[highlight type=”grey”]Transcription edited by Kenli S.[/highlight]
I’ll be following up a bit with what Henri spoke about this morning, so eloquently, I will touch on some of this issues relating to the central bank.
We’re in a mess. And I believe, as Henri pointed out, we’re in a mess primarily because of the central banks. I’ve become almost Marxian in having a uni-dimensional explanation for all things. For me, it’s money, it’s the central banks.
I’ve used this pitch before. When I was young, preachers would tell us that “money is the root of all evil!” You know and of course they meant an obsession with money or materialism is what leads people to making bad choices. Now I realize a good economist should understand government-controlled fiat money is the root of all economic evil and indeed many political problems. I think we can trace all of these problems to central banks.
So, there’s got to be some ways out. So what we’re going to do is look at:
- The global monetary system which is in the domain of the central banks; these monopoly, these institutions that exercise monopoly control over our money.
- And a fiat money system that we’ve never – a global, fiat money system that we’ve never – had before.
My email address is up there if anyone needs to contact me in the future or follow up on some questions here, feel free. I’m semi-retired. My intellectual and spiritual home is in Guatemala, at the Universidad Francisco Marroquín, which is perhaps the, or one of the most glorious educational institutions of the world, dedicated to the development of individuals, committed to a free and responsible society.
A society of free and responsible individuals, where all of our students, whether they are in architecture or medicine, economics or nursing, they all study Mises and Hayek. They all take 2 years of what we call Economic Processes and it’s all Mises and all Hayek.
So it’s an unusual place. It’s a wonderful place with wonderful people. It’s in a spectacular setting. If you have a chance to go to Guatemala, stop by. You’ll be most welcome to take a tour of the University. I also work a bit in India from time to time with my good friend Parth Shah. So that’s another place that I spend time.
Okay, so let’s look at the ‘Nature and Condition of Global Monetary System’ to see what it’s all about. Because this – what we have now – is what we could call monetary-central planning. Now, virtually every economist in the world, outside of those in Harvard, see the errors of central planning in terms of a generalized concept.
However, the same sorts of people that would see the faults of central-planning somehow overlook them when they are assessing the nature of monetary policy. Because what we have now is central -planning of the money supply. And more interesting, no economist, even those in France or in Harvard, would accept fixing the price of water; fixing the price of automobiles; or fixing the price of your lunch. They would reject that as a general concept.
But fixing interest rates? No problem! There is an amazing intellectual disconnect – it’s quite revealing. And in fact, my dearly departed Milton Friedman suffered from some of this same – I think myopia –when he took off his Microeconomic hat and put on his Macroeconomic hat; momentarily he became completely blind to some very important issues here.
Now, so central banks are basically overseeing this cartel of private commercial banks and they have a monopoly over currency issue. You’re all aware of that. We have a fractional reserve banking system where central banks are basically providing a very small fraction of total money supply. Most of the rest of the money supply is created through the loan process, credit creation from the private commercial banks. Now what we have for the first time in history is in infinitely elastic supply of money and it’s paper money; until there were two crimes, two monetary crimes, committed in the 20th century – both by American presidents.[alert style=”grey”]
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Franklin Delano Roosevelt made the private ownership of gold illegal. Illegal! A crime; a crime to own something, I mean, I don’t think it should be a crime to own a gun. It shouldn’t be a crime to own; but to own gold you could go to prison for an extended, I think it was a 10 year sentence. The fine was 10,000 dollars. And it was trying to wean the American economy and eventually then the global economy, unfortunately, off of the gold standard in other words, to allow the government to take over the control of money.
In fact this, without this, I think the development of a new deal and many of the disastrous consequences of the 20th century of the economic experiments might not have transpired. As long as people have gold it’s an escape from government or it was at that time as money and as an institution that existed. So we really lost a lot. I mean this was as fundamental as losing the right to free speech or something to my view.
And then, Richard Nixon! So what happened is that Roosevelt ended the use of gold as money and then Richard Nixon ended the linkage to the dollar of the dollar to gold, and thus the rest of the world came off of the gold standard because they were, in a sense, on a gold exchange standard with the dollar standard as sort of a intermediary. Richard Nixon repudiated that.
So in fact, the US Government has defaulted twice. These are formal defaults because they defaulted on their obligation to redeem dollars. This was a unilateral determination, in a court of law; this would be called a default. So don’t think the U.S. government is not willing, capable or able to default – they’ve done it before. And they may do it on their mountain of debt that we’re sitting on.
Now, so, what we can see is that we all know, I think here, that central banks were created as an instrument to support monarchies and imperialism. And today, central banks support democracy or democratic power acquisition, the acquisition of power through democracy and imperialism or you could call it neo-conservatism or you could call it drones killing innocent children in Pakistan. But without central bank policy, as it is today, you could not finance governments to do what they’re doing today – neither in Europe, nor in the U.S., nor in China, nor in Japan. Central bank policy is crucial for this fiscal misbehavior, this acute – this unsupportable, unsustainable, this frightening – accumulation of sovereign debt, that is on the verge of suffocating us.
Now so, what we’ve been through in the last years, since Alan Greenspan. I may ask them to turn the recording off for a minute because I want to tell you a secret. Alan Greenspan is not who you think he is. He was abducted by aliens. Up until 1997, Alan Greenspan was a responsible central banker. He followed the market, pretty much. He supplied the market with the liquidity, as the market required.
After 1997, which was a landmark moment when there was this financial disaster in East Asia. He was led in his beliefs by Robert Rubin, who was worried more about Goldman Sachs, than the rest of the world. Rubin convinced Greenspan, Greenspan – well actually, the aliens replaced him with a clone, so this is a pretty remarkable set of circumstances because the Alan Greenspan that exists; wherever he is, would never have gone along with this. Up until 1997 he would have said, “No, capital markets are stable, markets in general are stable. Markets don’t simply spin out of equilibrium on their own accord. There’s got to be something outside.” Anyway, the clone of Alan Greenspan, and his successor, embarked on this massive amount of monetary mischief, using logic that would not have passed muster when I was a graduate student.
One of my stories that I like to tell to groups like this, is that when I was a graduate student, I couldn’t raise my hand at the back of the monetary theory class and say, “Professor, I have an idea. I think that government should lower interest rates to below 1% to very close to zero; hold them there for many, many years; use them to finance government deficits that just run out of proportion and this will make everybody rich!” …because they would have called the police.
First they would have failed me from the class, thrown me out and then they would have called the police because they would have thought I was dangerous. To have an idea like that would have been sheer lunacy. Today, it’s conventional wisdom.
So, now we have this unconventional monetary policy that Henri described so well this morning that has generated a bond bubble. In other words by allowing those short and then long term interest rates to be pushed lower and lower and lower, they’ve triggered the mother of all bubbles: a sovereign debt bubble.
This is frightening and Henri and I spoke about it on the train from Paris yesterday. It’s terribly frightening. I don’t like to end my lectures on a sour note, but I’ve become extremely worried and conservatively pessimistic about the future of the global economy because of things are just so out of proportion now.
Now so what we then now look at are some alternative monetary systems. Of course we historically have had a commodity standard either gold or silver or both. In the past we have experience with free banking; I will discuss that in a moment. And then I’m going to end all this discussion on the crypto-currencies as our possible way out of all of this as a way of reforming it. So let’s look quickly here, because I think this lecture was meant to be longer than I’m allowed. So we’ve now got a global bubble.
Now this is what’s interesting. We look back in the post World War II period. We had localized or regional bubbles; there are many famous ones. Japan, in the 1980s was known as the bubble economy; it was very localized. It was a national bubble. It blew up in 1989; Japan had previously had more than three decades of 6% growth. It was the envy of the rest of the world. It was going to take over the world. It was going to take over the United States economy and then 1989, boom; it blew up in their face.
Japan has never recovered fully from that. Of course, you can’t feel sorry for the Japanese. If you go to Tokyo today it looks like they’re in pretty good shape. The good news is they got very rich during that period and they’ve been able to live off of that. But, they’ve never recovered to get beyond the long term average since the 1980s within about one and a half per cent of growth after 6% of growth. Then we have, for example, problems in East and Southeast Asia after 1997. The economies were booming, growing like crazy and they had a regional bubble… boom, it blows up in 1997.
In the U.S. we had a sectoral bubble; the dot com bubble that blew up in the end of the 1990s developing into the 1990s. Then we had a U.S. property bubble. We’ve never had a global bubble like the one we have now. It affects everyone. Greece is a microcosm for the global economy. And the problem is, whereas the E.U. or basically now the ECB and the Euro zone finance ministers might be able to sort out Greece—
though I don’t think they can because I don’t think they know how to do it. What they’ve been doing, I mean, it’s just a game! How did this pass intellectual credibility? They go in and trade pieces of paper to fix the problem; here are some Euros, here’s your bond. It’s fixed. Two weeks later, whoops, here are some long term bonds; we’ll trade them for your short term bonds. They’re just trading paper and it’s fixed. Nothing changes; they’re just handing pieces of paper around.
—Now they might be able to do that with Greece and they might be able to survive, but now every country in the world is looking more and more like Greece. Debt burden is the result; the country, it doesn’t matter whether it’s China, whether it’s the U.S., or whether it’s much of Europe, we’re seeing an unsupportable burden of sovereign debt, public sector debt.
Well, the end of the commodity standard is not the sole cause of this, but it is certainly a contributing factor because had there been a commodity standard, there would have to be adjustments.
You know in the past, when one government misbehaved; they printed too much money or they were excessive in their regulation, or providing too many subsidies, there would be costs to pay. They would cancel out flows or inflows; depending on what they did. There would be depreciating currency. There would be costs that would have to be paid and these costs would bring about adjustments.
Governments would have to change their policies and in a sense this is what happened in Greece. Greece was in the Euro zone; those mechanisms disappeared for Greece. The Greek government can misbehave all they wanted. They could keep running up larger and larger debts, expanding the public sector commitment, expanding the public sector employment, giving more and more benefits, without consequence; until they couldn’t.
Now the difference is, whereas this was somewhat localized, in the E.U. or Euro zone government been trying to sort it out, but haven’t done it. When you turn on a global stage, what we see is because the central bankers, this third point, all of them are behaving much the same. Twenty-four years ago, central bankers would be off doing their own thing for their own domestic need, okay? But now everyone is following the Fed. So these distortions that are being built into these economies aren’t being made apparent because they aren’t triggering these automatic adjustment responses that account for outflows and so on.
Except for today in India. Literally, India is one of the few places where we’re seeing very vivid evidence where these corruptive measures are forced on governments. Where the India ruby is collapsing and the Indian government is really almost on the verge of making some very tough decisions and I’m not saying that anyone likes them.
Especially since the old lady that runs the country, he looks like an old lady and acts like an old lady because he has no kahunas, that’s a Spanish term I use to say that his masculinity is in question, partly because he’s being dominated by a social democratic Italian woman who runs the country. So Prime Minister Singh has no capacity to make the right judgments in this regard, despite his undeserved credentials for what they did in the 1990s.
So we’re in a real mess here because we don’t have any limits on monetary policy or monetary misbehavior and all the central bankers are pretty much following with the Fed because they believe that they accept that sort of macroeconomic mumbo jumbo that the Fed is putting out. So this is what I was talking about; these disciplining pressures that would have emerged if central banks were acting according to their own domestic impulse. These things just are not present.
Now this confirms what Frank said at lunch today, “Anything that cannot go on forever; won’t.” Now it’ll go on and it’ll go on and then; it won’t! Now this is what happened during the great depression during the 1920s it was never going to end. The day before the markets crashed, there was no sense that it was going to happen. Literally from one day to the next it was going to go on forever. And then it didn’t. And this, the same was with the U.S. housing bubble, something more vivid for some of the people in the audience. Literally from one day to the next it happened that people don’t see it coming and it’s tragic.
Now eventually rising interest rates will burst this bubble. Interest rates cannot stay this low forever. I don’t know what’s going to trigger it. It could have been Detroit. I was somewhat hopeful that the failure of Detroit would be a signal. Okay, you know look, it’s time to call in these debts and start deleveraging to make a sensible retreat from public sector debt. It didn’t happen. So I’m even more pessimistic now. There was a missed opportunity.[alert style=”grey”]
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And an interesting thing is something will cause interest rates to drop and it most likely will be a panic. If people will start rushing to close out their short accounts, the global economy right now is awash with what we call the carry trade, the carry trade. The carry trade is where you borrow one asset at a lower price and then you, you’re basically taking a short position. So for example if you go buy a dollar at one and a half per cent you can work them into Indonesian Rupiah for eight per cent. Wow, so you’re making a fantastic carriage rate. So you’re borrowing an asset, converting it into another one and you’re earning this sort of arbitrage in a sense between that.
Now those things are going to be closed out sooner or later because if the exchange rate goes against you and you’re holding those Rupiah, and by the way the Rupiah is weakening substantially as we speak, then we could see a panic. And interest rates will go up. I think Henri and I agree it’s going to happen. I hope it doesn’t. I can’t be hopeful that it won’t happen because the whole discussion of the exit strategy from the unconventional monetary policy is unconventional. The same clowns that got us into the mess have got to get us out of it.
How can we have confidence, as Henri said, how can we have confidence in these people? They didn’t understand what the problem was because they let it happen. They didn’t interpret why it happened. And the fix is 180 degrees in the wrong direction from what they should have done. They should have let interest rates go up. They should have let asset prices go down. They should have cut public sector debt. They did the exact opposite of all these things.
How to best survive it? I don’t know. I really don’t. I know I would not like to move to a large urban area. That will be the most dangerous place to be if there’s a real financial meltdown. So I might be in Guatemala. I can eat bananas and papaya. They grow; you don’t have to wait for the politicians.
So, yes, how do we fix it? You have to start with the idea no monetary system is flawless. We know that. So the gold standard wasn’t flawless, but it was almost certainly better than the fiat money system we have today. In fact, a study by the U.S. central bank absolutely admitted that. Now in terms of the comparative flaws; the gold standard or free banking of good options are alternatives to our current central banks having a monopoly control over the fiat money system.
Now free banking is just a system whereby private commercial banks are not under the regulation of government. It’s a self-regulating mechanism; you don’t depend on deposit insurance from the government or any other outside authorities. And it performs probably better in terms of maintaining exchange rates if bank liabilities are converted into gold or silver as they were in the past. This would create opportunities for efficient currency arbitrage.
Now as I mentioned a moment ago, all the fiscal irresponsibility’s we see today depends upon central banks supporting them. Without the artificially low interest rates all this would be over. So that would be a massive improvement over what we have today. Then if we had restrictions on the ability of the central banks to push down interest rates, we wouldn’t be in this problem today! If interest rates had gone up, instead of down, we wouldn’t see the kind of problems we see today. There wouldn’t have been a meltdown because Lehman Brothers disappeared or Citibank.
Citibank could’ve and should’ve been broken up into smaller units, before the too big to fail banks began to fail. They control the much smaller proportion of total financial assets in the U.S. than they do now. Now they’re too humongous to fail. They’re frighteningly large now. They control a much larger fraction of total financial assets in the United States; and fewer of them controlling a much larger portion. So we would have been much better off. So what do we need? We need to have less government interference with private market activity.
Not many in the audience would disagree with that. Unless we have some spies and then maybe they’ll learn something. Market interactions tend to lead to efficient rules of governance. We would see this in free banking; banks would behave better if they knew they could fail. If they knew they had to depend on their reputation. And that can be done independent of any political authority. We would have competitive force for free banking during spontaneous order.
So these are the options I’ve looked at. The options I was going to review here; the current regime would be under fiat money, a commodity standard. How I talked about a commodity basket standard for example, so there are different ways to come up with that. Free banking, is probably a better approach and I don’t have enough time left to address that, that will have to be another lecture.
What we are facing is an insane situation. You know the popular definition of insanity is doing the same thing over and over and over and expecting it to turn out different the next time. This is what Henri pointed out, both the Keynesian and Bernanke accolades were saying,”Well, we just didn’t do enough of it.” You know if you’ll just let us do more. You know then Krugman said the stimulus wasn’t big enough. The deficit should have been much larger. And Bernanke said, “Well, just keep interest rates low just a little bit longer and we’ll get out of it.” This is just crazy.
Now the instability that we’re seeing is on a scale that is unimaginable. I never would have imagined we would get ourselves in such a terrible, disheartening set of conditions. And government is growing right along and, but, the rest of us are going to be paying a very high price.
How do we reform the monetary system? Don’t expect them to perform. I mean, why would central bankers want to reform the central banks? Why would politicians want to end bureaucrats? They don’t want to. Politicians and bureaucrats are beneficiaries. Private banks are beneficiaries. The private banks, I mean, if I didn’t know this story as well as I do, I would become a Marxist because what central banks have done; the central bank policy and this financial repression has been one of the most massive redistributions of resources from the productive class to the banking system.
We are seeing the financial annexation of our economy. Banks don’t want to lend money to industrialists, manufacturers and small businesses because they can make risk free, well not higher return, but, big returns on trading paper. Why take the risk of loaning it to someone? You have to get collateral from them. You have to check their background and that’s a very expensive and costly process. But if you just buy paper, you don’t have to hire all these employees to do so. Okay, well let me just end then.
Capitalism didn’t fail us. This was a monetary problem created by the central banks. So all of the problems we’ve gotten ourselves into, I can trace to these artificially low interest rates. These ultimately result in recession; you get this boom and then the bust in the classic Austrian business cycle framework.
We’ve got problems with deficit spending, more regulation, and regime uncertainty. This is what’s killing India right now. I think it is the uncertainty about what the economic and political regime will be in the future.
Thank you very much.[alert style=”grey”]
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[highlight type=”grey”]Transcription edited by Kenli S.[/highlight]