WEBVTT NOTE Not Guilty as Charged: The Foolish Attempt to Blame the Free Market for the Economic Collapse 1 00:00:00.000 --> 00:00:09.000 Well, this is the second time. Thank you all very much, by the way. It is, well, you guys must seriously need some extra credit. That's all I've got. 2 00:00:09.000 --> 00:00:24.000 All the same, though, it is a really unique type of individual who hears, hey, there's a lecture on campus. I think I'll go. You know, that's a really self-selected group, and I'm very glad that you're all able to be here. 3 00:00:24.000 --> 00:00:38.000 This is my second time at Penn State. The first time was in 1989. See, I can say this now. I'm long out of high school, so all the things I did that made me a dork in high school, it's long forgotten. You know, it's all over. 4 00:00:38.000 --> 00:00:48.000 I was the captain of the math team. People are laughing at that. Can you believe they're laughing at me up here? I was the captain of the math team. I was Mr. Math and everything. 5 00:00:48.000 --> 00:00:56.000 and Penn State hosted the Eastern Massachusetts, well I was on the Eastern Massachusetts all-star math team. 6 00:00:56.000 --> 00:01:01.000 So I made the all-star team. And Penn State sponsored the whole national thing. 7 00:01:01.000 --> 00:01:07.000 I did that for two years, like 89 and 90, so here I am again. 8 00:01:07.000 --> 00:01:11.000 So my dorkiness has just taken a slightly different tack now, that's all. 9 00:01:11.000 --> 00:01:16.000 Basically the same dorky guy, but slightly different emphasis basically. 10 00:01:16.000 --> 00:01:26.000 So what I'm going to do today is, just as the topic indicates, I'm going to try to look at what the heck is going on in the economy, 11 00:01:26.000 --> 00:01:35.000 but try to argue to you that it is not merely special pleading to say that this is not an example of the free market having failed. 12 00:01:35.000 --> 00:01:38.000 If I hear that one more time, I'm going to commit an atrocity. 13 00:01:38.000 --> 00:01:45.000 So tonight we're going to try to relieve ourselves of this misapprehension and try to get a hold of what the reality is. 14 00:01:45.000 --> 00:01:55.000 Now, I'm not going to assume any prior knowledge, yet here and there I might assume a little bit, and if that's the case, ask me about it in the question session. 15 00:01:55.000 --> 00:02:09.000 I have a book coming out on Monday, this will be my number nine for me, it's called Meltdown, and the subtitle, and I have nothing to do with the subtitle, it's like 900 words long, nothing to do with me. 16 00:02:09.000 --> 00:02:17.000 But, it's called a free market look at why the stock market collapsed, the economy tanked, and government bailouts will make things worse 17 00:02:17.000 --> 00:02:21.000 with a foreword by Ron Paul, which will sell more copies of the book than the book itself. 18 00:02:24.000 --> 00:02:30.000 So, the market has failed is the assessment we hear from all quarters. It's everywhere. 19 00:02:30.000 --> 00:02:37.000 Even people who ordinarily defend the free market find themselves so much on the defensive that they're willing to make concessions that, 20 00:02:37.000 --> 00:02:40.000 In my judgment, they shouldn't be making. 21 00:02:40.000 --> 00:02:42.000 And the situation we face... 22 00:02:42.000 --> 00:02:45.000 If only this would go in. It just won't. 23 00:02:45.000 --> 00:02:48.000 The situation we face is... 24 00:02:48.000 --> 00:02:53.000 There are some people, I think, who are, I don't know, on the right, let's say, politically, 25 00:02:53.000 --> 00:02:57.000 who are trying to downplay the seriousness of the situation. 26 00:02:57.000 --> 00:03:00.000 Although now that Obama is the president, now they'll say, 27 00:03:00.000 --> 00:03:02.000 Oh, it's terrible, terrible, terrible. 28 00:03:02.000 --> 00:03:06.000 Whereas six weeks ago, it was still kind of okay, and just the liberals are exaggerating it. 29 00:03:06.000 --> 00:03:24.000 The current economic downturn that we are experiencing is well on its way to becoming the longest one in the period following World War II. 30 00:03:24.000 --> 00:03:39.000 Also, in December, we unexpectedly, or at least it wasn't unexpected to some economists, but to many people, we unexpectedly saw the reduction of employment be even greater than anticipated. 31 00:03:39.000 --> 00:03:46.000 So unemployment rose to 7.2% in December, which is the highest in 16 years. 32 00:03:46.000 --> 00:04:02.000 Now it's worth noting that during the 1980s and 1990s, Republicans and Democrats alike began to massage the unemployment figures and the way they're calculated, so as to make them look better than they really are. 33 00:04:02.000 --> 00:04:06.000 Shocking, I know, right? They want to obscure the reality of the situation. 34 00:04:06.000 --> 00:04:22.000 If you accurately calculate the current unemployment rate the way they calculated it in the 1970s, so that you can compare episodes, what you actually find is that the unemployment rate is between 16 and 17 percent. 35 00:04:22.000 --> 00:04:30.000 Now, if you're interested in that, by the way, I recommend a website. Unfortunately, it's subscription only. Boo-hiss. 36 00:04:30.000 --> 00:05:00.000 but there is a website called shadowstats.com and the proprietor of this site gathers a variety of data including I believe the CPI which measures price inflation but also the employment figures he measures them the way they used to so that you can find out what's really going on so we have this fact we have the fact of mortgage foreclosures increasing dramatically we've got about two and a half million foreclosures that we've just found out about the average work week we know 37 00:05:00.000 --> 00:05:07.000 In fact, we found out that just last month, the part-time numbers, the numbers of people working in part-time jobs rose by 10% in a month, by 700,000 people, which is the highest jump I've ever seen. 38 00:05:30.000 --> 00:05:48.000 I don't know how long that is, but so that indicates that even these rosy employment figures that we're hearing, I mean they're not rosy, but relatively speaking they're rosier than they would be, if we could somehow factor in how many people are involuntarily employed in part-time work. 39 00:05:48.000 --> 00:05:59.000 And if we look at statistics regarding retail sales, industrial production, income, it's pretty wretched. 40 00:05:59.000 --> 00:06:03.000 Now, of course, the housing situation is more wretched still. 41 00:06:03.000 --> 00:06:07.000 And it's particularly wretched in certain parts of the country. 42 00:06:07.000 --> 00:06:10.000 Some parts are faring better than others. 43 00:06:10.000 --> 00:06:12.000 I live in Auburn, Alabama. 44 00:06:12.000 --> 00:06:14.000 We're sort of doing okay. 45 00:06:14.000 --> 00:06:16.000 Las Vegas is not doing okay. 46 00:06:16.000 --> 00:06:19.000 San Francisco is having some trouble. 47 00:06:19.000 --> 00:06:21.000 And as well it should. 48 00:06:21.000 --> 00:06:27.000 It doesn't make sense that a 2x2 cubicle should cost you $900,000. 49 00:06:27.000 --> 00:06:34.000 There was something wrong with that, and it's odd to me, although not altogether surprising, 50 00:06:34.000 --> 00:06:40.000 that the same federal government that claims to support affordable housing, right? 51 00:06:40.000 --> 00:06:45.000 What we need is affordable housing in this country, and then when housing prices start to come down, 52 00:06:45.000 --> 00:06:49.000 they act as if this is the greatest catastrophe in world history. 53 00:06:49.000 --> 00:06:54.000 But here it is, right? The market is trying to lower the price. You can't satisfy these people. 54 00:06:54.000 --> 00:06:59.200 They're too high, they're too low, they're never just right for the government. 55 00:06:59.200 --> 00:07:05.300 Now, the housing situation, of course, has been going on for, I don't know, at least arguably 10 years. 56 00:07:05.300 --> 00:07:14.600 It's not just since 9-11, whereby we've seen housing prices appreciating very dramatically, year in and year out. 57 00:07:14.600 --> 00:07:20.300 And in fact, in the recession of 2000-2001, a relatively mild recession, 58 00:07:20.300 --> 00:07:26.140 That was the only recession on record in which new housing starts did not decline. 59 00:07:26.140 --> 00:07:31.100 So housing has been extremely robust even during a recession 60 00:07:31.100 --> 00:07:35.900 that we had following the dot-com collapse of all those dot-com companies. 61 00:07:35.900 --> 00:07:38.460 So housing has been wonderful, it seems. 62 00:07:38.460 --> 00:07:43.820 It seemed to people that they could retire on the basis of their home equity they'd built up. 63 00:07:43.820 --> 00:07:47.260 They could take out loans, they could borrow against the equity of their homes, 64 00:07:47.260 --> 00:07:55.260 They could borrow it, go out and use it to finance plasma TVs and giant cars and whatever else. 65 00:07:55.260 --> 00:07:59.260 You know, a yacht, or if they get bored with their yacht, they could get a plane. 66 00:07:59.260 --> 00:08:02.260 Or a yacht where they could land a plane, like whatever. 67 00:08:02.260 --> 00:08:06.260 But the point is that it just seems like this is a cash cow. 68 00:08:06.260 --> 00:08:10.260 It's like, you know, physicists tell you there's no perpetual motion machine. 69 00:08:10.260 --> 00:08:13.260 But this seems like this is just a perpetual money machine. 70 00:08:13.260 --> 00:08:25.260 And we began to hear, right around that time, during that recession, when housing seemed to be the one robust sector, that you see, it just goes to show, housing prices never come down. 71 00:08:25.260 --> 00:08:34.260 This was the conventional, they always go up. Housing prices always go up. It's the best investment you can make, buying a house. 72 00:08:34.260 --> 00:08:42.260 In fact, you can buy houses and flip them. You can put in new carpeting, a couple new lights, repaint it, make 50 grand in three weeks. 73 00:08:42.260 --> 00:08:47.260 This is a great way to make money. This is what people were told, what everybody believed, and don't worry. 74 00:08:47.260 --> 00:08:53.260 There can never be a nationwide housing contraction. 75 00:08:53.260 --> 00:09:00.260 The housing market cannot decline nationwide, because real estate, everybody knows, is regional. 76 00:09:00.260 --> 00:09:05.260 Sure, this city may experience a decline, that city, but never the whole country. 77 00:09:05.260 --> 00:09:07.260 That was the conventional wisdom. 78 00:09:07.260 --> 00:09:37.260 and it was on the basis of that that we got this crazy mania in housing and in fact the Federal Reserve Chairman at that time, Alan Greenspan, is on record as having said it's impossible for there to be a national housing collapse, this just can't happen, real estate is a regional thing, so this is just a one for this, it's not a bubble, in other words these prices are not artificially high, these are sustainable housing prices, Greenspan said, in fact Greenspan told 79 00:09:37.260 --> 00:09:42.260 The best thing they could do was take out an adjustable rate mortgage. 80 00:09:42.260 --> 00:09:49.260 A mortgage that has a super, super low rate in the beginning, and then a few years down the line it could jump up. 81 00:09:49.260 --> 00:09:53.260 Well, that's what's happening to people now. They're finding that these rates are jumping up. 82 00:09:53.260 --> 00:09:57.260 And I'm not saying, by the way, that adjustable rate mortgages are in themselves bad. 83 00:09:57.260 --> 00:10:00.260 They're a way for lenders and borrowers to share risks. 84 00:10:00.260 --> 00:10:05.260 If they don't know what the future is going to hold, maybe interest rates will plummet. 85 00:10:05.260 --> 00:10:09.260 Maybe they'll rise. This way both lender and borrower can share the risk of that. 86 00:10:09.260 --> 00:10:15.260 Well, in this case we've seen what the risk was. The risk is that, in fact, credit is going to get tighter 87 00:10:15.260 --> 00:10:19.260 and people are going to find their mortgage payments doubling, tripling in some cases. 88 00:10:19.260 --> 00:10:27.260 And yet the geniuses, the people we're supposed to look to, to lead us out of this, all fell for the housing bubble. 89 00:10:27.260 --> 00:10:33.260 They all said this is a, if not quite permanent, in the rate of increase. 90 00:10:33.260 --> 00:10:44.260 Nevertheless, it's going to continually increase at one rate or another, and that this is a wonderful thing, there's nothing to worry about, the fundamentals of the economy are sound, as they all say in Washington. 91 00:10:44.260 --> 00:10:52.260 Alan Greenspan told us this, Ben Bernanke said that everything would be just fine by the end of 2008, housing would be robust again. 92 00:10:52.260 --> 00:10:59.260 Meanwhile, again, now we've got the fewest new housing starts we've had in years and years and years, 93 00:10:59.260 --> 00:11:04.260 And yet these are the people we're looking to, to tell us how to get out of this. 94 00:11:04.260 --> 00:11:14.260 Hank Paulson, the former Treasury Secretary, told everybody that our financial institutions are in excellent shape, the best shape I've seen them in my career. 95 00:11:14.260 --> 00:11:17.260 He said that in 2007. 96 00:11:17.260 --> 00:11:22.260 Ben Bernanke, he said, don't worry about the mortgage market, that maybe there are too many risky mortgages. 97 00:11:22.260 --> 00:11:28.260 My regulators already investigated the mortgage market, and it's better than ever, he said. 98 00:11:28.260 --> 00:11:41.260 The regulators looked at it and said it was great, because the experts we're supposed to trust all believed in the myths of the housing bubble. 99 00:11:41.260 --> 00:11:48.260 This thing's not going away. These inflated prices are not bubble prices, they are sustainable. 100 00:11:48.260 --> 00:11:54.260 And it's on that basis that we got all these rosy predictions. And that's totally wrong. 101 00:11:54.260 --> 00:11:59.260 And it's on this basis, by the way, that a lot of unsound investments in housing were made. 102 00:11:59.260 --> 00:12:05.260 People were just listening to the experts and the experts regulators. 103 00:12:05.260 --> 00:12:12.260 So, now, I've been a little harsh on these people, but it seems to me rather deserved, 104 00:12:12.260 --> 00:12:16.260 because these are the same people that when you tune in on TV, there they are smiling at you, 105 00:12:16.260 --> 00:12:20.260 and they're going to tell us what we should do to get out of this. 106 00:12:20.260 --> 00:12:25.260 One of my favorite investment advisors is a guy named Jim Rogers. 107 00:12:25.260 --> 00:12:31.260 I love the United States of America and I'm not going anywhere, but in 2007, at exactly the right time, 108 00:12:31.260 --> 00:12:36.260 Jim Rogers sold his home just before the bubble burst and moved to Singapore. 109 00:12:36.260 --> 00:12:43.260 There, people actually care about prosperity, and maybe my kids can grow up in some kind of prosperity. 110 00:12:43.260 --> 00:12:49.260 But Jim Rogers was on a financial show on CNBC not long ago and somebody was asking him, 111 00:12:49.260 --> 00:13:07.260 And Jim Rogers said, listen, if you had me on your show, and week after week after week, I was totally wrong, everything I said was wrong, would you keep inviting me on your show? 112 00:13:07.260 --> 00:13:15.260 Then why do we keep listening to these people? Why do we care what Ben Bernanke says, that he's the chairman of the Federal Reserve system now, in case you don't know? 113 00:13:15.260 --> 00:13:18.260 I mean, why should we care? Good question. 114 00:13:18.260 --> 00:13:24.260 So what I'm going to outline for you is what would be considered an unorthodox way of looking at things. 115 00:13:24.260 --> 00:13:32.260 But given the fact that all the orthodox models in economics utterly failed to see this collapse coming, 116 00:13:32.260 --> 00:13:36.260 given that those have failed, it's time to look at other alternatives. 117 00:13:36.260 --> 00:13:44.260 And what I'm going to lay out to you tonight is a thesis that won the Nobel Prize for the economist F.A. Hayek in 1974. 118 00:13:44.260 --> 00:14:04.180 An economist named James Galbraith said that of the roughly 15,000 professional economists 119 00:14:04.180 --> 00:14:10.580 in the country, he estimated that maybe 10 or 12 saw this collapse coming. 120 00:14:10.580 --> 00:14:15.280 So maybe ten or twelve of the people James Galbraith hangs around with saw it coming. 121 00:14:15.280 --> 00:14:22.280 But in fact hundreds of economists who follow the views of Professor Hayek have warned about 122 00:14:22.280 --> 00:14:28.300 this for years and yet, under the Bush administration and under the Obama administration, have any 123 00:14:28.300 --> 00:14:32.180 of these people been called to the White House, oh you saw this coming, maybe you can help 124 00:14:32.180 --> 00:14:33.180 get us out of it? 125 00:14:33.180 --> 00:14:34.180 No. 126 00:14:34.180 --> 00:14:38.660 The more you are blindsided by it, the more of a blockhead you are, the more we want to 127 00:14:38.660 --> 00:14:53.060 There is one more thing I should introduce in case people don't know about it, because 128 00:14:53.060 --> 00:14:57.500 you might wonder, how could this big downturn that we see in housing, why would it have 129 00:14:57.500 --> 00:15:02.640 such far-reaching effects in sectors of the economy that have nothing to do with housing? 130 00:15:02.640 --> 00:15:05.260 Why is it having such a big ripple effect? 131 00:15:05.260 --> 00:15:10.700 Part of the answer to that question is that when housing declines it's not just construction 132 00:15:10.700 --> 00:15:12.220 companies that suffer. 133 00:15:12.220 --> 00:15:16.980 Think about all the things that go into a new house when you buy it and all the raw 134 00:15:16.980 --> 00:15:23.060 materials and the production processes that go into creating those things that are necessary. 135 00:15:23.060 --> 00:15:26.220 Now all those things are going to suffer. 136 00:15:26.220 --> 00:15:33.060 And then on top of this we have the fact that institutions have been buying securitized 137 00:15:33.060 --> 00:15:37.060 Mortgages 138 00:15:37.060 --> 00:15:41.060 Mortgage-backed securities 139 00:15:41.060 --> 00:15:45.060 Securitization 140 00:15:45.060 --> 00:15:49.060 Securitization 141 00:15:49.060 --> 00:15:53.060 A mortgage 142 00:15:53.060 --> 00:15:57.060 A car debt 143 00:15:57.060 --> 00:16:10.060 Any type of debt, bundling a bunch of them, let's say the first three rows of people here, take all your credit card debt, bundle them all together in a single financial product, and we slice and dice it, and we sell little bits of it to investors. 144 00:16:10.060 --> 00:16:25.060 And when you pay your credit card payment every month, or your mortgage payment, or whatever kind of securitized debt it is, the investor who buys that, he's the one who actually gets this flow of payments coming from you and all the other people who are bound up 145 00:16:25.060 --> 00:16:29.060 in the securitized loan he has bought. 146 00:16:29.060 --> 00:16:34.060 Now overwhelmingly, the greatest degree of securitization occurred in housing, 147 00:16:34.060 --> 00:16:41.060 where the local bank or even some mortgage company will issue a mortgage to a family, 148 00:16:41.060 --> 00:16:47.060 but then instead of holding that mortgage and collecting the mortgage payments from that family, 149 00:16:47.060 --> 00:16:51.060 they would sell that to some investor or some institution, 150 00:16:51.060 --> 00:16:55.060 and that investor or institution would actually get the proceeds. 151 00:16:55.060 --> 00:17:02.060 So if it turns out that housing begins to decline and there are foreclosures, 152 00:17:02.060 --> 00:17:04.060 people can't make their mortgage payments, 153 00:17:04.060 --> 00:17:09.060 these mortgage-backed securities now are not worth as much as they were before 154 00:17:09.060 --> 00:17:13.060 because the stream of mortgage payments is going to be lower than expected. 155 00:17:13.060 --> 00:17:16.060 It's going to be interrupted in some cases by foreclosures. 156 00:17:16.060 --> 00:17:20.060 And so a lot of investors who have gone into this type of investment 157 00:17:20.060 --> 00:17:43.060 The first time I've ever spoken on this subject in public. It was not quite true. I've spoken on the business cycle theory that I'm about to get to, but I just want to make sure I don't miss anything. I like to do everything by heart, but if I miss something, I'm telling you, I wouldn't sleep tonight, kicking myself, but I deprive you guys of the opportunity to talk about it. 158 00:17:43.060 --> 00:17:50.060 I don't want to make sure I don't miss anything. I like to do everything by heart, but if I miss something, I'm telling you, I wouldn't sleep tonight, kicking myself that I deprived you guys of it. 159 00:17:50.060 --> 00:17:59.060 So let's look at this housing bubble, the contributing factors to it, and the last contributing factor will require us to explain what Hayek said. 160 00:17:59.060 --> 00:18:12.060 And I'm telling you, once you hear what Hayek says, this great economist who died, and he wrote his last book when he was like 92, or even over, no, I think he was 88 when he wrote his last book, and then he died in 1992. 161 00:18:12.060 --> 00:18:18.060 When you hear this, I'm telling you, you will understand the world better than 99% of your friends. 162 00:18:18.060 --> 00:18:22.060 And that's just what your friends love, by the way, when you know more than they do. 163 00:18:22.060 --> 00:18:25.060 That's just the way to become popular, by the way. 164 00:18:25.060 --> 00:18:30.060 So, one contributing factor, and I'm going to start with every other factor I'm going to give you, 165 00:18:30.060 --> 00:18:34.060 is relatively minor in my view, until we get to the last one. 166 00:18:34.060 --> 00:18:39.060 One contributing factor to why there was this artificial stimulus to home construction 167 00:18:39.060 --> 00:18:46.060 that is now coming back to bite us, you know, wherever, is something, is our Fannie Mae and Freddie Mac. 168 00:18:46.060 --> 00:18:52.060 Now, if there's anybody in the room who keeps hearing these, and you don't know what the frickin' heck this is, 169 00:18:52.060 --> 00:19:03.060 what, who, who are these people? Well, they're actually, these are actually nicknames for institutions that are supposed to help people get, you know, affordable mortgages. 170 00:19:03.060 --> 00:19:10.060 and Fannie and Freddie were both basically, Fannie was started in the 1930s as a government institution 171 00:19:10.060 --> 00:19:17.060 and then later sort of became a private company but sort of not, nobody really quite knew what Fannie Mae was 172 00:19:17.060 --> 00:19:22.060 is it a government agency, is it a private agency, it was called a government supported enterprise 173 00:19:22.060 --> 00:19:25.060 so some kind of weird middle of the road thing no one's quite sure 174 00:19:25.060 --> 00:19:32.060 Freddie Mac likewise, that was started much later and again that was started as an apparently private company 175 00:19:32.060 --> 00:19:33.560 in a private company. 176 00:19:33.560 --> 00:19:36.700 But what makes these institutions unusual 177 00:19:36.700 --> 00:19:39.100 in terms of so-called private companies 178 00:19:39.100 --> 00:19:42.320 is that they got special tax and regulatory advantages 179 00:19:42.320 --> 00:19:45.660 that other mortgage guarantors did not get. 180 00:19:45.660 --> 00:19:48.100 And in addition to many other advantages, 181 00:19:48.100 --> 00:19:52.300 everybody knew that the US taxpayer would bail them out 182 00:19:52.300 --> 00:19:53.460 if they ever went belly up, 183 00:19:53.460 --> 00:19:55.660 if they made so many risky mortgages 184 00:19:55.660 --> 00:19:58.120 and that people just couldn't make those payments anymore 185 00:19:58.120 --> 00:20:01.060 and Fannie and Freddie were just suddenly going under. 186 00:20:01.060 --> 00:20:03.660 Everybody knew the government would bail them out. 187 00:20:03.660 --> 00:20:05.860 And so therefore, Fannie and Freddie 188 00:20:05.860 --> 00:20:09.580 were able to attract more of the mortgage markets themselves. 189 00:20:09.580 --> 00:20:13.380 They were able to make riskier loans than a surely 190 00:20:13.380 --> 00:20:15.380 private organization would, because they 191 00:20:15.380 --> 00:20:17.700 knew that you and me would wind up paying for them 192 00:20:17.700 --> 00:20:18.780 if they went sour. 193 00:20:18.780 --> 00:20:20.980 If they paid off, well, they, of course, 194 00:20:20.980 --> 00:20:22.240 get to keep all the profits. 195 00:20:22.240 --> 00:20:23.940 They're not going to come to us and say, 196 00:20:23.940 --> 00:20:26.340 thanks to all the government advantages we got, 197 00:20:26.340 --> 00:20:27.860 we've earned a lot of profits, and we'd 198 00:20:27.860 --> 00:20:29.420 like to share them with you. 199 00:20:29.420 --> 00:20:33.420 The rules are they keep the profits. They spread the losses all around. 200 00:20:33.420 --> 00:20:37.420 Now if you were in that situation, you would probably make risky mortgages too. 201 00:20:37.420 --> 00:20:41.420 Why not? There's no reason not to. So that is a factor. 202 00:20:41.420 --> 00:20:46.420 Secondly, there is this piece of legislation called the Community Reinvestment Act. 203 00:20:46.420 --> 00:20:50.420 And that's passed in the late 1970s. 204 00:20:50.420 --> 00:20:56.420 But then given real regulatory enforcement teeth in the 1990s under Bill Clinton. 205 00:20:56.420 --> 00:21:06.420 And I do believe this plays a role, but not nearly the role that we often hear in conservative circles. 206 00:21:06.420 --> 00:21:10.420 And you know, I'm more or less, you know, I kind of sympathize with conservatives. 207 00:21:10.420 --> 00:21:16.420 I'm more of a libertarian myself, but I think a lot of them are just saying it's this one thing or it's this plus family. 208 00:21:16.420 --> 00:21:23.420 The depth of what we're facing here is far more, is far too substantial for it to be explained by something so small. 209 00:21:23.420 --> 00:21:39.420 But basically, the Community Reinvestment Act required banks to make loans in the neighborhoods in which they were resident and not simply extend loans, you know, like in the suburban areas and neglect the sort of the beginner city area. 210 00:21:39.420 --> 00:21:54.420 So they had to extend additional loans, and the understanding sort of was that if you're not extending loans to people of various racial groups in proportion to their percentage of the population, 211 00:21:54.420 --> 00:22:00.420 then the presumption is that you're guilty of discrimination. You're not offering enough loans to members of each particular group. 212 00:22:00.420 --> 00:22:06.420 So, therefore, what banks wound up doing was making loans that they might not otherwise have made 213 00:22:06.420 --> 00:22:12.420 because they didn't want to get sued and be ruined, basically. They didn't want $500 billion loss. 214 00:22:12.420 --> 00:22:17.420 Now, what I have here is a quotation. I think I'm just going to set up shop. Let's just move over. 215 00:22:17.420 --> 00:22:25.420 Okay. I have a quotation here from Andrew Klohner, who was the second of the Secretaries of Housing and Urban Development under Bill Clinton. 216 00:22:25.420 --> 00:22:38.420 This is what he said, and I hasten to point out, the Community Reinvestment Act is not the only federal law or regulation that required banks, in effect, to engage in affirmative action and lending. 217 00:22:38.420 --> 00:22:40.420 It's not just the Community Reinvestment Act. 218 00:22:40.420 --> 00:22:42.420 Fannie and Freddie were starting to require it. 219 00:22:42.420 --> 00:22:44.420 The Federal Reserve System was pushing it. 220 00:22:44.420 --> 00:22:46.420 The Federal Housing Administration was pushing it. 221 00:22:46.420 --> 00:22:48.420 It was everywhere. 222 00:22:48.420 --> 00:23:06.420 Andrew Cuomo, Secretary of Housing and Urban Development said after the AcuBank group was sued for discrimination and they were required as a penalty to make $2.1 billion in loans to so-called underserved communities. 223 00:23:06.420 --> 00:23:10.420 And here's what Andrew Cuomo said. 224 00:23:10.420 --> 00:23:14.020 The bank will take a greater risk on these mortgages, yes. 225 00:23:14.020 --> 00:23:18.220 Give families mortgages who they would not have given otherwise, yes. 226 00:23:18.220 --> 00:23:22.820 They would not have qualified but for this affirmative action on the part of the bank, yes. 227 00:23:22.820 --> 00:23:28.520 Lending that $2.1 billion in mortgages will be a higher risk. 228 00:23:28.520 --> 00:23:35.020 And I'm sure there will be a higher default rate on those mortgages than on the rest of the portfolio. 229 00:23:35.020 --> 00:23:37.820 Well, as long as he's comfortable with that, I guess that's all that matters. 230 00:23:37.820 --> 00:23:59.820 Another factor is something we might call the green-span put, which employs a stock market term. 231 00:23:59.820 --> 00:24:05.820 The green-span put was this idea that people had, that as long as Alan Greenspan is the Fed Chairman, 232 00:24:05.820 --> 00:24:11.660 Chairman, no matter how much we screw up on Wall Street, he'll rescue us somehow. Alan 233 00:24:11.660 --> 00:24:16.860 Greenspan will come right into the rescue. So therefore, what is the incentive again? 234 00:24:16.860 --> 00:24:22.740 To make riskier investments than you would otherwise have made. To buy mortgage packages 235 00:24:22.740 --> 00:24:26.980 that might be kind of risky. Man, the returns are so high. And if this thing should ever 236 00:24:26.980 --> 00:24:32.580 go bust, well, you know, old Alan's in our corner. He'll come save us. So what we have 237 00:24:32.580 --> 00:24:42.580 I have here, I have just a quotation from the Financial Times newspaper, who described this idea of the Greenspan hook, which is not something the Greenspan himself would ever admit to. 238 00:24:42.580 --> 00:24:49.580 He said, oh no, no, no, that's not me at all. But every financial guy knew the Greenspan was sort of unofficially known as Mr. Bailout. 239 00:24:49.580 --> 00:24:57.580 He'll always be there to line your pockets if you're a rich investor and you're a big, big, big time institution and you get in trouble. 240 00:24:57.580 --> 00:25:05.580 So the Financial Times said, when markets unravel, you can count on the Federal Reserve and its chairman Alan Greenspan eventually to come to the rescue. 241 00:25:05.580 --> 00:25:17.580 And as a result, the Financial Times says, there is a destructive tendency toward excessively risky investment, supported by hopes that the Fed will help if things go bad. 242 00:25:17.580 --> 00:25:21.080 Likewise, the economist Anthony Mueller says this, he said, 243 00:25:21.080 --> 00:25:28.580 Since Alan Greenspan took office, 1987, financial markets have operated under a quasi-official charter, 244 00:25:28.580 --> 00:25:33.080 which says that the central bank will protect its major actors from the risk of bankruptcy. 245 00:25:33.080 --> 00:25:38.580 Consequently, the reasoning emerged that when you succeed, you will earn high profits and market share, 246 00:25:38.580 --> 00:25:42.080 and if you should fail, the authorities will save you anyway. 247 00:25:42.080 --> 00:25:46.580 When monetary authorities repeatedly act to ward off economic downturns 248 00:25:46.580 --> 00:25:49.580 and continue to feed the markets with fresh liquidity, 249 00:25:49.580 --> 00:25:53.580 the belief in an eternal boom becomes more widespread with time, 250 00:25:53.580 --> 00:25:56.580 and economic activity becomes more intensive, 251 00:25:56.580 --> 00:25:59.580 and most importantly, prudence diminishes 252 00:25:59.580 --> 00:26:02.580 and new types of entrepreneurs appear. 253 00:26:02.580 --> 00:26:06.580 Not the old types who were very careful about weighing risk, 254 00:26:06.580 --> 00:26:09.580 but the new types who take great risks 255 00:26:09.580 --> 00:26:11.580 with the knowledge that they can keep the proceeds 256 00:26:11.580 --> 00:26:14.580 and probably socialize the losses. 257 00:26:14.580 --> 00:26:19.580 Now, all these things are factors of one type or another. 258 00:26:19.580 --> 00:26:26.580 But the most significant factor involves an institution that most Americans don't know the first thing about. 259 00:26:26.580 --> 00:26:29.580 And my secret opinion is that's just the way they like it. 260 00:26:29.580 --> 00:26:31.580 Not the American people, but the institution. 261 00:26:31.580 --> 00:26:32.580 The Federal Reserve System. 262 00:26:32.580 --> 00:26:34.580 You ask people, what is the Federal Reserve System? 263 00:26:34.580 --> 00:26:36.580 I mean, you may as well be speaking Chinese. 264 00:26:36.580 --> 00:26:40.580 I mean, no one has any idea what in the world you are talking about. 265 00:26:40.580 --> 00:26:43.580 They know that the dollar bill says Federal Reserve Note. 266 00:26:43.580 --> 00:26:56.580 That's about it. Otherwise, I don't know what this thing is, and when you try to follow it in the news and what the Fed is cutting rates, and they're doing this, and they're cutting this by 50 basis points, you're saying, what the heck? 267 00:26:56.580 --> 00:27:06.580 How do you expect me to understand any of this? But we do need to understand this, and this is why part of the reason I'm writing my book is to explain this so that the average person can get it. 268 00:27:06.580 --> 00:27:11.580 The average American has got to understand this system, got to understand the Federal Reserve System. 269 00:27:11.580 --> 00:27:15.580 For here, all I'm going to give is an extremely streamlined view. 270 00:27:15.580 --> 00:27:20.580 Just a couple of things about the Federal Reserve System, just in the interest of time. 271 00:27:20.580 --> 00:27:26.580 But the Federal Reserve System is basically responsible for money in the United States, for the supply of money. 272 00:27:26.580 --> 00:27:33.580 They can increase the supply of money, and they can contract the supply of money. 273 00:27:33.580 --> 00:27:38.580 They are also in a position to act as a lender of last resort. 274 00:27:38.580 --> 00:27:48.580 So if some institution should find itself in financial straits, the Fed has the ability to enter the market and just flood them with money. 275 00:27:48.580 --> 00:27:50.580 When it does that, where does this money come from? 276 00:27:50.580 --> 00:27:53.580 Well, typically the Federal Reserve just creates the money out of nothing. 277 00:27:53.580 --> 00:27:55.580 It just ejects it into the economy. 278 00:27:55.580 --> 00:27:58.580 That'd be a nice racket to have, right? 279 00:27:58.580 --> 00:28:08.580 And in fact, the economic consequences of what it does are very similar to what happens when a counterfeiter just starts injecting phone money into his local neighborhood economy. 280 00:28:08.580 --> 00:28:12.580 But that's another matter I'm not going to get into the Fed as a counterfeiter. 281 00:28:12.580 --> 00:28:16.580 But the point is, we've come in to call the Federal Reserve System the Fed, for short. 282 00:28:16.580 --> 00:28:26.580 And the Fed, when it increases the supply of money, when it just increases that supply, which it does through the banking system, through various means, it lowers interest rates. 283 00:28:26.580 --> 00:28:37.580 Because if banks now have fresh reserves they can lend, if they're going to be able to lend out these additional reserves in order to attract additional borrowers, they're going to have to lower the interest rate to attract them. 284 00:28:37.580 --> 00:28:46.580 Because banks are typically full up with loans at any given time, so if you give them more to lend, if they're going to be able to attract more people to borrow, the interest rate has to come down. 285 00:28:46.580 --> 00:28:51.580 They have a greater supply of things to lend, so in effect the price of lending goes down. 286 00:28:51.580 --> 00:29:05.580 So they can lower or increase interest rates, and that's the key thing, because in the wake of the dot-com boom and bust, and then 9-11, Alan Greenspan decided to just flood the economy with money. 287 00:29:05.580 --> 00:29:19.580 And he was going to target an important interest rate called the Federal Funds Rate at 1%, which is an astonishingly low rate, where he held it for a year, from 2003 to 2004, and this is in the heart of the housing bubble. 288 00:29:19.580 --> 00:29:28.580 This particular interest rate reverberates throughout the whole structure of interest rates, and it distorts people's decision-making process. 289 00:29:28.580 --> 00:29:34.580 In effect, it was the engine that pushed forth the housing model. 290 00:29:34.580 --> 00:29:41.580 It was only this continuous injection of new money and the continual pushing down of interest rates 291 00:29:41.580 --> 00:29:55.580 That made it seem like a good idea for people to buy $700,000 houses and have their fancy cars and buy plasma TVs and go on big vacations and have $1,000 in the bank, which is what a lot of people did. 292 00:29:55.580 --> 00:30:03.580 This was the enabler. People who become addicted to spending, the Federal Reserve System is the enabler of this addiction. 293 00:30:03.580 --> 00:30:13.580 So this is the point at which I want to introduce to you what this great economist, unsung, unfortunately, although he did win the Nobel Prize, which was amazing to me, 294 00:30:13.580 --> 00:30:19.580 F.A. Hayek, H-A-Y-E-K, what he had said, because today I hear, I've actually heard people say, 295 00:30:19.580 --> 00:30:24.580 well, you know, free market economists like F.A. Hayek have been proven wrong by what happened with the economy. 296 00:30:24.580 --> 00:30:31.580 Proven wrong? Have you read three sentences of what Hayek wrote? He anticipated exactly what just happened. 297 00:30:31.580 --> 00:30:36.380 What Hayek said is basically this, it's a very streamlined version. 298 00:30:36.380 --> 00:30:40.580 But let's suppose you have a Federal Reserve System, or a central bank as it's called, 299 00:30:40.580 --> 00:30:44.280 and it forces interest rates down. 300 00:30:44.280 --> 00:30:49.580 If you are a potential borrower, you are more likely to borrow when the interest rate is lower. 301 00:30:49.580 --> 00:30:51.880 I mean, just common sense. 302 00:30:51.880 --> 00:30:56.980 Well, think of it this way, imagine you're a businessman, you're an investor. 303 00:30:56.980 --> 00:31:01.980 Let's say you want to build a new physical plant, or you need to buy some new machinery, 304 00:31:01.980 --> 00:31:04.980 but you have to borrow the money because it's just too expensive. 305 00:31:04.980 --> 00:31:09.980 Or you want to expand your mining capacity, and you need to borrow for that purpose. 306 00:31:09.980 --> 00:31:12.980 The interest rate is 10%, you might just say, I'll forget it. 307 00:31:12.980 --> 00:31:15.980 I would never make a profit if I had to keep paying 10% interest. 308 00:31:15.980 --> 00:31:18.980 But suppose the interest rate comes down to like 3 or 2%. 309 00:31:18.980 --> 00:31:22.980 Well then you might do the calculations and say, this is a good investment. 310 00:31:22.980 --> 00:31:25.980 This investment will be profitable for me. 311 00:31:25.980 --> 00:31:29.980 So what the Fed does when it artificially pushes interest rates down 312 00:31:29.980 --> 00:31:34.980 is it makes people think that stupid investments are good ones. 313 00:31:34.980 --> 00:31:38.980 In effect, I don't want to say it makes the economy drunk, but it makes the interest rate drunk. 314 00:31:38.980 --> 00:31:41.980 And in turn, it makes investors kind of drunk. 315 00:31:41.980 --> 00:31:49.980 Well, well, well, maybe I will borrow $15 million to build my Cold Stone Creamery opening store. 316 00:31:49.980 --> 00:31:54.980 Because I'm sure forever people are always going to want a $7 ice cream cone. 317 00:31:54.980 --> 00:31:57.980 I can't see any of this business model. 318 00:31:57.980 --> 00:32:04.980 So, the artificially low interest rates get the economy going on an unsustainable investment boom. 319 00:32:04.980 --> 00:32:08.980 Because where does the investment typically go? 320 00:32:08.980 --> 00:32:12.980 Well, the longer term your investment project is, suppose you have an investment project 321 00:32:12.980 --> 00:32:16.980 that it's going to take you 10 years before this thing turns a profit. 322 00:32:16.980 --> 00:32:20.980 It's going to take 10 years before this thing starts producing consumer goods. 323 00:32:20.980 --> 00:32:26.980 Well, that is much more interest rate sensitive than a project that's going to take you one week. 324 00:32:26.980 --> 00:32:33.980 Because when you have to pay back a loan over ten years, you're very depressed that first year you're paying back a loan. 325 00:32:33.980 --> 00:32:35.980 And almost everything is interest you're paying. 326 00:32:35.980 --> 00:32:40.980 Like, if you've taken out a 30-year mortgage that first year, your mortgage payment is $2,300. 327 00:32:40.980 --> 00:32:42.980 And $2,000 of it is interest. 328 00:32:42.980 --> 00:32:44.980 Ho-ho! Whoa! 329 00:32:44.980 --> 00:32:49.980 So the longer term the investment is, the bigger the difference when the interest rate comes down. 330 00:32:49.980 --> 00:32:56.980 The Federal Reserve, fiat money, fractional reserve banking, Man Economy and State, The Theory of Money and Credit 331 00:33:19.980 --> 00:33:20.980 by Force. 332 00:33:20.980 --> 00:33:25.440 We want low interest rates, so we're going to have them, and they just push them down. 333 00:33:25.440 --> 00:33:28.340 But the other way is, the public saves more. 334 00:33:28.340 --> 00:33:33.900 Those are the two ways, the Fed forces them down, or the public saves more. 335 00:33:33.900 --> 00:33:38.820 Now when the public saves more, everything works out. 336 00:33:38.820 --> 00:33:42.460 Everything works out because when you save, you are indicating that you're not going 337 00:33:42.460 --> 00:33:48.220 to consume so much in the present, you're postponing your consumption for the future. 338 00:33:48.220 --> 00:33:56.220 Well great, that's when it makes sense for investors to engage in investment projects aimed at, wait for it, the future, okay? 339 00:33:56.220 --> 00:34:00.220 So the interest rate coordinates time here. 340 00:34:00.220 --> 00:34:13.220 So when the interest rate is low because people are saving more, investors invest in future oriented projects for when the big savers are going to spend in the future. 341 00:34:13.220 --> 00:34:18.220 When the interest rate comes down, on the other hand, because the Fed forces it down, 342 00:34:18.220 --> 00:34:22.220 people have not indicated that they're going to postpone their consumption for the future. 343 00:34:22.220 --> 00:34:26.220 Investors are going ahead, doing long-term investing, 344 00:34:26.220 --> 00:34:29.220 but meanwhile consumers are demanding goods right now. 345 00:34:29.220 --> 00:34:33.220 So businesses are engaged in product development, developing new products, 346 00:34:33.220 --> 00:34:36.220 whereas people are demanding more of the existing products right now. 347 00:34:36.220 --> 00:34:38.220 So there's a mismatch of time. 348 00:34:38.220 --> 00:34:40.220 So time is the important element here, 349 00:34:40.220 --> 00:34:47.220 which is left out of almost all current economic model that helps us understand the problem with what the Fed is doing. 350 00:34:47.220 --> 00:34:50.220 It's creating a time mismatch in the economy. 351 00:34:50.220 --> 00:34:58.220 It's encouraging people to engage in long-term investment geared toward the future at a time when people are consuming in the present 352 00:34:58.220 --> 00:35:00.220 and they are not deferring consumption in the future. 353 00:35:00.220 --> 00:35:06.220 So this mismatch is going to cause problems. It's going to make these projects not profitable at all. 354 00:35:06.220 --> 00:35:12.740 Secondly, if the interest rate comes down because people are saving, when people save 355 00:35:12.740 --> 00:35:19.740 resources, those resources are what investors use to see their projects through completion. 356 00:35:19.740 --> 00:35:22.940 But if interest rates have been brought down because the Fed just artificially forced them 357 00:35:22.940 --> 00:35:26.540 down, there are no additional resources in the economy. 358 00:35:26.540 --> 00:35:31.700 Ben Bernanke doesn't create new steel just because he forced interest rates down. 359 00:35:31.700 --> 00:35:33.500 There are no additional goods created. 360 00:35:33.500 --> 00:35:36.060 Just the interest rates have been forced down. 361 00:35:36.060 --> 00:35:40.260 So now the material wherewithal to see all this new investment through to completion 362 00:35:40.260 --> 00:35:47.580 does not exist and so therefore all these investment projects cannot be profitably completed 363 00:35:47.580 --> 00:35:51.100 and that's going to become obvious as the years go on. 364 00:35:51.100 --> 00:35:55.380 What investors will find is that their input process are going to be much higher than they 365 00:35:55.380 --> 00:36:00.560 anticipate because insufficient resources have been released. 366 00:36:00.560 --> 00:36:05.300 So for example, during the dot-com bust, one of the reasons the dot-coms went bust is that 367 00:36:05.300 --> 00:36:15.300 The Internet is the wave of the future. I'm going to start groceries.com. Everybody is going to want to buy his groceries on the Internet. Who wouldn't want to do that? 368 00:36:15.300 --> 00:36:21.300 Well, all right, I guess not many people apparently, but everybody thought any Internet business you could think of would be great. 369 00:36:21.300 --> 00:36:33.300 But now all of a sudden you've got this artificial boom, encouraged by artificially low-interest rates, and all these people are engaged in all this long-term investing, but there hasn't been any additional saved resources. 370 00:36:33.300 --> 00:36:38.300 The fixed goods they need to finish all their projects don't exist in the numbers they anticipated. 371 00:36:38.300 --> 00:36:40.300 They've been misled by the interest rate. 372 00:36:40.300 --> 00:36:46.300 So they found that programmers, computer programmers, suddenly were commanding double the salaries they used to do. 373 00:36:46.300 --> 00:36:55.300 They suddenly find that coveted domain names like TB.com, that cost $15,000 at the outset of the .com boom. 374 00:36:55.300 --> 00:37:00.300 Toward the end, business.com is costing $150,000. 375 00:37:00.300 --> 00:37:10.300 So suddenly, investors find that they have started on projects that cannot be profitably completed given the resource base that exists in the economy. 376 00:37:10.300 --> 00:37:16.300 When the free market is allowed to coordinate interest rates, it coordinates this production process perfectly. 377 00:37:16.300 --> 00:37:25.300 And a very useful analogy that the economist Ludwig von Mises made was to imagine a master builder building a home. 378 00:37:25.300 --> 00:37:33.300 Now this master builder, let's say he's been misled into thinking that he has 20% more bricks than he really has. 379 00:37:33.300 --> 00:37:37.300 So what's he going to do? He's going to lay the bricks more broadly than the otherwise would. 380 00:37:37.300 --> 00:37:40.300 He's going to anticipate building a larger house than the otherwise has. 381 00:37:40.300 --> 00:37:43.300 This is an analogy we're drawing with the economy as a whole. 382 00:37:43.300 --> 00:37:48.300 Imagine the economy as a whole as one house built by a master builder. 383 00:37:48.300 --> 00:37:54.300 Now let's suppose he continues to build, continues to build, at some point, and let's assume for the sake of argument 384 00:37:54.300 --> 00:38:24.300 He's been misled. Now, what is the best solution to this? Now, there are people who say that when we have an economic downturn like this, what we need is the Fed to pump more money in, keep it going, you know, just try to revive this corpse back to life. That's what we need to do. Just do more of the same that got us into this mess. That ought to solve this problem. 385 00:38:24.300 --> 00:38:27.700 and they keep saying let's do that let's do that well that's the equivalent of 386 00:38:27.700 --> 00:38:31.740 saying that the way to get this master builder out of his problem is to just 387 00:38:31.740 --> 00:38:35.380 keep getting him drunk so that he doesn't notice that he's got this 388 00:38:35.380 --> 00:38:39.700 dwindling supply of bricks he just keeps on laying them not even looking not 389 00:38:39.700 --> 00:38:45.540 knowing what's going on well if we did that he's obviously worse off if he has 390 00:38:45.540 --> 00:38:50.540 to destroy almost a whole house and squander all those resources and all that 391 00:38:50.540 --> 00:39:06.540 If he had had that labor time, then he would have been, if we had cut it off sooner, when he had laid, let's say, just two rows of words, that would have been, sure, there would have been some pain, but far better do that, than to let the guy almost finish the whole project and then say, oh, by the way, you don't have enough ribs for this. 392 00:39:06.540 --> 00:39:15.540 And that, in effect, is what the Fed is doing here. Every time we get told, well, the Fed, in order to avoid the recession, needs to just pump more money in. 393 00:39:15.540 --> 00:39:20.540 But the recession is inevitable because all the projects that have been started can't be finished. 394 00:39:20.540 --> 00:39:24.540 The resources aren't there to finish them. That's a fact. That can't be avoided forever. 395 00:39:24.540 --> 00:39:33.540 If you simply throw more money into the economy, all you're doing is encouraging investors to continue down this unsustainable trajectory. 396 00:39:33.540 --> 00:39:39.540 All you're doing is encouraging this home builder to just keep on putting bricks on a house he can never finish. 397 00:39:39.540 --> 00:39:42.540 That is obviously not going to help the situation. 398 00:39:42.540 --> 00:39:50.540 And as I pointed out a little while ago, when we had the downturn of 2000-2001, that's exactly what the Fed did. 399 00:39:50.540 --> 00:39:55.540 It said, you know, we've got to get out of this downturn, so let's just start flooding the economy with money. 400 00:39:55.540 --> 00:39:59.540 Let's just cut rates like mad, just throw a lot of money into it. 401 00:39:59.540 --> 00:40:06.540 And so remember, that's the first and only recession on record in which new housing starts did not decline. 402 00:40:06.540 --> 00:40:17.540 And so because of that, because the Fed was trying to postpone or mitigate the effects of the recession, all it did was sow the seeds for the worst one that we're enduring now. 403 00:40:17.540 --> 00:40:25.540 Because instead of people realizing right then what the real value of their houses was, they drew exactly the opposite conclusion. 404 00:40:25.540 --> 00:40:32.540 People said, well, you know what, everything else may go down as it is doing in this recession, but apparently housing just never does. 405 00:40:32.540 --> 00:40:45.540 So in the effort to avoid the pain of that recession, the Fed simply encouraged people to continue along unsustainable paths, both unsustainable investment patterns and unsustainable consumption patterns. 406 00:40:45.540 --> 00:40:53.540 People were misled into thinking their houses were worth more than they were, they borrowed money against these houses, they bought boats with them. 407 00:40:53.540 --> 00:41:09.540 Whereas if the recession had been allowed, yes, to go on fully at that time, people would have had a rational assessment of the values of their assets and we would not have perpetuated this unsustainable bout of consumption. 408 00:41:09.540 --> 00:41:15.540 Now that, in a nutshell, is what's called the Austrian business cycle theory. 409 00:41:15.540 --> 00:41:23.540 And it's named that because it was devised by people who belonged to something called the Austrian School of Economics. 410 00:41:23.540 --> 00:41:27.540 The Austrian School is not a physical building. It's a school of thought. 411 00:41:27.540 --> 00:41:33.540 And it's not physically in Austria. They're called that because the main figures in the school, 412 00:41:33.540 --> 00:41:42.540 beginning with Carl Menger in the 1870s and Boehm-Bawerk and Ludwig von Mises and F. A. Hyde were all Austrians. 413 00:41:42.540 --> 00:41:45.540 So this becomes known as the Austrian theory of the business cycle. 414 00:41:45.540 --> 00:41:52.540 And it explains a lot of the unexplained questions that require an answer. 415 00:41:52.540 --> 00:42:00.540 For example, it needs to be answered why it is that all of a sudden entrepreneurs of economy-wide 416 00:42:00.540 --> 00:42:07.420 Why suddenly seem to make disastrous business errors of the same type at the same time? 417 00:42:07.420 --> 00:42:08.420 Why should that be? 418 00:42:08.420 --> 00:42:10.380 That demands an explanation. 419 00:42:10.380 --> 00:42:11.380 Why should that happen? 420 00:42:11.380 --> 00:42:15.220 We understand, you know, a business might go out of business here or there, you know, 421 00:42:15.220 --> 00:42:17.020 nobody can forecast the future perfectly. 422 00:42:17.020 --> 00:42:21.340 You know, you're going to, some people are going to go out of business, but various sectors 423 00:42:21.340 --> 00:42:26.300 of the economy might go up and down, but why should the whole thing move in a cyclical 424 00:42:26.300 --> 00:42:27.300 pattern? 425 00:42:27.300 --> 00:42:28.700 What is the explanation of this? 426 00:42:28.700 --> 00:42:31.260 And normally the explanation you get is no explanation at all. 427 00:42:31.260 --> 00:42:35.140 Well, you know, the market has a weird psychology, nobody knows why, 428 00:42:35.140 --> 00:42:41.860 animal spirits, you know, sometimes people feel, they feel optimistic or they feel pessimistic. 429 00:42:41.860 --> 00:42:46.220 So apparently if all of us just had psychiatric help, we wouldn't have the cycle. 430 00:42:46.220 --> 00:42:48.980 But this is a totally unsatisfying explanation. 431 00:42:48.980 --> 00:42:54.380 And it suggests that there are no real factors accounting for the data check. 432 00:42:54.380 --> 00:42:58.780 and that helps to explain why there are different approaches to what now needs to be done. 433 00:42:58.780 --> 00:43:03.380 If you think that basically the downturn has no explanation, people just got pessimistic all of a sudden, 434 00:43:03.380 --> 00:43:07.780 then the way to revive it is to just stimulate it, just have this stimulus package. 435 00:43:07.780 --> 00:43:14.380 Let's just take this corpse and just get it going again by throwing a lot more money into the economy 436 00:43:14.380 --> 00:43:19.580 and basically saying to people, we want you to keep spending at your old level of spending. 437 00:43:19.580 --> 00:43:23.580 But we've just seen the old level of spending could not be sustained. 438 00:43:23.580 --> 00:43:26.260 People are broke, they can't pay it back now. 439 00:43:26.260 --> 00:43:28.700 They can't pay back all the debts they've wrapped up. 440 00:43:28.700 --> 00:43:30.460 We've got a credit card, it's gonna be the next thing 441 00:43:30.460 --> 00:43:31.860 that needs to be bailed out. 442 00:43:31.860 --> 00:43:34.140 Because we've got unpayable credit card debt. 443 00:43:34.140 --> 00:43:37.500 To say to people that the solution to our problems 444 00:43:37.500 --> 00:43:41.020 as an economy is for you guys to keep on spending 445 00:43:41.020 --> 00:43:44.700 as if nothing has happened is so absurd 446 00:43:44.700 --> 00:43:48.420 that only somebody in a lunatic asylum 447 00:43:48.420 --> 00:43:52.580 or on the editorial page of the New York Times would accept it. 448 00:43:52.580 --> 00:43:59.580 Whereas the Austrian approach is to say this downturn isn't because of, you know, animal spirits or, you know, unpredictable factors. 449 00:43:59.580 --> 00:44:03.580 It's because there have been real resource misallocations in the economy. 450 00:44:03.580 --> 00:44:07.580 Investment has been made in incorrect, unsustainable lines. 451 00:44:07.580 --> 00:44:09.580 That needs to be flushed out. 452 00:44:09.580 --> 00:44:15.580 We need to reallocate labor away from firms that were catering to this unsustainable level of spending. 453 00:44:15.580 --> 00:44:20.580 So maybe there aren't going to be as many cold stone cream reeds as there were marble slab or whatever they are. 454 00:44:20.580 --> 00:44:24.580 Maybe there won't be as many of those. There'll be fewer houses built. 455 00:44:24.580 --> 00:44:31.580 It takes time for labor and capital to be shuffled back around the economy into a sustainable pattern. 456 00:44:31.580 --> 00:44:39.580 But we need entrepreneurs who are informed by the price system to be allowed to do this peacefully and without interruption. 457 00:44:39.580 --> 00:44:47.580 Every time there's some distraction whereby the government starts spending 800 billion dollars or a trillion dollars on various things, 458 00:44:47.580 --> 00:44:51.580 That only confuses auto-criminalists, because now it's very hard for them to assess demand. 459 00:44:51.580 --> 00:44:57.580 Well, this demand is just coming from the government, so do I really want to expand here, should we really expand here? 460 00:44:57.580 --> 00:45:04.580 Is it really good for the government to engage in stimulus that results in the expansion of construction companies? 461 00:45:04.580 --> 00:45:07.580 I mean, how is that? That's not a long-term solution. 462 00:45:07.580 --> 00:45:11.580 At the end of this, we'll be in much more debt and we'll still have an unbalanced economy. 463 00:45:11.580 --> 00:45:13.580 We'll still have too many people in construction. 464 00:45:13.580 --> 00:45:19.140 We will not have solved any of the underlying problems that, let me see, I forgot to bring 465 00:45:19.140 --> 00:45:20.140 one thing. 466 00:45:20.140 --> 00:45:21.140 I forgot to bring my watch. 467 00:45:21.140 --> 00:45:22.140 Okay. 468 00:45:22.140 --> 00:45:23.140 Good. 469 00:45:23.140 --> 00:45:24.140 I sold it a little bit of time. 470 00:45:24.140 --> 00:45:25.140 Good. 471 00:45:25.140 --> 00:45:26.140 Now, let's... 472 00:45:26.140 --> 00:45:37.980 Let me give you some actual examples of this in practice, from history, which is my field. 473 00:45:37.980 --> 00:45:42.140 Nobody has ever heard of the Great Depression of 1920. 474 00:45:42.140 --> 00:45:43.140 Nobody. 475 00:45:43.140 --> 00:45:52.140 That's not because there wasn't one, it's because nothing was done to fix it. Nothing. 476 00:45:52.140 --> 00:45:57.140 Other than the market, and again, what proceeded in the Great Depression of 1920? 477 00:45:57.140 --> 00:46:04.140 Where you had a worse, the first year of the Great Depression of 1920 was worse than the first year of the Great Depression of 1929. 478 00:46:04.140 --> 00:46:09.140 In terms of employment, production, all the statistics, it was worse. 479 00:46:09.140 --> 00:46:14.940 And yet, what was done about it? What was done? Well, first of all, we had President Warren Harding elected in 1920, 480 00:46:14.940 --> 00:46:23.740 who was sort of like an amiable adult. So even if he had wanted to do something, by the time he got around to it, the thing's all over. 481 00:46:23.740 --> 00:46:31.640 So what you had was, again, a massive credit expansion, which led to over-investment in certain lines, under-investment in others. 482 00:46:31.640 --> 00:46:35.940 And the result was, well, we had this downturn in 1920. 483 00:46:35.940 --> 00:46:42.940 So what did they do? Did they have a big fiscal stimulus package? No, to the contrary, the government cut its budget. 484 00:46:42.940 --> 00:46:50.940 Now, we're told today that if the government cuts its budget, that's terrible, because we just need people spending. Spend, spend, spend, spend, spend, spend, spend. 485 00:46:50.940 --> 00:46:59.940 By the way, if that's what people did forever, we'd still be living in the Stone Age. You need to save in order to finance, you know, things like this, investment, whatever. 486 00:46:59.940 --> 00:47:04.940 But they didn't do a thing. The Fed was very new at that time and hardly knew what to do. 487 00:47:04.940 --> 00:47:10.940 So they did nothing. And the result was within 18 months the economy was on its way to recovery 488 00:47:10.940 --> 00:47:13.940 and before you knew it was setting production records again. 489 00:47:13.940 --> 00:47:20.940 In 1929 on the other hand, we have the first time in American history in which instead of allowing 490 00:47:20.940 --> 00:47:25.940 these underlying imbalances to be corrected, instead exactly the opposite was done at every turn. 491 00:47:25.940 --> 00:47:28.940 The government said, you know what, we're going to roll up our sleeves and fix this problem. 492 00:47:28.940 --> 00:47:30.940 to fix this problem. 493 00:47:30.940 --> 00:47:33.940 And it went on for year after year after year. 494 00:47:33.940 --> 00:47:37.940 Now today, there is some dispute about the unemployment figures of the 1930s. 495 00:47:37.940 --> 00:47:42.940 But no matter what set of statistics you look at, this is not an enviable decade. 496 00:47:42.940 --> 00:47:45.940 By 1940, you still have double-digit unemployment. 497 00:47:45.940 --> 00:47:47.940 Year after year after year. 498 00:47:47.940 --> 00:47:50.940 Now, sure, you can draw examples from history all day long, 499 00:47:50.940 --> 00:47:53.940 but those two are pretty close together in history. 500 00:47:53.940 --> 00:47:55.940 And you might think there's a little bit of a lesson there. 501 00:47:55.940 --> 00:48:01.940 But if you're not persuaded by that, then I direct your attention to what happened in Japan. 502 00:48:01.940 --> 00:48:07.940 Now Japan, again, had an insane credit-fueled boom in the late 1980s. 503 00:48:07.940 --> 00:48:10.940 And then that thing went bust. 504 00:48:10.940 --> 00:48:15.940 What did Japan try to do to reverse its economic decline? 505 00:48:15.940 --> 00:48:19.940 Did it say, well, you know, we need, after this credit-fueled boom, 506 00:48:19.940 --> 00:48:24.940 we need resources that have been misallocated to be now reallocated in sustainable lots? 507 00:48:24.940 --> 00:48:31.940 No, no, no. We're going to interfere with that process every step of the way and then pretend to be shocked that there's no recovery. 508 00:48:31.940 --> 00:48:37.940 So for over a decade and arguably until the present, the Japanese economy has stagnated. 509 00:48:37.940 --> 00:48:40.940 And let's just go down the list of what they tried. 510 00:48:40.940 --> 00:48:43.940 They tried partial nationalization of the banks. 511 00:48:43.940 --> 00:48:48.940 They tried trillions of yen in public works, stimulus spend. 512 00:48:48.940 --> 00:48:52.940 They pushed interest rates all the way down to zero. 513 00:48:52.940 --> 00:48:56.940 They had a special fund to help bail out zombie companies. 514 00:48:56.940 --> 00:48:58.940 And what did they get? 515 00:48:58.940 --> 00:49:00.940 Well, what you would expect. 516 00:49:00.940 --> 00:49:02.940 They got a night of a living dead economy. 517 00:49:02.940 --> 00:49:04.940 That's it. That's what they got. 518 00:49:04.940 --> 00:49:08.940 And now which one of those things has not been recommended 519 00:49:08.940 --> 00:49:11.940 or actually done in our own case? 520 00:49:11.940 --> 00:49:15.940 And then we're supposed to expect that the consequences are going to be different. 521 00:49:15.940 --> 00:49:19.940 Now all of this follows, though, by implication from Austrian business cycle theory. 522 00:49:19.940 --> 00:49:33.940 Because, as we've seen, now that we know that when you artificially interfere with the industry, it's like artificially interfering with any price, except that the industry, in effect, is a price that is present throughout the whole economic structure. 523 00:49:33.940 --> 00:49:42.940 So it's going to have economy-wide consequences. This is the solution to why businesses all seem to fail, because they're all misled by the same indicator. 524 00:49:42.940 --> 00:49:48.940 So this answers these questions, and it also helps us to figure out what is the way out. 525 00:49:48.940 --> 00:49:55.940 Well, if we know that the problem is excessive credit creation, then the solution cannot be excessive credit creation. 526 00:49:55.940 --> 00:49:59.940 The solution cannot be forcing interest rates down. That's what got us here. 527 00:49:59.940 --> 00:50:03.940 The solution can't be just throwing more money at it or going further into debt. 528 00:50:03.940 --> 00:50:09.940 Excessive debt is what brought this problem to life in the first place, where people suddenly couldn't make their mortgage payments. 529 00:50:09.940 --> 00:50:14.940 They can't make their credit card payments. That's not a sustainable structure of spending. 530 00:50:14.940 --> 00:50:18.940 And we do not want to stimulate that structure of spending back into existence. 531 00:50:18.940 --> 00:50:20.940 That would be a bad thing. 532 00:50:20.940 --> 00:50:24.940 Because since it is unsustainable, eventually it's going to have to collapse. 533 00:50:24.940 --> 00:50:29.940 And the collapse will just be all the harder if we don't just take our medicine now. 534 00:50:29.940 --> 00:50:36.940 Now if we look at the Japanese economy, by the way, we want to confirm the relevance of the Austrian Business Cycle Theory. 535 00:50:36.940 --> 00:50:42.940 Austrian Business Cycle Theory tells us that the further removed from consumer goods an investment is, 536 00:50:42.940 --> 00:50:46.940 The more interest rate sensitive it is and the more of an artificial boom there will be there 537 00:50:46.940 --> 00:50:48.940 when interest rates are artificially low. 538 00:50:48.940 --> 00:50:51.940 We look at the Japanese example, what do we see? 539 00:50:51.940 --> 00:50:55.940 The worst downturns are in the following order. 540 00:50:55.940 --> 00:51:01.940 And this happens to be the order of farthest away from consumer goods all the way down to the consumer. 541 00:51:01.940 --> 00:51:08.940 So we've got mining, manufacturing, wholesale and retail, and services. 542 00:51:08.940 --> 00:51:10.940 Services are right at the consumer. 543 00:51:10.940 --> 00:51:18.580 for a Massage, again, that's immediately consumable by the consumer, and that's sufferably least, 544 00:51:18.580 --> 00:51:24.840 but in increasing order of suffering, it's increasing order of how long in time these 545 00:51:24.840 --> 00:51:30.060 investments are from the fruits of them being reached, that's exactly what Austrian Business 546 00:51:30.060 --> 00:51:34.820 Cycle Theory would predict, it is not what this, we're not spending enough theory to 547 00:51:34.820 --> 00:51:40.340 predict, if that were the case, then the worst downturns should be in services and they should 548 00:51:40.340 --> 00:51:56.340 in consumer goods, but it's an empirical fact that in all these downturns, consumer goods do relatively well compared to real estate, capital goods, and goods farther down the line in the production process. 549 00:51:56.340 --> 00:52:03.340 So it is only the Austrian business cycle theory that can account for this. And notice now what the obvious implication of all this is. 550 00:52:03.340 --> 00:52:08.340 Now this has anything to do with the free market. This was an interference of the free market. 551 00:52:08.340 --> 00:52:13.340 When you push interest rates below where the market would have set them, 552 00:52:13.340 --> 00:52:18.340 how could the consequences possibly be the fault of the market? 553 00:52:18.340 --> 00:52:22.340 The Federal Reserve system is not a part of the free market. 554 00:52:22.340 --> 00:52:28.340 It was established by Congress in 1913. Its chairman is appointed by the U.S. government. 555 00:52:28.340 --> 00:52:33.340 It gets government-granted monopoly privileges. It is the very opposite of the free market. 556 00:52:33.340 --> 00:52:38.340 And for years and years, the Federal Reserve System has been doing this. 557 00:52:38.340 --> 00:52:41.340 And yet, the free market takes the blame. 558 00:52:41.340 --> 00:52:45.340 Capitalism has failed, we get told, over and over again. 559 00:52:45.340 --> 00:52:50.340 And that's why, in one of my chapters, I ended by noting 560 00:52:50.340 --> 00:52:55.340 that the Federal Reserve System is the elephant in the living room that everyone pretends not to notice. 561 00:52:55.340 --> 00:53:02.340 On TV, we've got all these explanations for what's going on, but with a few honorable exceptions, the Fed is never mentioned. 562 00:53:02.340 --> 00:53:05.340 You just hear crickets, so no mention of it at all. 563 00:53:05.340 --> 00:53:12.340 But meanwhile, the devastating results of what the Fed does are then blamed on capitalism. 564 00:53:12.340 --> 00:53:24.340 And so as I say to the folks, it's time to start considering the possibility that maybe it's the elephant that's wrecking all the furniture in the living room and not a little giant. 565 00:53:24.340 --> 00:53:39.340 And so, as I just sort of bring this to a close, I think if we're going to have some success in getting out of this, the Federal Reserve System needs to be put on the table, needs to be a part of national discussion. 566 00:53:39.340 --> 00:53:50.340 It hasn't been. It has existed for almost a hundred years. And during its hundred year existence, the value of the dollar has declined by 95%. 567 00:53:50.340 --> 00:54:02.340 95%! Now suppose that happened when we had the dollar back by gold. Well, we never hear the end of it. Oh, well, that just shows having the dollar back by something is a terrible idea. 568 00:54:02.340 --> 00:54:11.340 But when the Fed does it? No, nothing. Silence. Not even mentioned. And yet, we are sort of conditioned to believe that this is the best of all possible worlds. 569 00:54:11.340 --> 00:54:17.340 that this system that discombobulates the market through its artificial interest rate reductions 570 00:54:17.340 --> 00:54:25.340 that then leads to bankruptcies and the bankrupt firms then turn to the Fed to create more paper money to bail them out 571 00:54:25.340 --> 00:54:30.340 and we have these crazy cycles going on and people get thrown out of work and discombobulated 572 00:54:30.340 --> 00:54:38.340 Is this so obviously the best possible system that any non-trivial alternative is to be rejected out of hand? 573 00:54:38.340 --> 00:54:41.340 This is a legitimate subject for debate. 574 00:54:41.340 --> 00:54:45.340 And in case you're tempted to say, but you know, we did have Boehm and Bastiat. 575 00:54:45.340 --> 00:54:48.340 We did have economic cycles before we had a Federal Reserve system. 576 00:54:48.340 --> 00:54:50.340 So you can't blame all these people. 577 00:54:50.340 --> 00:54:53.340 The same causes are at work in all of those. 578 00:54:53.340 --> 00:55:02.340 In the Panic of 1819, 1837, 1857, 1873, 1893, and 1907, they're all based at the same cost. 579 00:55:02.340 --> 00:55:04.340 There is preceding the panic. 580 00:55:04.340 --> 00:55:14.340 In the pan, there is excessive money creation, which leads to misallocations of resources and eventually a bust. It happens in every single case. 581 00:55:14.340 --> 00:55:23.340 So it seems to me that if you're looking for confirmation of this theory, it is absolutely everywhere. 582 00:55:23.340 --> 00:55:29.340 Now the trick is getting the theory into circulation among the general public, 583 00:55:29.340 --> 00:55:43.340 so that we do not wind up suffering a ten-year depression and then, at the end, the added indignity of being told that it was the government's brilliant plan that eventually rescued us. 584 00:55:43.340 --> 00:55:45.340 So, thank you very much.