It's a pleasure to be back here in Houston for the Mises Circle.
I've spoken at this get-together two times before, and perhaps some of you were there
before when I spoke.
And if you were, I have good news and bad news.
First, the bad news.
I'm no better at public speaking today than I was then.
And I'd like to lodge a special protest at being put in the schedule between Charles
Goyette and Ron Paul, because it would be bad enough if I were here all by myself, but
the contrast may be heartbreaking for you, but at all events, that's the bad news.
But there is good news, and that is that today, unlike my typical lecture, I'm not going to
try to display some of those excruciatingly detailed statistical tables that no one can
ever see farther back than the first row.
So if you brought your telescope with you, put it away.
You won't need it today.
I'm going to talk actually about the current crisis more than I am going to talk about
history in any detail at least.
And I want to call to your attention before I get started something I wrote about this.
I've written a lot, I started writing about it as it was beginning to occur in its most
visible way in the summer of 2008 and so I must have written I don't know how many articles
since then about one aspect or another of the current economic troubles but most of
Some of them are quite highly focused, and many of them respond to the news of the day,
and so they're not any more than fugitive expressions of my views.
But I did write a more considered and well-documented piece that was published last year in something
called the Harvard Journal of Law and Public Policy.
And this is actually available online, so you don't have to pay for it or search around
too hard to find it.
So if you'd like to read what I've had to say about the current crisis and its background
and how it's unfolded, at least as of last year, you can go to the Harvard Journal of
Law and Public Policy on the web and find my article in the spring 2010 issue.
I don't have a lot of time to speak to you today, and this is a big subject, but fortunately
a good deal of what I might have said has already been mentioned by the preceding speakers,
so I can go through some things fairly quickly.
If I have a theme for today's talk, it would be that there's a recurrent pattern in our
Our History from the time the United States came into being, actually, but its form changed
about a century ago.
The general pattern is that government undertakes some kind of action.
It adopts a policy or it carries out some particular action, whether it's in the economic
realm or in foreign affairs.
And their upshot is that a crisis results from what the government has done.
Then the next thing that happens is that there being a crisis and a certain amount of apprehension
or fear attending that crisis, the government mounts a program to deal with the crisis.
So what we've got here is a world in which if the government weren't constantly coming
Life would go on reasonably placidly.
It's not that life would be heaven on earth.
We've got a world full of human beings and they have a lot of capacity to create trouble for themselves and their families.
But they don't need any help in that regard from the government.
and so if the government would just stay out of creating big troubles then the
rest of us could try to manage fairly well our local troubles but that's not
how our history is gone now for a long time the the typical way this this
pattern unfolded was that the government would go out and get the
country into some unnecessary war and then people would get stirred up about
the fact that we were at war and we had enemies and they had to be defeated so
So the government would have to mount a big effort to defeat our enemies and would do
so.
And this would always involve spending an extraordinary amount of money and bringing
a lot of men under arms and getting some of them killed and wreaking a lot of death and
destruction against somebody along the way and raising taxes, borrowing money, getting
The Theory of Money and Credit
pattern has been expressed, and that is in the economic realm. In the 19th century, there
were periodic financial booms and busts, there were economic cycles, there were crashes sometimes,
but the government's response to economic difficulties in the 19th century was by and
large to do nothing about them. And in fact, this was the general policy right up through
The Depression of the Early 1920s, which that much maligned to President Harding thought
was no occasion for the federal government to do anything special.
He thought if the government kept its own house in order, the market would take care
of itself.
And what do you know?
It did, even though that crash of 1920 which had been brought on by a sharp reversal in
and Federal Reserve Policy, which had been highly inflationary during World War I to
help the government finance the war, then the Fed became worried about the inflation
by 1920, reversed its policies and brought on a depression, 1920-21.
But because nothing was done by the government and the Fed itself actually changed course
was forced fairly quickly after it had caused this depression, it cleared up, within two years the economy was back to a high level of employment and reasonably rapid growth and hardly anybody you ever talked to has even heard of the depression of 1921.
But it was the last time that the government, as it were, successfully managed economic contractions by doing nothing.
Unfortunately, by the time the next contraction began in 1929, government officials had fallen in love with the idea that they could do positive things to help.
And as a result of their various actions taken to help, we got not just the normal contraction that lasted a year or so and cleared up in another year or so, but we got the Great Depression.
And if this sounds like an absurd way to think about why the Great Depression was great, I recommend you read some of my books.
And there's an argument behind that. I'm not just a nut running around, you know, a lone nut, as Murray used to say.
There are other nuts like me. So that's been the pattern since then. The government has dedicated itself to fighting business fluctuations, and as a result, we've had more than we needed to have. They've been worse than they needed to be, and it's still continuing.
Now the current crisis which became quite visible in September 2008, visible to the point actually
of panic I would say, brought the government quickly to the rescue, unfortunately.
And so since that time both the Treasury and the Federal Reserve have dedicated themselves
to compensatory policies of some kind, to saving the world, as Time magazine was crediting
Greenspan and Company with doing back in 1999.
So now it's Ben Bernanke, who again has been featured on the cover as the man of the year,
the man who saved the world this time.
It's not just the American economy, he saved the entire world, which is kind of astonishing
If you think about it, because if there's one thing that brought this crisis into being,
it was the enormous accumulation of debt of all kinds.
So the government's way of dealing with this orgy of debt is to have the Fed create an
orgy of debt.
Fancy that.
That's hair of the dog for you, I guess.
Every drunk understands this way of fighting depressions.
There's a lot of background here, and I don't have time to describe it in detail, but suffice
to say that this crisis has roots that go all the way back to 1933, which is when the
Federal Government first decided to help out the housing market in the depths of the Depression.
created a homeowners loan corporation and the next year it passed the National Housing Act which gave the administrator of the FHA authority to create a lending agency that would be a secondary lending agency that would buy mortgages from those institutions that initiated the mortgages and provide a secondary market, make those mortgages liquid instruments and therefore keep the money going more smoothly into financing homeownership for
for People Who Didn't Have the Money to Buy Homes Outright.
And that authority was exercised in 1938
when the FHA administrator created something we know
as Fannie Mae.
And Fannie Mae eventually was quasi-privatized 1968 to 70.
And in 1970, a very similar institution, Freddie Mac,
was created by Congress as a would-be competitor, and Fannie and Freddie undertook to make it possible for people who couldn't qualify under normal commercial conditions to get a mortgage loan to do so, because in effect the banks could slough off the risk onto Fannie and Freddie when they lent money to a deadbeat, and they collected their commissions and their costs and went on to the next sucker.
If there was any risk, Fannie and Freddie would pick it up because they now owned the paper.
And Fannie and Freddie didn't have to worry because they were government-sponsored enterprises.
And all of us understood that they were, which is to say we didn't have to worry about them
going belly up because the Treasury would come in and rescue them.
And because we all believed that, we were willing to lend Fannie and Freddie money for
just slightly more than we lent money to the U.S. government itself.
The spread was tiny, so in effect, we treated Fannie and Freddie as if they were the government,
and what do you know?
If you just waited long enough, they were.
Or vice versa.
At all events, you know, we assumed that the government would ride in and rescue Fannie
and Freddie, and sure as hell, it did, when they finally went broke.
So this housing business, pumping up the housing market to irrational extremes in order to
give credit to politicians who back this kind of nutty policy and in order to enrich the
people who were in on the Fanny Freddie gambit, worked very well while it worked, but of course
it was doomed to fail at some point and it did.
Now this would not have been possible in the form it took to the magnitude that it went
without accommodating Federal Reserve policies.
And I'm sure most of you know that after the crash of 2001, the Fed came in and basically
determined that it would replace the tech bubble with the housing bubble by shoving
Banking Interest Rates down to extraordinarily low levels, so low that if you take account
of the inflation in 2002, 3, 4, the real interest rate was actually negative. So you were being
given money basically to go out and invest in housing. And what do you know, many people
People decided to take the offer and so we had this housing boom and lots of banks and
lending institutions and MIT PhDs in math got rich off of this with their gimmicks like
credit default swaps that couldn't go wrong because they had the math to prove it.
They did.
Their math proved that they had covered all their risks.
You could not lose on credit default swaps.
Well, I guess reality has a way of knocking down
even MIT math PhDs, and it did this time with a vengeance.
But a lot of other things came along too.
The bank regulations associated with so-called Basel Rules
were changed in a way that encouraged banks
to leverage up absurdly with structured investment vehicles
and all those off-balance sheet ways of looking as if they had made adequate provision for reserves when they really hadn't,
making it look as if the paper they held was low-risk when it was high-risk, and so forth.
So, you know, if somebody tells you the crisis was because we didn't have enough regulation, I say on the contrary,
because we had too much and, of course, it was bad regulation as regulation usually is and hovering over all of this is something I've already suggested which was the understanding among the big financial players of what became known as the Greenspan put which is to say that the Fed would use its policies in effect to come in and guarantee these institutions against capitalism
Capital Losses if things went wrong. And if things went right, well, they just got richer
and richer. So, you know, what kind of a bet is that? You'd be a fool not to take that
bet. So lots of people from Goldman Sachs and Citigroup and all the rest of those boys,
they went big time into taking that bet. And they counted on the Fed to rescue them. And
You can't fault them. They were right. When they got in a bind, the Fed rode in and rescued them.
And the TARP program in the fall of 2008 was aimed at rescuing the same people.
And so we've got people who made a lot of money, who created a lot of economic havoc.
And the result was that most of them are walking away smelling like roses
Because of the help they got from the government, help which has put the economy in a terrible position
and has put it in a terrible position for its prospects right now, because as we look ahead, things are in bad shape
and there's not much prospect that they're getting better very fast if they get better at all.
Now when the Fed came in in 2008, it started doing extraordinary things.
It didn't just buy U.S. bonds as it normally did in its open market policies.
It bought any kind of paper you could think of. It had more than a dozen separate programs for lending everything from commercial paper to rotating credit accounts to you name it.
So if you needed to have money lent to you, the Fed was your place to go, and the result of this was that the Fed injected so much credit into the system by creating these accounts for people on its books that bank reserves went up from about $800 billion to more than $200 billion today.
So that's since a little more than two years ago. So bank reserves have more than doubled.
Excess reserves, that is the bank reserves in excess of what they're legally required to hold,
had always been close to zero because, you know, why hold reserves when you could use them for some
earning purpose? So excess reserves in this country had never been more than two or three billion
$1 trillion in our history, they leaped in a matter of a few months to more than a trillion
dollars.
From virtually zero to a trillion dollars.
The first time I ever graphed these data on my computer, I thought my computer had broken
down.
You know?
The line was going along like this, and then it went like that, straight up.
And I thought, what is going on here?
I must have a decimal point out of place, but I didn't. That's what they did. Now,
because the banks have been, well, basically many of them have been broke, and if they
valued their assets appropriately, we would see that they're broke, they're insolvent,
they should have gone bankrupt already, but they haven't because they haven't revalued
their assets correctly. They're still holding onto a lot of paper that they're valuing
the Federal Reserve, fiat money, fractional reserve banking, Human Action, man economy, methodological individualism, Human Action, man economy and state, The Theory of Money and Credit
They're willing to sit on a trillion dollars of lendable funds earning negative rate of
return.
That's how frightened the banks are today.
And I think they have some reason to be frightened.
The result is that the money stock, which normally would have exploded when the Fed
took these actions, has increased at a fairly moderate rate, actually, and M1, the currency
and Demand Deposits money stock went from 1.4 trillion before the crisis to 1.9 trillion
today.
That's not nothing, but that's not hyperinflation.
M2 money stock went from 7.5 trillion before the crisis to 8.9 trillion today, again.
That's a hefty increase by historical standards, but it's not hyperinflation.
The point is, however, that the banks are sitting on the potential for hyperinflation.
And the minute they really start seriously extending loans and making investments again,
rather than just letting that market sit in their Fed accounts, we could very quickly
have rapidly accelerating inflation.
Very rapidly accelerating inflation.
So I'm not saying it will happen.
Ben Bernanke has given us his word that he knows exactly how to control this.
He never knew anything before, but now he knows.
He didn't know there was a housing bubble, for example.
He thought everything was hunky-dory in 2006.
But now he knows exactly how to control this potential runaway, wild stallion of inflation
that he has tied by a string at the Federal Reserve System.
While the Fed was doing this, the Treasury was dishing out money as if there were no
tomorrow, first through the TARP program, then through a series of stimulus programs,
and the upshot was that the federal deficit, which had already been at record peacetime
The Federal Reserve made that look like child's play and went from the 2008 debt for total
federal debt to $5.8 trillion held by the public, 2010, two years later, $10 trillion
held by the public, almost doubled in just two years.
Finally, the federal government is financing almost 40% of all its spending by borrowing.
Never been anything near that before in our history except during wartime.
And laid on top of this was the fact that the government, as usual, along with its crony
capitalists, used this crisis as the pretext for all sorts of opportunism, including the
and the opportunism of extending the government's scope and power by laying these huge regulatory
programs on top of a financial crisis.
So the Obama administration has given us Obamacare and it's given us the Dodd-Frank financial
reform bill.
Imagine that, Dodd and Frank fixing the financial system.
These guys are like the greatest sinners in the whole housing bubble.
They should be in prison, but instead these guys, these guys instead are sponsoring the
legislation to fix the mess they made in the first place.
How people put up with this, I have no idea, but they're putting up with it and I hope
When I studied the Great Depression, which I did quite a bit in my career as an economic historian, I argued that one reason the Depression persisted so long was because of something I called Regime Uncertainty.
In 1970, from about 1935 on, the Roosevelt administration turned much more radical and
collectivist and anti-business.
And the president started bad-mouthing businessmen and investors at every opportunity and railing
against economic royalists and declaring that he relished their hatred and he longed to
get back at them and take a whack.
And he did in all sorts of ways.
And the result was business people had never been treated like this in our history, treated
as if they were criminals by the President of the United States.
And the President had all these young radicals like Cochran and Cohen and Landis and Douglas
and all these guys yelping to put regulators in charge of the economy instead of letting
business run it.
Don't let business just go out and sell securities, don't let them do it unless the Securities
and Exchange Commission approves what they're doing.
I let people just go out and set prices, you know, make sure that some government regulator
has overseen the price increase.
And as a result of all this kind of interference and threat to business and to investment,
long-term investment more or less froze up in the Great Depression.
Of course, it had fallen drastically in the early 30s when the contraction occurred, but
it never really recovered.
In fact, it never recovered until after World War II.
And that was because during the war, most of these zealous New Zealers had been pushed
onto the peripheries of power and they were no longer whispering in the ear of the president
as they had for Roosevelt in the late 1930s.
Well, this idea of regime uncertainty has taken a certain life of its own in the past
I don't think we're at the same situation for regime uncertainty we were at in the late 1930s.
Things aren't that bad, but they're somewhat bad in that respect.
For example, these big regulatory laws, you might say, well, there's no uncertainty, they've already been passed.
But that's not true at all.
Because if you look at this legislation, what you find is that it basically hands over in
undescribed ways to regulators, many of them regulatory bodies not yet created, the power
to determine the details of how the regulatory power will be exerted.
So if you're actually trying to run a business and you want to know how Obamacare will affect
You, or how the Dodd-Frank regulations will affect you, you still don't know.
And this is going to have to be fought out politically, which means there's tremendous
uncertainty surrounding the actual effect and type of effect these huge laws are going
to have.
So when businessmen think about making long-term investments today, they very sensibly are
are concluding most of the time this makes no sense.
Investment has not come close to recovering from its decline in 2008-2009.
It's at very depressed levels.
Consumption, which the government is always yelping about pushing up, consumption is back
to pre-crisis levels.
Consumers are depressed.
It's investors that are depressed and for good reason.
But until investment makes a strong comeback, we are not going to have a real, genuine,
strong recovery with increased employment.
At the rate we're creating private sector jobs now, it'll take six years to get back
to where we were three years ago.
Imagine that, nine years without any net creation of private sector jobs.
That's a national tragedy.
It didn't have to happen, and it wouldn't have happened that way, if the government had not ridden in to rescue us in 2008 and 2009.
Thank you very much.