WEBVTT NOTE The Source and Workings of the Latest Crisis 1 00:00:00.000 --> 00:00:02.400 Thank you, folks, very much. 2 00:00:02.400 --> 00:00:08.200 For some reason, I sort of imagined that it would be slightly creepy here on Jekyll Island, right? 3 00:00:08.200 --> 00:00:11.200 Yet it turns out it's beautiful. Of course, that's why they came here, right? 4 00:00:11.200 --> 00:00:14.400 You don't come to some dump, obviously. It's a beautiful place. 5 00:00:14.400 --> 00:00:16.800 My wife is home with our new baby, 6 00:00:16.800 --> 00:00:19.400 and I was trying to think of the most gentle way I could tell her 7 00:00:19.400 --> 00:00:23.200 that she's missing out on the best event we could have gone to in the past three years, 8 00:00:23.200 --> 00:00:28.600 but all the same, she's doing her good work at home. 9 00:00:28.600 --> 00:00:32.320 which also means, by the way, that I'll be leaving a little early. I'll be leaving around 10 00:00:32.320 --> 00:00:33.820 two o'clock, so 11 00:00:33.820 --> 00:00:35.320 if there's anything you want to 12 00:00:35.320 --> 00:00:39.560 ask me about, any sort of fringe question you're afraid to ask, you've got to hurry up and ask it 13 00:00:39.560 --> 00:00:42.280 because I've got to head out early today, because the 14 00:00:42.280 --> 00:00:45.160 crazy travel schedule starts up again in a 15 00:00:45.160 --> 00:00:47.540 couple of weeks for me. 16 00:00:47.540 --> 00:00:49.000 Now, over the past 17 00:00:49.000 --> 00:00:50.100 few 18 00:00:50.100 --> 00:00:52.380 Mises circles that we've had, 19 00:00:52.380 --> 00:00:56.500 where we have these one-day events around the country, 20 00:00:56.500 --> 00:01:02.300 In some of them I've had 45 minutes to speak and I've spoken on a specific thing like I spoke on 21 00:01:02.300 --> 00:01:07.020 the condition of the US economy in 1920 and 21 and how 22 00:01:07.020 --> 00:01:09.860 that was reversed 23 00:01:09.860 --> 00:01:15.420 and that has been viewed, I just checked, it's been viewed 72,000 times 24 00:01:15.420 --> 00:01:16.940 on YouTube so 25 00:01:16.940 --> 00:01:23.140 thank heavens the country is even dorkier than I dreamed. 26 00:01:23.140 --> 00:01:28.900 I gave a talk in South Carolina on sound money, generally in 45 minutes the basic case for 27 00:01:28.900 --> 00:01:35.200 sound money. In Houston I finagled some extra time because Doug didn't take his full time 28 00:01:35.200 --> 00:01:40.900 so of course I used it and I talked about something, a topic, Keynesian predictions 29 00:01:40.900 --> 00:01:46.760 versus American history. They don't come out very well. But here I have less time and the 30 00:01:46.760 --> 00:01:52.040 topic is far broader. So what I think I'm going to do is really is just make some 31 00:01:52.040 --> 00:01:57.200 comments that I think are relevant to rendering a judgment about the financial 32 00:01:57.200 --> 00:02:01.880 crisis and the causes and so on and so forth. We'll start with a couple of the 33 00:02:01.880 --> 00:02:06.720 conventional statements that you might hear, let's say, on right-wing radio about 34 00:02:06.720 --> 00:02:09.880 the financial crisis. And that's not to say that they're wrong, I just think 35 00:02:09.880 --> 00:02:15.120 rather that they're incomplete. And so for example, Fannie and Freddie are 36 00:02:15.120 --> 00:02:20.080 talked about a lot. Fannie and Freddie are operating with, in addition to the various 37 00:02:20.080 --> 00:02:27.960 tax and regulatory advantages they enjoy, an implicit government guarantee that if these 38 00:02:27.960 --> 00:02:34.600 mortgages go sour and Fannie and Freddie are in real trouble, well, the Treasury will extend 39 00:02:34.600 --> 00:02:39.080 them what was sort of understood to be an indefinite sort of line of credit, not just 40 00:02:39.080 --> 00:02:44.400 the couple of billion that was explicitly, that people knew about. 41 00:02:44.400 --> 00:02:47.120 And this seems to have been generally understood. 42 00:02:47.120 --> 00:02:52.880 For example, at Freddie Mac, we have a top executive noting in the wake of the collapse 43 00:02:52.880 --> 00:02:55.880 over there, we have this statement. 44 00:02:55.880 --> 00:02:59.520 It basically worked exactly as everyone expected. 45 00:02:59.520 --> 00:03:03.920 When things got bad, the government came to the rescue. 46 00:03:03.920 --> 00:03:05.820 Exactly as everyone expected. 47 00:03:05.820 --> 00:03:09.660 Another fellow at Freddie Mac says, the thinking was that if something really bad happened 48 00:03:09.660 --> 00:03:14.360 to the housing market, then the government would need Freddie and Fannie more than ever. 49 00:03:14.360 --> 00:03:18.800 would have to rescue them and you could multiply quotations of this sort. 50 00:03:18.800 --> 00:03:22.580 Now allow me, even though I've been speaking only a couple of minutes, a digression right 51 00:03:22.580 --> 00:03:24.640 from the start here. 52 00:03:24.640 --> 00:03:34.160 If you look at the major banking crises of the period before the creation of the Federal 53 00:03:34.160 --> 00:03:38.360 Reserve, and I'm talking about around the world, if you look at the period let's say 54 00:03:38.360 --> 00:03:47.080 1874-1913. There are four really major banking crises around the world, Argentina, Australia, 55 00:03:47.080 --> 00:03:51.480 Norway and Italy. What they all have in common is these governments are all artificially 56 00:03:51.480 --> 00:03:57.760 encouraging real estate. Norway in effect had a Fannie Mae. And more recently when we 57 00:03:57.760 --> 00:04:04.840 look at the debacle in Iceland, which is of course blamed on the free market as usual, 58 00:04:04.840 --> 00:04:12.840 Iceland had an explicit government guarantee, whereas Fanny and Freddy are only implicit guarantees. 59 00:04:12.840 --> 00:04:18.840 The government says they're not going to bail them out, but sort of with a wink, and people kind of suspect they would. 60 00:04:18.840 --> 00:04:24.840 In Iceland, this is an explicit government guarantee in the area of real estate. 61 00:04:24.840 --> 00:04:29.840 Well, of course, therefore, Fanny and Freddy, because they enjoy this implicit guarantee, 62 00:04:29.840 --> 00:04:35.740 as well as other advantages, are able to borrow more cheaply than anybody else could. 63 00:04:35.740 --> 00:04:40.080 And so they can borrow cheaply and then go out and buy these high-powered assets and 64 00:04:40.080 --> 00:04:43.560 they have a nice spread that they pocket for themselves. 65 00:04:43.560 --> 00:04:49.320 And so they grow bolder and bolder until we hit catastrophe. 66 00:04:49.320 --> 00:04:56.200 Now in July 2008, as Fannie and Freddie were heading toward ultimate collapse, Treasury 67 00:04:56.200 --> 00:05:03.080 Secretary Hank Paulson calmly observed that quote, their regulator has made clear that 68 00:05:03.080 --> 00:05:08.920 they are adequately capitalized. Well, two months later, you know, the whole thing is 69 00:05:08.920 --> 00:05:13.960 collapsed and the government has taken them over. And so Hank Paulson was confronted with 70 00:05:13.960 --> 00:05:19.080 this statement. I mean, didn't you just tell us in July that they're adequately capitalized? 71 00:05:19.080 --> 00:05:24.040 Everything's fine. And here's his reply. This is an exact quote. I never said the company 72 00:05:24.040 --> 00:05:31.040 was well capitalized. What I said is, the regulator said they are adequately capitalized. 73 00:05:32.240 --> 00:05:35.840 I read that to my wife on the phone last night. She said, what is this guy, five years old? 74 00:05:35.840 --> 00:05:42.840 We've got a real creepasaurus here. Now the other thing we get told a lot about is that 75 00:05:42.920 --> 00:05:48.780 lending standards declined. Like this is just some spontaneously occurring thing. Now it's 76 00:05:48.780 --> 00:05:54.420 It's true that there were various government policies that encouraged lending standards 77 00:05:54.420 --> 00:05:58.780 to go below where they ought to be, perhaps. 78 00:05:58.780 --> 00:06:03.060 And in fact, even Alan Greenspan, Alan Greenspan reflects on this. 79 00:06:03.060 --> 00:06:07.260 This is the big free market Alan Greenspan said in 2008. 80 00:06:07.260 --> 00:06:12.260 He said, I was aware that the loosening of mortgage credit terms for subprime borrowers 81 00:06:12.260 --> 00:06:17.300 increased financial risk and that subsidized home ownership initiatives distort market 82 00:06:17.300 --> 00:06:24.000 Outcomes. But I believed then, as now, that the benefits of broadened home ownership are 83 00:06:24.000 --> 00:06:30.400 worth the risk. Well, I'm glad you're willing to bear that risk, Alan. That's just super. 84 00:06:30.400 --> 00:06:37.900 Thanks a whole lot. But on these lending standards, it is true, as I say, that the central bank 85 00:06:37.900 --> 00:06:42.740 and various other institutions and pieces of legislation encouraged lending standards 86 00:06:42.740 --> 00:06:44.580 to Fall. 87 00:06:44.580 --> 00:06:50.140 But let's also note that when you have a monetary policy, such as the one the Fed pursued in 88 00:06:50.140 --> 00:06:57.060 the years of the housing bubble, that policy itself is going to lead to a drop in lending 89 00:06:57.060 --> 00:06:58.060 standards. 90 00:06:58.060 --> 00:07:01.380 Mises points this out in Human Action. 91 00:07:01.380 --> 00:07:08.540 Chapter 20 is the chapter on the business cycle, and he talks about how sometimes we 92 00:07:08.540 --> 00:07:14.580 We see the manifestation of this in the fact that loans are made that would not have been 93 00:07:14.580 --> 00:07:16.780 made otherwise. 94 00:07:16.780 --> 00:07:21.820 Because now the banks have got all this additional money, well previously they've already lent 95 00:07:21.820 --> 00:07:26.260 up to as much as they can go, everybody who wants to borrow is borrowing, but now you've 96 00:07:26.260 --> 00:07:29.300 got all this additional money to lend, how are you going to lend it out? 97 00:07:29.300 --> 00:07:34.380 You're going to have to lend it out to people you would otherwise not have lent to. 98 00:07:34.380 --> 00:07:38.420 And the analogy that I've used is that of a basketball team. 99 00:07:38.420 --> 00:07:45.100 Suppose you're picking people for your team from a pool of potential players, and then 100 00:07:45.100 --> 00:07:47.940 ten minutes later you get told, oh, by the way, you get to pick two more. 101 00:07:47.940 --> 00:07:49.740 Well, where are those two more going to come from? 102 00:07:49.740 --> 00:07:50.740 Logically. 103 00:07:50.740 --> 00:07:54.020 Of course, they're going to come from the pool of people you'd previously rejected. 104 00:07:54.020 --> 00:07:55.020 So there is this element. 105 00:07:55.020 --> 00:08:00.500 The Fed itself, its very activity is going to lead to a decline in lending standards. 106 00:08:00.500 --> 00:08:03.980 And we should also note that when we talk about Fannie and Freddie and we talk about 107 00:08:03.980 --> 00:08:12.620 Without a Housing Bubble, we should note that again in an atmosphere of stable, sound money, 108 00:08:12.620 --> 00:08:17.800 that is to say not the atmosphere that we had during the housing bubble, interest rates 109 00:08:17.800 --> 00:08:21.300 perform the role of a break. 110 00:08:21.300 --> 00:08:23.100 They put on the breaks. 111 00:08:23.100 --> 00:08:26.700 If people are just sort of arbitrarily deciding they all want to buy a lot of houses, like 112 00:08:26.700 --> 00:08:30.620 we're all a bunch of zombies and all we can think to do is buy houses, if we just keep 113 00:08:30.620 --> 00:08:35.620 If you keep on doing this, the banks ultimately are going to start running low on stuff to lend. 114 00:08:35.620 --> 00:08:39.620 Interest rates are going to shoot up and that's going to tend to put a break on things. 115 00:08:39.620 --> 00:08:44.620 Because certainly at least speculators will be less likely to want to flip houses when interest rates are so high. 116 00:08:44.620 --> 00:08:47.620 They're going to look to go do something else. 117 00:08:47.620 --> 00:08:53.620 But when you have what I've started to refer to as a Soviet Commissar in charge of money and interest rates, 118 00:08:53.620 --> 00:08:58.620 who can just sort of arbitrarily keep the thing going, just juice it up, keep it going, 119 00:08:58.620 --> 00:09:03.100 Well, you can persist in this artificial boom. You can persist in this bubble. 120 00:09:03.100 --> 00:09:08.700 There's additional credit to allow people to keep buying an asset whose price keeps on rising. 121 00:09:09.500 --> 00:09:14.540 The interest rate does not rise along with it. It's pushed down. It's kept low, and that, 122 00:09:14.540 --> 00:09:18.220 in effect, allows for the financing of more and more purchases of this type of asset. 123 00:09:19.020 --> 00:09:25.500 Now, these are points that I think are essential to use to supplement this story about Fannie and 124 00:09:25.500 --> 00:09:29.540 and Freddie and declining lending standards, and they involve the Federal Reserve, and 125 00:09:29.540 --> 00:09:31.100 they need to be raised. 126 00:09:31.100 --> 00:09:35.500 And what typically happens is because up until recently, you really couldn't talk about the 127 00:09:35.500 --> 00:09:39.820 Federal Reserve as a contributor to our problems. 128 00:09:39.820 --> 00:09:42.940 Really shouldn't talk about the Fed at all if you can get away with it, but if you do, 129 00:09:42.940 --> 00:09:47.100 you should speak of it in hushed, reverential tones and get out your incense and wave it 130 00:09:47.100 --> 00:09:49.340 in front of the sacred image of the chairman. 131 00:09:49.340 --> 00:09:54.260 But now that we're allowed to talk about it, it, I think, takes some of the heat off the 132 00:09:54.260 --> 00:09:55.260 and the Market Economy. 133 00:09:55.260 --> 00:10:00.620 Because if you can't talk about the Fed, when the Fed is the precipitating factor of the 134 00:10:00.620 --> 00:10:04.060 problem, well naturally the default position will be it must be the free market that caused 135 00:10:04.060 --> 00:10:05.060 it. 136 00:10:05.060 --> 00:10:09.420 And so by leaving out the elephant in the living room, we get these, well to say the 137 00:10:09.420 --> 00:10:14.100 least misleading diagnoses of our problems. 138 00:10:14.100 --> 00:10:21.420 Now the Austrian School of course has a business cycle theory that has I think attracted a 139 00:10:21.420 --> 00:10:27.420 I've been getting a lot of attention recently because of this particular financial crisis and because of the internet. 140 00:10:27.420 --> 00:10:32.420 That even though the gatekeepers are still there, who would rather that we not talk about this, 141 00:10:32.420 --> 00:10:36.420 not focus on a theory that points the finger at central banking, 142 00:10:36.420 --> 00:10:43.420 as Gary North says, you know, the gates are still up, but the walls are down. 143 00:10:43.420 --> 00:10:47.420 You know, so you still have Newsweek trying to tell you what to think. 144 00:10:47.420 --> 00:10:51.420 But meanwhile, you can just walk around Newsweek and get in and talk to the normal people. 145 00:10:51.420 --> 00:10:56.420 Well, Austrian Business Cycle Theory, which perhaps you've heard about and know something about, 146 00:10:56.420 --> 00:11:02.420 so I won't go into detail on it. There's a lot you can watch on YouTube and read about with regard to it. 147 00:11:02.420 --> 00:11:08.420 But what Austrian Business Cycle Theory is going to tell you in the Misesian formulation that you read about in Human Action 148 00:11:08.420 --> 00:11:15.420 is it's a story of malinvestment and overconsumption, that these phenomena are going to be evident in the business cycle. 149 00:11:15.420 --> 00:11:21.940 Now, by malinvestment, this is a word that's used a lot and often not defined, the Austrians 150 00:11:21.940 --> 00:11:27.620 mean something like the following, that we have a structure of production, that is to 151 00:11:27.620 --> 00:11:31.820 say when things are produced they don't just magically appear out of thin air. In fact, 152 00:11:31.820 --> 00:11:36.320 let me interrupt myself to point out that Rothbard explains this beautifully in something 153 00:11:36.320 --> 00:11:40.740 that we just put up, I say we, I had nothing to do with it whatsoever, it's all Chad Parrish, 154 00:11:40.740 --> 00:11:44.900 but we just put up on the website, Introduction to Microeconomics with Murray Rothbard, it's 155 00:11:44.900 --> 00:12:14.900 This is a recording of his course that he's teaching to undergraduates in 1986 and I find it very heartwarming not only because it's just wonderful to hear him but also to note the great rapport he has with the students like they laugh at his jokes and even if they don't he's laughing and having a great time like he interacts with them so well he explains things so simply and never once has he led on to them oh by the way you know I'm a genius who's written a huge treatise on this subject but he keeps it simple 156 00:12:14.900 --> 00:12:19.860 But yet, insightful, so he's talking about the structure of production that's necessary 157 00:12:19.860 --> 00:12:24.900 to produce a ham sandwich that you get down the street, and he's talking about, now, think 158 00:12:24.900 --> 00:12:28.500 about how far back this goes, he says, it's going to have to go back years and years, 159 00:12:28.500 --> 00:12:32.900 you're going to raise the pigs, you're going to raise the corn to feed the pigs, you're 160 00:12:32.900 --> 00:12:36.660 going to create tires for the trucks, you're going to transport, you're going to have refrigeration, 161 00:12:36.660 --> 00:12:40.380 this is just going to go on forever, right, and that's just for the ham, you know, forget 162 00:12:40.380 --> 00:12:43.700 about the bread and the butter, I mean, it's just, it's unbelievable, and he says the amazing 163 00:12:43.700 --> 00:12:48.700 The interesting thing is that this all comes together without a giant central planner. 164 00:12:48.700 --> 00:12:50.700 This just all happens. It all occurs. 165 00:12:50.700 --> 00:12:55.700 That's what microeconomics is interested in figuring out is how does it happen? 166 00:12:55.700 --> 00:12:58.700 How does this work? How does this all come together? 167 00:12:58.700 --> 00:13:02.700 Well, that's in effect what I'm talking about here, that there's a structure of production. 168 00:13:02.700 --> 00:13:07.700 It's not just like consumer goods just suddenly appear or there's like a machine and it just churns them out. 169 00:13:07.700 --> 00:13:09.700 It goes through a series of stages. 170 00:13:09.700 --> 00:13:24.700 You might think of it very, very simply, and they don't all follow this pattern, but, you know, like raw materials and you transform those into something else and go through a manufacturing process and then there are marketers and wholesalers and retailers and finally you get it. 171 00:13:24.700 --> 00:13:35.700 And there's a time dimension in the structure of production, okay, because obviously the raw materials are very, very far away from a finished consumer goods. So they're far away in time, not just conceptually. 172 00:13:35.700 --> 00:13:39.860 And so when you interfere with the structure of interest rates, 173 00:13:39.860 --> 00:13:43.260 these things that are more time-consuming are going to come to seem more 174 00:13:43.260 --> 00:13:46.060 more profitable now than they would otherwise have been. They're the most interest 175 00:13:46.060 --> 00:13:50.500 rate sensitive. The longer term a project is, the more interest rate sensitive it is. 176 00:13:50.500 --> 00:13:53.220 So when you interfere with interest rates to push them down artificially, you're 177 00:13:53.220 --> 00:13:57.760 going to give an artificial stimulus to interest rate sensitive things. 178 00:13:57.760 --> 00:14:01.620 So the higher stages of the structure of production, for example, or 179 00:14:01.620 --> 00:14:04.260 or housing, for example. Housing 180 00:14:04.260 --> 00:14:09.260 is interest rate sensitive. I mean, anybody who's ever been involved in buying or selling a house knows that, 181 00:14:09.260 --> 00:14:12.260 that the structure of interest rates is very significant there. 182 00:14:12.260 --> 00:14:18.260 So it's not surprising to see these things artificially stimulated, but it's an artificial stimulus. 183 00:14:18.260 --> 00:14:23.260 I mean, there's a reason that the market economy was giving you interest rates that were going to, 184 00:14:23.260 --> 00:14:26.260 in effect, discourage you from expanding those stages. 185 00:14:26.260 --> 00:14:32.260 It's ultimately that from the big picture point of view, the economy can't really sustain 186 00:14:32.260 --> 00:14:38.260 that much expansion in those stages. That's not in line with consumer preferences, ultimately. 187 00:14:38.260 --> 00:14:46.260 There isn't going to be a substantial enough stream of saving to support these long-term projects in the long run. 188 00:14:46.260 --> 00:14:52.260 And so this is malinvestment. Investment is directed into the wrong lines, basically, where it does not belong. 189 00:14:52.260 --> 00:14:56.260 But at the same time, the low interest rates lead to overconsumption by the public. 190 00:14:56.260 --> 00:15:01.260 That is to say, I mean, obviously, the interest rates are low. You feel like, well, I might as well blow my money now. 191 00:15:01.260 --> 00:15:03.260 Robert Wenzel, economicpolicyjournal.com 192 00:15:31.260 --> 00:15:37.340 He says, indeed the IPO market ground to a complete halt, not just the housing related 193 00:15:37.340 --> 00:15:39.620 sector of the IPO market. 194 00:15:39.620 --> 00:15:44.180 Over the last 12 months, this was a couple of months ago, non-construction manufacturing 195 00:15:44.180 --> 00:15:51.220 durable goods unemployment has climbed from 6.5% to 13.1%, mining, quarrying and oil and 196 00:15:51.220 --> 00:15:57.220 gas extraction unemployment climbed from 2.8% to 10.7% and so on. 197 00:15:57.220 --> 00:16:00.660 But as I say, we also have over consumption and we can see that in the fact that a lot 198 00:16:00.660 --> 00:16:07.380 A lot of people were buying a lot of things on the basis of wealth that they thought existed 199 00:16:07.380 --> 00:16:12.820 but really didn't, on the basis of inflated housing prices, inflated stock portfolios. 200 00:16:12.820 --> 00:16:17.580 Everybody feels rich and everybody goes out and the examples I always give, it's sort 201 00:16:17.580 --> 00:16:22.420 of unfair, is everybody thinks it's sensible to buy a six dollar cup of coffee or an eight 202 00:16:22.420 --> 00:16:25.800 dollar ice cream cone, whatever, hey, sky's the limit, right, I've got a half a million 203 00:16:25.800 --> 00:16:30.400 dollar house, next year it'll be three quarters of a million, you know, I mean, I got more 204 00:16:30.400 --> 00:16:34.000 and more, gazebos, you know, I'm lousy with gazebos, I don't know what to do with them 205 00:16:34.000 --> 00:16:35.000 all. 206 00:16:35.000 --> 00:16:39.280 So people make consumption decisions on this basis, but it's a false basis. 207 00:16:39.280 --> 00:16:42.280 And then ultimately they realize, wait a minute, I actually don't have the wealth that I thought 208 00:16:42.280 --> 00:16:43.400 I had. 209 00:16:43.400 --> 00:16:46.840 And so I think one of my favorite things ever, even though it's, I don't want to celebrate 210 00:16:46.840 --> 00:16:52.420 people's misfortunes, but just because of how revealing it is, is that ad with the guy 211 00:16:52.420 --> 00:16:56.680 riding around on the power mower and he's talking about how he's got the brand new house 212 00:16:56.680 --> 00:17:21.680 Mises in that chapter 20 of Human Action gives the allegory that I've used and some of us have used in the past of the master builder and it's a great allegory because it works for both the malinvestment and the overconsumption aspects of the boom. 213 00:17:21.680 --> 00:17:37.680 He describes the economy, he says, let's imagine the economy as being one guy, a master builder, whose task it is to build a house according to a blueprint, but he doesn't realize that he lacks the number of bricks that he would need to complete this structure. 214 00:17:37.680 --> 00:17:47.680 Well, what we conclude from this is that printing up green pieces of paper isn't going to get him anymore. If there are only this many bricks in the world, you can print up all the green pieces of paper you want. 215 00:17:47.680 --> 00:17:51.680 He still can't complete the house according to the original blueprint. 216 00:17:51.680 --> 00:17:55.680 So of course it's better for him to discover this error sooner rather than later 217 00:17:55.680 --> 00:17:59.680 so that he doesn't waste a lot of resources building a house that ultimately can't be finished 218 00:17:59.680 --> 00:18:03.680 because of mere physical constraints. He can't possibly finish it. 219 00:18:03.680 --> 00:18:08.680 So it's better for him to discover this error later. It would not be good to just keep cheering him on from the side. 220 00:18:08.680 --> 00:18:13.680 No, no, no. Keep on going, man. By the time you get to the end, we'll figure out some way to summon bricks out of thin air. 221 00:18:13.680 --> 00:18:19.680 That wouldn't be good, because then by the end, he's wasted his time that he could have devoted to something else. 222 00:18:19.680 --> 00:18:24.680 He's going to have to destroy perhaps most or even all of the house, so this would be bad. 223 00:18:24.680 --> 00:18:29.680 And the usefulness of this allegory is that, in effect, this is what a recession is. 224 00:18:29.680 --> 00:18:34.680 The recession is when the economy figures out there aren't enough bricks, figures out there's been malinvestment. 225 00:18:34.680 --> 00:18:38.680 We've been doing the wrong things with the resources we have. 226 00:18:38.680 --> 00:18:44.680 We've been over ambitious. We've been trying to start a series of projects that we're not wealthy enough yet to complete. 227 00:18:44.680 --> 00:18:47.680 There aren't enough saved resources to make them all possible. 228 00:18:47.680 --> 00:18:51.680 So therefore, we better quit doing this as soon as possible and start doing other things. 229 00:18:51.680 --> 00:18:56.680 In the same way, the master builder better quit doing what he's doing because he's embarked on something that's over ambitious. 230 00:18:56.680 --> 00:19:00.680 Well, now we think of this in a macro sense. The whole economy has been over ambitious. 231 00:19:00.680 --> 00:19:06.680 So now we have to sort out, using entrepreneurial skill and the price system, what's sustainable, what isn't, 232 00:19:06.680 --> 00:19:11.680 What lines should this production be going into and what should it not? 233 00:19:11.680 --> 00:19:15.680 It works very well because it's a wonderful allegory. 234 00:19:15.680 --> 00:19:20.680 If you were to encourage the master builder to keep going, you'd just make things worse. 235 00:19:20.680 --> 00:19:27.680 Likewise, with bailouts and with stimulus, we want to stimulate the same patterns of spending we've been having. 236 00:19:27.680 --> 00:19:32.680 Again, that just makes it worse because now you're continuing to do the wrong thing for even longer. 237 00:19:32.680 --> 00:19:36.960 But this allegory also works for the over-consumption angle as well. 238 00:19:36.960 --> 00:19:42.240 Because here we can think of the master builder as being, you know, just some regular American. 239 00:19:42.240 --> 00:19:48.280 And he's trying to buy, he's in effect buying more stuff than ultimately he can support. 240 00:19:48.280 --> 00:19:52.120 I mean, he's going to realize he doesn't have the bricks, ultimately. 241 00:19:52.120 --> 00:19:55.600 That he's engaged in a structure of consumption, in effect, 242 00:19:55.600 --> 00:20:00.040 that is not compatible with his real wealth position. 243 00:20:00.040 --> 00:20:05.040 but that he has overestimated because of these inflated asset prices. 244 00:20:05.040 --> 00:20:10.040 Now it's often said that what we need therefore is to prevent this sort of thing from happening again 245 00:20:10.040 --> 00:20:16.040 is more regulation of the economy. We can't have deregulation, we need more regulation. 246 00:20:16.040 --> 00:20:23.040 Now this is tricky because when you have a government system, and I take the Federal Reserve system that we have now 247 00:20:23.040 --> 00:20:29.040 as being a government system because the Federal Reserve has a government-granted monopoly on the money supply. 248 00:20:29.040 --> 00:20:34.840 It was created by the government, the whole thing is ultimately backstopped by the government. 249 00:20:34.840 --> 00:20:40.400 So when you have a system like this, it's not always clear whether so-called deregulation 250 00:20:40.400 --> 00:20:42.300 is the right thing to do. 251 00:20:42.300 --> 00:20:46.640 Because let's say you've got a government-granted monopoly of some good, but the government 252 00:20:46.640 --> 00:20:51.000 also says that as a condition of holding this monopoly, you can't raise the price above 253 00:20:51.000 --> 00:20:53.720 X dollars of your good. 254 00:20:53.720 --> 00:20:58.360 Well let's say that in the name of deregulation, we say, okay, never mind, the monopoly can 255 00:20:58.360 --> 00:21:02.360 You can charge whatever it wants, but it can continue to be a government monopoly. 256 00:21:02.360 --> 00:21:04.360 Well, would that necessarily be a step forward? 257 00:21:04.360 --> 00:21:07.360 Okay, so it's tricky when you have the government involved. 258 00:21:07.360 --> 00:21:14.360 It could be that either you get rid of all of it, you get rid of the monopoly and the price control, 259 00:21:14.360 --> 00:21:18.360 or you don't get rid of any of it, because maybe getting rid of just a portion makes things worse. 260 00:21:18.360 --> 00:21:20.360 It's not always clear. 261 00:21:20.360 --> 00:21:26.880 One could make a case that you need some type of regulation to deal with all the rotten 262 00:21:26.880 --> 00:21:31.120 consequences of the system we have now. One could at least make that argument. My own 263 00:21:31.120 --> 00:21:36.640 opinion of the subject is that regulation, deregulation, though, in this particular case 264 00:21:36.640 --> 00:21:41.120 is by and large a red herring, that I don't think that there are things that were going 265 00:21:41.120 --> 00:21:47.840 on on Wall Street and with banks that couldn't have gone on in the absence of any of this 266 00:21:47.840 --> 00:22:17.840 on the regulation front, I'm suggesting that we're sort of missing the point here, because we look at what the Federal Reserve causes, it causes moral hazard, because everybody knows that there's no physical constraint on how much money it can create, so in the last resort, anybody can be bailed out, or Fannie and Freddie can have its crummy securities purchased in huge, gigantic numbers, because you can just create the money. 267 00:22:17.840 --> 00:22:25.840 Alan Greenspan put when Alan Greenspan was Fed Chairman, people sort of took for granted that, well, you know, old Alan will bail you out one way or another. 268 00:22:25.840 --> 00:22:32.840 We have asset bubbles that are accentuated by the current system. We have distortions of the structure of production. 269 00:22:32.840 --> 00:22:40.840 We're directing investment spending into an unsustainable pattern. We're artificially encouraging debt finance for business and consumers alike. 270 00:22:40.840 --> 00:22:45.840 I mean, when credit can be created out of thin air, it's not a surprise that people use more of it. 271 00:22:45.840 --> 00:22:55.840 So we have this totally unstable, crazy system, and what's being recommended to us is, well, let's keep this crazy system, but let's run around like lunatics trying to regulate it. 272 00:22:55.840 --> 00:23:08.840 Well, this is sort of missing the point. It's the system itself is the problem. I mean, it would be like having a dam, but the dam is made out of, like, you know, paper mache or something, and saying, gosh, this dam is always springing a leak. We've got to just run around. 273 00:23:08.840 --> 00:23:12.840 Well, you know, why don't you build it out of concrete or something? Then you won't have this problem. 274 00:23:12.840 --> 00:23:22.840 Mises in effect put his finger on it when he said that one intervention into the market economy winds up causing problems, supposedly unforeseen problems, 275 00:23:22.840 --> 00:23:27.840 and so therefore there are calls for further interventions to correct the problems caused by the first intervention. 276 00:23:27.840 --> 00:23:35.840 So you get further and further in and you never consider the prospect that maybe it was the initial intervention that was the problem. 277 00:23:35.840 --> 00:23:43.480 In fact, Guido Hulsman, who I think is one of the great intellectuals of the Austrian 278 00:23:43.480 --> 00:23:50.040 School, in his book, The Ethics of Money Production, a book I highly recommend, he says this. 279 00:23:50.040 --> 00:23:51.160 He begins with a concession. 280 00:23:51.160 --> 00:23:55.300 He says, the banks must keep certain minimum amounts of equity and reserves. 281 00:23:55.300 --> 00:23:58.560 They must observe a great number of rules in granting credit. 282 00:23:58.560 --> 00:24:01.920 Their executives must have certain qualifications and so on. 283 00:24:01.920 --> 00:24:06.020 Yet these stipulations trim the branches without attacking the root. 284 00:24:06.020 --> 00:24:10.960 They seek to curb certain known excesses that spring from moral hazard, but they do not 285 00:24:10.960 --> 00:24:13.500 eradicate moral hazard itself. 286 00:24:13.500 --> 00:24:17.760 As we have seen, moral hazard is implied in the very existence of paper money. 287 00:24:17.760 --> 00:24:22.340 Because a paper money producer can bail out virtually anybody, the citizens become reckless 288 00:24:22.340 --> 00:24:23.880 in their speculations. 289 00:24:23.880 --> 00:24:28.400 They count on him to bail them out, especially when many other people do the same thing. 290 00:24:28.400 --> 00:24:33.620 To fight such behavior effectively, one must abolish paper money. 291 00:24:33.620 --> 00:24:37.700 Regulations merely drive the reckless behavior into new channels. 292 00:24:37.700 --> 00:24:42.480 One might advocate the pragmatic stance of fighting moral hazard on an ad hoc basis wherever 293 00:24:42.480 --> 00:24:43.580 it shows up. 294 00:24:43.580 --> 00:24:48.380 Thus, one would regulate one industry after another until the entire economy is caught 295 00:24:48.380 --> 00:24:51.220 up in a web of micro-regulations. 296 00:24:51.220 --> 00:24:58.340 This would, of course, provide some sort of order, but it would be the order of a cemetery. 297 00:24:58.340 --> 00:25:02.340 Nobody could make any potentially reckless investment decisions anymore. 298 00:25:02.340 --> 00:25:05.500 Everything would have to follow rules set up by the legislature. 299 00:25:05.500 --> 00:25:10.780 In short, the only way to fight moral hazard without destroying its source, fiat inflation, 300 00:25:10.780 --> 00:25:16.420 is to subject the economy to a Soviet-style central plan. 301 00:25:16.420 --> 00:25:22.020 Now let me leave with one final point on the regulation matter and then just wrap it up. 302 00:25:22.020 --> 00:25:27.900 Jeffrey Friedman and Vladimir Krauss are in the process of writing a book on this subject. 303 00:25:27.900 --> 00:25:33.620 The subtitle is, How Reasonable Regulation Caused the Financial Crisis. 304 00:25:33.620 --> 00:25:35.720 We just need reasonable regulation. 305 00:25:35.720 --> 00:25:40.000 And part of their argument runs as follows, it argues that when you have regulators who 306 00:25:40.000 --> 00:25:47.360 say, okay, we have to have capital requirements, and we also want to control the type of investments 307 00:25:47.360 --> 00:25:48.920 that these institutions are making. 308 00:25:48.920 --> 00:25:54.960 So what they've done, what they did in this case was to privilege a particular type of 309 00:25:54.960 --> 00:25:55.960 security. 310 00:25:55.960 --> 00:26:01.120 Say, if you're holding a government-supported, sponsored enterprise security, like Fannie 311 00:26:01.120 --> 00:26:06.780 Mae, Freddie Mac, with the implicit government guarantee, you only have to hold $2 in capital 312 00:26:06.780 --> 00:26:12.840 for every $100 in these AA or AAA GSE bonds. 313 00:26:12.840 --> 00:26:17.200 But for regular mortgage loans, you have to hold $5 per $100. 314 00:26:17.200 --> 00:26:20.880 And for commercial loans, it's $10. 315 00:26:20.880 --> 00:26:25.800 So you're artificially encouraging this desire to get into this particular type of security. 316 00:26:25.800 --> 00:26:31.120 So you are forcing a herd mentality on the economy, and then when this particular type 317 00:26:31.120 --> 00:26:37.080 of security turns out to be not so safe after all, well, there's a massive problem. 318 00:26:37.080 --> 00:26:41.000 Whereas in the free market, what typically happens is that some people invest in one 319 00:26:41.000 --> 00:26:45.880 thing and some people hold other things and they have different assessments and forecasts 320 00:26:45.880 --> 00:26:50.220 of what they think is going to happen with each of these, and some lose and some gain. 321 00:26:50.220 --> 00:26:54.280 But when we artificially privilege one particular type of asset and then that asset, the bottom 322 00:26:54.280 --> 00:26:57.280 If something falls out, we can't stand around and say, 323 00:26:57.280 --> 00:26:59.280 Well, gee, I guess the free market just doesn't work. 324 00:26:59.280 --> 00:27:02.280 And so, I think that's also a relevant point. 325 00:27:02.280 --> 00:27:07.280 Well, I'm very sad, actually, to follow George Selgin and Gary North, 326 00:27:07.280 --> 00:27:11.280 because George Selgin gave like the greatest paper I've ever seen in my life, 327 00:27:11.280 --> 00:27:16.280 and then Gary North spontaneously comes up with funny things and just knows everything. 328 00:27:16.280 --> 00:27:18.280 So that sort of stinks. 329 00:27:18.280 --> 00:27:20.280 But he did say something though, and he said that, 330 00:27:20.280 --> 00:27:50.280 Automatically condemned as being right-wing and fringe, whatever, and I wonder what's so right-wing about thinking that maybe the government shouldn't have a magical money-creation machine, I mean, like, if you really want to fight against war, wouldn't that be, like, if you were on the left, wouldn't you want to go after the Fed? I don't know why this would be necessarily just a so-called right-wing thing, but I think now it's not, we're not going to have this problem so much anymore, because thanks to the Ron Paul campaign, the growth of the Mises Institute and the financial crisis itself, people looking around 331 00:27:50.280 --> 00:27:57.280 Well, we've got a generation of young economists coming up. I didn't get emails three years ago from people saying, 332 00:27:57.280 --> 00:28:01.280 Hey, I want to get a PhD in economics. What should I do? I'm getting these all the time. 333 00:28:01.280 --> 00:28:06.280 I refer them to other people who know more about economics departments than I do. But I'm getting this all the time. 334 00:28:06.280 --> 00:28:12.280 So what's going to happen when a quarter of the economics profession is Fed skeptical? Like, what happens then? 335 00:28:12.280 --> 00:28:18.280 And then, are you really going to say all these people are crazy? Well, I suppose, well, today I guess we say most of the economists are crazy. 336 00:28:18.280 --> 00:28:25.280 So it is possible to say that, but public opinion is changing. It's possible to talk about this issue. 337 00:28:25.280 --> 00:28:33.280 You can go on CNBC and ask, should the Fed be abolished? It's still considered a little bit out of bounds, but people talk about it. 338 00:28:33.280 --> 00:28:39.280 Smart people talk about it. And a lot of us here at the Mises Institute, we get thanked by you folks. 339 00:28:39.280 --> 00:28:43.280 You come up and say, hey, thanks for everything you're doing. But the thanks go in the other direction, 340 00:28:43.280 --> 00:28:48.880 and the other direction because you guys are out there spreading the word about this, you guys are listening, 341 00:28:48.880 --> 00:28:52.280 we're all looking for answers and we know where to find them. 342 00:28:52.280 --> 00:28:57.080 And I feel like now, for the first time, certainly in my lifetime, 343 00:28:57.080 --> 00:29:00.880 I feel like even though, you know, they have all the shills on the payroll 344 00:29:00.880 --> 00:29:04.480 and they have the media that supports them in a knee-jerk way, 345 00:29:04.480 --> 00:29:07.280 either out of ignorance or more sinister motives, 346 00:29:07.280 --> 00:29:11.180 the point is that our numbers are growing, I think theirs are stagnating, 347 00:29:11.180 --> 00:29:15.980 And for the first time, I think we can say, we've got them right where we want them. 348 00:29:15.980 --> 00:29:18.980 So let's push forward. Thank you very much.