Today, it's my distinct pleasure to introduce the F.A. Hayek Memorial Lecturer.
William Budos received his B.A. in Economics from Brooklyn College.
He holds an M.A. in Economics from City University of New York and a Ph.D. in Economics from Penn State,
where he worked under Will E. Mason, an unduly neglected monetary theorist.
Bill is currently Professor of Economics at Trinity College,
College, where he has taught since 1981 and holds the George M. Ferris Chair of Corporation
Finance.
He has served as President of the Society for the Development of Austrian Economics
and is currently on the Board of Editors of the Journal of Private Enterprise.
Since 1993, he has been a visiting scholar and my colleague at NYU's Austrian Economics
Program.
He edited Will Mason's Magnum Opus on neoclassical versus classical monetary theories and has
has recently published The Social Science of Hayek's The Sensory Order.
He's published widely in monetary economics, the history of economic thought, and the economics
of science, and is currently working on the political economy of government and science
with co-author Thomas McQuade.
Bill is the leading authority on monetary and social thought of Hayek, and as my good friend
has guided me to much greater appreciation for the breadth and profundity of Hayek's contributions
to Monetary and Business Cycle Theory.
Bill will be addressing us today on Hayekian Social Orders and Institutions.
Thank you very much and special thanks to Joe for the kind remarks and also for inviting
me here.
It's been several years, a long hiatus since I was here last and many things have changed
and it's just wonderful to see the Mises Institute having arrived to this state and I just congratulate
Lew Rockwell, Joe and all the others who have made this possible.
For 30 plus years I've been teaching courses and almost all of my courses are an hour and
15 minutes in length and so I'm kind of pre-programmed, I guess, to speak for about an hour and 15
minutes.
Joe has made it very clear that once my time is up, I will be literally hauled off the stage.
So to ensure at least the higher probability that I'll be able to address some questions from the audience,
I'll probably stick to my text.
and I think if things work out well, there should be several minutes left over at the end for your questions or comments.
So let me just start and again, it's so great to be here, I'm thrilled and I'm going to talk today about some of the,
what in retrospect has been questions that sort of speak to what I've done in my research efforts.
So, these questions, which maybe haven't interested everyone, nonetheless have interested me, and I hope I can extend an invitation for you to think about these things and perhaps embark upon your own efforts in this direction.
Now, one thing we know, I'm going to start reading now, so I hope you don't take that the wrong way, but I think for time's sake I better do that.
We know from Hayek that a vital characteristic of markets is that they transmit local knowledge in a form that is widely available to market participants.
That they solve the problem of the division of knowledge.
But the basic idea that I wish to promote is that this knowledge enhancing characteristic is to be found in certain other social arrangements as well.
and that a fruitful way of looking at social orders in general is to focus on an understanding of their ability to, not only in terms of their knowledge using characteristics, but also in terms of their adaptive capacities.
And so, what I'm going to do is sketch out some ideas that I've been working on
that emphasizes the way in which social orders actually generate knowledge
and how they can be usefully applied to two distinct realms of inquiry
the scientific order and also the monetary order
So, as Hayek pointed out in Economics and Knowledge
The aim of my remarks this morning is to take seriously Hayek's claim. More specifically, I hope to explore the idea that social orders differ with respect to their knowledge using an adaptive capacity. And that such differences are very significant.
and why these kinds of knowledge problems, if you wish to call them that, matter in two fields of inquiry.
First, from the general field of the economics of science, I will examine the scientific order and the effect, specifically, of government funding and regulation on the production of scientific knowledge.
Research.
Second, I will consider whether we can assume that certain economic propositions apply with
equal cogency to laissez-faire and central banking monetary systems.
So there's a two-pronged approach that I'm going to pursue here today, one in the scientific
realm of the economics of science and another that I'll try to address in terms of the different
monetary orders.
In both cases, the object is to understand how the scientific and monetary orders function
under different institutional frameworks in terms of their knowledge using an adaptive
capacities.
Now social orders come in various guises and forms.
I shall refer to them quite simply as structures comprised of individuals interacting according
to specific routines, rules, routines and whatever institutions that may apply to them
as well. Now, for example, we can envision a particular social order, like the catallaxy,
the market order, as referring to, in the abstract, to an open-ended system of voluntary
exchange of property rights in which actors pursue ends under scarcity and whose behaviors
are constrained by rules and conventions governing those exchanges. The aim of each agent, of
The idea, of course, is to engage in action to relieve, as Mises put it, felt uneasiness, and in so doing, within the framework of property rights, the ongoing interactions of agents produce, as a byproduct of that process, an order of having various attributes and outcomes.
Now, I want to highlight just two general propositions that any order will satisfy ordinarily,
and my specific context for the moment will be the catallaxy.
Now, first, as a byproduct, an unintended consequence of individuals' actions, monetary
market prices are an emergent characteristic of the exchange process and could only have
arisen by that process and in no other way.
The system of exchange under the conditions specified, the institutional arrangements
that govern the operation of the order itself, transform the actions of individuals into
system level outputs, market prices, that could not have been generated or known in
the absence of the actual process from which they emerge. Such system level outputs are
not aggregated from the attributes of the system's individuals, because during the
The systems outputs represent a transformative process. We can say that prices are a kind of knowledge generated by the system itself.
Now this suggests that institutional arrangements matter for the market process and that the specific outputs the system generates will be institutionally dependent.
For example, the rental market for apartments will generate outputs in the form of prices, quantities and other characteristics of the goods that are exchanged.
But arguably those outputs and those outcomes are going to be different under laissez-faire than they will be under an interventionist sort of system.
The system in both cases is doing the best it can, presumably.
We also know that the system's capacity to produce prices and other outputs to best meet
the wishes of the consumers is different under each regime.
Now a second feature of the market process is that the market should be understood as
open-ended feedback systems.
The emergent constellation of monetary prices constitute relevant knowledge inputs for agents
to revise their plans and actions for engaging in subsequent exchanges. More than that, the
changing pattern of market prices itself induces a self-generating discovery process of entrepreneurial
activity and also the discovery of new preferences by consumers as well. How well the system
is able to satisfy the wishes of the consumer will depend on the feedback properties of
and the system, and those properties cannot be divorced from the framework of institutions
the system is governed by.
For example, returning to the rent control case mentioned above, the market under rent
control is affected by the absence of price feedback signals that correspond to underlying
supply and demand conditions.
The familiar makeshifts and workarounds we see in regulated markets, for example, such
such as the deterioration in the case of rent control, of the quality of housing, the disappearance
of high-end housing or apartments, are all reflections of the regulation that is imposed.
The system has adapted to the prevailing institutional situation, but its adaptive responses are not
the same as those to the prevailing institutional environment that would have been generated
by laissez-faire. Feedback systems like the market both under laissez-faire and intervention
are adaptive systems and their adaptive qualities may be efficacious or not depending upon the
institutional arrangements. Summarizing, my point is that social orders differ with
respect to their knowledge using and adaptive capacities. This perspective provides a way,
one of many ways, but certainly a way to analyze how alternative institutional arrangements
are likely to affect the way social orders function.
Now, let me just move on to the scientific order.
And again, I'm not playing a fair game here in some sense,
because what I'm concentrating on
is a particular kind of framework
in which I'm going to frame my discussion that
is governed largely by government intervention.
And that is a result of many factors, perhaps we can talk about those later.
But that's the context in which I wish to pursue my remarks to demonstrate how these
third party interventions, in this case into the scientific order, really do affect the
scientific order itself.
Now since the time of at least Michael Polanyi work in this area, we have reason to see science
is a particular kind of emergent social order, albeit not a strictly catallactic one, especially
regarding so-called basic research. You can talk about other kinds of research activities
regarding development and so forth, which are more closely aligned to a market context,
but basic research is generally not. That's what I want to talk about here. In general,
science has its own institutions by which individual scientists undertake and communicate
their knowledge findings to others, largely via publication, lectures, conferences, initiating
an essentially adaptive process of interaction among scientists as they debate and marshal
evidence to critique and extend the work of others. What emerges as warranted scientific
truth, okay, now this is again I'm talking about science in the case of like physics
or chemistry, which have strong empirical content to them, but what emerges as warranted
of Scientific Truth in the sense of codifiable and articulated propositions about the real
world reflect a process of interaction within the scientific community having the capacity
to transform the work of an individual scientist into something considerably different and
more possibly momentous.
We do not know ex-ante what scientific insights, for example, will be generated by this process
For the simple reason, scientific knowledge emerges precisely as something new.
That's what we usually mean by scientific knowledge, something we learned, something we didn't know before.
It's similar in this respect to a market process in that, in the market process on the other hand,
it's prices that emerge principally as a byproduct of these interactions.
But in science, we have a different kind of knowledge that's generated, scientific knowledge.
Perhaps more importantly for the purpose at hand, however, I want to emphasize that it's the institutional arrangements of any particular order that are likely to prove decisive in affecting the kind of knowledge science actually generates.
Now standard neoclassical economics of science, which has its roots in the work of Nelson Arrow and many others, specifically insulates science from any kind of institutional context.
In doing so, the main thrust of neoclassical work assumes widespread market failure, in quotes,
and science on the grounds that scientific knowledge is non-appropriable,
and hence creates a public goods problem requiring, as the story goes,
government subsidies to achieve so-called optimal output of knowledge.
Someone should tell, I don't know what that means anymore, but that's what they claim.
Nelson claimed that back in 1955.
Now, this is not to say that people have questioned this.
Indeed, there's a large emerging body of work by some very good people, Terrence Keighley, James Bennett up at GMU and others,
who have questioned this whole framework within which neoclassical economics has constructed this view of what science is and the necessity for government intervention.
I might add that Thomas McQuade and I, who Joe thankfully mentioned as my frequent co-author,
and I have examined science in some detail from the point of view of a particular kind
of Hayekian social order, and in particular our concerns have focused on how government
funding affects that order, and that's what I want to turn to now.
How is it?
What ways can we impact the effect of government funding on the actual scientific order itself?
Now, my remarks are going to cover those three things there, the three big D's as I like
to think of it, directional effects, destabilizing effects and distorting effects.
Now the driving force for government funding of science has historically centered on military
and defense considerations and only since the 1950s really on the presumed market failure
in basic research. Still more recently, see how these things morph into something very
different in fact, that argument has been applied to commercial R&D as well, especially
in Europe, and increasingly so in America.
While I believe these justifications are absolutely questionable and ought to be questioned, that discussion must be set aside for the time being.
A lot of work has been done in this. I want to concentrate on something a little bit different.
Instead, I want to briefly consider the ways government funding of science as such affects science in terms of its functioning as an adaptive social order.
Now, it's not necessary to presume, I might add, that scientists are angels on earth and have the highest and best of motives.
Scientists are all kinds of people. They have different kinds of intent.
Some of them approach their work vocationally as something they would do in any case, as long as they have the resources.
But other people are known to cut corners and so forth and so on.
So science is not this pure kind of enterprise necessarily. It's composed of real people.
But the problem here, of course, is that these real people have to have a source of income.
And the source of income is necessary for them not only to generate their own standards of living
and the custom that their wives would like to be accustomed to, but also they need resources for research.
Research. And so where's that going to come from? Well, during, for example, the 19th
century, there was no government funding of research to speak of. There's one important
exception maybe. John Adams saw to it that the Naval Observatory in Washington, D.C. came
under government funding after a long, long debate. But he got that. But other than those
sorts of things, maybe the Lewis and Clark, very little funding by government of science.
Science. Okay. Indeed, during the 19th century in America, as James Bennett points out, the United States became a leader in astronomical research and the building of observatories, all with private money. Okay. There you go. My argument, of course, for another day would be, let's use that kind of model for science today, but that's again another story. Okay.
So let me just highlight, if I might, some of these effects that Thomas McQuade and I have kind of thought about and organized in this fashion.
It's kind of a taxonomy, if you will, of the effects of government funding on science.
These directional effects, whether they're funded by government or private philanthropists or what have you,
have you, are always going to be designed to, not always, but generally will be designed
to satisfy the interests of the donors. And that's only natural. The donors have a vested
interest in seeing to it that certain kinds of questions are asked. Hopefully they also
have some kind of agenda, hoping that certain results will be obtained from that funding.
And that's all fine and dandy. In the world of philanthropy, there's enough separate units
and the use of philanthropists such that you get a wide and interesting diversity of scientists doing their own thing that generates a very vibrant kind of scientific order.
But when we turn to government, what we're talking about here is a big player.
We're talking about an institution, the government, which not only has the capacity to tax people
and use those tax funds to support funding, which is bad enough, of course, but to add injury to insult, the government also obviously has its own set of agenda items, its own ideology and its own kinds of constraints as governed by the political process and cow-tailing to it, okay?
So what we observe in these government funding, and this has been documented by all kinds of researches, Savage and others have written extensively on this, it's well worth your looking into, that government not only is not this isolated, disinterested funder of science, but rather tries to mold the direction of science to suit its aims.
And we see this all the time. For example, under George W. Bush, George Bush II, he allocated for NASA all kinds of funding that was designed to ensure space exploration, you know, sending probes out to Mars and all of that.
Obama comes into office and he immediately kills that NASA program and all the money that went with it and redirects those funds to NASA with the specific charge of sending satellites up so they can study earth climatology.
So all the governments do this, they have their own agendas and they all funnel money in the way that they think is best.
I could go on and on about this stuff. I mean, you can just imagine the kinds of sausage machine that we're talking about here with government funding.
But I think you get the point that government has a real interest and executes and implements its interests to achieve certain effects directionally on the course of science.
Now, this does not mean that the science that's being performed is necessarily second rate.
You know, if you're going to fund, say, breast cancer research at Sloan Kettering Hospital in New York, the presumption would be that those scientists are fully competent to generate sensible science.
It's not that the science gets corrupted per se, it's what the funding is used for that is the issue here.
So I don't want to be clear about that.
Let me move on to destabilizing effects, and here too, government funding is subject of course to the fleeting movements of political ideology and the process, the political process itself.
So you have one, as I explained with George W. Bush versus Obama's space exploration initiatives,
The one president comes in, one set of policy makers come in and they have a particular thing they want to do.
The next bunch come in and they want to reverse that, do something different.
The problem here is that in many cases the funding amounts are so large
that we're talking about massive, in effect massive reallocations of resources from one kind of use to another.
That is to say, the scientific community is responding in part to the ideology and the agenda items that the administration and its acolytes are putting forth.
And they will do that science. Scientists need the money, they're happy to do that.
The next bunch comes in, and by gosh, the funding priorities change, and those scientists have to switch or move, but in the process, a lot of graduate students have been educated according to the prior set of agenda items.
They're not trained to do something maybe new right away, this capital investment and so forth.
and so forth. So what we have here is this kind of, and it's demonstrable. You can actually track this stuff. You can see the tides of change wafting through the scientific community as the funding priorities change. These are destabilizing. It's analogous, not the same thing obviously, but it's similar to the effects
We talk about an Austrian business cycle theory. It's a different kind of reallocation. It
concerns different kinds of questions, but it's essentially the same process. And there's
examples up the kazoo that demonstrate that these things can be very significant. Back
in the 80s, Japan, for example, was trying to generate what was called then fifth generation
Supercomputers, these supercomputers. Japan invested hundreds and hundreds of millions
of dollars into the research for this. And of course, UK, Germany, France, America and
other countries said, we can't let the Japanese get ahead of us on this particular thing.
So they followed suit. And after billions and billions of dollars around the world spent
on this research, what came of it? Nothing. Very little. Nothing momentous. That's what
I mean by destabilizing. It can be severe, it can be minor, but it's something that we
have to keep track of because it does affect how well the scientific order is going to
function. Now, distorting effects. This is a little bit more slippery. This kind is the
This kind is the third effect, but a potentially much more serious and injurious effect that can affect the scientific order.
This occurs, I think how I define it anyway, if the evolved institutions of science that confer legitimacy on the work of scientists are replaced, negated, or bypassed.
Bypassed. Now certainly this can apply to private sciences if scientists cheat and don't get caught so that they bypass the procedures that scientists all accept for the kind of research they're doing. That can work there. But where we find this really much more seriously at stake is of course when government gets into the act. Now I'll just remind, probably some of you
I remember the Lysenko episode in Soviet Russia during the 1930s.
This is a classic illustration of how government can actually distort and destroy science.
Lysenko was his political hack. He was a political hack who was trained in agrarian techniques, uneducated.
and he got the ear of some party apparatchnik
and was laying out this idea about how
you can graft, the essential idea was you can
graft plants on and they will acquire the characteristics of the
other, the thing that you're grafting onto. Well,
that's not good genetics and it's certainly not consistent with
Mendelian genetics and up at that time
Soviet biology, Soviet genetics was world class. It was absolutely world class. They were educated in the West. They had very good scholars and everything, internationally recognized. No problem.
Lysenko gets into the act and they warmed with the strong arm tactics of the party, forced his theories on Soviet agriculture.
It wasn't just the way they reorganized production, but more importantly, in some ways, it was what they did to the scientific community.
Now, if you didn't buy into Lysenkoism, you were shipped off to a gulag, or you were disposed of in other ways.
Publish or perish had a new meaning here, actually, and in fact, that was a serious issue.
But, of course, it was all accepted during the 1930s. Interestingly, the ability of Soviet agriculture to recover from this fake fraudulent kind of science and the simultaneous disappearance of good science, at least in the genetics area, of course doomed much of the agricultural seven, five-year plans in Russia to ongoing under-production, starvation, and you know the story there.
Now, interestingly, Soviet genetics disappeared off the face of the earth and it didn't reappear until much later, after Khrushchev, or it may have been Brezhnev, finally acknowledged that they had made a little mistake with Lysenkoism, and only then was Soviet biology rehabilitated to some extent.
So this went on for many, many decades. It destroyed the science in the Soviet Union.
A more subtle story here would be, surrounds the work of this biologist, physician, won
a Nobel Prize in medicine, Baltimore, who was, at the time that I'm going to address,
He was president of the Rockefeller Institute, Rockefeller University, sorry, in New York, and he was a world-class biologist by far.
Well, he and some colleagues published a paper in 1986 in Cell Magazine, and some irate and abused graduate student, a postdoc student who was in the lab working, took offense at some things.
and she lodged a suit against Baltimore and the authors of the article claiming that fraud and misconduct, scientific misconduct had occurred.
Well, it turns out that after several inquiries at MIT and Tufts University, these charges were utterly dismissed.
But, two enterprising people in the government that were working with Representative Dingell
at the time caught on to this story and they started pursuing it and they adopted it as
their crusade to ferret out all cheating fraudulent scientists.
Well, they didn't come up with very much, but Representative Dingell saw an opportunity
Committee here. And he organized hearings to bring Baltimore and his colleagues before
Congress. And in the course of doing that, his aim was to rehabilitate his little subcommittee
on oversight that was languishing and essentially moribund, had been quite moribund for quite
some time. So this was a high-profile person that they hauled into Congress. The Baltimore
Baltimore was subjected, Dingell subjected Baltimore to the full force of adversarial
government assets, the National Institutes of Health Fraud Unit, the Office of Scientific
Integrity from the Health and Human Services Department, U.S. Treasury Document Examiners,
U.S. Secret Service Forensic Specialists and Subcommittee Investigators and Lawyers.
Baltimore's work, which had been cleared of any wrongdoing by scientists, as I mentioned,
at the university level, came under this vicious attack and Dingell used these hearings as
a way of publicly humiliating Baltimore and claiming that just because Baltimore may have
I have made some errors in some calculations in the paper, which he admitted to at the
get-go from years earlier, that errors was a sufficient reason to assume misconduct.
So any scientist who makes an error, according to Dingell, is guilty of fraud.
So you can just imagine what that would do to science if it were actually implemented
on a widespread basis.
The point here is that Baltimore's reputation was savaged by these congressional hearings
and it was a reputational hit that he could not reclaim.
He was fired, he was asked to leave Rockefeller University for the notoriety he had brought.
He ended up finally, I think, at Caltech as a professor, maybe a dean, I forget now.
But his reputation was sullied beyond redemption.
Even though, in the aftermath of the Dingell hearings and several years later, all of the
accusations were reinvestigated again by other university boards and they were all found.
Scientific error had been made, but there was no evidence of misconduct.
This is the way that government, through its regulatory oversight function, when it funds
science can actually affect what counts for science.
That's the point of my remarks here, that when you have, when you combine the funding
operation with a regulatory, and in this case, you might say, congressionally approved or
constitutional legitimated function in the regulation area, you have a very powerful
way of influencing what scientists can do and how you want to treat them.
There are other examples of this, I've just picked out the one that you may have heard
about, but there are many, many similar examples of such things going on.
In light of these things, I hope it suggests to you that the kinds of frameworks within
which scientists operate are going to be measurably affected by those arrangements.
And if you have a laissez-faire approach to science, absent the kind of regulatory oversight,
for example, that Dingell was able to bring to bear in Baltimore, then science will be
conducted in a different way and on different criteria and different self-generating, self-enforcing
mechanisms.
When you add funding with a regulatory function, you get a different animal altogether.
And I mention this because this is where we're moving, folks.
Obama has been very clear about this.
He's setting up a new research center, for example, that will be with sufficient funds.
Who said there was a deficit anyway?
But with a lot of money that is going to concentrate the approval process for bringing drugs to
market.
Of course, it doesn't occur to them that the problem there is the FDA, not the scientific community.
But that being said, Obama has made it very clear that he is going to be very active in getting the right science put forth to satisfy his agenda.
And how that's going to go on is, I think, a story that we won't really fully know for quite a while.
But I imagine it's going to be a nasty story.
Okay, so let me now turn to perhaps a more contentious item, monetary orders.
I think monetary orders can also be modeled, obviously, as social orders, in which the transactions here pertain to banks, the customers and the constraints imposed on them.
Here the transactions involve the issuing of loans and the redemption of notes and the
knowledge generated is visible at the level of reserves, individual banks and the market
premium required for those transactions to go through.
By drawing contrast between different monetary orders, we can carry out a form of comparative
institutional analysis, I hope, to highlight their respective knowledge using and adaptive
qualities.
So I'm going to talk about two different monetary orders, a central banking one and a free banking one, okay?
Free banking along the lines of Selgin, White and Horowitz, if you don't mind.
But let me just continue here.
Now turning first to central banking, obviously the appropriate framework here is an interventionist system
dominated by an institution that conducts centralized monetary planning
and which is effectively exempt from the consequences of its own actions.
Since its inception in 1913, the Federal Reserve has been complicit in causing all kinds of economic problems.
That's amply documented. I'm sure all of you are aware of that.
And the recent financial crisis, of course, highlights the failure of central banking,
as well as the failure of the attendant government policies that were deployed there.
It is also ushered in, however, something called quantitative easing, and quantitative easing is a non-traditional way of affecting reserves of the banking system, especially in an environment where the interest rate which the Fed controls, the Fed funds rate, is very close to zero.
So, these are new tools that have been deployed by the Fed, and in connection with not only that, QE1, when they bought all those mortgage-backed securities, and now QE2, when they're buying 600 billion of treasuries over the next several months, starting in past November.
They have entered into a new realm here and not only has the Bernanke seen to it that the balance sheet of the Fed has increased by 2.8 times since 2008, roughly, but also the Fed has now become a fiscal policymaker in many respects as well.
So the blending of monetary and fiscal policy has been achieved by Bernanke and little Timmy Geithner, so we're in a new era, essentially.
Now, I want to mention that as developed by monetary equilibrium theorists, it's important to differentiate between benign deflation, which is what Bernanke's agenda is pretty much about, and harmful deflation.
The basic argument is that falling prices are benign when output is increasing, but harmful if the deflation is caused by an excess demand for money.
And here I wish to suggest that monetary equilibrium argument that calls for an increase in the money stock in response to a perceived excess demand for money has questionable relevance for central banking.
and Central Banking. That is to say, my argument is that, and I'm not presuming anybody here is a free banker, I happen to buy into that, probably more than some of you, but the problem is, and here's the, I think I'm just going to lay it out and say it, that I think the problem here is that the monetary equilibrium theorists, who also usually are free bankers, have argued, to some extent, some more than others, that the Fed's activities
During the early phase of the financial crisis reflected, should have been designed to reflect
the existing excess demand for money. That is to say, to ward off deflation and its costs,
I know Steve Horowitz has publicly mentioned that the Fed should have increased the money
supply back then, not necessarily in the way they did through mortgage-backed security
purchases, but the money supply should have been increased to solve that particular problem.
System. I will argue that that attempt to generate increase in the money supply can work
quite well under a free banking system. But when you apply that insight to a central bank
regime, you're really changing the game altogether. And that result that you take from your free
Free banking model, and I'll try to apply it to your central banking model, is flawed.
So it's a misapplication of a approach that works in one institutional setting, free banking,
and is used to apply or give policy advice to a central bank in a different altogether,
obviously, institutional setting.
So that's the problem.
Now, in a free banking system, if there's an excess demand for money, you know, banks
Bankers will respond and they will issue more notes because people obviously want to hold
more notes or hold the period of time during which they're holding notes and hence banks
can increase their liabilities by increasing those notes.
Now there's nothing particularly dangerous about that, there are, I can't go into it
here, obviously, I haven't got much time left indeed, but the argument is that banks can
respond in some sort of way to these sorts of problems. No one has to oversee it, it
happens quite automatically in quotes, and it makes sense within the context of the free
banking model. I'm not saying here, and I know not everybody in this room is a free
Free Banker. My argument is not to defend free banking here. That's not my point today
at all. Rather, I'm simply trying to argue that when you take a proposition that does
make sense within that context and apply it to a contemporary policy setting, that's where
the mistake is being made. That's a big mistake in my judgment.
Now, I want to just try to demonstrate and use some really cheesy graphs here to show
that if you were to try to apply some of these principles that we can glean from free banking
models to the Fed's actual situation, that you don't end up with a clear-cut policy
I have adulterated that photograph. It came out of the New Yorker, and it was black and white. This is exactly what I'm looking for, because I can make it darker and more sinister, like darker, darker, darker.
This is just a took out of the St. Louis Fed and you can see here in the recession, the financial crisis in 07, 08, how M2 velocity fell quite substantially and MZM velocity, which is a somewhat broader measure of the money stock.
of the Money Stock, also fell, okay, so you can see that the pattern. Now the problem
here is, if you're, and this is the argument that the free bankers have made, that if you
look at this particular point in time here, right around here, where things are starting
to get pretty nasty, can you legitimately say, gee, we can anticipate velocity falling
through the floor and taking action at that point in time in order to forestall that maybe?
I don't think you can, but let's say that's what you argue, and so the question is no,
you haven't got that in, you have no basis for making that judgment in that particular
point in time, you don't know what's going to happen to velocity, and indeed, if you
look at it, even through the beginning of all eight, the variance in M2 velocity is
It's not out of step with what it had been doing previously to that.
So there's not a good case here that if you were on the board of governors of the Fed,
you could say, ah, I know for a fact, philosophy is going to go through the floor and we better
do something now about it.
Okay?
I don't think you can draw that conclusion.
Why can't you draw that conclusion?
Because the Fed is a centralized bank.
They're getting all their information from all over.
They have to deliberate.
They have to do this.
They can't act spontaneously in the same sense that a free bank or a laissez-faire banking
system can adjust on the spot to something like this, where a bank is maybe experiencing
an increase in its demand for its currency.
It's precisely because these laissez-faire banking systems are decentralized that allows
them to respond in a timely and fast and appropriate way.
Now whether you context that in the case of a free banking model or any other kind of laissez-faire system for banking, that's pretty much what we're talking about, at least I'm talking about here.
And that is something that's not available to a central bank.
Also, I put together here again the pattern of M2 velocity. I've collapsed the time period, as you can see, a little bit, and measured out the monetary base, the red dotted line.
And you can see here that even though the monetary base starts taking an enormous uptick really in the middle of 2008,
this is when the Fed started buying mortgage-backed securities, doubling its balance sheet very, very quickly.
And you can see that despite that, despite that response, the Fed was impotent to stop the fall in velocity.
Now, why was velocity falling? I mean, there's a lot of reasons there. A lot of them pertained to the policies themselves that were being pursued by the Fed, I think, and also a lot of it was due probably to the other policies that the government was punching out at this point.
You know, TARP, TAF, the housing subsidization and all of that sort of stuff. That all played a role here in neutralizing any effect the increase in the monetary base might have had.
And you can see here that it had no effect essentially on velocity.
So the Fed, even if it had been omnipotent, even if it had been omnipotent,
could probably never have adjusted in a fashion that would have approximated any other kind of laissez-faire banking system
in terms of the quickness, the timeliness and the appropriateness of the responses that a decentralized system can buy for you
The problem with central banking is that it is a hopelessly ill-adapted institution for a modern monetary system. It just can't work. It cannot work. It's not that they can even be right by accident. They can never be right.
And the reason they can never be right because there is no way that a centralized banking system can mimic how a different institutional arrangement is going to function.
In this particular example, a free banking system.
So, my concluding point is, and these are some of the things that I talk about in the paper, how the systems respond. I've just summarized those very quickly.
Here's Bernanke again, but he's part of the problem. He's part of the problem. If we put somebody else in there, it would not solve the problem, though, would it?
That's the real problem, and that's the Federal Reserve building in D.C.
I've altered that picture too.
I looked everywhere for sinister-looking Federal Reserve building pictures,
and this one was taken probably during a storm, and I just kind of manipulated it a little bit,
but it suits my purposes, and I thought you'd get a kick out of that one.
Well, anyway, I'll stop there, and thank you very much. I'll take some questions.
The gentleman in the white shirt there.
You said that government funding of science doesn't necessarily diminish the quality of the scientific research performed.
Can we still make the case that it certainly slows it down and it's not efficient?
Yeah, I think there's two ways of maybe answering that. If you look at the kind of science that's funded within agencies of the government, I think you're going to find exactly what you've indicated in the actual doing the science.
Science. But a lot of the government funding of science is doled out to universities and
it's doled out by things like the various agencies that are designed to allocate the
funds to institutions outside of the government. So in those cases, the scientists are just
Researcher, everyday scientist working in their labs at a university and they are constrained
by the funding they have and their research assistants and so forth. So you might want
to make an argument that sometimes what gets funded by government wouldn't have been funded
at all by private donors or philanthropists or in-house university funds. And we all know
And all those absolutely laughable stories about, you know, the funding hog farms for
seeing how much CO2 they produce, right?
Stuff like that you get with government funding too, because it's a political process, and
it's not meant necessarily to answer the kinds of questions that scientists would, if they
had their druthers, be particularly interested in probably.
So you get some of that, but on the other hand, the parity I've described between government
and privately undertaken science is of course contingent on the monitoring of those funds
and ensuring that in fact scientists deliver on what their proposals say they're going
to deliver on.
And of course, one of the dirty little secrets of this whole funding process, and it operates
to perfection with government funding is that scientists, it's well known, but it's hard
to find this data. It's well known among the scientific community that when scientists
put in a proposal, they're putting in a proposal to a funding agency of the government of research
they've already completed. And the funding is then used for the next research project.
So there's a lot of deception and gaming going on in the system, so there's that too.
I saw that gentleman in the blue suit there.
This is my view, I don't want to hear yours.
I think that the whole issue of government funding is based on a policy that there is
a distinction between basic and applied research.
I think the best way to kill that is to say, if you really wanted to make a case against government funding,
not just the research of public education, would be to kill that fallacy,
to show that there is no distinction between basic and by research.
Because if you cannot show that, there will always be a ground rule to make a case for government funding.
If somebody proves that there is a distinction between basic and applied research, they will always have the ground to justify facts and rules to define basic research.
The linear model in science, and the linear model is basic research leads to, applied research leads to research and development.
And that is from the work of Vannevar Bush, who produced this book called The Endless Frontier back in 1946,
and which led to this enormous expansion in government funding of science. That was his model.
It's all wrong. It was wrong then and it's wrong now.
What you find, and it's a lot of literature that's come out recently that demonstrates this,
that a lot of the theoretical insights that we gain in science
actually come out of the attempt to apply other research.
So there's all this mutual causation going on
where you could argue, as you have and I agree with you, that it's research and development
which generates a lot of the basic science, and it can go both ways, and it does, there's
no doubt about that. Yes, Guido.
Your talk, you addressed the relationship between spontaneous orders on the one hand and the distinction between benign and bad and deflation on the other hand.
I couldn't get much... I mean, a practical question. If you could push the button in September 2008, would you have abolished the Federal Reserve?
Yes. The question was, if I were king or something, right, and we're talking in the events of 2008, would I have pressed the button to abolish the Fed? Yeah.
Well, in this case you're talking about a legislated decrease in the money supply, I think, right? In Brazil where they did that.
Well, I think when you're in a recession, you don't have to contract the money supply, which might happen, I don't know.
So I wouldn't recommend that. What you do is stop the inflation.
Well, I would qualify remarks. If we could just get rid of the Fed and keep the money supply where it had been, I think we would have been fine.
You look at business cycles and the credit cycles.
There's always the hand of interventionists that is at play in these things.
I think the larger question, and I think probably a better answer to Guido's question would have been,
what we need is a system where we can have sound money.
And until we get there, I don't see any particular resolution of a lot of these problems.
I think we're going to go through these cycles again and again and again.
Yeah, I mean, yeah, something like that. So, you know, but I think I do, I would
argue that as you move toward more centralized banking, these problems get
worse. That's what I would argue. Last question, I'm told. Who wants to be the
highest bidder? Okay, way back there.
I think you did an excellent job outlining some of the mis-incentives from government funding for science, but to be able to evoke it and push it in some direction, there are some mis-incentives that come from the market structure, too, when we're speaking strictly about science and trying to have emergent knowledge, trying to have emergent knowledge, if the goal of science is emergent knowledge and not necessarily practicable, priceable knowledge. One thing I'm thinking of when you point out that hog farms are sort of obvious
The other question I have is, you didn't address, and I was hoping you might be able to address, intellectual property capture by private corporations where, for example, patentable information lasts for 19, now 30 years, renewables, so, Pfizer, for example, gets derivative research from the University of Texas on, you know, how to do that, how to do that, how to do that, how to do that, how to do that, how to do that, how to do that, how to do that, how to do that, how to do that, how to do that, how to do that, how to do that,
by Agra and then captures that market information for all 30 years.
would generate better computers, better things that people want, as opposed to smart bombs,
you know, nerve gas or whatever. So it's a complicated kind of question. Maybe we can
talk about it later. Thank you very much all. I appreciate it.