WEBVTT NOTE How the Fed Fools Some People Much of the Time 1 00:00:00.000 --> 00:00:07.080 In Lew's opening comments this morning, I noticed that he mentioned all of the speakers. 2 00:00:07.080 --> 00:00:13.640 Addressing you today were members of the Austrian School, who considered themselves Austrian economists, 3 00:00:13.640 --> 00:00:21.000 and that reminded me of an exchange I had in a more eclectic session recently, 4 00:00:21.000 --> 00:00:27.200 where most of the participants were, well, we'll say mainstream economists. 5 00:00:27.200 --> 00:00:32.000 And one of them asked me after the talk, 6 00:00:32.000 --> 00:00:36.960 did I mind being thought of as an Austrian economist? 7 00:00:36.960 --> 00:00:40.480 And I assume he meant as opposed to what, 8 00:00:40.480 --> 00:00:45.600 mainstream economists or just plain economists or whatever. 9 00:00:45.600 --> 00:00:48.200 To which I responded by recounting the story, 10 00:00:48.200 --> 00:00:54.880 true story actually, of the prisoner on death row, 11 00:00:54.880 --> 00:00:57.000 serial killer. 12 00:00:57.000 --> 00:01:02.800 It turns out, he was awaiting his imminent execution. 13 00:01:02.800 --> 00:01:10.900 And he had a priest in his company and was trying to make peace with himself and with the world. 14 00:01:10.900 --> 00:01:19.300 And he said, you know, Father, I don't mind if people think of me as a serial killer, 15 00:01:19.300 --> 00:01:25.400 as long as they don't think that's all that I am. 16 00:01:25.400 --> 00:01:30.400 So, I don't mind being thought of as an Austrian economist. 17 00:01:35.680 --> 00:01:41.000 Although today I will work in a few mainstream ideas, if you'll allow me. 18 00:01:41.000 --> 00:01:46.680 I noticed that the topic this afternoon, as announced by Lew, 19 00:01:46.680 --> 00:01:51.160 and as was printed in the earlier versions of the program, 20 00:01:51.160 --> 00:01:55.240 was how the Fed fools some of the people much of the time. 21 00:01:55.240 --> 00:02:25.240 I did notice in the final program, someone had put an S on FED, how the FEDs fool some of the people and I almost wondered if I was supposed to say something also about the IRS and possibly the Bureau of Alcohol, tobacco and firearms, but I think I'll restrict my remarks to the Federal Reserve, but I do want to call your attention to the significance of the title itself, obviously a takeoff on Lincoln's dictum about fooling people. 22 00:02:25.240 --> 00:02:31.240 and would remind most of you if you've read up on economics in the last couple of decades 23 00:02:31.240 --> 00:02:41.240 of the rational expectations revolution where economists claim that the Fed can't fool anybody any of the time 24 00:02:41.240 --> 00:02:47.240 and I'm pleased to say that Ludwig von Mises was in on the ground floor on the basic idea 25 00:02:47.240 --> 00:02:53.240 although he didn't push it to the extremes that the new classical economists have 26 00:02:53.240 --> 00:03:02.240 And let me just read a short passage from the third edition of Theory of Money and Credit, which was published in 1953. 27 00:03:02.240 --> 00:03:10.240 And in that book, Mises included an epilogue, written in 1953, on inflationary finance, 28 00:03:10.240 --> 00:03:18.240 government printing money to finance projects of one sort or another, either in the public sector or through lending and out through credit markets. 29 00:03:18.240 --> 00:03:28.240 And of course when he talked about inflationary finance, he wasn't talking about a general rise in prices, he was talking about inflation of the money supply, 30 00:03:28.240 --> 00:03:40.240 padding the money supply whether or not prices have yet risen. But of course he knew, as we all do, that rising price level is the ultimate consequence of increase in the money supply. 31 00:03:40.240 --> 00:03:42.740 On inflationary finance, he wrote, 32 00:03:42.740 --> 00:03:45.740 Here the famous dictum of Lincoln holds true. 33 00:03:45.740 --> 00:03:48.240 You can't fool all the people all the time. 34 00:03:48.240 --> 00:03:52.240 Eventually the masses come to understand the schemes of their rulers. 35 00:03:52.240 --> 00:03:56.240 Then the cleverly concocted plans of inflation collapse. 36 00:03:56.240 --> 00:04:02.740 Inflationism is not a monetary policy that can be considered as an alternative to a sound money policy. 37 00:04:02.740 --> 00:04:05.740 It is at best a temporary makeshift. 38 00:04:05.740 --> 00:04:10.940 The main problem of an inflationary policy is how to stop it before the masses have seen 39 00:04:10.940 --> 00:04:13.700 through their rulers' artifices. 40 00:04:13.700 --> 00:04:18.820 It is a display of considerable naivete to recommend openly a monetary system that can 41 00:04:18.820 --> 00:04:22.540 work only if its essential features are ignored by the public. 42 00:04:22.540 --> 00:04:30.500 This, by Mises in 53, a full eight years before John Moot wrote his article on rational expectation 43 00:04:30.500 --> 00:04:40.340 in nearly 20 years before Bob Lucas and others began to incorporate the idea of rational expectations into macroeconomic literature. 44 00:04:40.340 --> 00:04:46.840 Mises, of course, as I mentioned, didn't push this to the extremes that the new Classicals have. 45 00:04:46.840 --> 00:04:54.640 And in fact, for that reason, the Austrian School, radical as they seem in many respects, and rightly so, 46 00:04:54.640 --> 00:04:58.340 radical in the sense of going to the root of the matter, 47 00:04:58.340 --> 00:05:01.180 are very much middle ground on this issue. 48 00:05:01.180 --> 00:05:07.060 They're between the Keynesians who argue as if the central bank can fool all the people all the time 49 00:05:07.060 --> 00:05:11.620 and manage the economy and make it behave in ways that it otherwise wouldn't. 50 00:05:11.620 --> 00:05:14.900 That's the aim of the demand management policies. 51 00:05:14.900 --> 00:05:22.500 The new classicals are at the other extreme, arguing that the Fed can't fool any of the people any of the time, 52 00:05:22.500 --> 00:05:29.100 that rational expectations simply undo any damage that the Fed might otherwise cause. 53 00:05:29.100 --> 00:05:36.100 The Austrians certainly are in the middle on this issue. Yes, the Fed can fool some 54 00:05:36.100 --> 00:05:43.420 of the people much of the time and that gives rise to artificial growth, to a boom or bubble 55 00:05:43.420 --> 00:05:49.740 economy as we've heard it called, which ultimately must collapse, hence the Austrian theory of 56 00:05:49.740 --> 00:06:07.740 Mises would argue in terms of money as a tool of calculation, and if money prices and particularly the interest rate are distorted by money creation, then the calculations will be incorrect, the economy will be set on an unsustainable growth path. 57 00:06:07.740 --> 00:06:14.000 of Path. Hayek would argue in terms of prices being signals, and particularly especially 58 00:06:14.000 --> 00:06:24.580 the interest rate on the issue of unsustainable growth. Jam the signals by pumping money through 59 00:06:24.580 --> 00:06:31.160 credit markets. Jam the signals and the economy will be misguided. This does not require that 60 00:06:31.160 --> 00:06:36.460 we assume that market participants are actually fools, they're simply reacting to prices 61 00:06:36.460 --> 00:06:38.340 that aren't telling the truth. 62 00:06:38.340 --> 00:06:41.420 And even knowing, as people will eventually come to know, 63 00:06:41.420 --> 00:06:43.500 that the signals are being jammed 64 00:06:43.500 --> 00:06:46.140 doesn't necessarily solve the problem. 65 00:06:46.140 --> 00:06:49.860 In a phrase, knowing that a signal is jammed 66 00:06:49.860 --> 00:06:51.620 is not the same thing as knowing 67 00:06:51.620 --> 00:06:54.220 what the unjammed signal would be. 68 00:06:54.220 --> 00:06:58.460 And therefore, the economy is still misdirected, 69 00:06:58.460 --> 00:06:59.660 set off on the wrong course 70 00:06:59.660 --> 00:07:03.260 that will eventually require an adjustment. 71 00:07:03.260 --> 00:07:05.380 We have reason, I think, to believe 72 00:07:05.380 --> 00:07:08.460 that the signals are now being jammed. 73 00:07:08.460 --> 00:07:12.500 The twist I want to add to today may seem novel to some 74 00:07:12.500 --> 00:07:16.100 and obvious to others, but as the market recasts, 75 00:07:16.100 --> 00:07:20.540 or I'm sorry, as the market reacts over a period of time 76 00:07:20.540 --> 00:07:24.780 to central bank policy, trying to guess what it will do next, 77 00:07:24.780 --> 00:07:28.260 and as the central bank reacts to the market's reaction, 78 00:07:28.260 --> 00:07:29.100 guess what? 79 00:07:29.100 --> 00:07:31.820 The jammer, the central bank, doesn't know 80 00:07:31.820 --> 00:07:34.900 what the unjammed signal would be either. 81 00:07:34.900 --> 00:07:47.700 This is a point that Mr. Grant drove home this morning by suggesting that Greenspan didn't know what the natural rate or the market rate of interest might be. 82 00:07:47.700 --> 00:07:52.300 We know what the discount rate is. I'll show you something about that in a little bit. 83 00:07:52.300 --> 00:08:01.300 We know what the federal funds rate is. But do we know what the market rate would be, the so-called natural rate? 84 00:08:01.300 --> 00:08:06.300 What would the natural rate be in the absence of the Federal Reserve manipulations? 85 00:08:06.300 --> 00:08:12.300 That we don't know, and Alan Greenspan doesn't know either. 86 00:08:12.300 --> 00:08:17.000 So how does the Fed fool much of the people some of the time? 87 00:08:17.000 --> 00:08:22.300 Well, the short answer is by fooling himself too. 88 00:08:22.300 --> 00:08:24.900 He doesn't know what the interest rate should be. 89 00:08:24.900 --> 00:08:30.400 He's struggling like you are and like I am to figure this out. 90 00:08:30.400 --> 00:08:36.080 In the long run, and in the absence of central bank actions, 91 00:08:36.080 --> 00:08:42.480 the interest rate that clears the market for loanable funds is called the natural rate. 92 00:08:42.480 --> 00:08:48.320 The amount of funds lent at that rate is equal to the amount of funds borrowed at that rate. 93 00:08:48.320 --> 00:08:56.000 And in fact, that amount constitutes what Dr. Shostak referred to earlier today as the funding pool. 94 00:08:56.000 --> 00:09:26.000 The Funding Pool, the amount of funds supplied and demanded at the market clearing rate of interest and of course the point of his lecture is that if growth, economic growth is based on the funding pool, is based on the amount that savings actually supports then it's healthy, it's sustainable, it works, it gives us increased output but if it's greater than that because of Federal Reserve manipulation, because of credit expansion, then the economy is set out on a 95 00:09:26.000 --> 00:09:30.200 on a path of unsustainable growth. 96 00:09:30.200 --> 00:09:33.360 The term itself, natural rate of interest, 97 00:09:33.360 --> 00:09:36.080 came from a Swedish economist, Newton Vicksel, 98 00:09:36.080 --> 00:09:38.920 but it was adopted by von Mises 99 00:09:38.920 --> 00:09:43.560 in putting together his Austrian theory of the business cycle. 100 00:09:43.560 --> 00:09:46.760 The natural rate is essentially the market rate, 101 00:09:46.760 --> 00:09:51.480 the rate that's undisturbed by a central bank. 102 00:09:51.480 --> 00:09:54.640 If business, the business cycle then plays itself out 103 00:09:54.640 --> 00:09:59.640 in terms of movements of the rate of interest from that natural rate. 104 00:09:59.640 --> 00:10:03.640 And if the rate is too low, then capital will be misallocated, 105 00:10:03.640 --> 00:10:09.640 the economy will be set out on an unsustainable growth path, a bubble, 106 00:10:09.640 --> 00:10:14.640 as you've heard earlier today, that eventually will collapse. 107 00:10:14.640 --> 00:10:17.640 This is the Austrian story of boom and bust. 108 00:10:17.640 --> 00:10:23.640 The forthcoming book mentioned by Lew, I'm starting now to call it my forever forthcoming book, 109 00:10:23.640 --> 00:10:48.640 But in that book I set out a framework of what I call capital-based macro and show that macroeconomics fashioned after Mises and Hayek has much to say about a lot of issues including, and importantly including, the business cycle, but much else as well, deficit finance, fiscal policy, tax reform, and a lot of other issues. 110 00:10:48.640 --> 00:10:58.400 issue, so I'm generalizing from what Mises and Hayek taught us about cyclical variation. 111 00:10:58.400 --> 00:11:06.240 Now at this point I want to depart slightly from the Austrian framework and bring in the 112 00:11:06.240 --> 00:11:11.560 unemployment rate, which is the statistics that you most normally see reported in Wall 113 00:11:11.560 --> 00:11:14.760 Street Journal and elsewhere. 114 00:11:14.760 --> 00:11:20.320 Ever since the Keynesian Revolution, cyclical movements have been tracked not in terms of 115 00:11:20.320 --> 00:11:25.440 misallocated capital structure or as distortion of the interest rate, as the Austrians would 116 00:11:25.440 --> 00:11:33.680 have it, but as movements in the unemployment rate, as Keynesianizes the whole view of cyclical 117 00:11:33.680 --> 00:11:34.680 variation. 118 00:11:34.680 --> 00:11:41.600 Nonetheless, we have a benchmark here that allows us to translate from one framework 119 00:11:41.600 --> 00:11:53.800 to another, corresponding to what we call the natural rate of interest, is something that has been called the natural rate of unemployment. 120 00:11:53.800 --> 00:12:06.800 And it's telling, I think, that that term, coined by Milton Friedman, was so named precisely to pick up its kinship with Vicksel and his natural rate of interest. 121 00:12:06.800 --> 00:12:24.400 And so without too many qualifications, we could argue that an economy experiencing the natural rate of interest and therefore a funding pool that's consistent with sustainable growth would at the same time experience what could rightly be called a natural rate of unemployment. 122 00:12:24.400 --> 00:12:33.700 Or we could say in the long run, in the absence of central bank action, the rate of unemployment experienced by the economy, well, is the natural rate. 123 00:12:33.700 --> 00:12:39.500 Unemployment of this sort, the natural unemployment, has the same economic significance 124 00:12:39.500 --> 00:12:47.300 as unsold cans of corn or unsold bags of sugar on the grocery store shelf. 125 00:12:47.300 --> 00:12:50.800 In other words, inventories. 126 00:12:50.800 --> 00:12:55.600 A certain level of unemployment, like a certain level of inventories, is consistent with, 127 00:12:55.600 --> 00:12:59.000 even essential to, the functioning of the economy. 128 00:12:59.000 --> 00:13:08.200 Some people in even a healthy economy are just breaking into the job market, looking for a job or between jobs, looking for a better job and so on. 129 00:13:08.200 --> 00:13:18.400 This is the unemployment primarily that we consider to be natural and healthy and not symptomatic of anything wrong with the economy. 130 00:13:18.400 --> 00:13:25.300 So, if unemployment is at its natural rate, well, the economy is said to experience full employment. 131 00:13:25.300 --> 00:13:30.900 This is just the terminology of mainstream economics that I'm sure you've encountered before. 132 00:13:30.900 --> 00:13:36.500 If unemployment is above its natural level, well, the economy is experiencing a recession. 133 00:13:36.500 --> 00:13:39.500 It's very far above the corner of depression. 134 00:13:39.500 --> 00:13:45.500 If unemployment is below the natural rate, we say that the economy is overheated, 135 00:13:45.500 --> 00:13:50.100 a term that you've all heard, which really means, translated back into Austrian terms, 136 00:13:50.100 --> 00:13:57.100 Unsustainable growth rate, unsustainable levels of employment and output. 137 00:13:57.100 --> 00:14:04.100 Now, at this point, I could be critical of the idea of the natural rate. 138 00:14:04.100 --> 00:14:10.100 It's made up of something called frictional unemployment, a term that Mises took exception to. 139 00:14:10.100 --> 00:14:16.100 He offered the much more insightful term speculative unemployment, 140 00:14:16.100 --> 00:14:33.100 Meaning that if a job seeker speculated that if only he looks further, he might find something better, he will decline current job offers, speculative unemployment, but nonetheless part of the natural rate. 141 00:14:33.100 --> 00:14:39.100 But today, at least for the sake of argument, I want to adopt this idea of the natural rate 142 00:14:39.100 --> 00:14:47.100 and look at it as simply a sustainable rate that involves no recession and no overheating. 143 00:14:47.100 --> 00:14:52.100 Now the problem comes when we try to quantify the levels. 144 00:14:52.100 --> 00:14:56.100 What is the natural rate of unemployment? 145 00:14:56.100 --> 00:15:01.100 But according to the mainstream, conventionally and for some time macroeconomics of all persuasions 146 00:15:01.100 --> 00:15:05.100 have settled in on five or six percent of the labor force. 147 00:15:05.100 --> 00:15:09.100 If no more than five or six percent of the labor force are unemployed, 148 00:15:09.100 --> 00:15:11.100 we say the economy is fully employed. 149 00:15:11.100 --> 00:15:14.100 That means that it's experiencing unemployment 150 00:15:14.100 --> 00:15:18.100 that's not in excess of the so-called natural rate. 151 00:15:18.100 --> 00:15:23.100 Now we've noticed that when unemployment gets very far beyond this range, 152 00:15:23.100 --> 00:15:27.100 one way or the other, many macroeconomists, 153 00:15:27.100 --> 00:15:36.100 Especially the apologists of the administration argue that the national rate itself has changed. 154 00:15:36.100 --> 00:15:45.100 So for instance, during the Ford administration, when the unemployment rate flirted with the double digits between 9 and 10 percent, 155 00:15:45.100 --> 00:15:52.100 economists, apologists of the Ford administration argued that the national rate itself had risen. 156 00:15:52.100 --> 00:15:56.100 And we really weren't experiencing much of a recession at all. 157 00:15:56.100 --> 00:16:00.100 Now, when the unemployment rate is flirting with the 4% level, 158 00:16:00.100 --> 00:16:07.100 apologists of the Clinton administration are arguing that the natural rate itself has fallen, 159 00:16:07.100 --> 00:16:13.100 and that the economy is not in a bubble at all. 160 00:16:13.100 --> 00:16:17.100 So in practice, at least as a politically-charged rhetoric has it, 161 00:16:17.100 --> 00:16:22.100 the natural rate itself is something a little different from the natural rate. 162 00:16:22.100 --> 00:16:28.100 It's the thing that keeps changing to make sense out of the current policies. 163 00:16:28.100 --> 00:16:33.100 It's certainly true that five or six percent is not chiseled in stone. 164 00:16:33.100 --> 00:16:38.100 Followers of Mises and Hayek know this well. There are no economic constants. 165 00:16:38.100 --> 00:16:45.100 These things can change with changes in the real factors, productivity and all such. 166 00:16:45.100 --> 00:16:51.100 But neither does it change to suit the visions of politicians and policy makers. 167 00:16:51.100 --> 00:16:58.100 So, for today's purposes, I'm going to stick with the conventional natural rate and just show you. 168 00:17:01.100 --> 00:17:06.100 I've been tracking the rate of employment and a few other statistics for a while now, 169 00:17:06.100 --> 00:17:14.100 and I show you here that that band in the middle between 5 and 6 percent involves rates of unemployment 170 00:17:14.100 --> 00:17:17.100 that are consistent with full employment. 171 00:17:17.100 --> 00:17:21.600 and anything above that, we identify as recession 172 00:17:21.600 --> 00:17:26.700 and anything below that is a bit worrisome because it's a bubble, it's unsustainable 173 00:17:26.700 --> 00:17:35.500 unless there are serious arguments that the natural rate itself has changed. 174 00:17:35.500 --> 00:17:41.200 Now let's put the unemployment rate over that period, about 10, 11 years is what I'm using 175 00:17:41.200 --> 00:17:46.400 to show you what the unemployment rate has actually done. 176 00:17:46.400 --> 00:17:50.720 Look at the unemployment rate from 89 through present. 177 00:17:50.720 --> 00:17:56.160 What we see is that in 89 and 90, we were within the full employment range. 178 00:17:56.160 --> 00:17:58.880 The economy seemed to be doing fine. 179 00:17:58.880 --> 00:18:02.800 91, 92, we slipped into the Bush recession, 180 00:18:02.800 --> 00:18:07.360 largely as a result of aftermath of the savings and loan debacle 181 00:18:07.360 --> 00:18:11.200 and a few other things that were going on at the time. 182 00:18:11.200 --> 00:18:16.320 We had the Bush recession, something that Bush denied during the campaign. 183 00:18:16.320 --> 00:18:27.820 but also something that hit its trough or peak, if you're looking at unemployment rates, in mid-1992, well before the election in November. 184 00:18:27.820 --> 00:18:35.820 So we were coming out of the Bush recession at the time of that election, but not far enough to save Bush from defeat. 185 00:18:35.820 --> 00:18:45.820 If you look at the 92 to present period, you see the bull market that you read so much about, with unemployment and almost steady decline. 186 00:18:45.820 --> 00:18:50.320 and I'll say almost, I'll make this qualification, you'll see the significance in a minute, 187 00:18:50.320 --> 00:18:56.820 because there seems to be a leveling off in the full employment range in 1996. 188 00:18:56.820 --> 00:19:02.820 Greenspan seems to have engineered, if you take conventional wisdom seriously, 189 00:19:02.820 --> 00:19:10.320 a soft landing of sorts, by coming out of recession without throwing the economy into the unsustainable region. 190 00:19:10.320 --> 00:19:18.640 But then look at 97-99 and you see the economy going into the unsustainable region. 191 00:19:18.640 --> 00:19:25.800 I might even say that when I first started tracking unemployment on this graph, this particular kind of graph, 192 00:19:25.800 --> 00:19:35.200 actually the bottom of the graph was 4.5% and over the last several months I've had to adjust my graph to pick up the new low figures. 193 00:19:35.200 --> 00:19:42.200 Now, down as low as 4.2. If it goes any lower, I'll have to redo my graph once again. 194 00:19:42.200 --> 00:19:50.200 But let me raise the issue point blank. Is this new unemployment rate in the low fours flirting with 4% 195 00:19:50.200 --> 00:19:59.200 Is that an unsustainably low rate of unemployment or is that a bubble? 196 00:19:59.200 --> 00:20:07.600 Now, there are several arguments to the effect that it's a new natural rate of unemployment. 197 00:20:07.600 --> 00:20:11.240 I'll consider them briefly, only to reject them. 198 00:20:11.240 --> 00:20:16.280 One is that labor unions are more restrained, they're less powerful, their wage demands 199 00:20:16.280 --> 00:20:19.600 reflect more reasonable expectations. 200 00:20:19.600 --> 00:20:24.760 But we know that labor unions have been on the wane for years, not just since 96, and 201 00:20:24.760 --> 00:20:31.440 Their actions affect relative employment in any case, causing less unemployment in labor 202 00:20:31.440 --> 00:20:40.440 in unionized industries and more in non-union. That's not a plausible reason. Increased technology, 203 00:20:40.440 --> 00:20:47.360 improved technology, particularly the personal computer. Here again, there's a timing problem. 204 00:20:47.360 --> 00:20:54.600 We've had the personal computer from the early 80s, not just since 96. The advocates of this 205 00:20:54.600 --> 00:21:07.600 And for this reason, recognize the timing problem and point out that, yes, but during the first decade or so, everyone just played solitary and minesweeper. 206 00:21:07.600 --> 00:21:18.600 And now we're beginning to see the real productivity gains. I reject that in part because, well, I still play minesweeper. 207 00:21:18.600 --> 00:21:26.700 The third is demographic reasons, baby boomers and women coming into the labor force in greater numbers. 208 00:21:26.700 --> 00:21:30.500 Baby boomers reaching their high job security years. 209 00:21:30.500 --> 00:21:37.200 Sounds plausible, but those are long-term sweeping trends that would take place over a course of many cycles. 210 00:21:37.200 --> 00:21:42.400 If you look at the graph, you see that what's happened is something during a single cycle. 211 00:21:42.400 --> 00:21:47.600 In a single business cycle, we've gone from what used to be called full employment, 212 00:21:47.600 --> 00:22:09.600 supposedly to some lower figure. I suggest an alternative explanation, and to show you that, I'll put on a chart that has the discount rate on it as well as the unemployment rate. 213 00:22:09.600 --> 00:22:13.080 Now, the Federal Reserve has always been a political animal, 214 00:22:13.080 --> 00:22:17.800 but the Greenspan Fed under the Clinton administration, particularly so, 215 00:22:17.800 --> 00:22:23.280 asked you to recall the State of the Union address in 1993, 216 00:22:23.280 --> 00:22:26.680 when I hardly remember what was said that evening, 217 00:22:26.680 --> 00:22:28.960 but I remember what I saw that evening. 218 00:22:28.960 --> 00:22:31.360 And what I saw was Alan Greenspan 219 00:22:31.360 --> 00:22:34.880 seated between Hillary Clinton and Tipper Gore. 220 00:22:34.880 --> 00:22:38.480 And I don't know how much you know about the planning of State of the Union, 221 00:22:38.480 --> 00:22:45.280 but it's not open seating and Greenspan was charted to sit there. 222 00:22:45.280 --> 00:22:49.980 He signed on as a team player by agreeing to sit there. 223 00:22:49.980 --> 00:22:53.780 The next day you could have read in the papers 224 00:22:53.780 --> 00:22:57.780 and seen the pie charts and the bar charts and all the rest explaining what was going on 225 00:22:57.780 --> 00:23:01.680 but the seating chart is what told the story. 226 00:23:01.680 --> 00:23:06.880 One of my colleagues at Auburn apologizes for Greenspan saying that 227 00:23:06.880 --> 00:23:10.440 the symbolic subservience was a way of buying himself 228 00:23:10.440 --> 00:23:12.600 substantive independence 229 00:23:12.600 --> 00:23:16.140 I don't think it works that way 230 00:23:16.140 --> 00:23:18.540 I think that he became a team player 231 00:23:18.540 --> 00:23:23.640 now in the interest of time I'm going to summarize what comes next 232 00:23:23.640 --> 00:23:25.860 but even though you see a number of 233 00:23:25.860 --> 00:23:28.020 changes in the discount rate 234 00:23:28.020 --> 00:23:32.440 there's one that stands out if you look at the chart very closely 235 00:23:32.440 --> 00:23:36.480 and it's a one where for the first time 236 00:23:36.480 --> 00:23:42.520 What was economically advisable and what was politically advisable were two different things. 237 00:23:42.520 --> 00:23:51.160 Coming out of the Bush recession, the discount rate was ratcheted up in several steps, increasing 238 00:23:51.160 --> 00:24:00.080 it from 3% to as high as 5.25 and engineering this soft landing which seemed to be working. 239 00:24:00.080 --> 00:24:06.680 And then you notice that in January of 1996, Greenspan cut the discount rate. 240 00:24:06.680 --> 00:24:11.840 This was the first instance in which there was a dilemma where he could either do the 241 00:24:11.840 --> 00:24:17.520 economically correct thing according to mainstream theory or do the politically correct thing 242 00:24:17.520 --> 00:24:21.640 in view of the oncoming election. 243 00:24:21.640 --> 00:24:24.400 He cut the discount rate. 244 00:24:24.400 --> 00:24:29.680 He did it in January of 1996 when the unemployment rate had popped up from about five and a half 245 00:24:29.680 --> 00:24:37.400 to 5.8%, which turned out to be because of a big blizzard in January, more respectable 246 00:24:37.400 --> 00:24:44.720 commentaries at the time indicated that the rate change was unwarranted, meaning that 247 00:24:44.720 --> 00:24:50.800 he wasn't really trying to fight the January blizzard, but rather was trying to fight the 248 00:24:50.800 --> 00:24:57.920 battle of the election for next November and therefore he set the economy off on an unsustainable 249 00:24:57.920 --> 00:25:04.460 growth path with that change. And also, significantly, it's dating from that time that you begin 250 00:25:04.460 --> 00:25:12.660 to see speculation against the Fed where changes in the unemployment rate will produce perverse 251 00:25:12.660 --> 00:25:19.280 reactions in the Dow Jones average. In other words, I can account for several different 252 00:25:19.280 --> 00:25:24.380 instances where three-tenths of a percent decrease in the unemployment rate, which would 253 00:25:24.380 --> 00:25:30.580 would seem good for the economy, nonetheless cause the Dow Jones Average to plummet as 254 00:25:30.580 --> 00:25:34.880 people speculate about whether Greenspan is going to take off his political hat and put 255 00:25:34.880 --> 00:25:39.080 on his economic hat or keep his political hat on. 256 00:25:39.080 --> 00:25:47.460 So it's from that point, January of 96, that Greenspan has pursued a policy of what I call 257 00:25:47.460 --> 00:25:48.460 dead reckoning. 258 00:25:48.460 --> 00:25:52.780 Are you familiar with the term dead reckoning as an old maritime term? 259 00:25:52.780 --> 00:25:59.780 It means that if you're in a fog, you can't see the stars, you don't have communications. 260 00:25:59.800 --> 00:26:04.500 Your only guide to where you are is what you did in the past, how you set your rudder and 261 00:26:04.500 --> 00:26:09.500 how you set your sails, and from that you determine where you are now. Well, I would 262 00:26:09.500 --> 00:26:14.060 argue that Greenspan is in a fog, that the signals he's looking at are polluted signals 263 00:26:14.060 --> 00:26:20.660 because most of the interest rate, price signals and so on are based mainly on what people 264 00:26:20.660 --> 00:26:36.220 He keeps getting criticized for fighting inflation when there are no signs of inflation, according 265 00:26:36.220 --> 00:26:37.220 to the critics. 266 00:26:37.220 --> 00:26:42.960 And what I argue is there is a sign of inflation, and it happened in January of 96, that he 267 00:26:42.960 --> 00:26:47.860 knew what he did in 96, he knew he was setting the economy off on an unsustainable boom, 268 00:26:47.860 --> 00:26:51.780 He knew that corrections had to be made for that at a later time. 269 00:26:51.780 --> 00:26:59.620 And so he takes this extremely low unemployment as a sign of a bubble. 270 00:26:59.620 --> 00:27:05.260 I might point out here that if we actually had competitive banking, if we had a decentralized 271 00:27:05.260 --> 00:27:10.140 banking system, if we had a market-determined interest rate, it would be idle speculation 272 00:27:10.140 --> 00:27:14.740 about whether a 4.2 rate was sustainable or not sustainable. 273 00:27:14.740 --> 00:27:17.680 Just wait and see, that's all, okay? 274 00:27:17.680 --> 00:27:23.440 But if you have a central bank that's trying to make decisions on the basis of these issues 275 00:27:23.440 --> 00:27:28.320 then it becomes very critical and what's important is not, or what's important is what Alan Greenspan 276 00:27:28.320 --> 00:27:34.240 thinks and he's given us reason to think that he believes it's unsustainable and he talks 277 00:27:34.240 --> 00:27:41.680 about over exuberance, he uses the word unsustainable in connection with it, okay? 278 00:27:41.680 --> 00:27:49.040 And now, at the risk of going a minute over my time, let me just show you another graph 279 00:27:49.040 --> 00:27:53.340 that will put into perspective recent changes in the interest rate. 280 00:27:53.340 --> 00:27:59.240 The political, or the popular press by the way, is not very good at reporting interest 281 00:27:59.240 --> 00:28:03.800 rate changes because they blur the distinction between the discount rate, which is what I 282 00:28:03.800 --> 00:28:08.720 had on the last graph and it's on this one too, and the federal funds rate, which the 283 00:28:08.720 --> 00:28:12.600 The Fed can influence but can't fully control. 284 00:28:12.600 --> 00:28:18.560 The last two rate hikes were not in the discount rate, it stayed at 4.5% for some months now, 285 00:28:18.560 --> 00:28:20.000 hasn't changed. 286 00:28:20.000 --> 00:28:24.800 But the other plot of interest rates on there is the federal funds rate, and it shows the 287 00:28:24.800 --> 00:28:29.840 federal funds rate inching up, those are the rates, target rates that the Fed has set for 288 00:28:29.840 --> 00:28:35.240 itself in the last couple of open market committee meetings. 289 00:28:35.240 --> 00:28:40.240 And now, I've brought you almost to the brink of a prediction, okay? 290 00:28:40.240 --> 00:28:43.520 Lew Rockwell told us that we didn't predict. 291 00:28:43.520 --> 00:28:45.240 But I've brought you to the brink of prediction. 292 00:28:45.240 --> 00:28:50.280 I've showed the federal fundraising rising significantly above the discount rate. 293 00:28:50.280 --> 00:28:58.960 And you might think that I'm going to flout the rules that Rockwell laid down and predict 294 00:28:58.960 --> 00:29:04.000 what Greenspan's going to do next, but instead I'll affirm those rules and say that, guess 295 00:29:04.000 --> 00:29:08.000 Greenspan doesn't know what he's going to do either, okay? 296 00:29:08.000 --> 00:29:10.000 Thank you very much.