WEBVTT NOTE Current Market Conditions: 5 Nov. 2008 1 00:00:00.000 --> 00:00:17.480 I'm sitting here with Mark Thornton, senior fellow and resident fellow at the Mises Institute, 2 00:00:17.480 --> 00:00:25.160 and we're going to be talking about the relationship of the Fed to the boom-bust cycle in the most 3 00:00:25.160 --> 00:00:26.160 present case. 4 00:00:26.160 --> 00:00:30.160 So, you're not going to get too technical on this, are you, Mark? 5 00:00:30.160 --> 00:00:33.160 No, not too technical, pleasure to be here. 6 00:00:33.160 --> 00:00:34.160 Okay. 7 00:00:34.160 --> 00:00:41.920 Well, I guess it was inevitable that there would be a dispute about the extent of the 8 00:00:41.920 --> 00:00:44.400 Fed's responsibility for the boom and therefore the bust. 9 00:00:44.400 --> 00:00:46.160 Do you want to address that? 10 00:00:46.160 --> 00:00:47.160 Yes. 11 00:00:47.160 --> 00:00:50.800 I mean, it's a big problem and so everybody's trying to blame everybody else. 12 00:00:50.800 --> 00:00:56.300 Now that the campaign is over, you notice that the Republicans were blaming the Community 13 00:00:56.300 --> 00:01:04.560 Reinvestment Act, giving away loans to people with subprime credit, and the Democrats were 14 00:01:04.560 --> 00:01:09.760 blaming monetary deregulation for the problem. 15 00:01:09.760 --> 00:01:17.880 And of course, we've been blaming Alan Greenspan and the Fed right along since 2003 for this 16 00:01:47.880 --> 00:02:00.880 The Central Bank manipulates the interest rates in the money supply, leading to massive malinvestment in the economy, which subsequently comes undone. 17 00:02:00.880 --> 00:02:09.880 None of those other boom bust cycles had community reinvestment acts or things of that nature in them. 18 00:02:09.880 --> 00:02:13.880 They didn't have Fannie Mae and Freddie Mac back in the 1920s. 19 00:02:13.880 --> 00:02:31.880 and so we would label Fannie and Freddie and the Community Reinvestment Act as features of this business cycle but not the cause of a business cycle that involves a huge credit bubble which subsequently goes bust. 20 00:02:31.880 --> 00:02:35.880 So you're looking at necessary and sufficient conditions for a sign and blank. 21 00:03:05.880 --> 00:03:07.880 The Theory of Money and Credit 22 00:03:35.880 --> 00:04:05.480 The Austrian Business Cycle Theory is an across the board, even macroeconomic boom that was 23 00:04:05.480 --> 00:04:12.040 funded in some sense supported by the Fed affecting all of a particular type of investment 24 00:04:12.040 --> 00:04:13.040 equally. 25 00:04:13.040 --> 00:04:14.040 But that's not true. 26 00:04:14.040 --> 00:04:15.040 No. 27 00:04:15.040 --> 00:04:16.040 Of course it's not true. 28 00:04:16.040 --> 00:04:23.800 We heard this from all of the naysayers about the housing bubble in 2003, 2004, 2005, 2006, 29 00:04:23.800 --> 00:04:30.520 including Greenspan himself that, well, there's not really a housing bubble because it's only 30 00:06:00.520 --> 00:06:07.020 A real drawdown on their access to capital and real resources like labor. 31 00:06:07.020 --> 00:06:08.020 Yeah. 32 00:06:08.020 --> 00:06:17.020 Now, to establish the Fed's culpability here, what money data are you looking at? 33 00:06:17.020 --> 00:06:25.020 Well, you know, I don't look at any particular measure of the money supply. 34 00:06:25.020 --> 00:06:51.020 I look at all of the measures of the money supply. Credit, right across the board, you should see some general patterns. So I look at the monetary base, I look at M1, I look at M2, I look at the true money supply that we calculate here at the Institute, as well as specific indices that relate to housing itself. 35 00:07:21.020 --> 00:07:43.020 When you look at all of the measures back in 2001, when the bubble really got started in the American economy, a lot of the seeds were set in place before then, but you see tremendous increases in monetary measures in 2001. 36 00:07:43.020 --> 00:08:13.020 and this is the very first time that I've ever seen where housing did not go into a slump during a recession and we had a recession at that time and housing prices did not decline on a real adjusted basis construction of homes continued did not decline that's the first time we've ever saw that and you know so housing prices go up and down 37 00:08:13.020 --> 00:08:21.740 with the economy, generally speaking. But in this case, that didn't happen. So that's 38 00:08:21.740 --> 00:08:30.500 a very clear indication that a bubble is brewing in the economy where there's no real other 39 00:08:30.500 --> 00:08:39.860 explanation for it except for the great availability of credit in the economy, incredibly low interest 40 00:08:39.860 --> 00:09:09.420 The Federal Funds Rate is down from 6.5% down to 1% which indicates that the Fed is 41 00:09:09.420 --> 00:09:24.420 The Federal Reserve is going to an easier monetary policy and then, of course, when you look at the monetary measures, the monetary base M1, M2, they all are increasing at very rapid rates. 42 00:09:24.420 --> 00:09:28.420 The Fed funds rate is something that the Fed controls directly. 43 00:09:28.420 --> 00:09:37.420 They control that directly and that's where they're injecting money into the banking system. 44 00:09:37.420 --> 00:10:07.420 and if you look at a chart of the federal funds rate and short-term interest rates on treasuries you'll see that they go hand in hand with one another and people have brought this up to me they say well you know it looks like short-term rates are actually in front of or taking place prior to changes in the federal funds rate so that the Fed is not really controlling the money supply and interest rates 45 00:10:07.420 --> 00:10:22.420 The Fed is really catching up to the market, but of course it's really the market that is forecasting what the Fed is going to do, and there's very sophisticated markets in the economy whereby market players can predict what the Fed is going to do. 46 00:10:22.420 --> 00:10:29.380 We all have some ability to predict what the Fed is going to do. 47 00:10:29.380 --> 00:10:32.040 They signal us beforehand. 48 00:10:32.040 --> 00:10:39.040 They give us policy statements that they are tending to go in an easier direction or a 49 00:10:39.040 --> 00:10:42.000 neutral position or a stricter position. 50 00:10:42.000 --> 00:10:47.220 So it's not really the market that's setting the rate and the Fed is just following along. 51 00:10:47.220 --> 00:10:52.380 It's that the market is able to predict what the Fed is going to do. 52 00:10:52.380 --> 00:11:05.380 This is even more complicated in light of monetary deregulation than, for example, it would be to discern these patterns in the 1920s. We have so much information. 53 00:11:05.380 --> 00:11:17.380 Right. We have a whole new mystery of banking, as Doug French has pointed out. Everything was fairly straightforward in the 1920s. 54 00:11:47.380 --> 00:12:11.620 The Federal Reserve has made the Fed less able to directly control money aggregates. 55 00:12:11.620 --> 00:12:20.300 The Fed now has a much more complex financial industry that it's regulating and these firms 56 00:12:20.300 --> 00:12:28.840 now have more scope in their activities and a greater ability to move funds around prior 57 00:12:28.840 --> 00:12:34.500 to of course the crisis, the onset of the crisis and I think you've got the derivatives 58 00:12:34.500 --> 00:12:54.780 and also, is it at all possible to understand this bubble absent a thorough understanding 59 00:12:54.780 --> 00:12:57.780 of the relationship between interest rates and the capital stock? 60 00:12:57.780 --> 00:13:01.740 I mean, it seems like the study that came out the other day from Henderson and Hummel 61 00:13:01.740 --> 00:13:07.540 Capital is looking only at money aggregates but not focusing on the effects of interest 62 00:13:07.540 --> 00:13:10.180 rates on the capital structure. 63 00:13:10.180 --> 00:13:14.780 Well that's true but I don't think it really has to get that complex. 64 00:13:14.780 --> 00:13:21.180 We had lower interest rates, we had big increases in the money supply during the boom which 65 00:13:21.180 --> 00:13:24.060 started in 2001. 66 00:13:24.060 --> 00:13:30.020 That continued as interest rates remained low and as the money supply continued to expand 67 00:14:00.020 --> 00:14:08.580 Coincided with increases in the interest rates, a decline in the growth of the money supply, 68 00:14:08.580 --> 00:14:15.140 and then of course the bubble continues onward from that point, but it's money that's already 69 00:14:15.140 --> 00:14:17.780 in the system that it's carrying on. 70 00:14:17.780 --> 00:14:28.880 Along with Hummel and Henderson's article, I hesitate to criticize something that calls 71 00:14:28.880 --> 00:14:34.680 for the Dismantling of the Federal Reserve, but I think that their basic point is just 72 00:14:34.680 --> 00:14:35.680 incorrect. 73 00:14:35.680 --> 00:14:42.120 When they first came out with this in Investor's Business Daily, I pointed out to them that 74 00:14:42.120 --> 00:14:45.440 the money supply was growing very rapidly when the bubble started. 75 00:14:45.440 --> 00:14:53.520 The money supply continued to expand as the bubble filled out and the bubble topped off 76 00:14:53.520 --> 00:14:58.640 when the Fed started being more restrictive. 77 00:14:58.640 --> 00:15:05.000 You can't really exonerate Alan Greenspan and the Fed in any way for the bubble. 78 00:15:05.000 --> 00:15:10.680 As a matter of fact, when they started to increase interest rates, that's exactly when 79 00:15:10.680 --> 00:15:18.480 Alan Greenspan, using the bully pulpit, said that there was no housing bubble and that 80 00:15:18.480 --> 00:15:26.920 everything in credit markets was great and that these home mortgages and second mortgages 81 00:15:56.920 --> 00:16:02.400 and Money and said that everything was fine, that things were now better than ever in terms 82 00:16:02.400 --> 00:16:08.440 of regulating the mortgage industry and things of that nature. 83 00:16:08.440 --> 00:16:17.440 So they were cheerleading on all of these just crazy financial packages and loans that 84 00:16:17.440 --> 00:16:24.260 were being made even though that they were pulling the plug on the party. 85 00:16:24.260 --> 00:16:26.400 They were increasing interest rates at the time. 86 00:16:26.400 --> 00:16:30.560 I suppose that it's not at all surprising that there would be disputes about the culpability 87 00:16:30.560 --> 00:16:37.320 of the Fed for this current boom-bust cycle because, of course, the disputes over the 88 00:16:37.320 --> 00:16:44.520 1920s still continue to this day, with the Austrians pointing to expansionary money policies 89 00:16:44.520 --> 00:16:50.360 from the Fed and the monitors typically saying, well, there's no evidence of inflation in 90 00:16:50.360 --> 00:16:51.960 the 1920s at all. 91 00:16:51.960 --> 00:17:00.920 That's right. The problem is the Fed has the economic power to back up their position. 92 00:17:00.920 --> 00:17:09.080 They control either directly as employees or through grants or as former employees, virtually 93 00:17:09.080 --> 00:17:18.400 all of the PhD monetary and macroeconomists in this country. It's hard to find a prominent 94 00:17:18.400 --> 00:17:25.040 monetary theorist or macro-money person who hasn't directly benefited from the Fed. 95 00:17:25.040 --> 00:17:30.160 And of course, and this is something they'll admit to, I mean, if you go against the grain 96 00:17:30.160 --> 00:17:34.240 of the Fed, you know, they don't take kindly to that sort of thing. 97 00:17:34.240 --> 00:17:41.640 So it's very difficult to get prominent people to come out against the Fed. 98 00:17:41.640 --> 00:17:44.960 Everybody's sort of pro-Fed, au naturel. 99 00:17:44.960 --> 00:17:47.960 Things have changed on Main Street, I think. 100 00:17:47.960 --> 00:17:56.320 More and more normal people are willing to blame the Fed, so there are a few more investment 101 00:17:56.320 --> 00:18:01.560 advisors who aren't just crazy for the stock market anymore and that are against the Fed, 102 00:18:01.560 --> 00:18:06.600 and there are a few normal people who realize that the Fed is at the heart of our problem 103 00:18:06.600 --> 00:18:15.600 and of course the number of people that are finding their way to Mises.org are really 104 00:18:45.600 --> 00:18:52.600 The Federal Reserve, fiat money, fractional reserve banking, Human Action, Man Economy and State, The Theory of Money and Credit 105 00:19:15.600 --> 00:19:30.240 The Money Supply that gets built on top of that can simultaneously shrink because banks 106 00:19:30.240 --> 00:19:37.800 are not willing to make loans to people when you are entering a recession, when people are 107 00:19:37.800 --> 00:19:46.160 When people are losing their jobs, when people are defaulting on loans and on mortgages, it's 108 00:19:46.160 --> 00:19:51.680 perfectly rational for banks to say, I don't want to lend at any interest rate. 109 00:19:51.680 --> 00:19:53.040 We're protecting ourselves. 110 00:19:53.040 --> 00:20:00.840 We're doing the right, rational, economic thing by not making as many loans and making 111 00:20:00.840 --> 00:20:06.760 those loans on either traditional terms or even stricter than traditional terms. 112 00:20:06.760 --> 00:20:13.360 In the boom, in the bubble, you're making loans on no terms at all, essentially, but 113 00:20:13.360 --> 00:20:20.880 in this phase, during the contraction, the Fed is trying to stimulate the money supply, 114 00:20:20.880 --> 00:20:28.840 but they need the banks to cooperate and to lend out money, and banks have resorted at 115 00:20:28.840 --> 00:20:32.040 least to the old traditional norms, if not more strict. 116 00:20:32.040 --> 00:20:38.360 Well, so let's just back up a second to the boom again. If the money supply is expanding 117 00:20:38.360 --> 00:20:43.480 dramatically as it was during the boom, there's less pressure on the Fed to increase the money 118 00:20:43.480 --> 00:20:53.820 base. Am I right? That's correct. Yes. Because banks are willing to make loans, that increases 119 00:20:53.820 --> 00:21:03.280 is the expansion process to its fullest extent. And also, of course, there's been a secular 120 00:21:03.280 --> 00:21:11.780 trend towards a smaller amount of bank reserves financing a larger amount of loans. That's 121 00:21:11.780 --> 00:21:17.060 been going on ever since the Fed took control. So let's say I'm on the Fed and I want to 122 00:21:17.060 --> 00:21:23.740 create a boom. I lower the federal funds rate dramatically and I notice that the money supply 123 00:21:23.740 --> 00:21:30.740 The Federal Reserve, fiat money, fractional reserve banking, Human Action, Man Economy and State, The Theory of Money and Credit 124 00:21:53.740 --> 00:22:13.620 Bank of Japan experienced the same thing after its stock market crash in 1989. They lowered 125 00:22:13.620 --> 00:22:20.880 interest rates to zero, but banks were not willing to lend. The economic circumstances 126 00:22:20.880 --> 00:22:41.000 The Federal Reserve is a natural economic response to the Fed in the 1920s and 30s. 127 00:22:41.000 --> 00:22:46.040 They lowered interest rates after the stock market crash, they increased the monetary 128 00:23:16.040 --> 00:23:28.040 Let me ask a fundamental question about the relationship between the Fed and money creation. 129 00:23:28.040 --> 00:23:41.040 I suppose it's more true under a deregulated environment that market conditions are largely responsible for the creation of money. 130 00:23:41.040 --> 00:24:11.040 The Fed has the ultimate responsibility in credit markets these days. It determines the price of money. If it's maintaining a very low price for credit, then more credit is going to be 131 00:24:11.040 --> 00:24:21.040 In 2001, Greenspan was taken into the banking system and then expanded throughout the banking system, causing the bubble. 132 00:24:21.040 --> 00:24:33.040 So there's really no denying the historical significance of what Greenspan did in 2001, 133 00:24:33.040 --> 00:24:40.040 in the interest rate, opening the floodgates of credit and keeping the housing market in 134 00:24:41.160 --> 00:24:46.000 an upward spiral at a time when it otherwise should have gone into a contraction. And this 135 00:24:46.000 --> 00:24:53.000 is essentially what created the market conditions in banking and home construction where people 136 00:24:55.200 --> 00:25:02.200 thought that housing prices could never go down, that nobody ever lost money in housing. 137 00:25:03.040 --> 00:25:33.040 and that all new sorts of people came into the home construction arena and made profits even though they had no experience in the business and it was that kind of setting the psychological tone by providing super abundance of credit which caused this bubble and there's really no other explanation that really holds water and the fact that Greenspan and Bernanke piled on 138 00:25:33.040 --> 00:26:03.040 Chair leading the market right before they were reversing policy course means that I think that they share really all the blame for everything that took place and this sure you know lending standards were reduced and there were some corrupt business practices that take place but you know when the Fed increases the availability of credit increases the amount the banking the banking system has to lend it 139 00:26:03.040 --> 00:26:15.040 to people with lower credit standards, lower credit ratings, because all the other people who have good credit are already covered. 140 00:26:15.040 --> 00:26:27.040 And so really all aspects, even the things that don't appear to be related to the Federal policy, like these unscrupulous mortgage lenders 141 00:26:27.040 --> 00:26:44.080 and the Green-Span Put, the Bernanke Put, the Green-Span Put, the Green-Span Put, the 142 00:26:44.080 --> 00:26:51.920 And now the Bernanke put, which is a market way of saying that everybody believed that 143 00:26:51.920 --> 00:26:57.760 if there was trouble in the housing market or any other market, that the Fed would come 144 00:26:57.760 --> 00:27:03.040 to the rescue, that the Fed would fix everything and that nobody would lose money. 145 00:27:03.040 --> 00:27:11.800 So every aspect of this bubble is directly the result of Fed actions, Fed speeches and 146 00:27:11.800 --> 00:27:16.880 and the perception that they created in markets that all investment was riskless. 147 00:27:16.880 --> 00:27:23.800 Yeah, and I should really apologize to you because for years I've been doubting you on 148 00:27:23.800 --> 00:27:29.680 this point about the guarantee of the too big to fail aspect of these housing mortgage 149 00:27:29.680 --> 00:27:30.680 things. 150 00:27:30.680 --> 00:27:37.560 I really had my doubts that you were right about this and yet history has borne you out 151 00:27:37.560 --> 00:27:38.560 completely. 152 00:27:38.560 --> 00:27:44.560 It's rewarding lately. It's rewarding getting letters from people that said that they didn't 153 00:27:44.560 --> 00:27:52.400 buy a house in 2004, 2005, or 2006 because they read my article on Mises.org. That's 154 00:27:52.400 --> 00:28:03.480 very rewarding, but it was a tough time between 2003 and, say, 2007 when, you know, in 2007, 155 00:28:03.480 --> 00:28:08.200 basically no one in the media, no one in the Fed, no one on Wall Street would even admit 156 00:28:08.200 --> 00:28:11.040 to a Housing Bubble. 157 00:28:11.040 --> 00:28:20.040 And now, of course, it's fairly obvious what happened and I think why it happened more 158 00:28:20.040 --> 00:28:31.180 precisely is that there's a scientific way of identifying the cause, the effect and attributing 159 00:28:31.180 --> 00:28:36.720 blame here and I think that when you look at all the evidence, not just some kind of 160 00:28:36.720 --> 00:28:43.720 The Federal Reserve, fiat money, fractional reserve banking, Human Action, Man Economy and State, The Theory of Money and Credit 161 00:29:06.720 --> 00:29:10.560 The Lowering of Standards, which gets identified as corruption. 162 00:29:10.560 --> 00:29:15.980 Same thing happened with Enron, you know, oh, corruption, corruption, corruption, but 163 00:29:15.980 --> 00:29:20.920 there's all this easy money, banks were lending it to anybody that would be willing to take 164 00:29:20.920 --> 00:29:21.920 it. 165 00:29:21.920 --> 00:29:26.920 And so Enron came up with new deals of how they could take more money. 166 00:29:26.920 --> 00:29:29.640 And that's the story. 167 00:29:29.640 --> 00:29:34.120 Well, wait, thank you for taking us through the evidence, and I'm sure there'll be more 168 00:29:34.120 --> 00:29:35.920 talks along these lines in the coming days. 169 00:29:35.920 --> 00:29:37.920 Thank you, Dr. Targman. Thank you, Jeff.