WEBVTT NOTE Economists and the Myths of Central Banking 1 00:00:00.000 --> 00:00:03.920 My topic today is Economists and the Myths of Central Banking. 2 00:00:03.920 --> 00:00:09.800 The important point about the whole notion of central banking is that it was developed 3 00:00:09.800 --> 00:00:16.480 by basically free market economists, economists we would think of as free market economists. 4 00:00:16.480 --> 00:00:24.120 And also the case itself was pretty much comprehensively presented during the 18th century, the early 5 00:00:24.120 --> 00:00:25.660 18th century. 6 00:00:25.660 --> 00:00:29.640 And it was demolished throughout the 18th century. 7 00:00:29.640 --> 00:00:35.240 The individual who is known as sort of the father of central banking is John Law. 8 00:00:35.240 --> 00:00:43.240 And I'll get to a few events of his life in a moment, since it seems that the morals of bankers are now fair game. 9 00:00:43.240 --> 00:00:48.740 We can go a little into some of the adventures in Law's life. 10 00:00:48.740 --> 00:00:57.040 But later on in the century, as I'll go through briefly, other economists, almost all other economists of note that wrote during the 18th century, 11 00:00:57.040 --> 00:01:27.040 certainly British economists and some French economists demolished the case for central banking not only were they opposed to central banking but the best economists of the 18th century were completely opposed to fractional reserve banking completely they all favored 100% banking in fact some went as far as to say that every man should be his own banker they even opposed the issuing of paper banknotes backed by 100% gold 12 00:01:27.040 --> 00:01:35.040 In particular, an individual named Vandalin wanted a complete gold and or silver currency, okay? 13 00:01:35.040 --> 00:01:43.040 So, given that the case for central banking was destroyed intellectually in the 18th century, 14 00:01:43.040 --> 00:01:52.040 how is it that today, right now, we're in the midst of our third and hopefully our final crisis of central banking of the 20th century? 15 00:01:52.040 --> 00:02:04.040 As we see, every crisis in central banking brings forth arguments and apologies by economists for central banking and proposals to extend it even further. 16 00:02:04.040 --> 00:02:15.040 It's sort of like the welfare state or even civil rights legislation. If it fails, if some of it fails, well then it must be that there's too little of it. We have to have more of it. 17 00:02:15.040 --> 00:02:30.040 Now the exception that I mentioned, the person who was not opposed to, in fact, favored fractional reserve banking, was Adam Smith, who was known as someone with impeccable free market credentials. 18 00:02:30.040 --> 00:02:40.040 So let me go through some of the early arguments, and then we'll talk about some of the crises of central banking and how economists have responded. 19 00:02:40.040 --> 00:02:49.040 In particular, how economists are today responding to the SNL we're living through and we have been living through in the 80s. 20 00:02:49.040 --> 00:03:00.040 Some very interesting responses. In fact, as we'll see, there are calls for a global central bank now on the part of Keynesians. 21 00:03:00.040 --> 00:03:03.040 And we'll go through some of those ideas. 22 00:03:03.040 --> 00:03:16.040 As I mentioned, John Law was the first central banker. Not only did he develop the first intellectual case, but he actually was, in practice, a central banker. 23 00:03:16.040 --> 00:03:26.040 Let me just go through some more notable incidents in his life. He was born in Edenburg in April of 1671. 24 00:03:26.040 --> 00:03:34.040 In 1871, he inherited a great deal of money from his father and wasted it on riotous living so that by 23 he was broke. 25 00:03:34.040 --> 00:03:43.040 Shortly thereafter, still in his early 20s, he killed a man and a dual over married woman who was convicted of murder and sentenced to death. 26 00:03:43.040 --> 00:03:50.040 He was pardoned by the king. He had a silver tongue, so he persuaded everyone. 27 00:03:50.040 --> 00:03:56.040 But then on appeal he was thrown back in jail and finally bribed the jailer and escaped to the continent. 28 00:03:56.040 --> 00:03:59.040 This was all before he could print money up on his own. 29 00:03:59.040 --> 00:04:07.040 He remained in jail for six, rather he remained on the continent for six years earning money by gambling. 30 00:04:07.040 --> 00:04:15.040 In 1705 he wrote his best known work, proposing reform of the Scottish currency, 31 00:04:15.040 --> 00:04:20.040 which basically call for what is now a modern central bank. 32 00:04:20.040 --> 00:04:27.040 In 1708, while gambling in Paris, he met the duke of Orléans who became the regent to the young king. 33 00:04:27.040 --> 00:04:37.040 So that when the king was having problems with his finances, he took to law's scheme. 34 00:04:37.040 --> 00:04:40.040 He asked law to set up what in effect became a central bank. 35 00:04:40.040 --> 00:04:45.360 of the Central Bank, and within four short years, law had set off a massive speculative 36 00:04:45.360 --> 00:04:50.240 orgy in France and had caused a hyperinflation, almost single-handedly destroying the French 37 00:04:50.240 --> 00:04:52.440 currency. 38 00:04:52.440 --> 00:04:56.880 So the Central Bank, the first Central Bank, there was the Bank of England, which was quasi-Central 39 00:04:56.880 --> 00:05:03.800 Bank at the time, but the first sort of full Central Bank collapsed within four years. 40 00:05:03.800 --> 00:05:10.800 So what were some of Law's doctrines? 41 00:05:10.800 --> 00:05:13.800 They're very recognizable. 42 00:05:13.800 --> 00:05:17.800 First of all, Law claimed that the king was the owner of the money supply, 43 00:05:17.800 --> 00:05:24.800 meaning that money should be used by the king as a tool, as a tool of policy. 44 00:05:24.800 --> 00:05:28.800 He also believed that money is a voucher for buying goods. No one should hold money. 45 00:05:28.800 --> 00:05:31.800 As soon as you've got money, you should go out and spend it right away. 46 00:05:31.800 --> 00:05:37.800 It was illegitimate to stop up the money supply, so he was very, very against hoarding. 47 00:05:37.800 --> 00:05:44.800 He believed, in fact, when people spent less, it thrusts the economy into a deep recession. 48 00:05:44.800 --> 00:05:53.800 Also, he believed that the fact that prices went up and down under a gold and silver standard, gently, 49 00:05:53.800 --> 00:05:59.800 but still the fact that prices changed, that prices weren't completely and rigidly stable, 50 00:05:59.800 --> 00:06:04.800 He believed call for government action, as most economists today believe. 51 00:06:04.800 --> 00:06:09.800 And because he believed that gold and silver would always be somewhat unstable, 52 00:06:09.800 --> 00:06:12.800 because they are determined by supply and demand. 53 00:06:12.800 --> 00:06:17.800 The price of apples fluctuates, the price of McDonald's hamburgers fluctuates, the price of everything fluctuates. 54 00:06:17.800 --> 00:06:21.800 Anything that's bought and sold on a market is going to fluctuate in price, 55 00:06:21.800 --> 00:06:25.800 as people's values change, as the supplies of the goods change. 56 00:06:25.800 --> 00:06:28.800 And this of course is true of gold and silver. 57 00:06:28.800 --> 00:06:39.800 So, he was against gold and silver, and in fact he believed that they represented a massive waste of resources. He was in favor then of paper money. 58 00:06:39.800 --> 00:06:56.800 Now, how to get paper money into circulation? He believed that the way to do so was by an institution that had already been established in the 17th century, and certainly in the English speaking world, banks. 59 00:06:56.800 --> 00:07:03.040 People tended to trust banknotes, so he wanted to use banks as a way of inflating the money supply. 60 00:07:03.040 --> 00:07:11.640 In fact, he was one of the first economists that pointed out that when banks lend money, they increase the money supply, okay? 61 00:07:11.640 --> 00:07:19.760 That took most economists, the economic profession as a whole, didn't fully realize that until the early 20th century. 62 00:07:19.760 --> 00:07:23.080 And on top of the banks, he wanted a central bank. 63 00:07:23.080 --> 00:07:28.600 He believed that the central bank would issue notes by buying and selling mortgages and land, 64 00:07:28.600 --> 00:07:35.160 which is very comparable to today's open market operations, buying and selling government securities. 65 00:07:35.160 --> 00:07:39.840 And in that way, it would manipulate the money supply and assure stability, stability of the price level. 66 00:07:39.840 --> 00:07:42.240 So his ideas are very, very modern. 67 00:07:42.240 --> 00:07:45.560 He wanted to stabilize the price level, also something I didn't mention. 68 00:07:45.560 --> 00:07:48.560 He believed that interest rates were always too high. 69 00:07:48.560 --> 00:07:49.560 You always had to push them down. 70 00:07:49.560 --> 00:07:53.560 Now, if you push them down, you would increase investment spending and that would increase income. 71 00:07:53.560 --> 00:07:58.560 So he was in favor, as modern Keynesians are, of continuously pushing down interest rates. 72 00:07:58.560 --> 00:08:04.560 So the seeds of both the two great schools of macroeconomic thought in today's world, 73 00:08:04.560 --> 00:08:07.560 the monetarists, who were in favor of stabilizing the money supply, 74 00:08:07.560 --> 00:08:15.560 and the Keynesians, who were in favor of pushing down interest rates, were in law's writings and thought. 75 00:08:15.560 --> 00:08:34.560 Now, as I mentioned, the 18th century, the later 18th century, saw a number of writings by economists that looked at the law's practical experience, the experience of the bank, and opposed it, and opposed its intellectual case for banking. 76 00:08:34.560 --> 00:08:47.560 I'll just name some of the writers, some of the more important writers are Richard Cantillon, Jacob van der Linde, David Hume especially, and a French economist named Turgot, T-U-R-G-O-T 77 00:08:47.560 --> 00:09:00.560 Basically, their writings were a reaction to law, and they were very, very hard money, okay, they wrote throughout these writings, outpouring of these writings throughout the 18th century 78 00:09:00.560 --> 00:09:05.760 Let me just focus on Turgot, briefly give you his response to law. 79 00:09:05.760 --> 00:09:09.560 He was a French economist and a statesman. 80 00:09:09.560 --> 00:09:14.200 He was staunchly in favor of laissez-faire, laissez-faire economy, and he was also staunchly 81 00:09:14.200 --> 00:09:18.200 opposed to all but 100% banking. 82 00:09:18.200 --> 00:09:21.120 Not a tool of government to be used. 83 00:09:21.120 --> 00:09:26.080 It arises on the market from barter, it arises always as a useful good. 84 00:09:26.080 --> 00:09:29.760 He said that all money is essentially merchandise. 85 00:09:29.760 --> 00:09:34.760 All of the merchandise, supply and demand determines and should determine the value of money. 86 00:09:34.760 --> 00:09:39.760 And gold and silver were chosen by the market for good reason. 87 00:09:39.760 --> 00:09:45.760 They had all the qualities that fit them to be a good money. 88 00:09:45.760 --> 00:09:51.760 They're very durable, their supply increased very slowly over time, and so on. 89 00:09:51.760 --> 00:09:56.760 And finally, he said to the lawyer, he said, look, he responded directly to the lawyer, he said, 90 00:09:56.760 --> 00:10:08.760 You claim that money is always in short supply, but the point is, if there really is a shortage of money, the market will immediately respond by increasing the value of money, that is, lowering prices. 91 00:10:08.760 --> 00:10:20.760 There's nothing wrong with lowering prices. We see, for example, in the high tech industries in the 80s, that as the supplies of goods and services have increased due to technological innovation, we've had a fall in costs and prices. 92 00:10:20.760 --> 00:10:25.760 This is a natural development or evolution of the market economy. We don't have to be worried about falling prices. 93 00:10:25.760 --> 00:10:31.760 In particular, we don't have to turn over the whole monetary apparatus to the government to prevent them. 94 00:10:31.760 --> 00:10:37.760 And he said that nothing can ever be stable. Nothing that's exchanged on the market can ever be perfectly stable in value. 95 00:10:37.760 --> 00:10:48.760 It's not something that we desire. Regarding paper money, he said that it can never be issued by the king in a way that gives everyone who wants more money that exact amount. 96 00:10:48.760 --> 00:10:53.760 In other words, what he was getting at was that when you issue paper money, you're going to redistribute people's incomes. 97 00:10:53.760 --> 00:10:58.760 The people that get it first are going to find their real incomes going up. 98 00:10:58.760 --> 00:11:02.760 People who get it last or people on fixed incomes are going to be defrauded. 99 00:11:02.760 --> 00:11:06.760 So he made that very important point. 100 00:11:06.760 --> 00:11:11.760 And he also pointed out that fractional reserve banking is unsound. 101 00:11:11.760 --> 00:11:15.760 He said, look, what if a merchant who needed to invest more in his business 102 00:11:15.760 --> 00:11:20.760 took out call loans, loans that could be called in by the lenders at any time, 103 00:11:20.760 --> 00:11:26.760 and then invested this money in his business in a one-year or two-year program of expansion. 104 00:11:26.760 --> 00:11:32.760 He'd go bankrupt very quickly, Virgo pointed out. He says this is exactly what fractional reserve bankers do. 105 00:11:32.760 --> 00:11:37.760 So the case for central banking was pretty much demolished by the end of the 18th century 106 00:11:37.760 --> 00:11:42.760 and for fractional reserve banking in general. 107 00:11:42.760 --> 00:11:49.760 How was it revived? It was really revived by Adam Smith, interestingly enough. 108 00:11:49.760 --> 00:11:56.760 Adam Smith, like his predecessors in the 18th century, opposed most of law's ideas, to be fair. 109 00:11:56.760 --> 00:12:03.760 When it came to banking, and I'm quoting here, he referred to law's splendid but visionary ideas, 110 00:12:03.760 --> 00:12:09.760 which contributed to an excess of banking. So he only was worried about an excess of banking. 111 00:12:09.760 --> 00:12:14.760 He thought that fractional reserve banking was great. He thought it was great for the following reason. 112 00:12:14.760 --> 00:12:24.760 He felt that all the gold and silver that were lying in people's cash balances, their money holdings, were simply wasted resources. 113 00:12:24.760 --> 00:12:32.760 He said that we can save our resources just as if we could build a wagon. He called it a wagon way through the sky. 114 00:12:32.760 --> 00:12:38.760 If instead of a costly highway we could somehow have a wagon way through the sky which didn't absorb any resources, 115 00:12:38.760 --> 00:12:49.760 which allowed wagons and carts to simply fly over the land, which is fine fantasy, but the metaphor itself is crazy. 116 00:12:49.760 --> 00:12:53.760 And then applying for money is doubly crazy. 117 00:12:53.760 --> 00:12:57.760 So he believed that we could save our resources by having banks print up money. 118 00:12:57.760 --> 00:13:05.760 Now here, he said, well, when banks print up money, he knew the 18th century analysis, which was that when you print up money, you raise prices in the economy, 119 00:13:05.760 --> 00:13:12.760 in the economy, you redistribute incomes, and that drives gold and silver out of the country in the form of balance of payments deficits. 120 00:13:12.760 --> 00:13:19.760 So you get rising prices, you get a depreciating currency, but Smith, this is what he believed was a theoretical innovation. 121 00:13:19.760 --> 00:13:28.760 He said, no, we're not going to get rising prices. He said, sound banks, he uses the term the judicious operations of banking. 122 00:13:28.760 --> 00:13:36.760 If banks just restrict the amount of money that they inject into the economy to the needs of business, 123 00:13:36.760 --> 00:13:41.760 well then what will happen will be that the gold and silver will automatically leave without raising prices. 124 00:13:41.760 --> 00:13:44.760 We won't have an increase in prices. 125 00:13:44.760 --> 00:13:50.760 So here he diverged from law and from the other 18th century economists. 126 00:13:50.760 --> 00:13:56.760 So the point is that his prestige and influence now legitimize fractional reserve banking 127 00:13:56.760 --> 00:14:01.760 after its intellectual supports have been completely destroyed 128 00:14:01.760 --> 00:14:07.160 and, in effect, he really changed the course of British monetary theory 129 00:14:07.160 --> 00:14:13.480 which would have continued to develop in a very hard money fashion without his writings 130 00:14:13.480 --> 00:14:16.920 now what's interesting is that he then said that he was in favor of free banking 131 00:14:16.920 --> 00:14:20.360 that is, he wanted to get the government completely out of banking 132 00:14:20.360 --> 00:14:26.000 he believed that the banks followed sound rules of finance, that everything would be fine 133 00:14:26.000 --> 00:14:32.000 He never really criticized the Bank of England. In fact, he called it a great engine of state. 134 00:14:32.000 --> 00:14:35.000 He seemed to be comfortable with it. 135 00:14:35.000 --> 00:14:40.000 In fact, he sort of whitewashed it. He said, there's any inflation, it's not really the Bank of England's fault. 136 00:14:40.000 --> 00:14:46.000 It's the fact that the government's putting too much pressure on them to loan the government money, finance deficits. 137 00:14:46.000 --> 00:14:52.000 And this is going to come up again later in the 19th century, where central bank, 138 00:14:52.000 --> 00:14:56.000 Three bankers aren't necessarily opposed to central banking. 139 00:15:00.000 --> 00:15:03.000 Let me just mention, so we can get to the 20th century, 140 00:15:03.000 --> 00:15:08.000 just let me briefly mention how the idea of central banking developed in the 19th century. 141 00:15:08.000 --> 00:15:15.000 In the early 19th century there was a debate between hard money, anti-inflation type economists 142 00:15:15.000 --> 00:15:18.000 called the bullionists in Great Britain. 143 00:15:18.000 --> 00:15:30.000 The Bank of England began to refuse to pay gold and silver out for their notes in 1797, it was legitimized by the government, it was called a bank restriction or suspension. 144 00:15:30.000 --> 00:15:44.000 And predictably prices began to rise rapidly in the early 1800s, exchange rates depreciated, the price of gold went above its mint par, and the bullionists said well that's the result of inflation. 145 00:15:44.000 --> 00:15:54.000 The Bank of England is now not restrained by paying out gold for its notes and therefore it's inflating as we would naturally predict. 146 00:15:54.000 --> 00:16:03.000 The anti-bullionists oppose the bullionists and they claim that anything and anybody but the Bank of England was responsible for the rising crisis. 147 00:16:03.000 --> 00:16:07.000 Bad harvests, military spending, country banks and so on. 148 00:16:07.000 --> 00:16:37.000 Now out of this debate came one of the most, what I consider to be the most overrated and muddled thinkers in the history of monetary thought, a guy named Henry Thornton, and without really going through in detail what he had to say, basically what Thornton said was that fractional reserve banking is great, and central banking is great, however fractional reserve banks will tend time to time to get into difficulty, they won't be able to 149 00:16:37.000 --> 00:16:41.560 to always pay out gold for their notes. 150 00:16:41.560 --> 00:16:45.560 And central banks then should stand behind these fractional reserve banks. 151 00:16:45.560 --> 00:16:51.040 The central bank should operate as what has come to be called a lender of last resort. 152 00:16:51.040 --> 00:16:56.520 The central bank should always stand ready to bail out the fractional reserve banking system. 153 00:16:56.520 --> 00:16:58.000 He disagreed with Smith. 154 00:16:58.000 --> 00:17:04.160 He said, when the banks issue paper money, gold will flow out of the country. 155 00:17:04.160 --> 00:17:10.360 But basically, if you see balance of payments deficits, it's generally not due to inflation, okay? 156 00:17:10.360 --> 00:17:21.960 So he denied what the 18th century writers had kept pushing on, that balance of payments deficits, outflows of gold and so on are basically due to inflation. 157 00:17:21.960 --> 00:17:33.960 Thornton said, no, they're not really due to inflation, there's various things changing in the real economy that cause gold to flow out and the bank should be there to bail out the fractional reserve banks. 158 00:17:33.960 --> 00:17:46.960 Later on, and especially if the public lost confidence, he was very, very fearful, being a banker himself, a thorn, he was very fearful of the public losing confidence in the banks when gold began to flow out. 159 00:17:46.960 --> 00:17:57.960 If gold was leaving the country, the public had a tendency to rush in, turn in their notes, pull out their gold, and that would cause an internal drain of gold, even more gold would flow out and the banks would collapse. 160 00:17:57.960 --> 00:18:07.960 So he wanted a lender of last resort. So throughout the 19th century, this idea of central banking as a lender of last resort developed. 161 00:18:07.960 --> 00:18:17.960 There was another controversy later on in England by the banking and currency school, in which it was emphasized by the banking school that the gold standard is great. 162 00:18:17.960 --> 00:18:26.960 None of these guys opposed the gold standard. What they didn't like was the fact that whenever the banks inflated too much, gold would leave the country and the money supply would shrink. 163 00:18:26.960 --> 00:18:33.680 would shrink and that would cause recession. So they were opposed to deflation, they wanted 164 00:18:33.680 --> 00:18:38.720 the government always to stand ready to stop the central bank, to stand ready to stop the 165 00:18:38.720 --> 00:18:45.720 deflation of the money supply. So they wanted, in other words, as opposed to people in the 166 00:18:45.720 --> 00:18:51.640 18th century who said, well, when you have an outflow of gold and you have a recession 167 00:18:51.640 --> 00:18:55.000 and so on, you should stop the increase in the money supply and that will get the gold 168 00:18:55.000 --> 00:19:08.000 The banking school people said, no, no, no, we should do the exact opposite. We have to keep the price level stable and so on. 169 00:19:08.000 --> 00:19:20.000 And finally, this ended with this development, it was consummated of this idea of lender of last resort by a writer named Walter Badgett, 170 00:19:20.000 --> 00:19:29.000 who said, not only should the central bank stand ready to be a lender of last resort, but it should let the public know, let the banks know in advance 171 00:19:29.000 --> 00:19:35.000 that if the banks are in difficulty, they'll always be there to lend money to bail the banks out. 172 00:19:35.000 --> 00:19:43.000 And what was interesting is that, like Smith, Walter Badgett, this proponent of central banking, said, well, the ideal system is a free banking system, of course. 173 00:19:43.000 --> 00:19:48.000 But the next best is central banking with a lender of last resort. 174 00:19:48.000 --> 00:19:56.000 All right, now, at least during the 19th century, as I said, people were in favor of the gold standard. 175 00:19:56.000 --> 00:20:03.000 Even the pro-central bank types, almost all of them, were in favor of the gold standard. 176 00:20:03.000 --> 00:20:08.000 It was just that they were definitely fearful of deflation. 177 00:20:08.000 --> 00:20:11.000 Let me jump to the 20th century. 178 00:20:11.000 --> 00:20:14.000 So now what we have is well-established economic thought that the central bank, 179 00:20:14.000 --> 00:20:17.000 you need a central bank to act as a lender of last resort. 180 00:20:17.000 --> 00:20:36.000 The alternative, at least in Great Britain, of 100% gold standard, in which the banks will not fail, because every liability, dollar or pound of liability issued is backed up 100% by gold, that alternative just dropped out, dropped in sight, at least in Great Britain pretty much. 181 00:20:36.000 --> 00:20:42.000 Even the people who oppose central banking, such as the currency school, were in favor of fractional reserve banking. 182 00:20:42.000 --> 00:20:56.000 And in fact, sort of against their own best judgment, were in favor of central bank to operate the gold standard in the same way that it would operate if there was no bank money. 183 00:20:56.000 --> 00:21:03.000 So everyone sort of was tied into a central bank. Let me just put a footnote. That's not true in the United States. 184 00:21:03.000 --> 00:21:19.000 In the United States, Thomas Jefferson, his favorite economist was a French economist named Count de Tracey, and de Tracey in his writings was one of these hard money 18th century typewriters. 185 00:21:19.000 --> 00:21:32.000 Jefferson had or himself translated de Tracey's book early in the 19th century and a whole tradition of 100% banking grew up in the United States 186 00:21:32.000 --> 00:21:36.000 And it was very, very vibrant until the 1880s even. 187 00:21:36.000 --> 00:21:42.000 One of the most famous American economists, monetary theorists of the late 19th century, was Francis A. Walker. 188 00:21:42.000 --> 00:21:51.000 He believed in 100% banking. So it was a whole tradition, which was anti-central banking, anti-fractional reserve banking in the United States. 189 00:21:51.000 --> 00:22:01.000 Now, what happened? Well, the dawning of the 20th century was really the dawning of the era of the fear and loathing of gold. 190 00:22:01.000 --> 00:22:06.000 Okay, we can call it chrysophobia or aurophobia. 191 00:22:07.720 --> 00:22:09.960 What began to happen was that economists began to say, 192 00:22:09.960 --> 00:22:14.960 look, central banks, we need more than a lender of last resort 193 00:22:14.960 --> 00:22:17.840 to actually control the money supply, 194 00:22:17.840 --> 00:22:19.200 to manipulate the money supply, 195 00:22:19.200 --> 00:22:22.320 not just to supplement the banking system, 196 00:22:22.320 --> 00:22:24.280 but to manipulate it. 197 00:22:24.280 --> 00:22:27.160 So what evolved now was the idea of the central bank, 198 00:22:27.160 --> 00:22:29.040 not only the lender of last resort, 199 00:22:29.040 --> 00:22:39.940 but it's more than that, okay, as the political authority that controls the money supply and this involves the dumping of the gold standard. 200 00:22:39.940 --> 00:22:52.180 Now, one of the most prominent economists, certainly in the U.S. at the turn of the century, was Irving Fischer, okay, 201 00:22:52.180 --> 00:22:59.820 and he's been called the greatest economist that America has ever produced by Milton Friedman in Milton Friedman's latest book 202 00:22:59.820 --> 00:23:03.580 and in his famous book written in 1911 203 00:23:03.580 --> 00:23:09.500 it was called The Purchasing Power of Money and basically what it was was just a book-length attack on the gold standard 204 00:23:09.500 --> 00:23:13.140 arguing that the purchasing power of money must be stabilized 205 00:23:13.140 --> 00:23:15.220 the gold standard is incapable of doing this 206 00:23:15.220 --> 00:23:16.540 and a lot of formula 207 00:23:16.540 --> 00:23:19.140 formulas in that book 208 00:23:19.140 --> 00:23:25.140 So it had an air of scientific authenticity. 209 00:23:25.140 --> 00:23:41.140 In fact, the quantity theory, or the equation of exchange, MV equals PT, was, I guess, characterized by Fisher as equivalent to the law of the expansion of gases in the natural sciences. 210 00:23:41.140 --> 00:23:48.140 So he really sort of found, in fact, in his latest book, Milton Friedman equates it with the law of gravity. 211 00:23:48.140 --> 00:23:54.700 The equation of exchange is to the social sciences with the law of gravity is to the physical sciences. 212 00:23:54.700 --> 00:24:04.700 So based on this equation and the manipulations of this equation, what Irving Fisher told us was that 213 00:24:04.700 --> 00:24:12.260 basically that gold will never be stable. It was a series of historical accidents that caused gold to be chosen as money. 214 00:24:12.260 --> 00:24:17.860 It wasn't the result of an evolutionary market process, but just simple accidents. 215 00:24:17.860 --> 00:24:33.820 yes you have to ask Murray about that what was he tied into the yeah he has a 216 00:24:33.820 --> 00:24:58.580 Well, the point is, and with this equation of exchange, what you do is, if your goods 217 00:24:58.580 --> 00:25:02.460 and services are growing by 3% per year, okay? 218 00:25:02.460 --> 00:25:07.260 With more goods and services, the natural result will be that prices on the market fall. 219 00:25:07.260 --> 00:25:10.180 Well to prevent that, you would have government increase the money supply approximately at 220 00:25:10.180 --> 00:25:14.820 three percent per year, a flaky amount of paper currency, and that would prevent the 221 00:25:14.820 --> 00:25:15.820 fall in prices. 222 00:25:15.820 --> 00:25:19.660 I mean that's the argument that Fisher made, very simply put. 223 00:25:19.660 --> 00:25:27.100 We'll get to it in a few more minutes, I'll come back to this. 224 00:25:27.100 --> 00:25:35.420 And basically the purpose of the book was to educate the public to the need for alternative, 225 00:25:35.420 --> 00:25:36.420 some alternative to the gold standard. 226 00:25:36.420 --> 00:25:41.780 In fact, Fisher is the father of what I call the ABG standard, anything but gold. 227 00:25:41.780 --> 00:25:48.180 The last chapter of his book is just filled with various schemes to replace the gold standard. 228 00:25:48.180 --> 00:25:54.020 And very interestingly, he himself preferred pure fiat money as an ideal standard, but 229 00:25:54.020 --> 00:25:56.980 he feared the government would abuse it. 230 00:25:56.980 --> 00:26:00.660 and that the public wouldn't buy it, the public was still too tied into gold. 231 00:26:00.660 --> 00:26:06.700 So he offered a bizarre alternative, he said, look, let's have Austria-Hungary stabilize 232 00:26:06.700 --> 00:26:12.100 its currency unit, the Goulding, Austria-Hungary was not on the gold standard at the time and 233 00:26:12.100 --> 00:26:17.620 they seemed to have a stable price level, so he said, let's trust them to take a basket 234 00:26:17.620 --> 00:26:20.980 of commodities and stabilize the prices of those commodities, that's called the tabular 235 00:26:20.980 --> 00:26:21.980 standard. 236 00:26:21.980 --> 00:26:26.500 Then the rest of us will go on to the Goulding standard, we'll all have fixed exchange rates 237 00:26:26.500 --> 00:26:31.580 with the Goulding. So that was his practical alternative. He believed that pretty much 238 00:26:31.580 --> 00:26:37.820 get rid of gold. And that was in 1911. Now, in Great Britain, John Maynard Keynes, who 239 00:26:37.820 --> 00:26:47.740 was a famous gold hater or orophobe, was writing against the gold standard from 1913 onward. 240 00:26:47.740 --> 00:26:51.240 Early on, he said we should have a scheme similar to Fisher's, what's called a gold 241 00:26:51.240 --> 00:26:55.940 exchange standard, in which one or two currencies keep the price of gold fixed and other currencies 242 00:26:55.940 --> 00:27:04.940 tie-on. We had that in the 1920s. It didn't work. Later on, though, Keynes began to believe 243 00:27:04.940 --> 00:27:12.260 that, or change his focus. He didn't believe it was enough to economize on gold and to 244 00:27:12.260 --> 00:27:17.740 stabilize the price level. In the late 1920s, his philosophical thinking developed, and 245 00:27:17.740 --> 00:27:23.340 he believed that Great Britain could actually abolish scarcity. We could get rid of scarcity. 246 00:27:23.340 --> 00:27:33.340 that everyone could be in a position of a Vanderbilt in the United States if the British government and central bank could drive the interest rate down to zero. 247 00:27:33.340 --> 00:27:42.340 So he really believed that the high interest rate was what was preventing this dawning of an era of a paradoxical era. 248 00:27:42.340 --> 00:27:44.340 We have no more scarcity. 249 00:27:44.340 --> 00:27:52.340 So then he became much more eager to have some sort of scheme for pay for money. 250 00:27:52.340 --> 00:28:22.340 He really believed that the future of British culture depended on this and he began to defame gold, really nutty terms, he actually anthropomorphized the gold standard and talked about it as coming down from heaven in a golden coat and he referred to the aura sacra famis, which I guess is sort of a pun, it could mean the sacred reputation of gold or at the same time the accursed reputation of gold. He wanted to defame the gold standard and get rid of it. He believed that when you have 251 00:28:22.340 --> 00:28:31.340 If you try to lower your own interest rates by pumping money into the economy, all you're going to do is cause capital to flow out and gold to flow out. 252 00:28:31.340 --> 00:28:37.340 And he hated that. He hated it with a purple passion, the fact that the British government was stopped by the gold standard from pushing down the interest rate. 253 00:28:37.340 --> 00:28:40.340 Alright, so what did he propose? He had three different proposals. 254 00:28:40.340 --> 00:28:43.340 First, he believed we should have international bank cooperation. 255 00:28:43.340 --> 00:28:51.340 In the early 30s, he believed that all central banks were the important central banks to get together and all inflate together and drive down the interest rate. 256 00:28:51.340 --> 00:28:58.140 When this cooperation wasn't forthcoming, he then turned to a system of economic nationalism 257 00:28:58.140 --> 00:29:03.020 devised by the Nazi economic czar, Dr. Helm R. Schott. 258 00:29:03.020 --> 00:29:07.820 He wanted high tariffs, bilateral trade agreements, where you don't have free trade, but you have 259 00:29:07.820 --> 00:29:14.060 governments of each country agreeing on barter, bartering different goods. 260 00:29:14.060 --> 00:29:18.620 He wanted government centralization of foreign exchange, and he wanted complete political 261 00:29:18.620 --> 00:29:24.140 Control of the Domestic Investment Decisions and Foreign Investment Decisions. 262 00:29:24.140 --> 00:29:30.140 Now he changed his mind in the early 40s and his disciples claim that he changed his mind 263 00:29:30.140 --> 00:29:36.500 because he basically saw the errors of his way, that he was panicked by the Great Depression 264 00:29:36.500 --> 00:29:39.300 into proposing the scheme of economic nationalism. 265 00:29:39.300 --> 00:29:41.580 That's not really true. 266 00:29:41.580 --> 00:29:47.060 A free market economist, Michael Halperin, pro-gold standard economist, did some detective 267 00:29:47.060 --> 00:29:52.620 of Work, talked to people at the U.S. State Department in the 1940s, and he found out 268 00:29:52.620 --> 00:30:01.620 that there was a meeting between Keynes and some State Department officials in the 1940s. 269 00:30:01.620 --> 00:30:09.180 Great Britain would follow after the war, and he felt that he could convince the American 270 00:30:09.180 --> 00:30:13.340 officials that this was very reasonable for Great Britain to do. 271 00:30:13.340 --> 00:30:17.580 But the State Department officials reacted and said if you do that, we're going to have 272 00:30:17.580 --> 00:30:18.580 an economic war. 273 00:30:18.580 --> 00:30:20.980 The U.S. will respond by economic warfare. 274 00:30:20.980 --> 00:30:23.660 So Keynes was taken aback by that. 275 00:30:23.660 --> 00:30:29.260 And also another State Department official named Leo Poslowski told him that when he 276 00:30:29.260 --> 00:30:37.260 spoke to Helmore Schock, Keynes' hero, in the early 1930s, and Schock was just implementing 277 00:30:37.260 --> 00:30:43.220 his program of economic nationalism, Poslowski said what would you do if all the democracies 278 00:30:43.220 --> 00:30:47.540 respond by economic warfare 279 00:30:47.540 --> 00:30:50.020 and shock them, well then I have to give up my program. 280 00:30:50.020 --> 00:30:55.420 And so Keynes, that shock Keynes, that shock himself would 281 00:30:55.420 --> 00:30:57.420 give up the program. 282 00:30:57.420 --> 00:31:00.980 So then he brought forth his third proposal. 283 00:31:00.980 --> 00:31:03.140 And that was that 284 00:31:03.140 --> 00:31:06.100 we'd have an international currency union 285 00:31:06.100 --> 00:31:09.940 in which we'd have basically a central bank, a world central bank which would issue 286 00:31:09.940 --> 00:31:14.820 do something called Bancor, these paper reserves, and on the basis of those paper reserves which 287 00:31:14.820 --> 00:31:19.980 had a nominal link to gold, they had some link to gold but it could be changed, all 288 00:31:19.980 --> 00:31:25.900 the other currencies, all the other countries would inflate their paper money and push down 289 00:31:25.900 --> 00:31:26.900 interest rates. 290 00:31:26.900 --> 00:31:30.100 What he wanted was for the rest of the world to inflate as quickly as Great Britain so 291 00:31:30.100 --> 00:31:33.180 that Great Britain could push down interest rates. 292 00:31:33.180 --> 00:31:37.980 He also, now even at that stage after proposing this, he really didn't give up the idea of 293 00:31:37.980 --> 00:31:42.820 of Economic Nationalism, until this plan was in place. In fact, he said that anyone who 294 00:31:42.820 --> 00:31:49.740 opposed exchange control and high tariffs and so on for England was as much of a traitor 295 00:31:49.740 --> 00:31:55.260 to Great Britain as people who proposed getting rid of the British Navy before they secured 296 00:31:55.260 --> 00:31:59.540 a peace with Germany and Japan. So he was still tired of economic nationalism. He never 297 00:31:59.540 --> 00:32:05.340 really fully gave it up, despite what his followers claimed. 298 00:32:05.340 --> 00:32:11.500 Let me go through some of the failures of central banking. 299 00:32:11.500 --> 00:32:19.020 We had the first failure in the 1930s, basically the Fed did follow a Fisher rule, whether 300 00:32:19.020 --> 00:32:23.220 deliberately or not, during the 1920s, the US price level was stabilized, and this involved 301 00:32:23.220 --> 00:32:28.820 a massive inflation because we had a tremendous amount of technological innovation and accumulation 302 00:32:28.820 --> 00:32:33.340 of capital goods during the 1920s, so that meant that prices would have naturally fallen 303 00:32:33.340 --> 00:32:37.340 and possibly fallen by a substantial rate. 304 00:32:37.340 --> 00:32:40.340 But that was offset by the Fed inflating the money supply. 305 00:32:40.340 --> 00:32:46.340 So we had the Fed ready to operate as a lender of last resort 306 00:32:46.340 --> 00:32:52.340 and operating to control the money supply in such a way that we had stable prices. 307 00:32:52.340 --> 00:32:57.340 And in fact, Irving Fisher was so pleased with this that he really dubbed this 308 00:32:57.340 --> 00:33:02.340 as the era of permanent prosperity, that we would never have another depression. 309 00:33:02.340 --> 00:33:32.340 Okay, now, the Austrian economists, as mentioned in the film last night, Ludwig von Mises and also Hayek pointed out that they follow, by the way, the 18th century tradition, in which they believe that when you inflate bank money, it redistributes incomes, it distorts prices, it causes resources to be changed around, and that, in fact, the U.S. was setting itself up for a possibly great depression. The Austrians were right, Fisher was terribly wrong, and we had a depression, and that was the first failure. So monetary control, 310 00:33:32.340 --> 00:33:38.340 All by central bank failed and by 1931 the public had lost confidence in the U.S. banking 311 00:33:38.340 --> 00:33:44.340 system and there was a run on the banks that lasted for two years. 312 00:33:44.340 --> 00:33:50.060 We had a collapse of banks, people losing their checking accounts and so on. 313 00:33:50.060 --> 00:33:54.180 The Fed continued to pump reserves into the banking system trying to operate as long as 314 00:33:54.180 --> 00:34:00.820 last resort but they couldn't offset the public's loss of confidence and we had the Glass-Steagall 315 00:34:00.820 --> 00:34:06.460 Civil Act coming in which allowed the Fed to pump even more reserves in, so we had a 316 00:34:06.460 --> 00:34:07.460 failure. 317 00:34:07.460 --> 00:34:09.780 A failure of central banking. 318 00:34:09.780 --> 00:34:14.460 What were the economists' reactions? 319 00:34:14.460 --> 00:34:21.060 The early Chicago school, the course of Milton Friedman, in particular Henry Simons, who 320 00:34:21.060 --> 00:34:27.060 was the most influential monetary theorist among them, attacked gold. 321 00:34:27.060 --> 00:34:33.060 They said, well look, the problem is that the central bank didn't have enough elbow room to maneuver. 322 00:34:33.060 --> 00:34:37.060 What they needed to do was to aggressively support the price level. 323 00:34:37.060 --> 00:34:39.060 If you support the price level, you'd never have this recession. 324 00:34:39.060 --> 00:34:47.060 We would have had a small recession in 1929, 1930, but it wouldn't have turned into this route in which your banks began collapsing and so on. 325 00:34:47.060 --> 00:34:55.060 And Simon basically harked back to Fisher and claimed that the value of gold rests on Hocus Pocus. 326 00:34:55.060 --> 00:34:59.940 and the production of gold is a squandering of world resources 327 00:34:59.940 --> 00:35:04.660 and it's an utterly inadequate standard of rules to guide monetary policy 328 00:35:04.660 --> 00:35:10.340 I'm quoting Simon's there and so he basically blamed the Great Depression on deflation 329 00:35:10.340 --> 00:35:15.100 caused by the fact that the central bank didn't operate 330 00:35:15.100 --> 00:35:19.660 competently as a controller of the money supply 331 00:35:19.660 --> 00:35:22.980 now he preferred as Fischer did 332 00:35:22.980 --> 00:35:52.980 a purely fiat money, but once again he saw that you couldn't sell this to the public, so he wound up proposing a standard, what he called a dollar standard disguised as a gold standard, and in fact he supported Keynes' plan for the International Currency Union, he said that, Keynes' plan seems to be the best thing around right now, people will be fooled by the link to gold, there's some link to gold there, and therefore he was 333 00:35:52.980 --> 00:36:08.980 in favor of this. And also very interestingly, the plan that was finally accepted for the post-war world was that of Edward M. Bernstein, who described himself in a recent book as a qualified monetarist. 334 00:36:08.980 --> 00:36:20.980 So the Bretton Woods system was sort of a second best policy for the Fisher-Simons types. The second failure occurred when Bretton Woods broke down. 335 00:36:20.980 --> 00:36:25.980 The U.S. dollar was linked to gold at the price of $35 per ounce. 336 00:36:25.980 --> 00:36:29.980 All the other currencies were linked to the dollar at fixed exchange rates. 337 00:36:29.980 --> 00:36:39.980 Now, since the U.S. government owned a stock of gold that far exceeded the amount of outstanding dollars in 1949, 1950, 338 00:36:39.980 --> 00:36:43.980 the U.S. gold stock was something like $40 billion. 339 00:36:43.980 --> 00:36:45.980 Now, Americans had no planes on that gold stock. 340 00:36:45.980 --> 00:36:47.980 We could not convert dollars for gold. 341 00:36:47.980 --> 00:36:49.980 Only foreign central banks and governments could. 342 00:36:49.980 --> 00:36:56.980 and there are only 12 billion dollars outstanding. So there was more than enough gold to cover those liabilities. Now what sort of incentive did that set up? 343 00:36:56.980 --> 00:37:06.980 What the US government did then was to run what was called a deficit without peers. The US government just printed up new money to pay for its deficits, especially during the Vietnam War. 344 00:37:06.980 --> 00:37:15.980 We had great society programs and big defense expenditures being paid for by just printing up new money. 345 00:37:15.980 --> 00:37:19.820 printing up new money, and the other countries that were tied into the U.S. dollar would 346 00:37:19.820 --> 00:37:24.300 accept these dollars as good as gold. They would hold these dollars to back their own 347 00:37:24.300 --> 00:37:31.300 currency. So the U.S. generated a worldwide inflation, especially during the 60s. Eventually, 348 00:37:31.300 --> 00:37:37.380 of course, the dollar liabilities rose to something like $75 billion, and the U.S. gold stock 349 00:37:37.380 --> 00:37:44.580 fell to around $12 billion. In 1971, when President Nixon slammed shut the gold window, 350 00:37:44.580 --> 00:37:48.580 The rate at which gold is flowing out, we had about two weeks left of gold reserves. 351 00:37:48.580 --> 00:37:56.580 So this didn't work. The central bank didn't have the will to stabilize the price system. 352 00:37:56.580 --> 00:38:00.580 Simon's and Fisher would have liked. They certainly had the opportunity there. 353 00:38:00.580 --> 00:38:05.580 Now to be fair, you had the Keynesian connection here. 354 00:38:05.580 --> 00:38:10.580 The Keynesians wanted low interest rates. They wanted cheap money. They didn't want stable prices. 355 00:38:10.580 --> 00:38:14.580 and they tended to prevail, especially during the 1960s. 356 00:38:14.580 --> 00:38:19.580 Now, the Keynesians, during this period, after the gold window was shut, 357 00:38:19.580 --> 00:38:23.580 pretty much had a system that they were comfortable with from 1971 to 1979, right? 358 00:38:23.580 --> 00:38:30.580 We didn't really have a dollar linked to gold by fixed rate, especially after 1973. 359 00:38:30.580 --> 00:38:33.580 The dollar wasn't fixed to anything. 360 00:38:33.580 --> 00:38:38.580 The central bank had a lot of elbow room to operate, and what did we get? 361 00:38:38.580 --> 00:38:52.580 So what did we get? We got the double-digit inflation rates of the quarter years, extremely high inflation, so high that it scared the Fed, and the Fed began to aggressively tighten money in 1979-1980. 362 00:38:52.580 --> 00:39:01.580 Carter appointed Paul Volcker as the chairman, and Volcker began to implement what are called monetary policies. 363 00:39:01.580 --> 00:39:03.580 Now let me just say a few words about Milton Friedman. 364 00:39:03.580 --> 00:39:11.580 Milton Friedman, from the 50s onward, was in favor of implementing the hardcore Fisher-Simons program. 365 00:39:11.580 --> 00:39:19.580 That is, getting rid of any dollar standard disguised as a gold standard, getting rid of any fixed exchange rates, 366 00:39:19.580 --> 00:39:23.580 having a pure fiat money that was controlled by the Fed. 367 00:39:23.580 --> 00:39:27.580 Now Milton Friedman didn't trust the Fed to do this without any sort of a rule. 368 00:39:27.580 --> 00:39:37.580 So what Milton Friedman wanted was not... he made it very easy for the Fed. He said, look, you don't have to worry about stabilizing the price level on a day-to-day basis or even a long-run basis. 369 00:39:37.580 --> 00:39:45.580 According to his research, the velocity of money, the rate at which an average dollar would turn over, is spent in the economy, was stable. 370 00:39:45.580 --> 00:39:50.580 So all that meant was that the Fed would simply have to increase the money supply at a steady rate. 371 00:39:50.580 --> 00:39:56.940 rate. Simply add maybe 3%, 4% to the money supply every year and that would offset the 372 00:39:56.940 --> 00:40:02.940 fall in prices of goods in general and we'd have a stable price level. And he was also 373 00:40:02.940 --> 00:40:08.100 against any sort of fixed exchange rate. He was in favor of a pure floating exchange rate 374 00:40:08.100 --> 00:40:12.420 so that the Fed had only one goal, simply to keep the money supply growing at a fixed 375 00:40:12.420 --> 00:40:22.220 interest rate. Now, what happened in the early 80s was that we had a recession when Paul 376 00:40:22.220 --> 00:40:28.340 Volcker implemented monetarist policies, which do tend to work to the extent they are followed. 377 00:40:28.340 --> 00:40:34.060 When you strain the money supply, you do reduce the rate of inflation, and that did occur. 378 00:40:34.060 --> 00:40:40.140 So the monetarists were riding high for a while, but what occurred was that we had a 379 00:40:40.140 --> 00:40:48.140 We had a number of things. We had financial deregulation, which made it very difficult to focus on the correct money supply. 380 00:40:48.140 --> 00:40:51.140 The money supplies were growing at different rates and giving off different signals. 381 00:40:51.140 --> 00:40:57.140 We had now money market mutual funds people were holding, and some economists counted that as part of the money supply. 382 00:40:57.140 --> 00:41:03.140 We had people more widely holding small certificates of deposit, which were counted by some economists in the money supply. 383 00:41:03.140 --> 00:41:11.140 So we had different monetary aggregates giving different rules, giving different indications about whether money was growing quickly or slowly. 384 00:41:11.140 --> 00:41:14.140 So we had a problem with measuring the money supply. 385 00:41:14.140 --> 00:41:21.140 Also, velocity, which is also really the demand for money more correctly, was changing. 386 00:41:21.140 --> 00:41:28.140 During a recession, people tend to hold money, to hold more money in relation to their income than they do during normal times. 387 00:41:28.140 --> 00:41:36.140 So velocity was falling, demand for money was rising, and it continued to change even if we came out of the recession. 388 00:41:36.140 --> 00:41:44.140 So that Milton Friedman had predicted a recession in the mid-80s, which never came about. 389 00:41:44.140 --> 00:41:51.140 So to some extent the monetaries were discredited for that reason, and also freely floating exchange rates. 390 00:41:51.140 --> 00:41:56.140 The monetaries, Milton Friedman in particular, told us that with freely floating exchange rates, 391 00:41:56.140 --> 00:42:09.140 Governments would never have to worry about their exchange rates going up or down, they wouldn't have to worry about the effects of their monetary policies on their balance of payments, whether they're in surplus or deficit. 392 00:42:09.140 --> 00:42:19.140 And therefore, if you don't have to worry about money flowing out of the country, gold flowing out of the country, then there's much less reason to implement protectionism. 393 00:42:19.140 --> 00:42:29.140 So with freely floating exchange rates, monetary policy would be very easy to implement and we wouldn't have a lot of appeals to Japanese bashing and protectionism. 394 00:42:29.140 --> 00:42:40.140 But in fact we got the opposite. In fact we did get that, excuse me. From 1981 to 1985, the US dollar appreciated greatly in value, making our goods much more expensive for the rest of the world. 395 00:42:40.140 --> 00:42:45.260 World. And in fact we heard calls for protectionism, widespread calls for 396 00:42:45.260 --> 00:42:51.620 protectionism. Also the exchange rates tended to be more volatile, they moved 397 00:42:51.620 --> 00:42:56.300 much more rapidly than anyone tended to expect. So theoretically you would 398 00:42:56.300 --> 00:42:59.180 expect that if countries are are inflating at different rates, greatly 399 00:42:59.180 --> 00:43:04.320 different rates, you would have very rapidly changing exchange rates. But no 400 00:43:04.320 --> 00:43:12.880 no one quite expected events to play out that way so there was, true or not, the perception 401 00:43:12.880 --> 00:43:21.880 that monetarism had failed and we then, the crisis continued, the crisis of central bank 402 00:43:21.880 --> 00:43:28.320 continued, the feds failed as a lender of last resort, it could not prevent the savings 403 00:43:28.320 --> 00:43:34.280 and loans, loan debacle, in fact federal deposit insurance which was instituted in the 1930s 404 00:43:34.280 --> 00:43:40.280 to restore public confidence in the banking system added to the problem. 405 00:43:40.280 --> 00:43:49.280 It gave the managers of banks an incentive to invest in very high-risk loans 406 00:43:49.280 --> 00:43:53.280 in exchange for the promise of high returns, high profits. 407 00:43:53.280 --> 00:43:58.280 And they were permitted to do this by legislation in the early 80s, which deregulated them. 408 00:43:58.280 --> 00:44:07.280 This deregulation in the face of continued federal deposit insurance was really the downfall of the SNL. 409 00:44:07.280 --> 00:44:16.280 Now where are we today? What are economists' reactions to the latest failure of central banking? 410 00:44:16.280 --> 00:44:20.280 Well, we have a Keynesian reaction, we have a monetarist reaction, we have a free banking reaction. 411 00:44:20.280 --> 00:44:27.760 Reaction. Basically the Keynesians claim that that the full Keynesian program was 412 00:44:27.760 --> 00:44:32.020 never really tried, okay, that if they go back to Keynes's third proposal they say 413 00:44:32.020 --> 00:44:36.280 look we really can't have we really can't have fiscal policy and monetary 414 00:44:36.280 --> 00:44:40.360 policy in a world where there's no cooperation because for example if the 415 00:44:40.360 --> 00:44:43.920 U.S. wants to push down interest rates to stimulate income and production here in 416 00:44:43.920 --> 00:44:47.920 in the U.S. The result will be, especially in today's world, 417 00:44:47.920 --> 00:44:51.920 occurring very quickly, 418 00:44:51.920 --> 00:44:55.920 the result will be capital flowing out of the U.S., 419 00:44:55.920 --> 00:44:59.920 interest rates jumping back up. If the Fed continues to try to push down 420 00:44:59.920 --> 00:45:03.920 interest rates, we'll have a capital flight out of the U.S. That is, investors will be 421 00:45:03.920 --> 00:45:07.920 spooked and they'll pull money out of the U.S. so that we really can't have an independent 422 00:45:07.920 --> 00:45:11.920 monetary and fiscal policy. Or if we try to have a fiscal policy, 423 00:45:11.920 --> 00:45:19.920 So if we try to deficit-spend, that may very well push up interest rates, draw capital in, and push up the American exchange rates. 424 00:45:19.920 --> 00:45:28.920 So what many of these Keynesians argue now is for international bank cooperation. 425 00:45:28.920 --> 00:45:38.920 Two of them, John Williamson and C. Fred Bergsten, who are both former, one is a former IMF advisor, British treasury consultant, 426 00:45:38.920 --> 00:45:43.560 and the other is the former Assistant Secretary of Treasury under President Carter. 427 00:45:43.560 --> 00:45:46.280 They advocate a crawling target zone 428 00:45:46.280 --> 00:45:48.080 with or without soft buffers. 429 00:45:48.080 --> 00:45:51.840 They can't really tell if they're ex-bureaucrats. 430 00:45:51.840 --> 00:45:54.480 Basically what that means is that 431 00:45:54.480 --> 00:45:56.920 they want some bureaucrats to set 432 00:45:56.920 --> 00:46:01.400 what they call fundamental equilibrium exchange rates between different countries, 433 00:46:01.400 --> 00:46:03.160 set these fixed exchange rates 434 00:46:03.160 --> 00:46:05.380 and permit them only to change 435 00:46:05.380 --> 00:46:10.620 as a result of differing rates of inflation among the different currencies but what they 436 00:46:10.620 --> 00:46:16.740 want is that all cooperating governments will agree to target their, what's called aggregate 437 00:46:16.740 --> 00:46:21.020 demand, the amount of spending in the economy via deficits. 438 00:46:21.020 --> 00:46:27.820 So what they want to do is push down interest rates together so that they can operate with 439 00:46:27.820 --> 00:46:28.820 fiscal policy. 440 00:46:28.820 --> 00:46:32.580 So they want to reimpose fiscal policy on the world economy, a policy that failed, the 441 00:46:32.580 --> 00:46:42.580 Keynesian policies failed badly in the 60s and 70s. They want to re-impose it, but now with international bank cooperation, central bank cooperation. 442 00:46:42.580 --> 00:46:52.580 There's another individual named Richard N. Cooper, professor of economics at Yale, member of the Council of Foreign Relations. 443 00:46:52.580 --> 00:47:00.580 His goal is to really have a global central bank. He makes no bones about that, to have a global monetary authority. 444 00:47:00.580 --> 00:47:12.580 He wants them to issue currency by purchasing securities of member countries, that is to operate, as central banks do today, nationally, through open market operations. 445 00:47:12.580 --> 00:47:16.580 He wants national governments then to be able to use fiscal policy again. 446 00:47:16.580 --> 00:47:24.580 In other words, they would then be able to deficit spend again, but only to the extent of their allocation of this new currency. 447 00:47:24.580 --> 00:47:32.180 In other words, they would print up government bonds and sell them to the central bank for this world currency. 448 00:47:32.180 --> 00:47:39.340 Each person would have an allocation, so the amount, each country would, so the amount of the inflation would be coordinated. 449 00:47:39.340 --> 00:47:41.820 Nobody would get out of step. 450 00:47:41.820 --> 00:47:48.820 Finally, we have James Tobin, an old-line Keynesian, who keeps putting forth this proposal for monetary reform, 451 00:47:48.820 --> 00:47:53.220 1972, 1978, 1982, and he never gives up on it. 452 00:47:53.220 --> 00:47:57.900 Basically, he wants to go back to Keynes' proposal of economic nationalism. 453 00:47:57.900 --> 00:48:02.780 He said that he would welcome a world currency and common monetary and fiscal policy, but 454 00:48:02.780 --> 00:48:05.060 that's just impossible in today's world. 455 00:48:05.060 --> 00:48:11.140 So instead, he advocates, regretfully, I'm quoting, throwing some sand into the wheels 456 00:48:11.140 --> 00:48:15.100 of our excessively efficient money markets. 457 00:48:15.100 --> 00:48:23.620 What he wants to do is to put a 1% tax on all spot conversions of currency from one currency 458 00:48:23.620 --> 00:48:28.740 to another, which would mean that you would have on a three month, if an American wanted 459 00:48:28.740 --> 00:48:38.220 to invest in a Japanese treasury bill, the differential would have to be 8%, that is 460 00:48:38.220 --> 00:48:49.220 You have to have an 8% higher return on the Japanese bill than on the U.S. bill to justify that 1% tax on that transfer. 461 00:48:49.220 --> 00:48:54.220 What's the monetarist's response to this latest crisis? 462 00:48:54.220 --> 00:49:03.220 I was recently at a conference on liberty and banking, which Milton Friedman's long-time co-author Anna Schwartz attended. 463 00:49:03.220 --> 00:49:16.220 She said that basically Milton Friedman has thrown in the towel on monetarism in the sense of having the central bank fix a steady rate of monetary growth. 464 00:49:16.220 --> 00:49:24.220 And he's now in favor of simply freezing the monetary base forevermore, never allowing it to change again. 465 00:49:24.220 --> 00:49:35.220 That is, the Fed can never go in and issue currency and deposits against securities, no more open market operations. 466 00:49:36.220 --> 00:49:44.220 We freeze that and then he would completely deregulate the financial system so that we would have basically free banking stock of base money. 467 00:49:44.220 --> 00:49:52.220 And in that way he feels that we could approximate stable price level. 468 00:49:52.220 --> 00:49:55.660 Okay, some other monetarists, interestingly enough, 469 00:49:55.660 --> 00:49:57.980 well, a quasi-monitorist, Robert Mundell, 470 00:49:57.980 --> 00:50:02.380 and also Humphrey and Kelleher, two monetarists, 471 00:50:02.380 --> 00:50:07.160 are in favor of sort of a global central bank. 472 00:50:07.160 --> 00:50:08.540 I was surprised to read this, 473 00:50:08.540 --> 00:50:11.420 but they believe that we have a dirty floating system 474 00:50:11.420 --> 00:50:13.720 where governments intervene to buy and sell the dollar, 475 00:50:13.720 --> 00:50:17.060 so the dollar is really the basis, 476 00:50:17.060 --> 00:50:18.340 is really a reserve currency, 477 00:50:18.340 --> 00:50:23.380 the base of national currencies throughout the world. 478 00:50:23.380 --> 00:50:27.660 So that to keep the dollar growing at a fixed rate, 479 00:50:27.660 --> 00:50:31.180 or to keep world reserves growing at a fixed rate, 480 00:50:31.180 --> 00:50:36.180 they would consider a world central bank, 481 00:50:37.820 --> 00:50:40.100 as proposed by Robert Mundell. 482 00:50:40.100 --> 00:50:44.420 Finally, some Austrian economists have reacted 483 00:50:44.420 --> 00:50:47.180 to the crisis of the 1970s and 80s. 484 00:50:47.180 --> 00:50:53.100 I'm thinking here of Larry White and George Selgin by going back to 18th century thinking, 485 00:50:53.100 --> 00:50:59.500 but not the good hard money 18th century thinking, but the thinking of Adam Smith. 486 00:50:59.500 --> 00:51:07.340 Their claim is that fractional reserve banking is unstable because we have a central bank, 487 00:51:07.340 --> 00:51:09.820 so that they're afraid of getting rid of the central bank. 488 00:51:09.820 --> 00:51:16.100 Basically, they reject Adam Smith's versions of why under fractional reserve banking we 489 00:51:16.100 --> 00:51:18.820 We would not have a rise in the price level. 490 00:51:18.820 --> 00:51:24.000 What they claim is that, to make a long story short, Smith is right, gold is too costly 491 00:51:24.000 --> 00:51:27.100 to serve as money. 492 00:51:27.100 --> 00:51:32.740 It's a massive waste of resources to have people holding idle gold, so that George Selgin 493 00:51:32.740 --> 00:51:38.760 in particular is in favor of increasing bank liabilities, raising the price level and driving 494 00:51:38.760 --> 00:51:40.780 gold out of monetary use. 495 00:51:40.780 --> 00:51:45.780 Now in the stylized account of how fractional reserve banking arises, how free banking would 496 00:51:45.780 --> 00:51:53.300 Arise, they both believe that, since it was a jointly written article, that starting with 497 00:51:53.300 --> 00:51:57.980 100% gold reserve, that under free banking, the reserves would go down to one half of 498 00:51:57.980 --> 00:51:58.980 one percent. 499 00:51:58.980 --> 00:52:03.580 This would involve a massive inflation, it would involve stimulating an Austrian business 500 00:52:03.580 --> 00:52:07.020 cycle and instability of the banking system. 501 00:52:07.020 --> 00:52:13.260 But they claim that that wouldn't be so, that in fact there are many mechanisms that would 502 00:52:13.260 --> 00:52:17.180 that develop on the market to prevent the instability of free banking. 503 00:52:17.180 --> 00:52:21.740 In fact, it seems that they're very, very interested, their primary interest is in keeping 504 00:52:21.740 --> 00:52:30.340 the free banking system stable, not really on the effects on the overall economy. 505 00:52:30.340 --> 00:52:39.900 So also I find in just one or two more little criticisms, Selgin and White in saying that 506 00:52:39.900 --> 00:52:43.900 that the reserves of the free banking system would be determined by the market, okay? 507 00:52:43.900 --> 00:52:47.900 The market would give the owners, the entrepreneur owners of the banks, 508 00:52:47.900 --> 00:52:53.900 information about exactly what level of reserves is required, okay? 509 00:52:53.900 --> 00:52:57.900 That really relies on a theory of entrepreneurship that comes from Israel Kirzner, okay? 510 00:52:57.900 --> 00:53:05.900 And that doesn't really offer much scope for uncertainty and error and mistakes, okay? 511 00:53:05.900 --> 00:53:10.900 So I think the whole free banking case is based on a defective theory of entrepreneurship. 512 00:53:10.900 --> 00:53:16.900 Also, it seems that they bring back central banking to the back door. 513 00:53:16.900 --> 00:53:20.900 They say, well, look, if some banks do get into trouble, if they do make mistakes, 514 00:53:20.900 --> 00:53:27.900 we'll have these super clearing houses that evolve on the market that are able to print up currency 515 00:53:27.900 --> 00:53:29.900 and act as lenders of last resort. 516 00:53:29.900 --> 00:53:33.900 So they're introducing central bank type institutions here. 517 00:53:33.900 --> 00:53:39.420 here. Also, they're very in favor of option clauses, which exist in Scotland. They're 518 00:53:39.420 --> 00:53:42.900 called post notes here in the United States. Basically, what the bank would do is to say, 519 00:53:42.900 --> 00:53:47.900 look, if we get into trouble, we have the right to refuse payment for six months or 520 00:53:47.900 --> 00:53:54.700 a year. So people's money balances are wiped out. They now are holding short-term liabilities 521 00:53:54.700 --> 00:54:01.420 against the gold standard, against the banks rather. And again, how's that different from 522 00:54:01.420 --> 00:54:05.700 and the Central Bank's suspending specie payments when they get into trouble, right? 523 00:54:05.700 --> 00:54:12.980 And finally, they're very in favor of, where you wouldn't own a fixed dollar claim against 524 00:54:12.980 --> 00:54:17.060 the bank, but they would issue you an equity share, okay, as the Money Market Mutual Fund 525 00:54:17.060 --> 00:54:18.700 does today. 526 00:54:18.700 --> 00:54:24.360 The value of that share would depend on how well the investments of the bank or the mutual 527 00:54:24.360 --> 00:54:25.780 fund does. 528 00:54:25.780 --> 00:54:29.660 And they claim that that's another way of protecting against bank runs, but I see that 529 00:54:29.660 --> 00:54:35.060 That simply is giving up banking. That's not really banking. It's a mutual fund institution, 530 00:54:35.060 --> 00:54:41.380 so it's a lot different from banking. So I don't see free banking as the answer. I see 531 00:54:41.380 --> 00:54:50.700 as the answer the original 18th century tradition in which you have 100% banking with full financial 532 00:54:50.700 --> 00:54:55.820 deregulation. Murray Rothbard, for example, supports that. I support that. Hans Hoppe 533 00:54:55.820 --> 00:54:59.780 Hoppe supports that approach, and I think that is the correct approach, and that is 534 00:54:59.780 --> 00:55:02.340 the development of the Turgot-Hume tradition.