WEBVTT NOTE What the Fed Has Done and Is Doing to Us 1 00:00:00.000 --> 00:00:12.000 ...among the publications of such august and stodgy economic think tanks as the American Enterprise Institute and the National Bureau of Economic Research. 2 00:00:12.000 --> 00:00:18.000 As your title suggests, these articles delineate chilling scenario of the American economy. 3 00:00:18.000 --> 00:00:25.000 Not only do they all contend that deflation is close at hand, but they also assert in common two other propositions. 4 00:00:25.000 --> 00:00:30.120 First, that the effects of deflation are an unmitigated disaster for economic activity 5 00:00:30.120 --> 00:00:35.020 and consumer welfare, and second, that the Federal Reserve system needs to take prompt 6 00:00:35.020 --> 00:00:39.300 action to head off such impending devastation to the economy. 7 00:00:39.300 --> 00:00:45.480 In particular, they argue that the Fed must dexterously shift gears and become a deflation 8 00:00:45.480 --> 00:00:51.920 fighter rather than the supposedly staunch and valiant inflation fighter it has been 9 00:00:51.920 --> 00:00:55.080 for the last two decades. 10 00:00:55.080 --> 00:00:59.480 A few authors even despair of whether the Fed is now constitutionally capable of making 11 00:00:59.480 --> 00:01:05.240 such a shift, as if any central bank in history would be unwilling or unable to create massive 12 00:01:05.240 --> 00:01:08.880 quantities of new money at the drop of a hat. 13 00:01:08.880 --> 00:01:16.280 Most of the growing host of deflation-phobes prudently leaves the precise details of the 14 00:01:16.280 --> 00:01:21.680 impending deflationary debacle to our imagination, with vague references to the Great Depression 15 00:01:21.680 --> 00:01:26.680 in the U.S. in the early 1930s, or to the experience of Japan since 1998. 16 00:01:26.680 --> 00:01:34.680 However, others, such as market pundit Donald L. Luskin, a self-proclaimed un-reconstructed supply-sider, 17 00:01:34.680 --> 00:01:37.680 delight in conjuring up warred deflationary scenarios. 18 00:01:37.680 --> 00:01:41.680 According to Luskin, deflation is, quote, going to be a world of hurt. 19 00:01:41.680 --> 00:01:45.680 If you thought inflation was a nightmare, wait until you live with a deflation. 20 00:01:45.680 --> 00:01:49.680 Prices of everything eventually go down. Geez, I thought that would be great. 21 00:01:49.680 --> 00:01:53.680 I hope everything goes down to what Nicholas Murray Rothbard used to say. 22 00:01:53.680 --> 00:01:58.680 Stocks, real estate, wages, the whole thing. You're a little poorer every day. 23 00:01:58.680 --> 00:02:01.680 And if you're in debt, then you're really in trouble. 24 00:02:01.680 --> 00:02:07.680 You'll have to make those same mortgage payments even though the value of your house is going down every month. 25 00:02:07.680 --> 00:02:10.680 But that doesn't mean that deflation is any bed of roses for lenders either. 26 00:02:10.680 --> 00:02:18.680 Sure, it's nice to have locked in a stream of payments and money that will buy you more and more apples and paperclips and houses as prices collapse. 27 00:02:18.680 --> 00:02:43.680 The only ones who are worse off are the creditors who took part in generating the inflationary credit, that is the banks, and those profligate firms and consumers that borrowed and spent it. 28 00:02:43.680 --> 00:02:45.680 So I don't cry for them. 29 00:02:45.680 --> 00:03:03.680 Regardless of whether they indulge in such rhetorical excesses or whether they dispassionately state their case in formal academic jargon, however, contemporary deflation-phobes fail to analytically distinguish between the melange of different phenomena that are commonly jumbled together under the current name of deflation. 30 00:03:03.680 --> 00:03:10.280 Indeed, academic macroeconomists are the most likely of all to be blind to this conceptual muddle 31 00:03:10.280 --> 00:03:16.080 because modern macroeconomics was born of John Maynard Cain's obsessive deflation phobia, 32 00:03:16.080 --> 00:03:19.080 especially with regard to money wage rates. 33 00:03:19.080 --> 00:03:28.280 As a result, they are not inclined to disentangle and give a coherent account of the separate economic processes designated as deflationary. 34 00:03:28.280 --> 00:03:33.580 Nor are they able to figure out which kinds of deflationary processes are benign 35 00:03:33.580 --> 00:03:38.380 and represent an improvement of economic efficiency and welfare, and which kinds are malign 36 00:03:38.380 --> 00:03:43.180 and distort monetary calculation and impair economic productivity and well-being. 37 00:03:43.180 --> 00:03:48.680 Fortunately, Austrian monetary theory, developed primarily by Ludwig von Mises and Murray Rothbard, 38 00:03:48.680 --> 00:03:53.780 provides us with the means to cut through the tangle of deflation-phobic fallacies 39 00:03:53.780 --> 00:03:56.380 that we have recently been bombarded with. 40 00:03:56.380 --> 00:04:26.380 In what follows, I will carefully define inflation, I will then use Austrian monetary theory both to identify and analyze the different kinds of deflation and to distinguish between deflations that are natural and benign products of a free market economy and compulsory deflation that represents a gross and maligned violation of property rights, a deflation which no one talks about but which is now taking place in Argentina. Everyone calls it responsible austerity measures. 41 00:04:26.380 --> 00:04:32.380 Before World War II, when the terms inflation and deflation were used in academic discourse or everyday speech, 42 00:04:32.380 --> 00:04:36.380 they generally referred to increases or decreases in the stock of money respectively. 43 00:04:36.380 --> 00:04:41.380 A general rise in prices was viewed as one of the several consequences of inflation of the money supply. 44 00:04:41.380 --> 00:04:47.380 Likewise, a decline in overall prices was viewed as one effect of deflation of the money supply. 45 00:04:47.380 --> 00:04:53.380 Under the influence of the Keynesian Revolution, however, the meaning of these terms began to change after the mid-1930s. 46 00:04:53.380 --> 00:05:05.380 By the 1950s, the definition of inflation as a general rise in prices and of deflation as a general fall in prices became firmly entrenched in academic writings and popular speech. 47 00:05:05.380 --> 00:05:12.380 We can ignore here whether or not this change in usage lends itself to conceptual clarity and analytical precision. 48 00:05:12.380 --> 00:05:19.380 The point is that today when professional economists or members of the lay public utter or write the term deflation, 49 00:05:19.380 --> 00:05:29.880 They invariably mean a decline in the overall prices of commodities and services purchased by the average consumer as reflected in the price index such as the CPI. 50 00:05:29.880 --> 00:05:41.880 Movements in the price of consumer goods are relevant for identifying the existence and degree of inflation or deflation because consumer goods are the final output and rationale of all economic activity. 51 00:05:41.880 --> 00:06:01.880 Moreover, as Carl Menger, the founder of Austrian Economics, has taught us, the prices of the myriads of intermediate and original inputs into the production process, broadly categorized as capital goods, labor and natural resources, are ultimately determined by a market imputation process, starting with the prices of consumer goods. 52 00:06:01.880 --> 00:06:31.880 Thus, when economists, business forecasters and Alan Greenspan scrutinize indexes of input prices, such as the producer price index or indexes of raw commodities prices, they do so because they incorrectly believe that changes in these indexes are predictors of future changes in general consumer prices, as if input prices determine product prices rather than the other way around. 53 00:06:31.880 --> 00:06:39.880 Defined as a general fall in consumer prices, deflation implies an increase in the value or purchasing power of the monetary unit. 54 00:06:39.880 --> 00:06:43.880 In the US, an increase in the amount of consumer goods that can be purchased for a dollar. 55 00:06:43.880 --> 00:06:49.880 Now, there are a number of different factors that tend to increase the value of the dollar. 56 00:06:49.880 --> 00:06:55.880 These deflationary factors and the processes they initiate may be benign or maligned, good or bad, 57 00:06:55.880 --> 00:06:59.880 with respect to economic efficiency, productive activity and consumer welfare. 58 00:06:59.880 --> 00:07:06.120 depending on whether they result from the voluntary choices of laborers, capitalists, entrepreneurs and consumers 59 00:07:06.120 --> 00:07:10.600 or the coercive intervention of a government central bank such as the Fed. 60 00:07:10.600 --> 00:07:16.760 As we shall see below, while the deflation-phobes have bemoaned the imaginary evils 61 00:07:16.760 --> 00:07:20.280 of deflationary scenarios that are actually benign, 62 00:07:20.280 --> 00:07:26.520 they have completely ignored the one instance of deflation that has actually materialized and is truly malign. 63 00:07:26.520 --> 00:07:37.520 According to Austrian theory, the value of money, which is the inverse of overall consumer prices, is determined like the individual prices of its component consumer goods by supply and demand. 64 00:07:37.520 --> 00:07:51.520 An increase in the value of a dollar and a corresponding decline in overall dollar prices may thus proceed either from an expansion of the demand for or contraction of the supply of money or a combination of both. 65 00:07:51.520 --> 00:07:59.520 There are four basic causes of deflation, two operating on the demand side and two on the supply side of the money relation. 66 00:07:59.520 --> 00:08:12.520 The economic processes associated with these factors may be categorized as growth deflation, cash building deflation, bank credit deflation and confiscatory deflation. 67 00:08:12.520 --> 00:08:18.520 I will analyze each in turn below and then appraise its effect on economic efficiency and consumer welfare. 68 00:08:18.520 --> 00:08:30.520 Let me start with growth efficiency. One component of the demand for money is the total quantities of the various commodities and services that people supply to the market in exchange for money. 69 00:08:30.520 --> 00:08:42.520 The aggregate supply of goods therefore constitutes what Austrians call the exchange demand for money, because by selling goods, including their own labor services, people are exercising a demand to acquire money. 70 00:08:42.520 --> 00:09:12.520 Hence, if supplies of goods in the economy increase, due for example to increased saving and investment in additional capital goods, and to technological improvement, as is the usual case in the historical market economy, then all other things equal, including the supply of dollars, their producers will be induced by competition to offer more units of the product for a dollar, and the exchange value of the dollar will be bid up. This means that on the other side of the market, consumers will need 71 00:09:12.520 --> 00:09:19.120 to give fewer dollars to obtain a given good and therefore a price deflation will occur. 72 00:09:19.120 --> 00:09:22.840 This is precisely what occurred in the past three decades with respect to products of 73 00:09:22.840 --> 00:09:27.600 the electronics and high tech industries such as hand calculators, video game systems, personal 74 00:09:27.600 --> 00:09:32.660 computers and DVD players. As a consequence of rapid technological improvement and its 75 00:09:32.660 --> 00:09:37.280 embodiment in additional capital goods, labor productivity increased phenomenally in these 76 00:09:37.280 --> 00:09:43.040 These industries driving down per unit costs of production and increasing profit margins. 77 00:09:43.040 --> 00:09:47.600 Since the resulting expansion of the supplies of goods forthcoming from these industries 78 00:09:47.600 --> 00:09:52.120 outstripped the expansion of the supply of dollars during this period, the effect was 79 00:09:52.120 --> 00:09:57.320 a spectacular drop in the prices of PCs, for example, and a corresponding rise in the dollar's 80 00:09:57.320 --> 00:10:00.920 purchasing power in terms of computing power. 81 00:10:00.920 --> 00:10:05.360 Note that this substantial price deflation in the high-tech industries did not impair 82 00:10:05.360 --> 00:10:09.200 and in fact facilitated the enormous expansion of profits, 83 00:10:09.200 --> 00:10:12.240 productivities and outputs in these industries. 84 00:10:12.240 --> 00:10:15.120 The price deflation that was observed in the past three decades 85 00:10:15.120 --> 00:10:17.240 in selected high growth industries, however, 86 00:10:17.240 --> 00:10:21.240 was not an unprecedented or even unusual occurrence. 87 00:10:21.240 --> 00:10:23.880 In fact, historically, the natural tendency 88 00:10:23.880 --> 00:10:25.320 in the industrial market economy 89 00:10:25.320 --> 00:10:27.760 under commodity money such as gold 90 00:10:27.760 --> 00:10:30.720 has been for general prices to persistently decline 91 00:10:30.720 --> 00:10:32.760 as ongoing capital accumulation 92 00:10:32.760 --> 00:10:34.920 and advances in industrial techniques 93 00:10:34.920 --> 00:10:38.280 led to a continual expansion in the supplies of goods. 94 00:10:38.280 --> 00:10:42.000 Thus, throughout the 19th century and up until the First World War, 95 00:10:42.000 --> 00:10:45.760 a mild deflationary trend prevailed in industrialized nations 96 00:10:45.760 --> 00:10:50.360 as rapid growth in the supplies of goods outpaced the gradual growth in the money supply 97 00:10:50.360 --> 00:10:52.920 that occurred under the classical gold standard. 98 00:10:52.920 --> 00:10:56.200 For example, in the U.S. from 1880 to 1896, 99 00:10:56.200 --> 00:10:59.520 the wholesale price level fell by about 30 percent 100 00:10:59.520 --> 00:11:02.160 or by 1.75 percent per year, 101 00:11:02.160 --> 00:11:06.760 while real income rose by about 85% or around 5% per year. 102 00:11:06.760 --> 00:11:09.360 So we had economic growth and deflation. 103 00:11:09.360 --> 00:11:11.320 This deflationary trend was only interrupted 104 00:11:11.320 --> 00:11:13.720 during periods of major wars, 105 00:11:13.720 --> 00:11:15.480 such as the Napoleonic Wars in Europe 106 00:11:15.480 --> 00:11:17.120 and the American Civil War, 107 00:11:17.120 --> 00:11:18.720 because the belligerent governments 108 00:11:18.720 --> 00:11:21.600 invariably financed their war spending 109 00:11:21.600 --> 00:11:23.600 by printing paper fiat money. 110 00:11:24.760 --> 00:11:27.000 Furthermore, note that the fallen prices 111 00:11:27.000 --> 00:11:29.200 and average production costs of consumer goods 112 00:11:29.200 --> 00:11:31.600 occurring during the growth process 113 00:11:31.600 --> 00:11:35.640 does not necessarily entail a decline in the nominal price of labor. 114 00:11:35.640 --> 00:11:39.680 If the supply of labor is fixed, money wage rates remain constant, 115 00:11:39.680 --> 00:11:45.000 while real wage rates rise to reflect the increase in the productivity of labor. 116 00:11:45.000 --> 00:11:51.280 Since the purchasing power of every dollar earned rises with the decline of consumer prices. 117 00:11:51.280 --> 00:11:56.200 Needless to say, economics as well as common sense tells us that the effect of such price deflation 118 00:11:56.200 --> 00:12:00.280 on economic activity and consumer welfare is entirely benign, 119 00:12:00.280 --> 00:12:08.080 because it is the result of the voluntary exchanges of property titles among resource owners, capitalists, entrepreneurs and consumers. 120 00:12:08.080 --> 00:12:15.080 These transactions generate a natural increase in the value of money that is a necessary complement to the growth of real wealth and income 121 00:12:15.080 --> 00:12:18.680 and the greater satisfaction of human wants that they provide. 122 00:12:18.680 --> 00:12:25.880 Okay, let me talk a little bit about hoarding, which I call cash building deflation. 123 00:12:25.880 --> 00:12:33.380 Although a handful of mainstream economists might be persuaded that price deflation associated with economic growth is benign, 124 00:12:33.380 --> 00:12:42.880 they would all scoff at the view that hoarding, a second factor tending toward price deflation, enhances economic efficiency and welfare. 125 00:12:42.880 --> 00:12:51.380 Hoarding occurs when an individual deliberately chooses to reduce his current spending on consumer goods and investment assets below his current income, 126 00:12:51.380 --> 00:12:56.380 preferring to add the unspent income to its cash balance held in the form of currency 127 00:12:56.380 --> 00:13:02.380 and immediately spendable checking and savings deposits at banks. 128 00:13:02.380 --> 00:13:07.380 However, hoarding is nothing but an increase in what is called a cash balance demand for money. 129 00:13:07.380 --> 00:13:12.380 That is, the average amount of money that the individual desires to keep on hand over a period of time. 130 00:13:12.380 --> 00:13:17.380 It usually stems from a more pessimistic or uncertain attitude towards the future, 131 00:13:17.380 --> 00:13:24.380 of the Future, caused possibly by the onset of a recession, a natural disaster or the imminent prospect of war. 132 00:13:24.380 --> 00:13:33.380 Under such circumstances, market participants appraise the value of the services yielded by a dollar in hand more highly than before, 133 00:13:33.380 --> 00:13:41.380 relative to the services of consumer goods or the interest yield on investment goods that can be currently purchased for the dollar. 134 00:13:41.380 --> 00:13:44.380 All other things equal, including the number of dollars in existence, 135 00:13:44.380 --> 00:13:54.380 This increase in the demand to hold money will result in the bidding up of the market value of the dollar in terms of goods. 136 00:13:54.380 --> 00:14:03.380 A pervasive price inflation will result, characterized by a reduction in the flow of dollar spending and dollar income. 137 00:14:03.380 --> 00:14:09.380 But the deflationary process caused by hoarding is also benign and productive of greater economic welfare. 138 00:14:09.380 --> 00:14:19.380 is initiated by the voluntary choices of some money holders to refrain from exchanging their title to their money assets on the market in the same quantities as they had previously. 139 00:14:19.380 --> 00:14:26.380 However, with the supply of money fixed, the only way in which this increased demand to hold money can be satisfied is for each dollar to become more valuable, 140 00:14:26.380 --> 00:14:32.380 so that the total purchasing power represented by the existing supply of money increases. 141 00:14:32.380 --> 00:14:35.380 This is precisely what price deflation accomplishes. 142 00:14:35.380 --> 00:14:43.380 An increase in aggregate monetary wealth or the real supply of money in order to satisfy those who desire additional cash balances. 143 00:14:45.380 --> 00:14:48.380 Now let me talk a little bit about bank credit deflation. 144 00:14:49.380 --> 00:14:55.380 There are two major factors that have historically operated on the supply of money to produce price deflation. 145 00:14:55.380 --> 00:14:58.380 Okay, so now we're talking about the supply side of money. 146 00:14:58.380 --> 00:15:19.380 The most familiar is a decline in the supply of money that results from a collapse or contraction of fractional reserve banks that are called upon by their depositors en masse to redeem their notes and demand deposits in cash during financial crises. 147 00:15:19.380 --> 00:15:29.380 Before World War II, bank runs generally were associated with the onset of recession and were mainly responsible for the deflation that always characterized recessions. 148 00:15:29.380 --> 00:15:37.380 What is called bank credit deflation typically came about when depositors lost confidence that banks were able to continue redeeming the titles, 149 00:15:37.380 --> 00:15:47.380 represented by the bank notes and checking account balances, to the property they had entrusted to the banks for safekeeping and which the banks were contractually obliged to redeem upon demand. 150 00:15:47.380 --> 00:16:01.380 This property was usually gold and silver money, and fractional reserve banks were not able to distort their contractual obligations to all its rightful owners at once because they had created multiple titles to this property in the course of their lending operations. 151 00:16:01.380 --> 00:16:11.380 This meant that their outstanding stock of redeemable notes and demand deposits were expanded to a large multiple of a commodity money reserve they kept on hand. 152 00:16:11.380 --> 00:16:17.380 During financial crises, bank runs caused many banks to fail completely and their notes and deposits to become worthless. 153 00:16:17.380 --> 00:16:26.380 In the case of other banks, the threat that their depositors would suddenly demand cash payments all at once was sufficient to induce them to reduce their lending operations, 154 00:16:26.380 --> 00:16:33.380 to build up their ratio of reserve to note and deposit liabilities in order to stave off failure. 155 00:16:33.380 --> 00:16:43.380 Both of these factors resulted in a large contraction of the money supply, and given a constant demand for money, a corresponding increase in the value of money. 156 00:16:43.380 --> 00:16:52.380 After national banks took legal custody of the public's gold deposits, which occurred in the US shortly after the Fed was established in 1914, 157 00:16:52.380 --> 00:17:07.380 The Central Bank itself usually engineered bank credit deflation during financial crises provoked by its previous inflationary policy in order to protect these gold deposits and to avert depositors' loss of faith in the entire banking system. 158 00:17:07.380 --> 00:17:20.380 Once again, our judgment must be that deflation, even when caused by a contraction of bank credit amidst numerous bank failures, has a salutary effect on the economy and enhances the welfare of market participants. 159 00:17:20.380 --> 00:17:34.380 For is initiated by a voluntary and contractual redemption of property titles to money by bank depositors, who perceive that the fractional reserve banks are no longer functioning to safely and securely store their cash balances. 160 00:17:34.380 --> 00:17:45.380 When any firm that trades on its trustworthiness, be it a financial services firm, an armored car company or a law firm, loses the confidence of its customers or clients that it is operating in their best interests, 161 00:17:45.380 --> 00:17:52.380 It will be rapidly purged from the market by an adjustment process that reallocates resources and improves the welfare of consumers. 162 00:17:52.380 --> 00:17:58.380 Bank credit deflation represents just such a benign and prerogative market adjustment process. 163 00:17:58.380 --> 00:18:08.380 In fact, in the era before the 1930s, when the natural flexibility of prices and wage rates prevailed and was not impeded by legal constraints, 164 00:18:08.380 --> 00:18:13.380 bank credit deflations in the US were swift and devoid of severe economic dislocations. 165 00:18:13.380 --> 00:18:29.380 Let me briefly review one episode. In the fall of 1839, there occurred a financial crisis in the U.S. which resulted from a massive expansion of the money supply during the 1830s, initially stimulated by the legally privileged Second Bank of the United States. 166 00:18:29.380 --> 00:18:39.380 From the peak of the business cycle in 1839 to its trough in 1843, the money supply contracted by about one-third, 34%. 167 00:18:39.380 --> 00:18:44.380 That's as much as occurred during the first four years of the Great Depression. 168 00:18:44.380 --> 00:18:52.380 Almost one-quarter of the nation's banks collapsed, including the Bank of the United States, and wholesale prices fell by 42%. 169 00:18:52.380 --> 00:19:04.380 Despite, or rather because of, the massive deflation of prices, real GNP and real consumption actually increased during this period by 16% and 20% respectively. 170 00:19:04.380 --> 00:19:10.380 So income was going up more slowly than before, but it was going up during this massive bank credit deflation. 171 00:19:10.380 --> 00:19:20.380 However, real investment did decline during the period by 23%, which was a benign development because the malinvestments of the previous inflationary boom needed to be liquidated. 172 00:19:20.380 --> 00:19:25.380 Now let me talk about a bad kind of deflation, confiscatory deflation. 173 00:19:25.380 --> 00:19:30.380 Not all types of price deflation are the outcome of benign market processes, however. 174 00:19:30.380 --> 00:19:35.380 There does exist a maligned form of deflation, coercively imposed by governments and their central banks, 175 00:19:35.380 --> 00:19:41.380 that violates property rights, distorts market processes and lowers economic welfare. 176 00:19:41.380 --> 00:19:49.380 This kind of deflation involves an outright confiscation of people's cash balances by the entrenched political bureaucratic class. 177 00:19:49.380 --> 00:19:55.540 Alas, confiscatory deflation has been almost completely ignored by the deflation-phobes, 178 00:19:55.540 --> 00:20:00.300 despite the fact that it has occurred quite a few times in the last two decades, in Brazil, 179 00:20:00.300 --> 00:20:05.840 the former Soviet Union, and Argentina in the 1980s, in Ecuador two years ago, and currently 180 00:20:05.840 --> 00:20:07.660 once again in Argentina. 181 00:20:07.660 --> 00:20:13.020 In fact, one of the few contemporary economists to identify and condemn confiscatory deflation 182 00:20:13.020 --> 00:20:17.020 as a malign form of deflation was Murray Rothbard. 183 00:20:17.020 --> 00:20:22.980 Deflation is imposed upon the economy by the political authorities as a means of obstructing 184 00:20:22.980 --> 00:20:27.980 an ongoing bank credit deflation that threatens to liquidate an unsound financial system built 185 00:20:27.980 --> 00:20:32.820 on fractional reserve banking. Its essence is an abrogation of bank depositors' property 186 00:20:32.820 --> 00:20:39.340 titles to their cash stored in immediately redeemable checking and savings accounts. 187 00:20:39.340 --> 00:20:44.300 A glaring example of confiscatory deflation is the current situation in Argentina. In 188 00:20:44.300 --> 00:20:50.380 In 1992, after yet another bout of hyperinflation, Argentina pegged its new currency, the peso, 189 00:20:50.380 --> 00:20:55.020 to the US dollar at the rate of 1 to 1. 190 00:20:55.020 --> 00:21:00.140 In order to maintain this fixed peso-dollar peg, the Argentine Central Bank pledged to 191 00:21:00.140 --> 00:21:05.580 freely exchange dollars for pesos on demand and to back its own liabilities, consisting 192 00:21:05.580 --> 00:21:11.660 of peso notes and commercial bank reserve deposits, almost 100% by dollars. 193 00:21:11.660 --> 00:21:40.660 Unfortunately, this arrangement, while it inspired confidence in international lenders because of IMF and U.S. approval and their implicit bailout guarantee, did not prevent the massive and inflationary bank expansion as investment dollars flooded into the country, they found their way into the central bank which was then able to create additional peso reserves. 194 00:21:40.660 --> 00:21:50.660 The latter were given to the fractional reserve bank system, which was then able to inflate bank credit by multiplying bank deposits on top of each new dollar or peso of reserves. 195 00:21:50.660 --> 00:22:04.660 As a result, Argentina's money supply increased at an average of 60% per year from 1991 through 1994, during the so-called currency war that is so beloved by the supply-siders in the Wall Street Journal. 196 00:22:04.660 --> 00:22:16.660 After declining to less than 5% for 1995, the growth rate of the money supply shot up to over 15% in 1996 and nearly 20% in 1997. 197 00:22:16.660 --> 00:22:28.660 With the peso overvalued as a result of the increasingly inflated domestic product prices and foreign investors losing confidence that the peso would not be devalued, 198 00:22:28.660 --> 00:22:39.660 The influx of dollars ceased and the inflationary boom came to a screeching halt in 1998 as the money supply increased by about 1% and the economy went into recession. 199 00:22:45.660 --> 00:22:53.660 In 1999, the money supply shrank slightly. In 2000, the money supply shrank by almost 20%. 200 00:22:53.660 --> 00:23:01.500 The money supply continued to contract at a double-digit annual rate through June 9, 2001. 201 00:23:01.500 --> 00:23:06.300 In 2001, domestic deposits began to lose confidence in the banking system and a bank credit deflation 202 00:23:06.300 --> 00:23:13.500 began in earnest as the system lost 17% or $14.5 billion worth of deposits. 203 00:23:13.500 --> 00:23:21.020 On Friday, November 30th alone of 2001, $700 million of deposits were withdrawn from Argentine 204 00:23:21.020 --> 00:23:22.020 banks. 205 00:23:22.020 --> 00:23:28.140 Even before the Friday bank run, the central bank only possessed $5.5 billion of reserves, 206 00:23:28.140 --> 00:23:33.580 ultimately backing $70 billion worth of dollar and convertible peso deposits. 207 00:23:33.580 --> 00:23:39.260 In response, on Saturday, December 1st, President Fernando de la Rua and his economy minister, 208 00:23:39.260 --> 00:23:44.920 Domingo Cavallo, announced a policy that amounted to confiscatory deflation to protect the financial 209 00:23:44.920 --> 00:23:48.220 system and maintain the fixed peg to the dollar. 210 00:23:48.220 --> 00:23:53.540 Specifically, cash withdrawals from banks were to be limited to $250 per depositor per 211 00:23:53.540 --> 00:23:59.860 week for the next 90 days, and all overseas cash transfers exceeding $1,000 were to be 212 00:23:59.860 --> 00:24:01.860 strictly regulated. 213 00:24:01.860 --> 00:24:06.460 Anyone attempting to carry cash out of the country by ship or by plane was to be interdicted. 214 00:24:06.460 --> 00:24:11.780 Finally, banks were no longer permitted to issue loans in pesos only in dollars, which 215 00:24:11.780 --> 00:24:14.220 were exceedingly scarce. 216 00:24:14.220 --> 00:24:17.740 Depositors were still able to access their bank deposits to make payments by check or 217 00:24:17.740 --> 00:24:22.820 or debit cards. Nonetheless, this policy was a crushing blow to poor Argentines who 218 00:24:22.820 --> 00:24:28.900 did not possess debit or credit cards and who hold mainly bank deposits not accessible 219 00:24:28.900 --> 00:24:34.500 by check. Predictably, Cavallo's cruel and malign confiscatory deflation developed a 220 00:24:34.500 --> 00:24:39.980 severe blow to cash businesses such as retail trade and according to one report, quote, 221 00:24:39.980 --> 00:24:44.860 brought retail trade to a standstill. This worsened the recession and riots and looting 222 00:24:44.860 --> 00:24:49.860 Soon broke out that ultimately cost 27 lives and millions of dollars of damage to private businesses. 223 00:24:49.860 --> 00:24:57.860 These events caused the state of siege to be declared and eventually forced President De La Rua to resign from his position two years before the end of his term. 224 00:24:57.860 --> 00:25:05.860 By January 6, the Argentine government, now under President Eduardo de Haldi and Economy Minister Jorge Remes Lenacov, 225 00:25:05.860 --> 00:25:12.860 conceded that it could no longer keep the inflated and overvalued peso pegged to the dollar at the rate of one to one. 226 00:25:12.860 --> 00:25:17.860 and it devalues the peso by 30% to a rate of 1.4 pesos per dollar. 227 00:25:17.860 --> 00:25:22.860 Even at this official rate of exchange, however, it appears that the peso is still overvalued 228 00:25:22.860 --> 00:25:27.860 because pesos were trading for dollars on the black market at far higher rates. 229 00:25:27.860 --> 00:25:30.860 The Argentine government recognized this 230 00:25:30.860 --> 00:25:34.860 and instead of permitting the exchange rate to depreciate to a realistic level 231 00:25:34.860 --> 00:25:38.860 reflecting the past inflation and current lack of confidence in the peso, 232 00:25:38.860 --> 00:25:43.860 It intensified the confiscatory deflation imposed on the economy earlier. 233 00:25:43.860 --> 00:25:46.860 It froze all savings accounts above $3,000 for a year. 234 00:25:46.860 --> 00:25:53.860 A measure that affected at least one-third of the $67 billion of deposits remaining in the banking system. 235 00:25:53.860 --> 00:25:59.860 $43.5 billion of these deposits are in dollars and the remainder in pesos. 236 00:25:59.860 --> 00:26:07.860 Depositors who hold dollar accounts not exceeding $5,000 will be able to withdraw their cash in 12-month monthly installments 237 00:26:07.860 --> 00:26:37.860 In the meantime, as one observer points out, 238 00:26:37.860 --> 00:26:46.860 Mr. Lenikov frankly admitted that this latest round of confiscatory deflation was a device for protecting the inherently bankrupt fractional reserve system, declaring, 239 00:26:46.860 --> 00:26:53.860 If the banks go bust, nobody gets their deposits back. The bunny on hand is not enough to pay back all depositors. 240 00:26:53.860 --> 00:26:57.860 Bankrupt Fraction Reserve System, declaring, quote, 241 00:26:57.860 --> 00:27:00.860 If the banks go bust, nobody gets their deposits back. 242 00:27:00.860 --> 00:27:05.860 The bunny on hand is not enough to pay back all depositors. 243 00:27:05.860 --> 00:27:09.860 So we have an August economy minister finally admitting this. 244 00:27:09.860 --> 00:27:13.860 Unlike the bank credit deflation that Lenikov is so eager to deflate, 245 00:27:13.860 --> 00:27:19.860 which would permit monetary exchange to proceed with a smaller number of more valuable pesos, 246 00:27:19.860 --> 00:27:32.860 Confiscatory deflation tends to abolish monetary exchange and propels the economy back to grossly inefficient and primitive conditions of barter and self-sufficient production that undermine the social division of labor. 247 00:27:32.860 --> 00:27:41.860 In the meantime, many of its unfortunate Argentine victims have recognized confiscatory deflation for what it essentially is, bank robbery by the political elites. 248 00:27:41.860 --> 00:27:46.860 Ramona Ruiz, a retired textile worker, railed at an empty ATM machine. 249 00:27:46.860 --> 00:27:49.860 That is my money inside that bank, mine. 250 00:27:49.860 --> 00:27:52.860 Another unidentified woman yelled at a government spokesman, 251 00:27:52.860 --> 00:27:54.860 how dare you take my savings. 252 00:27:54.860 --> 00:27:59.860 Jose Valenzuela, an Argentine salesman, stated, 253 00:27:59.860 --> 00:28:04.860 quote, it's as if while I am talking to you I am swiping the change from your pocket. 254 00:28:04.860 --> 00:28:13.300 Finally, and I knew there was one, there may be something good about unions, finally, Argentine 255 00:28:13.300 --> 00:28:19.180 union leaders denounced the policy as, quote, the hijacking of a nation's savings, unquote. 256 00:28:19.180 --> 00:28:24.340 So there you have it, good deflation and bad deflation. As Frank Schostock pointed out, 257 00:28:24.340 --> 00:28:30.100 the U.S. is not on the precipice of any sort of deflation. I would go on if I had time 258 00:28:30.100 --> 00:28:36.100 and talk a little bit more about the supply sliders and their ridiculous claims, but I'll stop here. Thank you.