WEBVTT NOTE Federal Reserve: Handmaiden of Tyranny 1 00:00:00.000 --> 00:00:12.000 I was a graduate of the University of Cambridge in England and there I studied under some of the leaders of Keynesian thought. 2 00:00:12.000 --> 00:00:23.000 In fact, I didn't study under anybody who didn't believe in Keynesian thought between 1951 and 1954 at Cambridge. 3 00:00:23.000 --> 00:00:43.000 My supervisors there were Joan Robinson who was a neo-communist, good friend of Rosa Luxemburg, the well-known conservative thinker. 4 00:00:43.000 --> 00:00:59.000 Nicky Caldor was another supervisor of mine. Subsequently, he went on to become economic advisor to the Wilson Labor Government and managed to advise them as to how to put a few more coffins into the economy of the British Isles. 5 00:00:59.000 --> 00:01:08.880 I was also supervised by Richard Kahn, who invented the multiplier theory for Keynes. 6 00:01:08.880 --> 00:01:17.080 Richard Goodwin, an American economist, was on the lam from the McCarthy Committee. 7 00:01:17.080 --> 00:01:21.940 It was not until very late in life that the names of Friedrich A. von Hayek and Ludwig 8 00:01:21.940 --> 00:01:31.420 von Mises had much of an impact on my thought. I didn't find out about them in books. I found 9 00:01:31.420 --> 00:01:40.340 out about them through bitter experience working as a journalist in a modern economy and presenting 10 00:01:40.340 --> 00:01:51.460 myself as an opponent of government intervention in the economic life of my native land Australia. 11 00:01:51.460 --> 00:01:59.860 That country suffers from a long tradition of protectionist economic policies and government 12 00:01:59.860 --> 00:02:08.220 intervention on a grand scale. My criticisms of the government in the 1960s made them so 13 00:02:08.220 --> 00:02:18.820 furious that they raided my house with 14 police, tried to have me incarcerated and 14 00:02:18.820 --> 00:02:25.860 Unfortunately I was managed to sue the Commonwealth Government of Australia for having invaded 15 00:02:25.860 --> 00:02:32.300 my premises with an illegal warrant and won what became a landmark victory for personal 16 00:02:32.300 --> 00:02:40.620 freedom in Australia. So I know from personal experience that governments get very nasty 17 00:02:40.620 --> 00:02:47.620 when you try to stop them pushing you around. 18 00:02:47.620 --> 00:02:52.820 And really through a long experience of dealing with bureaucrats 19 00:02:52.820 --> 00:02:57.780 and politicians in my life as a journalist over 25 years, 20 00:02:57.780 --> 00:03:01.220 I found out in a very practical way 21 00:03:01.220 --> 00:03:04.860 how valid are the views of people like 22 00:03:04.860 --> 00:03:08.220 von Hayek and von Mises. 23 00:03:08.220 --> 00:03:17.260 I quote, I was reading the little booklet that was given out today with the papers for 24 00:03:17.260 --> 00:03:23.220 this conference and I have this quote here from von Hayek where he said, sometimes I 25 00:03:23.220 --> 00:03:28.660 have feared that liberty is only valued when it is lost and I can tell you when the police 26 00:03:28.660 --> 00:03:38.660 freedom becomes very, very valuable. 27 00:03:38.660 --> 00:03:49.660 I think that there must be a lot of other people like myself who are brought up in an ingrained tradition of Keynesian thought 28 00:03:49.660 --> 00:03:59.660 and who found out about people like von Hayek, von Mises and also Milton Friedman 29 00:03:59.660 --> 00:04:09.660 through one's life experience of finding out what governments are capable of doing 30 00:04:09.660 --> 00:04:13.660 and what central banks are capable of doing. 31 00:04:13.660 --> 00:04:27.660 And there is no greater example of the damage to personal freedom, to economic freedom and to economic stability than what we have seen in the last 15 years in this country, 32 00:04:27.660 --> 00:04:35.660 where there has been a social revolution in the United States. It was called the Great Society. 33 00:04:35.660 --> 00:04:46.660 As a result of this revolution, a new class of Americans was created, a class of almost 65 million dependent Americans. 34 00:04:46.660 --> 00:04:58.660 Adding the number of civilian government employees to this total, we reach a grand total of just short of 79 million Americans today who live on a government check. 35 00:04:58.660 --> 00:05:04.660 The number of non-government civilian employees in this country is approximately 83 million. 36 00:05:04.660 --> 00:05:16.660 So we have now reached the astounding situation in America where the number of non-government workers is approximately equal to the number of government employees and other dependent Americans, one for one. 37 00:05:16.660 --> 00:05:26.660 This revolution has been largely accomplished in the last 20 years and the most virulent revolutionary phase has occurred in the last 15 years. 38 00:05:26.660 --> 00:05:31.660 Let me summarize a few numbers with which you are all no doubt familiar. 39 00:05:31.660 --> 00:05:44.660 In the twenty-three years between 1960 and 1983, total government outlays, federal, state and local in this country, rose to eight and a half times their 1960 level. 40 00:05:44.660 --> 00:05:51.660 Over the same period, gross national product, less government outlays, rose about five times. 41 00:05:51.660 --> 00:05:58.660 So in the broad, government outlays have risen almost twice as fast as non-government part of gross national product. 42 00:05:58.660 --> 00:06:04.660 The rate of advance of government outlays accelerated mightily during the 1970s. 43 00:06:04.660 --> 00:06:12.660 Five years ended in 1965, 34% increase. Five years ended in 1970, 68%. 44 00:06:12.660 --> 00:06:22.660 Five years ended in 1975, 63%. Five years ended in 1980, 80% increase in government outlays in five years. 45 00:06:22.660 --> 00:06:30.660 The driving force in this fantastic explosion of government outlays was federal transfer payments. 46 00:06:30.660 --> 00:06:42.660 Between 1964 and 1983, total federal government outlays rose nearly six times, but federal transfer payments rose over eleven times. 47 00:06:42.660 --> 00:06:58.160 In order to finance this unprecedented change in the nature of the allocation of after-tax 48 00:06:58.160 --> 00:07:04.220 incomes in the United States, it was necessary to resort to inflationary finance. It was 49 00:07:04.220 --> 00:07:11.180 necessary because taxpayers in the United States would not count on increases in rates 50 00:07:11.180 --> 00:07:31.100 The Age of Inflation was the result of an attempt to bring about a social revolution 51 00:07:31.100 --> 00:07:41.100 in the United States against the will of the taxpayers of the United States. Two main sources 52 00:07:41.100 --> 00:08:01.100 The first was Brackett Creek, which allowed major unlegislated increases in the rates of taxation to occur, and the second was a confiscation of wealth in the form of financial assets. 53 00:08:01.100 --> 00:08:10.400 To give you a couple of examples, the Dow-Jones bond index in terms of 1977 prices fell by 54 00:08:10.400 --> 00:08:17.180 more than one half between January 1977 when Jimmy Carter came to power and January 1981 55 00:08:17.180 --> 00:08:24.720 when Ronald Reagan came to power. Between 1975 and 1983, the real value of the Dow-Jones 56 00:08:24.720 --> 00:08:31.720 industrial average fell by about one quarter. There was a major confiscation of wealth in 57 00:08:32.840 --> 00:08:39.840 the form of financial assets. That and bracket creep were the two means used to make an obligatory 58 00:08:44.640 --> 00:08:51.640 change in the allocation of incomes and wealth in this country. 59 00:08:51.640 --> 00:08:58.920 Between 1965 and 1980, the proportion of gross national product absorbed by Federal 60 00:08:58.920 --> 00:09:06.420 Government transfer payments rose from 4.5% to 13%. 61 00:09:06.420 --> 00:09:11.960 Between 1960 and 1980, the number of dependent Americans and Government employees rose from 62 00:09:11.960 --> 00:09:22.360 from 37.9 million to 78.9 million. There were 40 million more dependent Americans and government 63 00:09:22.360 --> 00:09:33.360 employees in 1980 than there were in 1960. I would call that a socialist revolution in 64 00:09:33.360 --> 00:09:40.840 a so-called free country. In all these revolutionary changes involving 65 00:09:40.840 --> 00:09:46.160 and Confiscation of Wealth, Hidden Taxes on Income and the Creation of a New Class of 66 00:09:46.160 --> 00:09:55.320 Dependent Americans, the Central Bank played a vitally important role. Without the active 67 00:09:55.320 --> 00:10:00.960 cooperation of the Central Bank in fostering inflation, this social revolution could not 68 00:10:00.960 --> 00:10:07.360 have occurred. It could not have occurred because without the veil of inflation, the 69 00:10:07.360 --> 00:10:12.760 The stark reality of the diversion of wealth and income to a new class of dependent Americans 70 00:10:12.760 --> 00:10:20.720 would not have been supportable. It could only be achieved by stealth. The need to raise 71 00:10:20.720 --> 00:10:28.480 taxation by overt legislative action involving large increases in rates of taxation would 72 00:10:28.480 --> 00:10:35.720 have imposed impossible strains on the political process. 73 00:10:35.720 --> 00:10:41.840 For most of the last 15 years, the Federal Reserve has been able to hide its actual intentions 74 00:10:41.840 --> 00:10:48.280 by adopting a policy of so-called interest rate targeting. The Federal Reserve was able 75 00:10:48.280 --> 00:10:54.480 to suggest its good intentions by presenting its policy target as that of holding down 76 00:10:54.480 --> 00:11:01.320 interest rates during a period of endemic inflation. Rather than follow the path of 77 00:11:01.320 --> 00:11:09.040 of Mummitary Aggregate Targeting, the Central Bank adopted the policy of interest rate targeting. 78 00:11:09.040 --> 00:11:15.640 This meant in effect that the Federal Reserve maintained a permanent policy posture of accommodation 79 00:11:15.640 --> 00:11:19.040 of cash. 80 00:11:19.040 --> 00:11:25.980 The accommodative stance of the Federal Reserve became most overt under Arthur Burns, who cooperated 81 00:11:25.980 --> 00:11:32.980 The need for urgent provision of super-abundant money during the run-up to the 1972 and 1976 elections dominated Bern's policy requirements. 82 00:11:32.980 --> 00:11:42.660 Burns policy led to a strong expansion of money during 1970-73 and 1976-79. The need 83 00:11:42.660 --> 00:11:49.300 for urgent provision of super-abundant money during the run-up to the 1972 and 1976 elections 84 00:11:49.300 --> 00:11:55.560 dominated Burns policy requirements. Paul Volcker provided another huge burst of liquid 85 00:11:55.560 --> 00:12:04.880 funds for the run-up to the 1980 elections. During the whole of the period of the 1970s, 86 00:12:04.880 --> 00:12:12.120 the Federal Reserve fought tooth and nail against a formal system of monetary targeting. 87 00:12:12.120 --> 00:12:16.840 It's not surprising that this should have been so. The Federal Reserve was intimately 88 00:12:16.840 --> 00:12:23.220 involved in the political process of social revolution in the 1970s. Burns and G. William 89 00:12:23.220 --> 00:12:29.700 William Miller were both deeply committed to the presidents they served, Nixon and Ford, 90 00:12:29.700 --> 00:12:38.700 and Volcker is a lifetime bureaucrat who wants to please his bosses. As an aside it may seem 91 00:12:38.700 --> 00:12:47.220 strange to you as you look at all the various different M's that we have these days, we've 92 00:12:47.220 --> 00:13:16.220 The reason for the invention of these M's was an attempt by the Federal Reserve to pull the wool over the eyes of those, notably the Congress, who wanted to impose a system of monetary targeting. 93 00:13:16.220 --> 00:13:26.220 In March 1975, as you're all very well aware, there was a resolution passed called House Concurrent Resolution No. 133, 94 00:13:26.220 --> 00:13:33.220 which required the Federal Reserve to set up annual monetary targets and to abide by those targets. 95 00:13:33.220 --> 00:13:37.220 The Federal Reserve officials got around that in two ways. 96 00:13:37.220 --> 00:13:43.220 One, they invented a diversity of targets so that at any given time they could say, well, we hit that one. 97 00:13:43.220 --> 00:13:54.220 And then they proceeded to change the base period. First of all they did it every quarter, then they did it every six months, then they did it every year, and now they do it every now and again when it's convenient. 98 00:13:54.220 --> 00:13:57.220 And we had one of those just recently. 99 00:13:57.220 --> 00:14:26.220 So the Federal Reserve officials have used their talents, their knowledge and their will to evade any attempt by Congress to require them to have what would be described as a reasonably responsible monetary policy. 100 00:14:27.220 --> 00:14:33.540 Policy, which can be judged by objective criteria. 101 00:14:33.540 --> 00:14:41.860 The effects of the policy of inflationary finance in the United States were felt worldwide. 102 00:14:41.860 --> 00:14:48.840 An important part of the policy of enforced transfers of resources and income inside America 103 00:14:48.840 --> 00:14:54.460 was the need to depreciate the American currency in its international aspect. 104 00:14:54.460 --> 00:15:00.140 In 1971 and 1980, the trade-weighted value of the United States dollar fell from about 105 00:15:00.140 --> 00:15:06.820 125 to about 85, a decline of about 30 percent in the relative value of the world's most 106 00:15:06.820 --> 00:15:13.540 important currency. The effect of this huge depreciation of the US dollar was to spread 107 00:15:13.540 --> 00:15:20.140 the inflationary incubus throughout the world financial system. In this way, the foundations 108 00:15:20.140 --> 00:15:25.500 were laid for the current crisis of the debts of the LDC countries. I believe that that 109 00:15:25.500 --> 00:15:33.620 crisis originated from the failures of domestic United States policy. Due to the policies 110 00:15:33.620 --> 00:15:39.860 of the Federal Reserve in administering and reinforcing the New Deal controls over interest 111 00:15:39.860 --> 00:15:45.980 rates and the financial markets generally in the United States, it was less and less 112 00:15:45.980 --> 00:15:52.140 open to the American banks to make profitable loans inside the United States. Hence they 113 00:15:52.140 --> 00:16:00.020 were obliged to expand their operations internationally. After all, in 1978, by which time the price 114 00:16:00.020 --> 00:16:09.820 level in this country had doubled since 1968, five-year treasury bonds were still showing 115 00:16:09.820 --> 00:16:39.820 The American banks experienced a huge flood of deposits from overseas. Naturally, they weren't going to lend that out at some ridiculous rate of interest inside this country, so they went around the world trying to find places where they could lend it, and they lent it to these so-called sovereign debtors, including 116 00:16:39.820 --> 00:17:09.820 The Federal Reserve administered a structure of controls over interest rates, 117 00:17:09.820 --> 00:17:26.820 These interest rate controls, in an environment of spiralling inflation, were of course part and parcel of the policy of attempting to hide the true costs of inflation. 118 00:17:26.820 --> 00:17:41.820 These true costs were hidden by manipulating interest rates, the effect of which was to rob depositors and lenders of their wealth. 119 00:17:41.820 --> 00:17:50.820 In the process, the Federal Reserve almost succeeded in bankrupting the entire savings and loan and savings bank industry in this country. 120 00:17:50.820 --> 00:18:00.820 The bankruptcy of those industries was avoided only by a hair spread in 1981. 121 00:18:00.820 --> 00:18:05.820 It was the Federal Reserve controls over domestic interest rates inside the United States 122 00:18:05.820 --> 00:18:14.820 that stimulated the flood of US bank loans to LDC countries. 123 00:18:14.820 --> 00:18:34.820 Consequently, I believe that one additional result of the United States Federal Reserve policy during the 1970s was to set up LDC countries for bankruptcy. 124 00:18:34.820 --> 00:18:44.820 And those countries now are going through a tremendously painful process of adjustment, which will take them some years. 125 00:18:44.820 --> 00:18:55.820 They were in effect like borrowers who suddenly find that they've got unlimited access to easy money. 126 00:18:55.820 --> 00:19:01.820 They went on a spree, quite understandable, the money was being pushed down their throats. 127 00:19:01.820 --> 00:19:08.820 There was no possibility of them being able to repay that money, nor is there any possibility of it. 128 00:19:08.820 --> 00:19:17.820 300 billion of those LDC loans are not repayable and will not be repayable for years, if ever. 129 00:19:17.820 --> 00:19:23.820 However, due to the efforts of governments in these LDC countries, 130 00:19:23.820 --> 00:19:53.820 In all of these ways, the United States policy has contributed to 131 00:19:53.820 --> 00:20:00.500 an economic disaster and a social and political disaster throughout Latin America and in many 132 00:20:00.500 --> 00:20:18.880 East European countries. Fortunately, there is a ray of hope due to the operation of free 133 00:20:18.880 --> 00:20:33.320 Money Markets in the United States. As the 1970s wore on, interest rates started to rise. 134 00:20:33.320 --> 00:20:38.640 As the money illusion lifted, for years, the American financial markets suffered from a 135 00:20:38.640 --> 00:20:47.480 money illusion. As I said, by 1978, you were still only getting 7% on a 10-year US bond. 136 00:20:47.480 --> 00:21:00.800 But between 1978 and 1981 this money illusion just lifted and stark reality started to impose 137 00:21:00.800 --> 00:21:07.120 itself on the thinking of the financial markets who had gone on for 10 years during a period 138 00:21:07.120 --> 00:21:12.000 of doubling of the price level in the United States without any significant rise in interest 139 00:21:12.000 --> 00:21:13.000 rates at all. 140 00:21:13.000 --> 00:21:36.000 Anyway, as the money illusion lifted, the participants in the financial markets in the United States came to realize the full extent of the disaster that was occurring. Attempts to protect themselves were initiated by lenders. It's astonishing how long it took the financial markets to wake up. 141 00:21:36.000 --> 00:21:45.240 The most important development aimed at mitigating the rape of wealth holders was the development 142 00:21:45.240 --> 00:21:53.200 of the money market mutual funds. That was a tremendously important development which 143 00:21:53.200 --> 00:21:59.560 began the counter-attack by the financial markets against the destruction that was being 144 00:21:59.560 --> 00:22:21.560 In 1978 there were $6.4 billion invested in these money market mutual funds. In 1979 there was $33.4 billion. In 1980 $61.4 billion. In 1981 $150.9 billion and in 1982 $182.2 billion. 145 00:22:21.560 --> 00:22:41.560 The force of the explosion of these money market mutual funds started the process of breaking down the whole structure of Federal Reserve control over interest rates and laid the foundations for the deregulation of the financial markets which we are now seeing spreading like wildfire. 146 00:22:41.560 --> 00:22:50.560 Once the money market mutual fund steamroller got going, it was clear that the days of Federal Reserve controls over interest rates were ending. 147 00:22:50.560 --> 00:22:56.560 This in turn laid the foundations for what I have called the revolt of the financial markets. 148 00:22:56.560 --> 00:23:03.560 Since 1981 we have seen unprecedented real interest rates in the United States. 149 00:23:03.560 --> 00:23:16.560 In 1981 I think we had something like a 12% rate on a 30-year US bond and we had something like 10%, 9% or 10% inflation. 150 00:23:16.560 --> 00:23:25.560 In 1983, we've still got nearly a 12% nominal yield on a 30-year US bond, and we've got 3 or 4% inflation. 151 00:23:25.560 --> 00:23:38.560 The financial markets have revolted, and you can almost hear the participants in the financial markets of this country saying never again. 152 00:23:38.560 --> 00:23:45.560 Well, that will remain to be seen how many years will pass before they have the wool pulled over their eyes again. 153 00:23:45.560 --> 00:23:52.800 For the moment, the money illusion has completely disappeared, to be replaced by a deep-seated 154 00:23:52.800 --> 00:23:57.800 suspicion and scepticism in the financial markets. 155 00:23:57.800 --> 00:24:02.540 This revolt of the financial markets is a powerful deterrent to the use of Federal Reserve 156 00:24:02.540 --> 00:24:03.540 power. 157 00:24:03.540 --> 00:24:09.900 This was clearly shown during 1982-83, the most recent example, and the most vivid example 158 00:24:09.900 --> 00:24:26.400 The Federal Reserve began a major expansionary monetary policy, which led to a rise in money 159 00:24:26.400 --> 00:24:35.900 M1 of about 13% between July 1982 and June 1983. The initial reaction of the financial 160 00:24:35.900 --> 00:24:52.900 to that big, very big input of liquid funds by the Federal Reserve beginning in July was to rise bond futures and therefore drop interest rates quite sharply. 161 00:24:52.900 --> 00:25:02.900 And between July and October of 1982 bond futures rose quite sharply, but by October of 1992 it was all over. 162 00:25:02.900 --> 00:25:08.900 And in October of 1983 bond futures are no higher than what they were in October of 1982. 163 00:25:09.900 --> 00:25:16.900 The period during which the financial markets were prepared to go along with an expansionary policy of the Federal Reserve 164 00:25:16.900 --> 00:25:22.900 was very short, in this case it was three months as far as the bond futures markets were concerned. 165 00:25:22.900 --> 00:25:35.180 I think that is a very encouraging development as the effect of that was to limit the extent 166 00:25:35.180 --> 00:25:40.940 to which the Federal Reserve could continue to pursue that expansionary policy. The policy 167 00:25:40.940 --> 00:25:49.120 continued until about April of 1983 when all growth in the banks reserves ceased. But by 168 00:25:49.120 --> 00:25:54.720 By that time, interest rates had started to rise and it was quite obvious that the financial 169 00:25:54.720 --> 00:26:01.520 markets were not going to countenance a continuation of the expansionary Federal Reserve policy 170 00:26:01.520 --> 00:26:12.240 at the nominal interest rates that applied when that policy was initiated. 171 00:26:12.240 --> 00:26:17.080 I can think of no more remarkable example of the success of free markets in holding 172 00:26:17.080 --> 00:26:23.400 Inflation and in frustrating the intentions of an irresponsible central bank and the experience 173 00:26:23.400 --> 00:26:29.560 of the revolt of the financial markets in the United States in the last three years. 174 00:26:29.560 --> 00:26:40.800 Admittedly, it is not a very strong basis on which to base one's hopes of stable money 175 00:26:40.800 --> 00:26:49.180 and of a limit on the proclivities of politicians, but it is the best thing that we have got 176 00:26:49.180 --> 00:26:55.080 at the moment. Subsequent deregulation of the financial markets in the United States 177 00:26:55.080 --> 00:27:01.440 has reinforced the process of liberation, making it more difficult for the Federal Reserve 178 00:27:01.440 --> 00:27:09.480 to repeat its disastrous policies of the 1970s. The damage that has resulted from the experience 179 00:27:09.480 --> 00:27:37.480 The capital structure of the United States has been eroded. Savings have been reduced, and those that have been made have been wasted. Unemployment has been raised to extreme levels. The prospect of economic growth for the United States is very limited, due to the shortage of savings and the reluctance of the financial markets to permit any reduction in real interest rates. 180 00:27:37.480 --> 00:27:48.480 I'd just like to conclude by making a couple of points about our current situation. 181 00:27:48.480 --> 00:28:02.480 As of now, after one year of economic recovery, the United States real gross national product is about 6% greater than what it was in 1978. 182 00:28:02.480 --> 00:28:09.480 Between 1968 and 1978, real U.S. gross national product rose about 50%. 183 00:28:09.480 --> 00:28:13.480 Since 1978, it's risen about 6%. 184 00:28:13.480 --> 00:28:18.480 This country is stuck. 185 00:28:18.480 --> 00:28:26.480 What are the prospects of further expansion? 186 00:28:26.480 --> 00:28:48.480 The Federal Reserve has initiated a policy of monetary restriction since last June, which I believe will bring about an end to economic expansion in 1984 and possibly leading into 1985. 187 00:28:48.480 --> 00:28:59.480 So I can imagine the situation where in 1985 the real gross national product of the United States might be 10% greater than what it was in 1978. 188 00:28:59.480 --> 00:29:26.480 As far as the rest of the world is concerned, Latin America is in such a state of economic confusion and destruction that it will take several years for that group of nations to get back to where they were in about 1980. 189 00:29:26.480 --> 00:29:41.480 As far as Western Europe is concerned, while the United States real GNP between fourth quarter 82 and fourth quarter 83 might go up by 6%, in Western Europe it's gone up by about 2%. 190 00:29:41.480 --> 00:30:03.480 During the period of the age of inflation, I remember I had lunch with Rupert Murdoch and dinner with Rupert Murdoch in 1978, while this was going on, and Rupert said to me, well, you know, what's going to happen after all this? 191 00:30:03.480 --> 00:30:18.480 And I said, I think it would be wrong to believe that you're going to be able to get out of a mess, a disaster, of these proportions without a very long period of pain. 192 00:30:18.480 --> 00:30:28.480 Well, so far there's been five years of negligible economic growth in this country, the longest period of negligible economic growth for fifty years. 193 00:30:28.480 --> 00:30:36.480 and that negligible economic growth is quite likely going to persist for another couple of years 194 00:30:36.480 --> 00:30:46.480 while the economic and financial system of this country tries to readjust to the disaster that has occurred.