Destructive Myths About Money, Interest Rates and Business Cycles

0:00Given the time limits, I'm only going to talk about two destructive myths, but they're extremely dangerous and destructive, and they currently guide Federal Reserve policy. The relationship among money, interest rates and business cycles is and has been for centuries the subject of countless myths. So pervasive had these myths become that eventually a special term, monetary cranks, was invented to designate their fabricators. Despite the fact that these dangerous myths had been refuted time and again by economists beginning in the 18th century, many have persisted to our day while new ones continue to crop up and take root at a dizzying pace. The persistence of the mythology of money in the contemporary world is mainly attributable to the fact that it serves the purpose of governments because it obscures from their citizens the destructive effects of the absolute monopoly of the money supply possessed by their central banks.

1:00Since World War II, the economics profession, which like paper fiat money is also largely a creation of government intervention, has been complicitous in formulating and disseminating myths about money to the public. Thus, monetary crankism eventually gained academic respectability under the name of macroeconomics, whose modern practitioners have refined, systematized and added to the body of monetary myths. The most prolific and persuasive fabricator of monetary myths in the 20th century was John Maynard Keynes. Not coincidentally, Keynes is the acknowledged founder of macroeconomics, and his major work was entitled The General Theory of Money, Interest and Employment.

1:46The absence of the word prices in the title is significant, as is the absence of any discussion of the function of the price system in the text. For as Murray Rothbard pointed out, the hallmark, and I'm quoting Murray Rothbard, the hallmark of crackpot economics is an analysis that somehow leaves out prices and talks only about such aggregates as income, spending and unemployment." It is therefore no surprise or accident that Keynes included a chapter in the general theory in which he explicitly praised the crackpot ideas on money, interest and depression put forth over the ages by mercantilists, medieval supporters of usury laws against interest, underconsumption theorists and above all assorted monetary cranks of the late 19th and early 20th century.

2:35One of the latter was named Silvio Jessel, who had proposed stamped money that would automatically lose a fixed percentage of its value every month, unless its holder paid the government a tax for a monthly stamp on each note. This scheme, Jessel believed, would encourage people to treat money like rotting vegetables and try to get rid of it by spending it quickly rather than saving it. Keynes anointed Jessel as a, quote, strange unduly neglected prophet, unquote. The great American economic journalist, Henry Hazlitt, referred to Keynes' exaltation of such ideas as the canonization of the cranks, unquote. Ludwig von Mises perceptively characterized the main idea of monetary crankism.

3:21Mises noted that most people unfamiliar with economic theory believe that credit expansion and an increase in the quantity of money in circulation are good means for lowering the rate of interest permanently below what height it would attain on a non-manipulated capital and loan market. Okay, and I was quoting Mises there. Monetary cranks seemingly go further, but Mises pointed out, they are only more consistent than other people are. They want to reduce the rate of interest to zero and thus abolish altogether the scarcity of capital. All the arguments advance in favor of the thesis that the rate of interest can be reduced by credit expansion from 5% or 4% to 3% or 2% are equally valid for reduction to zero.

4:07The monetary cranks are certainly right from the point of view of the monetary fallacies approved by popular opinion." So they're simply more consistent than people like Alan Greenspan that want to lower the rate to some neutral level. Regarding Keynes, Mises wrote, his teachings were even more contradictory than those of his predecessors who were dismissed as monetary cranks. He merely knew how to cloak the plea for inflation and credit expansion in the sophisticated terminology of mathematical economics. Mises' characterization of the basic idea of the monetary cranks, especially Keynes, is a good description of one of the main goals of the current research program of modern macroeconomics, which is to discover a formula for a so-called neutral interest rate.

4:52This magic formula will supposedly guide central banks in continually readjusting and fine-tuning the structure of interest rates to ensure a low inflation rate and a very low or natural rate of unemployment. Okay, now this type of monetary crankism is much more dangerous than the older kind because this type of monetary crankism, under the guise of modern macroeconomic theory, guides the policies of all central banks, okay? Okay, unfortunately, the academic myth-making seems to have been effective in misleading the public into supporting an unsound and exploitative monetary system based on monopoly central banks. It is thus imperative to relentlessly expose and refute the most dangerous monetary myths in order to alert the public to the destruction caused to their living standards and wealth and to the overall economy by the cycle of inflation, financial crisis and recession that inevitably results from the political monopoly of the money supply.

5:59Okay, so here are two of the most dangerous prevailing myths about money. One's old, one's new, and I'll give you a short analysis of why they are not true.

6:12The first myth, myth number one, is that low interest rates are necessary to stimulate investment, prevent recession and keep the economy growing. This is the ancient and undying myth that is at the heart of monetary crankism and modern macroeconomics. This is Paul Krugman economics. The intellectual case for this myth was clearly and definitively demolished by the Austrian theory of the business cycle, which was developed by Mises and Friedrich von Hayek in the early 20th century. And yet it remains entrenched in modern macroeconomics and drives the policies of all modern central banks. But why is this considered to be a myth? Is it not true that lower interest rates induce greater investment in the economy and therefore more rapid rate of economic growth?

7:03Is it not also true that the Fed and other central banks can permanently maintain interest rates at some low, neutral level that is consistent with a high rate of investment, full employment and rapid growth in the economy with a low rate of inflation? The answer to the latter two questions is a resounding no. These questions are based on fallacies that were long ago refuted by Mises, Hayek and other Austrian business cycle theorists. To begin with, and contrary to what macroeconomics from Keynes to Paul Krugman contend, a fall in interest rates does not cause an increase in investment. Rather, the basic or pure interest rate and the quantity of investment are together determined by people's time preferences, or the degree to which they prefer consumption goods in the present or near future to consumption goods of the same quantity and quality in the more remote future.

7:54All other things equal. When people's time preferences fall, the difference between the value they attach to a satisfaction in the present and to the same satisfaction in the future also falls. As a result, the proportion of income they spend on current consumption decreases, while the proportion of income they voluntarily save for the future increases. So, if someone faces the prospect of a child going to college with the accompanying huge expenses, as I have found out this year, their time preferences fall. They begin in advance to begin to save more for consumption that goes along with sending a child to college. And they cut back on what they spend on entertainment and so on at the present.

8:40In any case, this fall in the overall consumption saving ratio, an increase in voluntary savings to be allocated to future consumption results in more funds available for investment by business and a lower interest rate. Thus, the interest rate gauges the degree to which people prefer a means of satisfaction available today to an equal means of satisfaction available in the future. Let me make this very concrete. For instance, if the pure interest rate is 5% per year, It implies that, in general, people consider the sum of dollars available today to be five percent more valuable than the same sum available one year from now. Now, if people suddenly re-evaluate the difference in value between goods available at different times, because they're saving for their retirement, or to send their child to college, or to buy eventually, let's say, a boat, for any of these reasons, okay, once that happens they'll begin to save more, they'll begin to shift more of their income into the future to buy consumer goods in the future. This does not damage the economy

9:40it does not cut down on spending that send us into a recession. So let me reiterate then that the quantity of voluntary savings and investment and the pure interest rate are co-determined by people's subjective time preferences, how they feel about present versus future satisfaction. The interest rate is therefore a ratio of market Prices of Consumer Goods, which are separated in time. Now this brings us to the second question of whether the Fed is able to peg the interest rate at some allegedly optimum non-market level. The Fed can certainly peg an interest rate, such as the Fed funds rate, which it does today, which is the rate on overnight loans between banks, in the same way that a city council can peg rents or Congress can peg gasoline prices below their market clearing levels.

10:27In both cases, of course, both sound theory and Bitter Historical Experience teaches us that an attempt to politically manipulate market prices results in nullifying their rationing function, causing persistent shortages and causing the distortion of economic calculation. The artificially lowered prices of gasoline or rental housing lead entrepreneurs to misallocate resources to the production of lower valued goods in other industries despite severe shortages of the price control product. Likewise, when the Fed pegs an interest rate below the natural rate consistent with social time preferences and the availability of voluntary savings, it causes a similar distortion of economic calculation. The misallocation of scarce resources is much more pervasive than in the case of the pegging of a particular commodity price, however, because the interest rate is the ratio of all present and future commodity prices and figures into and falsifies profit calculations throughout the entire economy.

11:28The only means by which the Fed can control the Fed funds rate is by the continual injecting of new bank reserves into the economy. In lending out these new reserves, the fractional reserve banking system creates new money out of thin air in the form of checkable deposits. At the same time, in order to find borrowers for these newly created loanable funds, the banks lower the structure of interest rates on credit markets below the natural rate, which is consistent with voluntary savings. This expansion of bank credit and the money supply and the artificial lowering of interest rates stimulates an unsustainable investment boom, since most of the additional credit is borrowed by business. Eventually, when the interest rates rise, and they typically do, the crisis typically occurs when the Fed, facing accelerating inflation of consumer prices or perhaps an expanding real estate or financial bubble, brings the expansion of Credit to a Screeching Halt. In so doing, the Fed is forced to stop taking its short-run interest rate and finally release the interest rate to rise back towards the level dictated

12:31by people's choices about present and future consumption. As entrepreneurs recalculate their previous investment plans and projects with these higher interest rates, the malinvestments of the boom are revealed and liquidated and we have a depression. So to sum up that myth, low interest rates, contrary to the myth that low interest rates spur investment and economic growth, when the Fed attempts to depress interest rates and keep them low, thinking that it can increase the amount of investment in the economy, what it does is to act in defiance of what people really want in terms of present and future. And the additional investments that are undertaken based on this counterfeit credit eventually really squander scarce resources and lead to depression.

13:19Let me get to the second myth. The second myth is the new myth. It is no longer possible to meaningfully measure the money supply. Now, after the inflationary decade of the 1970s and early 1980s, it seemed that the economic profession, businessmen and investors, and even the public at large, were beginning to disabuse themselves of myth number one. They were beginning to understand that low interest rates were not the royal road to to Vigorous Growth, but the downward path to chronic inflationary recession. They were also beginning to dimly perceive that interest rates were really a market phenomenon beyond the control of central banks, which could only exercise control over the supply of paper money, which they monopolized.

14:04As evidence of this intellectual revolution, the peculiar kind of monetary crankism embodied and post-war Keynesian macroeconomics was in headlong retreat by the late 1970s, so Keynesian macroeconomics is falling apart. Unfortunately, in the late 1980s, a new myth gained currency that permitted a return to interest rate manipulation by the Fed that we still have today. Not surprisingly, the emergence of this myth coincided with the revival of Keynes' ideas and was disguised as a new brand of macroeconomics known as the new Keynesianism. The most prominent proponent of this myth was none other than the maestro of monetary cranks himself, Alan Greenspan. In the early 1990s, Greenspan revealed that for years the Fed had been unable to control or even accurately measure the money supply.

14:55Greenspan even maintained that the very notion that it was possible to measure and control money was, quote, outdated. Now instead of getting tossed out of his job on his ear for gross ineptitude or an advance for Greenspan's case of dementia, for if the Fed can count and control anything, it certainly can count and control the number of dollars it itself creates. Leading macroeconomists and financial pundits praised Greenspan's profound insight and honesty. Shortly thereafter, Greenspan announced that the Fed was going to give less weight to the monetary aggregate, so it weren't going to worry about how much the supply of money was increasing. And one prominent macroeconomic writer named Alan Greenspan, who had also worked as a Fed vice chairman, pointed out that Greenspan's remarks were greeted with yawns in both academia and the financial market because it was old news.

15:51Macroeconomics was also saying things like, or had already been saying that there would be no, that there is no possibility of measuring and controlling the money supply. Okay, now is that true, okay, that the money supply cannot be meaningfully controlled? What reasons they give that it could not be? And I only have a few minutes, so I will sum them up. Basically, there were a lot of financial innovations in the late 70s, early 1980s. We had the creation of many new financial assets like money market mutual funds, short-term certificates of deposits, sweep accounts, now accounts, okay, and so on. and supposedly now all of these things performed to some extent the different functions of money. So now we could never really tell anymore, it was said, what really was money in the economy.

16:40So the Fed now was producing four or five different measures of the money supply. This myth that the supply of dollars in the economy cannot be meaningfully quantified and compared over time, of course, does one thing. It stops outside observers from monitoring the Fed and figuring out whether and to what extent the Fed's policy is inflationary. It also gives the Fed a new scientific rationale for once again indulging in manipulating interest rates. Now, what's the Fed's incentive to manipulate interest rates? Well, the reason why the Fed pegs interest rates at artificially low levels is its eagerness to serve the interests of its political masters by monetizing their huge budget deficits to pay for their wars and so on and maintaining a cheap money policy that stimulates and subsidizes not the whole economy but interests sensitive sectors of the economy that typically comprise politically connected firms and unions like energy, steel, construction, auto and investment banking.

17:43I'm excusing myself, five minutes? Four minutes, thank you Mark. See, I can count on, like, Greenspan. I can add up fingers. Okay. Well, to make a long story short, Austrian economists show that this is all hokum. This is a total myth that the money supply cannot be measured. The money supply is stated in common units. Those common units are the dollar. Those dollars that exist in currency that you have in your purses and wallets can certainly be added together. That's known as currency. Also, those immediate claims to obtaining dollars that you own, which are your checking accounts and your savings accounts, also can be added together. They're also stated in terms of dollars. There is no mystery about adding up money.

18:33The other things that you own, things like money market mutual funds, certificates of deposit, corporate bonds and so on, they can help you economize on the amount of money you hold. The fact that you own money market mutual funds or corporate bonds that can easily be sold off and redeemed or sold for money. They allow you to economize and reduce your demand for money, but they're not part of the supply of money. Why? Because they have to be sold for money before you can use the money to spend. As Austrian economists point out, the money supply is simply the general medium of exchange. of Exchange. Anything that is acceptable in exchange or anything that you can redeem safely and immediately for dollars to exchange is part of the money supply. And every Thursday at 4.30, the Fed receives reports that allows it to quantify what the money supply was in the economy, what the different accounts, how many dollars were in different accounts from the previous week's Monday, okay?

19:36So let me sum up. There is a single supply of money in the economy. It can be measured. It is composed of concrete units that are stated in a common denominator. So there is a complete fabricated myth that the money supply cannot be meaningfully measured. Now let me just end by saying one other thing. The myth that the money supply cannot meaningfully be measured directly contradicts the entire method of macroeconomics, which is based on the claim that almost anything can be aggregated. Macroeconomists aggregate or add together into one figure, which is called the GDP, we all see this coming out every quarter, the entire output of the U.S. economy, despite the fact that there is no common unit available for adding together personal computers, Shaquille O'Neal's basketball services, McDonald's hamburgers, Barry Manilow Macroeconomics claims to meaningfully calculate an aggregate price level and an inflation rate for the entire economy, despite the fact that each household in the American economy purchases a different collection or basket of goods, the prices of which change at different or varying rates.

20:54So it is especially absurd and contradictory for the macroeconomics profession to claim that money, a good that is expressed in homogeneous units like dollars or pounds or euros, cannot be meaningfully aggregated, but such is the way of monetary cranks from ancient times to the present. Thank you.