Hello, Frank. How are you? I'm okay. These are crazy times, huh? Oh, yeah. It's mad. What do you think about what happened in the markets today? Well, I mean, it's just a little bit of a knee-jerk reaction. I mean, they're just a little bit responding. They're hoping that the Congress will approve the package
Yesterday's stock market fall was widely blamed on the failure of the package. Do you accept that explanation?
Basically, not always, but over time it reflects the facts of reality, and the facts of reality
are that the real economy in America was badly damaged by reckless policies, fiscal and monetary
policies over many years, and now it's sort of a payoff time, so to speak, and on a daily
basis obviously we cannot predict what may happen, but over time we can say that the
the market is going to reflect the real facts and the real facts are not very good.
You've been a great profit of this all along, writing for years on the Mises site, getting
the timing down almost exactly right.
I mean quite often you send articles in and then suddenly the next week the very topic
will be in the headlines.
You saw this one coming, huh?
Yeah, look, you know, I mean, it's not only myself, most many practitioners in this game,
I mean, who follow Mises, I would say, and sort of a more commonsensical approach, you
know, would have seen that things are going to come, because you cannot have indefinite
bull market, which is fed by such a crazy lose monetary policies, you know, that eventually
When do you date the loose monetary policies and the tightening that precipitated the disaster?
I basically think that the problem started, first of all, in 2001 when Mr. Greenspan started
to loosen its monetary stance, its interest rate stance. They lowered the interest rate
from 6% in January 2001 to 1% by June 2003, and then they kept at this level until June
2004. And thereafter, they basically were moving by baby steps and started to tighten
by quarter of a percent. So we had a, and they raised basically the rates by September
In 2007, we had 5.25%. The point is that when they have lowered interest rates to such an extent, from 6% to 1%, it has given a foundation platform for various activities, which I call them bubble activities, which shouldn't be there.
and that's really manifested in real estate boom and everywhere, in fact, we got them.
And the money supply, doesn't matter how you measure, for instance, if you measure in terms
of the way I look at it, so-called AMS, Austrian AMS, for instance, you know, it's jumped from
a slight negative we had in early 2001.
In early 2001, it basically reached at one stage almost 9% by 2006, and it sort of stood
at this level for quite some time.
So this is quite a massive increase that we had, as Mises would say, quite significant
misallocation of resources, squandering of real resources from good activities towards
bad activities, so to speak, that the market would not promote.
And right now we are in the midst of the effect of the tighter stance, which Fed Greenspan
introduced in June 2006, again I'm saying by baby steps.
And so from 1% to 5.25%, it doesn't matter how small the steps are, you're going to
strangle all those activities, false activities that have been created.
And that's really what we have right now.
are experiencing the artificial forms of life of false activities now under pressure.
Now, what precipitated the tightening, do you suppose? Why did Greenspan decide that things had gone too far?
Well, the usual stuff with the central bank, as always, that they're starting to feel that there's going to be inflation, right?
and the way they measure inflation, the consumer price index or whatever.
So initially, he lowered the interest rate because he was fearing deflation.
Even later, Bernanke joined the board, Bernanke encouraged Greenspan to a large extent to
avoid deflation.
So he said, well, we're going to buy insurance and we lower interest rate to 1 percent.
Once he started to realize that the consumer price index is not collapsing any longer and
They make the assumption, they always make the assumption, if you put the money, it won't have any effect, and if you take the money, it still won't have any effect, they're playing some kind of neutrality, you know, they make a distinction between money and liquidity as if there's any difference, liquidity and money is the same thing, but they label it different all the time, and they say, we pump liquidity, that's it, now we take the liquidity out, no effect whatsoever on the economy for them. Well, it's the old monetarist story, right?
So, neutral money, money and money out, what does it matter? It doesn't affect the capital stock. It doesn't affect the shape of investment.
That's right. I mean, even Friedman was a little bit smart and all that.
Basically, he would say, all right, in the short term, maybe we can have it, but it's not really important.
Over time, it's all, it's basically, money won't have much effect.
And particularly, rational expectation completely removed all this importance of money altogether.
and they would say expectation will adjust everything, bingo, and so money became really not an important issue altogether.
Yeah, the efficient market hypothesis, everything that's going on is exactly right all the time.
That's right, and everything adjusts quickly and that's the problem with all those models because, you know, like if you assume that money is non-neutral
and it starts with the legs, which Friedman incidentally was accepting the time legs, but
for him legs were quite mechanical and he didn't really elaborate why the time legs.
As opposed to Mises, Mises really said it clearly that money starts at a particular
point and the effect goes from one individual to another individual, from one market to
another market and that's really the beauty about all that because that's really exactly
You can see how markets really work. You can see that money, in a financial market, every dealer will tell you, money goes from one asset to another asset, really. That's clear non-neutrality of money.
It's remarkable to think that the whole thing is a surprise in some ways to central bankers
and the people that follow these markets so carefully and closely and are in charge, but
not entirely a surprise to people like you who are well-schooled in the theory.
We all basically have indebted to Mr. Mises for giving us all the knowledge, put it this
and of course Murray Rothbard. I believe that some other people like the market players
were not versed in Austrian economics but intuitively they are responding and getting
to the same results in fact. I read various financial commentaries and some of them reaching
the right conclusions although they cannot articulate as let's say the Austrians are
Now, we've got Congress rejecting the bailout package, which you don't suppose was going
to do any good, right?
You wrote that it was actually going to prolong the problems, so we've got Congress rejecting
that.
They may or may not approve it, but what's the central bank doing now to patch things
up and what are going to be the effects of that?
Well, as far as I'm concerned today, for instance, Fed, Fed got so many tools today, I'm actually
surprised that Fed actually made the announcement of this package, because that can bypass the
package easily, Bernanke already yesterday pushed $700 billion into the market in terms
of money pumping, so that can, even if the Congress, let's say, would not approve the
The package, you know, Bernanke almost got all the tools, he still waits for another
tool to get the approval from the Congress to pay interest on deposits, banks that bank
help hold with the Fed, and he got, he can pump at Liberty today, so for all the intent
and purposes, the package is more just, they introduce it just for psychology sake rather
than anything else, to say how we're doing something, we try to save you, but there's
no need for that, Bernanke got all the means to do it.
But when you say pumping money, the normal analysis would say that this is going to result in inflation, but you disagree with that.
Well, the interesting thing is that until today, and there are two things to this, until today Bernanke made the impression that he pumps, right?
But he still was lacking one tool which prevented him to expand the money supply, or the balance sheet of the Fed, so to speak, which is the interest rate target, because the way the interest rate target operates prevents the Fed at the same time to maintain the target and expand money at liberty.
Why does the Fed have to obey the target?
Well, it doesn't have to, but because they're saying, well, that's our policy right now,
so in order to carry credibility, they will say, okay, we're setting the target.
And the reason why we're setting the target is because we believe where the interest rate level of interest should be,
The underlying philosophy of interest rate targeting is that they try to hit the so-called
neutral interest rates where everything is instead of equilibrium and everything is hunky-dory
and balanced.
So, the moment you don't abide by the target you set, it means that you don't really know
where you're going.
So, in terms of credibility, they have to play the game.
But in action terms, there's no need for that.
Bank of Japan decided not to target anything and sort of lower the interest rate to zero.
After the event, they said, well, the target will be zero right now.
But Benanke doesn't want to have federal funds rate at zero at the moment.
But right now, last week at least, we had, and I presume also yesterday, federal funds
rate already fell to zero.
So they basically, when it's needed, they may not play the target.
Okay. So what are they planning with this deposit, paying interest on the deposit plan?
Well, with the interest on the deposit, it works as following.
What will happen is now, if for instance, let's say the interest rate target today,
today it's 2%, the federal funds rate target, and if Benanke decides to push money,
Let's say 400 billion just like that. How it does it? By buying assets from the financial markets like treasury bonds, it injects money to the system.
The interest rate will fall to below 1%, to below 2%, could fall to zero.
So obviously, he said, well, the federal open market operation automatically says, well, we have, sorry, the open market desk at New York said, well, we have the target.
and to maintain the target, that's what our job is. So they all try to offset it by immediately taking money out of the system, in other words, by basically selling assets to the market.
And so at the end of the day, there won't be much effect on the money supply, and actually was the game, was the situation until now.
So Bernanke said, look, because he's a monetarist and he likes to pump money effectively, he said, look, I need to have the unlimited capacity to print money to expand my balance sheet, the balance sheet of the Fed, and the only way I can do it, if I'll be able, let's say, two things, one is, if the government will start issuing debt, for instance, then it can help me, by issuing debt, the government will create pressure
on the interest rate market, on the Fed funds market, because the government will absorb
cash from the public.
And once the interest rates will start going above the target, then I can actually pump
money because I have to suppress the interest rates going above the target, then it's good
for me.
And that's really how Benanke was monetizing, how the debts get monetized, put it this way.
But now, if we have a situation where Treasury is not issuing debt, and I would like to have
The easiest way is to print money. How do we do it? Let's pay interest to banks. Banks are holding their reserves and some of the money they need to settle checks with the central bank, with the Fed.
Right now the FED doesn't pay them any interest.
So now if the FED will start paying interest, let's say the interest is the same as the
target, let's say 2% at the moment, then when the FED will pump money, there won't be any
incentive for the various banks to lend to each other in the FED funds market.
Because the moment you pump money, the FED funds rate will fall to below the target.
And if you offer them the rates of a target, why would you lend below the target?
So first of all, nobody will lend because everybody knows that we can get the money
without doing anything, just to sit on cash.
Second, why lend even?
By lending, you're incurring some risk.
So that's really the solution now.
You're paying them interest on deposit and they'll sit on liquidity.
And that's how Bernanke believes he will be able to pump money or expand his balance sheet,
Which is true, but the point is now, that's to your second question, will it create inflation?
Well this is dependent very much on what money will do next because as Mises suggested, money
has to move from one market to another market, etc., etc., and will this money move?
And that's where the bank lending is coming into the game because if banks will not lend,
because banks may sit on the cash forever, ever, and that's what they did during the
of the Great Depression, because the risk is too high. They don't really know whether
the lending will end up in bad assets or good assets. And given the fact that they have
accumulated so many bad assets, they probably will not lend at all. And that's really the
observation that Murray Rothbard made in his various writings, that during the Great Depression,
banks have chosen not to lend because the risk of accumulating bad assets was far too
Bank of Japan has pumped to the bank's deposits money at the pace of almost 300% at one stage,
and the banks didn't land there, and lending continued to collapse.
So I presume that similar things will happen here, so therefore the overall, if lending
will not increase, then we can actually conclude that this will not be inflationary, what Bernanke
is going to do, but later on it may explode because one of these days the economy will
start going ahead and then we may end up in serious trouble.
So once you end the credit crunch, then the inflation begins?
That's right, because the banks will see so much liquidity, eventually it will have to go.
But initially, if they don't want to lend, and things are very paralyzed, nothing is going to happen in this sense.
Well, it's a difficult proposition, because on one hand, downward pressure on prices would be a good thing right now.
That's the saving grace for consumers, and the credit crunch will force that.
Yeah, I mean, the fall in prices and this is part of the adjustment is a great thing
because prices do not cause anything as some people believe it, you know, it just brings
things to some perspective. The fact of reality is that we're not as rich as we thought we
are, you know, and we're much poorer than we believed we are, and that's really what
The prices are indicating also to us. So it's good to have this adjustment, that this will live in the reality rather than an illusion.
Meanwhile, while this is happening, you've got banks accumulating massive reserves and preparing for the next round of lending, and that's when the danger hits, that's when the inflation takes off.
Yeah, that's exactly right. Once things will start improving and they're sitting on massive ability to amplify all that, that's where the trouble will start.
What happened to prices in Japan? You're making a close analogy between the US and Japan here. What was the Japanese experience?
Well, the Japanese experience took a long time for the prices to move, but they started
gradually to move also.
The interesting thing in Japan is that Japan has never recovered since the early 90s.
Because they allowed the zombie activities, that's what the various politicians really
want in America, to stay alive.
So nothing really, it's all paralyzed there, in fact, I mean, the economy there has never recovered, and the lending hardly moved either, so that's why, I mean, it moved a little bit here and there for a short brief period of time, so the price inflation has gone up a little bit, but nothing really to ride home about, put it this way, because nothing really happened there. It's still in a paralyzed state. Yeah, because they did not let the liquidation take place. They didn't, you see.
They kept all the zombies alive for the last 20 years, and that's really what you have.
And that's really what the guys in America are saying, well, let's keep everybody happy.
How can you do it?
Yeah, right. Eventually, these bad deaths are going to have to be washed out one way or the other in order for economic recovery to take place.
Exactly right. I mean, that's the way I understand it. And that's how I believe Mises understood that he was saying that a recession, whatever we call a recession, is the first step, a stage for recovery.
It allows, enables the good activities to take over and start to build up capital and start to move ahead because, like, you know, every businessman understands it.
That's really what surprises me. On a micro level, everybody understands the logic of this, but all of a sudden, on a micro level, somehow they're getting confused, which is really beyond me.
Yeah, yeah. So until this liquidation occurs, we can expect a long period of recession.
But is there a way that federal policy can assist in making the liquidation more orderly?
You know, some people are arguing this, that, look, everything is moving too quickly,
we need a little bit of monetary injections, maybe the congressional bailout, whatever.
as a way of softening the blow.
Well, I mean, all those things sound sort of appealing psychologically,
but I think it's all false, the reason being very simple, because when you say,
well, let's delay it a little bit, it means let's continue to support those zombies for a little bit longer.
That's really what it means. And the longer you keep them, the worse it's going to be for the recovery.
In the UK, for instance, they basically don't bail them out, they say we nationalize them.
That's the same thing what the US wants to do, to nationalize.
But if you nationalize, you still basically give resources to those activities, which
are not supposed to be there any longer, because real activities are still channeled to them,
real resources.
What you're saying is that it's nearly, well, it is impossible to fight price trends, and yet that's what the political class and the class of central bankers is attempting to do.
Yeah, they basically try to defy the reality that somebody is insolvent, and there's no way it can become profitable.
And then basically gambling, they say, maybe this activity will become profitable if I'll wait for another thousand years, and after a thousand years it'll be profitable.
In the meantime, it kills all the other guys who can't really deliver goods and makes a hell of a difference for our life.
Can you say a few words about the international impact of what's going on in the U.S. right now?
Well, the international impact is that the most large banks were all involved in this,
I mean, they all were involved in this whole monetary system. Every central bank copies
the Federal Reserve, I mean, so everybody is coordinating with everybody else. So, you
know, there are some certain time lags, but on balance they all pumped a hell of a lot
of Money.
They started to tighten the different degrees and now they're all in the phase of economic
bias right now.
That's what you see in Europe, that's what you see in the UK, and that's what you may
start seeing in countries like Australia, and also in the Southeast Asian economies
gradually will hit there, and particularly China.
China created a lot of good things because it moved away from communism, but then for
For every class, they also created a lot of minuses by pushing a lot of money, creating
a lot of false activities, so they have created a lot of wealth, but they're also squandering
it now very rapidly, started to squander it.
You work at Man Financial and you're one of the economists there, and I presume there
are others, right?
And probably they don't all agree with you, right?
Well I mean, most people don't agree with me, definitely.
But I was thinking the other day, you know, that it's interesting you watch the television news and now suddenly the bears that have been with, you know, various firms of one sort or another are now emerging saying, look, I told you so, but it occurred to me that it must be very difficult in times and boom times to be a bear because everybody's saying, look, your forecasts are not correct, look at the thought market, it's soaring, everything's going great, and all you do is sit over there in the corner and complain, right? That's right.
Well, so the solution to this is I found a solution that during the bull market, for
instance, you don't emphasize too much the structural issues that we are right now witnessing.
And you sort of try to pay attention to liquidity, monetary liquidity, which Mises and Austrian
economics gives you a lot of tools, plenty of tools for that, to evaluate the market
movement on a short-term basis.
I found that with Austrian economics you can also cater for even for bull markets but many
Austrians making the mistake during bull market that they're only focusing on the structural
issues which is correct but they don't happen in the short term, that's the problem.
Right, so you have actually called these short-term price movements very quickly as I think back
to it now. For five years, you have had both long-term articles, long-term forecasts and
short-term forecasts.
That's right. That's right. So using the money supply, for instance, using the Austrian
methods to evaluate what money is, you can do quite well in terms of assessing short-term
movement also. But I believe that ultimately what helps good analysis is the correct theory.
And I think at the bottom line, you know, theory is very important and then with theory
you try to read the data. But when people only look at the data and try to extract theory
from that, that's where the problem starts.
Are you resisting the temptation to run around and say, I told you so?
I never do this. You know, one has to be humble in this, you know, because it's very dangerous,
I mean, very dangerous.
That's right, even though the people who are correct about the housing boom and everything, nobody really likes those people even now, right?
No, they don't, because you see, if you're bullish, let's say, during the bull market and you're right, then you'll be praised and you'll be worshipped.
Now, if you're wrong, they won't do anything to you because you were bullish in the bull market, let's say.
Thank you for being so frank with us over the years. It's been a great help to our readership.
Are you interested in having some more of these conversations? I think these are great benefits to people.
Yeah, I'm happy to do it.