20:00.120 And likewise, if you pump money, obviously you cannot have a neutral outcome. 185 00:20:00.120 --> 00:20:16.120 Now this tug-of-war can go for a long time and what will dictate this particular procedure, not what central bank can push interest rates and keep them at a low level for many years if they want. 186 00:20:16.120 --> 00:20:21.120 The only thing which will stop them is what we call the subsistence fund or the pool of funding. 187 00:20:21.120 --> 00:20:27.120 If the pool of funding is still there and what I call the kitty is still okay, things can go on for quite a while. 188 00:20:27.120 --> 00:20:34.120 However, if the kitty gets towards a level of emptiness, then of course everything will fall apart and the music will stop, right? 189 00:20:34.120 --> 00:20:37.120 So we really don't know what's the situation right now. 190 00:20:37.120 --> 00:20:42.120 But all I can suggest is that this particular game stops occasionally. 191 00:20:42.120 --> 00:20:46.120 The central bank usually stops it before the kitty gets empty. 192 00:20:46.120 --> 00:20:54.120 Or if the economists tell Mr. Greenspan or whoever in the central bank that they have overshoot, 193 00:20:54.120 --> 00:21:04.120 In other words, the federal funds right now, all of a sudden, below the natural rate, below the natural rate, and they say, hey, that's not good, we have to bring it back to the natural rate. 194 00:21:04.120 --> 00:21:10.120 That's really what Greenspan is doing right now. We have to raise it. We have to raise it to so-called equilibrium. 195 00:21:10.120 --> 00:21:22.120 And by doing this, of course, they're setting in process economic bust. Why? Because all the early recipients of money, all the various activities which were funded on the back of printing presses, now they're under pressure. 196 00:21:22.120 --> 00:21:34.120 And they're suffering because they don't get any more the money which allows them to transfer real wealth from the last recipients, they're going under or they're going bankrupt and we have so-called economic bust. 197 00:21:34.120 --> 00:21:39.120 And obviously after a while we have a repetition of this entire story. 198 00:21:39.120 --> 00:21:41.120 So what I would like to conclude here is the following, right? 199 00:21:41.120 --> 00:21:55.120 that the central bank activities, even if you give them the knowledge of the natural interest rates precisely and even if they'll bring it there, right, the federal funds rate, they will have to maintain it. 200 00:21:55.120 --> 00:22:04.120 The act of maintenance means intervention. Intervention means redistribution of wealth. It doesn't matter for a woman how it could have various permutations. 201 00:22:04.120 --> 00:22:10.120 It also means setting boom, bust, cycle, disruption. It can never be neutral to the real economy. 202 00:22:10.120 --> 00:22:18.620 So the only proposition as far as having meaningful neutral interest rate, if somebody wants to use such expression, is to have free market. 203 00:22:18.620 --> 00:22:24.120 What does it mean, proper free market? Proper free market means you cannot have their central bank. 204 00:22:24.120 --> 00:22:30.620 There's no central bank, there's free banking as such, there's proper, honest money like gold or whatever market will decide. 205 00:22:30.620 --> 00:22:36.620 Obviously under these conditions, right, you can, whatever interest rate will match, that will be the interest rate. 206 00:22:36.620 --> 00:22:41.180 In the free market, nobody will start to tell you this is below equilibrium, above equilibrium. 207 00:22:41.180 --> 00:22:47.180 The whole notion of equilibrium will be meaningless, right, and nobody will be even preoccupied with such a thing. 208 00:22:47.180 --> 00:22:55.620 So therefore, the only idea of true natural interest rates is when you have free market conditions. 209 00:22:55.620 --> 00:23:03.620 Now, I would like to go quickly through the action of the Fed and what does it mean today to our world today, first of all. 210 00:23:03.620 --> 00:23:08.060 The first diagram here shows you the federal funds target rate. 211 00:23:08.060 --> 00:23:12.700 Various targets were set over time in between 1990 until present, right? 212 00:23:12.700 --> 00:23:15.540 And in order to adhere to a particular target, 213 00:23:15.540 --> 00:23:19.740 Fed has to conduct various pumping of money or various injections of money. 214 00:23:19.740 --> 00:23:22.500 Sometimes they take money, sometimes they push money in. 215 00:23:22.500 --> 00:23:26.260 And that's what the fluctuation in the so-called percent of change in credit, 216 00:23:26.260 --> 00:23:30.540 or it's called Fed credit or the Federal Reserve balance sheet, displays here. 217 00:23:30.540 --> 00:23:34.620 Obviously, those generations of fluctuations are not smooth at all, right? 218 00:23:34.620 --> 00:23:40.060 And given the fact that the monetary pumping is so volatile, 219 00:23:40.060 --> 00:23:44.420 it has an immediate effect on the money supply in the system. 220 00:23:44.420 --> 00:23:49.780 Here we present the money FMS, which relies on the Austrian money supply definition. 221 00:23:49.780 --> 00:23:52.900 FMS stands for the Falset Money Supply Definition, 222 00:23:52.900 --> 00:23:56.340 which again relies on the Austrian money supply definition. 223 00:23:56.340 --> 00:24:00.420 And you can see that the Austrian money supply definition in this case, 224 00:24:00.420 --> 00:24:07.120 The money supply moves in tandem, that's the dotted line, with the monetary pumping of the Fed, the Fed balance sheet. 225 00:24:07.120 --> 00:24:15.120 So, and so you can see all these fluctuations, obviously those fluctuations in money set in motion fluctuations in various markets. 226 00:24:15.120 --> 00:24:24.520 An average fluctuation, because as I said at the beginning, when money is pumped, there are always first receivers, last receivers, there are first markets and there are last markets. 227 00:24:24.520 --> 00:24:30.920 For instance, the time lag between money injection and bond market, there's no time lag at all. 228 00:24:30.920 --> 00:24:34.620 Stock market, four months. Gold market could be up to seven months. 229 00:24:34.620 --> 00:24:37.220 Oil market could be up to 12 months. 230 00:24:37.220 --> 00:24:40.420 Base metals could be maybe up to two years sometime, right? 231 00:24:40.420 --> 00:24:43.320 And it depends on what kind of base metal we're talking, right? 232 00:24:43.320 --> 00:24:50.420 So therefore, if you take on average nominal economic activity, one can reach, again, using some kind of econometrics, 233 00:24:50.420 --> 00:24:57.420 on average about 21 months lag, that's an average lag between pumping money and nominal economic activity. 234 00:24:57.420 --> 00:25:01.420 So based on this information, we can first of all say the following, 235 00:25:01.420 --> 00:25:07.420 that the current monetary policy of the Fed already laid foundation for a significant slowdown 236 00:25:07.420 --> 00:25:10.420 that perhaps which may start from the second half of this year, right? 237 00:25:10.420 --> 00:25:15.420 Also the current monetary policy also suggesting, all other things being equal of course, 238 00:25:15.420 --> 00:25:21.820 We may have a so-called boom or recovery by the year end as far as nominal activity is concerned. 239 00:25:21.820 --> 00:25:24.820 Nominal don't, again, just in nominal income. 240 00:25:24.820 --> 00:25:28.220 Now, we shouldn't forget that nominal GDP is a nominal income. 241 00:25:28.220 --> 00:25:30.020 It's just money. 242 00:25:30.020 --> 00:25:33.620 The more government prints, the harder GDP will be. 243 00:25:33.620 --> 00:25:38.420 It's got nothing to do with so-called real stuff because as one of the speakers has suggested, 244 00:25:38.420 --> 00:25:41.220 we cannot measure such a thing, real output. 245 00:25:41.220 --> 00:25:43.220 It cannot add up potatoes and tomatoes. 246 00:25:43.220 --> 00:25:44.420 It's not edible, right? 247 00:25:44.420 --> 00:25:53.920 So whenever economists tell you that the economy grew in real terms by 4 or 5%, this is all nonsense in real terms because nobody knows such a thing, how can it measure? 248 00:25:53.920 --> 00:26:03.420 Now, another interesting thing, that if we take the changes in monetary policy of the Fed, or the Fed's balance sheet percentage changes, 249 00:26:03.420 --> 00:26:12.420 and against the movement in a consumer price index, which we also regard as a nonsensical indicator, nevertheless everybody uses, so we have to use it also, 250 00:26:12.420 --> 00:26:22.420 and also given the fact that the Fed reacts to this indicator, so what we observe here is that using the past monetary injection, because it operates with a lag of 17 months here, 251 00:26:22.420 --> 00:26:30.420 one should not be surprised if the gross momentum of the consumer price index may start even softening. It's quite possible, right? 252 00:26:30.420 --> 00:26:41.420 Bear in mind that Fed responds to the consumer price index, or to be more precise, to personal consumption deflator, excluding food and energy. 253 00:26:41.420 --> 00:26:45.420 In other words, it deals with a human being which doesn't eat and doesn't drive cars, right? 254 00:26:45.420 --> 00:26:46.920 That's what the Fed does, right? 255 00:26:46.920 --> 00:26:48.920 But nevertheless, that's what they are doing. 256 00:26:48.920 --> 00:26:58.920 And bear in mind, look at this chart, you can see that the CPI here is driven by past monetary policies. 257 00:26:58.920 --> 00:27:01.920 And Fed reacts to the CPI. What does it mean? 258 00:27:01.920 --> 00:27:06.920 That Fed responds to its previous old policies, now it's like a dog chasing its own tail. 259 00:27:06.920 --> 00:27:08.920 They're moving in circles all the time, right? 260 00:27:08.920 --> 00:27:13.920 and yet they tell you that they are defending against inflation that they themselves create, right? 261 00:27:13.920 --> 00:27:19.920 Now, if we were to have a slowdown, there is always a possibility that this may crack. Why? 262 00:27:19.920 --> 00:27:25.920 Because the underlying foundations of American economy, as many speakers have suggested here, is not good at all. 263 00:27:25.920 --> 00:27:29.920 I don't want to go into structure right now. I'm almost finishing here. 264 00:27:29.920 --> 00:27:35.920 All I can suggest is that if you look at the underlying pool of funding, which I don't know exactly how big it is right now, 265 00:27:35.920 --> 00:27:39.920 The Theory of Money and Credit 266 00:27:39.920 --> 00:27:43.920 The Theory of Money and Credit 267 00:28:05.920 --> 00:28:35.920 To support various debts is shrinking, so what I'm suggesting here is if the slowdown were to become significant and the bottom line cannot support all that, you can have a situation where bank lending will start falling apart, in other words, bank loans may shrink, money supply may evaporate or fall quite rapidly, and you can have a nasty scenario also. Now I'm not here to forecast gloom and doom. I believe businessmen should not operate under the scenario of gloom and doom. 268 00:28:35.920 --> 00:28:39.520 Even if I'm espousing Austrian economics, I think it's a bad business. 269 00:28:39.520 --> 00:28:44.920 If you practice business under the conditions of gloom and doom, it's basically siege mentality. 270 00:28:44.920 --> 00:28:49.120 You have to live in the cave. You have to abandon and abdicate from this life. 271 00:28:49.120 --> 00:28:51.520 So you have to follow, live normally, right? 272 00:28:51.520 --> 00:28:55.120 But bear in mind that risk factors are very high, right? 273 00:28:55.120 --> 00:29:01.120 And bear in mind that you have to be more conservative, as Adrian Day has suggested, very rightly. 274 00:29:01.120 --> 00:29:03.120 One has to look for quality. 275 00:29:03.120 --> 00:29:08.120 It didn't suggest you don't be in stocks. It said you can be in stocks, but search for quality, right? 276 00:29:08.120 --> 00:29:11.120 In other words, don't buy nonsense, don't buy speculation. 277 00:29:11.120 --> 00:29:15.120 That's really what our message is today. Thank you very much.