Problems in Cycle Theory

0:00So the subject of my lecture is problems in Austrian business cycle theory and it's slightly ambiguous because what I mean by this problem is in two senses, problem is that the Austrian business cycle theory deals with and then problems of the Austrian business cycle theory. Since I count myself as an Austrian economist, it's of course true that not all Austrian theories are problematic, only some of them are, but we'll start with the problem that Austrian business cycle theory is to deal with and as always in economics there are certain phenomena that we want to deal with and the phenomenon that we deal with in macroeconomics are one of the phenomena that we deal with is the evolution of the economy.

0:57Let's say here, I put on my macroeconomic hat and we have here the evolution of GDP, let's say in the course of time, and we see these observed data, of course, if you look at the actual statistics, it never looks like that night, it swings absolute, in fact, much more, but I'll neglect this here and take this idealized, snaky curve. And what we know of course, for theoretical reason, is that this curve is the resultant effect of several causes that operate independently of one another and compose to produce this effect. And now the question is, how do we interpret this here?

1:47So how do we interpret this here? What are these different causes that come into play? I will just talk about two fundamentally different approaches. According to one approach, we interpret this entire evolution as resulting from an equilibrium process. And in the other approach, we reckon that both equilibrium forces are the same, come into play, but there's also a disequilibrium component, so that at least in part the observed data result from disequilibrium. Now the problem with the equilibrium interpretation is the following. We have, let's say, such cases here, let's say we have something, let's say we have a Trothier, somewhere in between, let's say in 1929, and there's something like this, and then it goes on like this.

2:49So we have this phenomenon here, so how do we make sense out of this in terms of equilibrium, of an equilibrium interpretation? Well, we would have to say that all of this was planned, or that it resulted, for example, from cyclical movements or seasonal movements that we have in the economy. So at this point, GDP decreased, nominal GDP decreased very dramatically, but all of this was planned, people were anticipating it and in fact there's also no such thing as unemployment, people just left the factories and so on, hang out a little bit at home. Some people are starving, but that's not really starving, it's kind of a radical diet. All right, so that would be the coherent equilibrium interpretation of a general equilibrium theorist who says, well, all of the data that we observe are always resulting from a perfect equilibrium process would have to hold such an interpretation.

3:50But of course, we do not need to pursue this in any more detail since it is fatally absurd. I think from our own experiences we know that we constantly make errors and often things happen that we did not anticipate and often things did not turn out the way we wished them to turn out. Now, in all these cases then we have this equilibrium component, something happens that was not planned the way it turned out to be. And so we have the observed phenomena, observed data, resulting from both actions that produce the results that they were meant to produce and actions that did not produce the results that were meant to produce.

4:37So we have something like water plants, there are bankruptcies, unemployment, there are factories that are not used anymore, that's sent idle and so on. In other words, what we have in such cases as 1929 and other historical situations is a situation of clusters of errors, right?

5:05Clusters of errors. No need to admire my handwriting. So many entrepreneurs, many market participants, at more or less the same time and the problem that we face in cycle theory is to explain this or in a crisis theory is to explain this and as Professor Garrison and others pointed out that Professor Garrison in particular in his lecture, well what the Austrian theory does is to provide an explanation of these classes of errors. It's an explanation of how it comes to the crisis. So what does the Austrian theory So what I can do, I can be brief here, since we already, since you've been introduced this already, so what the Austrian theory says is, well, there is such a thing as a ranking of investment projects, right?

6:15These are more or less important. Of course, there is some subjectivism involved. It depends from individual to individual. But let's say if I abstract from all these individual differences, I would say, okay, by and large, what is most important for each individual is to stay alive. So food, certain marginal quantities of food tend to be pretty high. and then comes protection, something like this, so physical security and then clothing, housing and so on, always in terms of marginal units, that is after the first elementary unit of housing, then you get better, additional quantities of better food and so on, right? So in any case all these things have different importances and the question is, since we have a given amount of resources at our disposition, We cannot do all the things that we want to do, since I'm a great lover of gold, for example, I would like to drive a golden car, I would like to have a chauffeur, many other things, ultimately I'm not very materialistically oriented person, so golden car would be sufficient probably.

7:25and so the question is we have to cut short our resources are limited and at some point we have to draw the line they'll say all these things we use our resources to attain all these things and we renounce to these other things now that holds true both at the individual level and at the level of society at the level of society in the market economy the line is drawn by the market process Entrepreneurs compete on the market for factors of production and they buy these factors of production, use them for projects that aim at the satisfaction of consumer desires. The whole pricing, as Professor Salerno has explained, at least I hope he has explained it, It starts from the prices that consumers are supposedly ready to pay for the consumer's goods that we as entrepreneurs will offer them.

8:28And in the light of this estimate, in the light of what we believe consumers will pay for the factors of production, we go to the factor markets and buy factors of production. And in this buying process, for factors of production, we are in competition with other entrepreneurs who also want to make money. That prevents prices of useful resources from falling to zero. In particular, that prevents wages from ever falling to zero because labor, human labor, is the one ingredient that we need for all production processes. And as a consequence of this entrepreneurial market process, all resources, all factors of production that we have at our disposition are used and brought into play.

9:14Now, entrepreneurs in a market economy buy the factors of production with money and part of the money that they use or these buying activities in this market process is provided through the credit market, through the credit process. Now, the following thing can happen if you have, for example, a fractional reserve banking system. The banks have some leeway to increase the quantity of money substitutes. For example, they can give you a credit line, provide you with a deposit account out of nothing. It does not come out of savings.

9:59In this case, then you have additional quantities of money substitutes at your disposition. In this position, the entrepreneur who gets them can appear with these money substitutes on the factor markets and by factors of production. Now what the Austrian theory says is, if the entrepreneurs do not anticipate the consequences that the higher quantity of money will have on prices, what will be the consequence? and if the quantity of money increases, prices will increase, sooner or later in the future prices will increase. So what will happen in particular, the prices of consumer goods will increase. So if we had an equilibrium process, what would happen is that the entrepreneurs would say, okay, there is inflation going on, as a consequence the prices of consumer goods in the future will be higher than they would have been otherwise.

10:53and so we can offer higher prices for factors of production. I always think that they are in competition with the other entrepreneurs. So their interest is to bid as high as possible, as low as possible, but if necessary higher in any case than the other entrepreneurs in order to make themselves the buck rather than let the other entrepreneurs do it. So they bid up factor prices and that's If we have an equilibrium process, nothing will change, that is, we will have some redistribution, I cannot go into detail talking about this, will be some redistribution, other projects will be pursued, etc., but by and large, the line would remain at the same level as before, and all that would happen is that the whole process takes place at a higher level of prices.

11:41Factors of production are bought at higher prices, but the products are sold also at higher prices. Now what the Austrian business cycle theory said is, if entrepreneurs do not anticipate this, then entrepreneurs will now, in their calculus, perceive some investment project as being feasible, as being profitable, that would not have been, appear to be profitable otherwise. So the additional quantity of money is not offered on the credit market, the interest rate is lower than it would otherwise have been. So there's the quantity of credit, so we have a shift of the supply curve, and as a consequence the interest rate is lower than it otherwise would have been.

12:38Now, in the entrepreneurial calculus, certain projects appear to be profitable. That is, let's say number 6 and 7 also appear to be profitable and thus feasible, but they are really not. Why are they not? Well, because it is still so that the quantity of real resources that we use in the investment project has not increased. All that has increased is the quantity of money. So in fact, what we have in such a situation is the error. The error is inherent in the situation from the very outset, from the very moment the entrepreneur set out to start additional investment projects that cannot be all realized. Now notice that it's not a central point, but notice that, of course, this is a simplified account of the whole situation.

13:32This is not necessarily the case that in the later busts then, the project six and seven will be abandoned. Think of the example that Professor Garrison has given. You have the house builder, five houses could be built in equilibrium. And then we suddenly start trying to build seven houses and then we go for a while until we discover that with what is rest then of the brick material, does not mean that then finally we'll choose to realize what is here what would in a normal situation equilibrium situation have been number one two three four it might very well be the case that we decide to complete the houses number one two six seven could also be so there's no necessity there the point is we cannot do all these things because our physical resources are limited Okay, now, what take does this theory give us on the data, on the interpretation of the data?

14:42Okay, let me go back to my diagram. This is what we observe in the real world, that's the actual factual record that we observe. And so there are these discontinuities at this point here, at this point, and here, and here, and here.

15:40Now that's the real record, and here we have, thank you, so that you can all enjoy this, okay. So this is nominal GDP, this is real GDP. In nominal GDP, we have the following situation.

16:27Okay, something like this. And now these dots are connected.

16:37So this is in fact the record that we observed that is a calculated record because it's assumed to be real data. So we have here our nice business, stylized business cycle in GDP. So what does this mean? Here the quantity of money increases and it's not anticipated. So people start investing in resources, in projects that cannot be completed. that would not have been chosen if we had not mass error on the side of entrepreneurs. What that means is that economic growth is smaller than it would otherwise have been. We would have had this growth curve, in fact, but we are on this one.

17:29So you see, if we just look at the data we observe, well, in real terms, The data that we get from the statistical bureau and so on, actually might show a small increase in economic growth. Well, that's not the relevant consideration. The relevant consideration is, could our growth have been higher than that? And it would have been much higher, had it not been for the wasting of resources, for the misallocation of resources, due to the influx of the additional money quantities. okay so growth would have here been higher but it is lower as a consequence of the misallocation of resources now comes to bust right now comes to bust at one point entrepreneurs realize huh right we cannot go on as before it's impossible to complete all these projects that we have started so we've got to cut short somewhere draw the line anew right think of the house example So again, in the equilibrium process, we could have built five houses, now we started out to build six, and at that point we realized, well that's not possible to complete all the six, we go on with four, and in fact we complete four, so now, in fact, in the bust phase then, the GDP declines, nominal GDP declines, the entrepreneurs realize what's going on, and they now decide to do

18:55with the resources what can be done with the resources that is they put them to the most effective use under given circumstances and here then we have real economic growth again right the bus phase here I've assumed also idealized that the bus phase is short could be a couple of weeks or a few months and then it goes on so we have real growth here in this phase and we again on a on the growth path until, what happens again, SIN sets in, the central bank increases the quantity of money or something like this, right, and again our entrepreneurs don't realize what's going on, they think that everything is good and fine, they set out for all these new investment projects, so again they are really misallocating resources, right, here it looks like a boom, prices rise, income rises, people go on a vacation, having nice and five-star restaurants and so on but in fact there as Mises said well they are burning the furniture and think they have found a great technique for

19:57heating. So this would have could have been our growth path but that is actually what we get so we impoverish ourselves relative to what we could have had and again so that's all of course a very nice scenario that I give here there are situations and historically many in many cases such situations have existed where you have absolute decline right so here it's a kind of a nice story and I put on this story because it's important to keep in mind that we are talking here about relative about a comparative consideration right it's not because we observe in the higher economic real economic growth rate that everything is in order the problem still persists we are in poverty impoverishing ourselves relative to what we could have attained and again at some point entrepreneurs realize what's going on there is a bust and how does this bust manifest itself well for example by a by a run on the on the fractional reserve banks by a deflationary process as it has been described by Irving

21:08Fischer and others and so on right and then again the bust is actually the So, the point of time...

21:44You see, I'm still far away from being a great artist, but I'm trying my best though. In any case you get the point. So here again the growth rate could have been higher and it remains lower than it would have been possible. So that's what the Austrian theory says. The further you get away from, you proceed in time, the lower is of course the growth rate that is at each point accessible to you.

22:41and accessible to you compared to what would have been accessible if we hadn't engaged in this knowledge from the very first place, so you can imagine what kind of real wealth our Western societies could have had if the Bank of England in 1844 had not obtained the monopoly of being the central bank of England, if in the United States the Federal Reserve system had not been established in 1913 and so on, or if we had not started fractional I would be pretty high up here, and we are there in fact. Capitalism has run an amok, as the leftists say, in the status in particular, only for a very short period of time. By and large, it coincided with the time of the, what we call the classical gold standard, which came into existence during the 1870s and then lasted, roughly speaking, until World War I.

23:41So there you had wild west capitalism and what you had, in fact, were enormous growth rates. That's the kind of story, if you just let it go on, that's the kind of thing that brings you very high up on a growth path. We instead have chosen to establish all these institutions, which are the institutional equivalent of stabbing oneself in the leg. Then go on and you think, oh, this is a great feeling, it's kind of a massage. And suddenly you look down, oh, there's this knife here, and then you take it out and it goes for a while and then you say, oh, again. So that's the Austrian story. So the important thing is again, this year we call this boom, and Professor Garrison has said, well it's actually an unsustainable period of growth.

24:35I feel uncomfortable about calling it growth at all, because we have to distinguish between unsustainable growth and real growth. For me growth is a little bit like being pregnant, either you are pregnant or you are not. and you're not unsustainably pregnant or pregnant, you are pregnant or not, so there is growth or not. This is not a period of growth, it is a period of absolute impoverishment, which is somehow concealed by the fact that due to the redistribution process that comes into being as the quantity of money is increased, the whole thing is somewhat concealed, some people in fact do get better off. Okay, so the boom is a misnomer, right? It's a period of illusion. It's a period during which we believe we are better off than we really are.

25:31Yeah, so now what's the problem in this scenario? Now turning to the problems of Austrian business, problems with Austrian business cycle theory. Well, one problem is that the theory, in the way Mises formulated it and Hayek developed it further on, was a little bit too mechanistic. It boiled down to an explanation of how error came about. So the claim was somehow that by increasing the quantity of money, we there, it's a factor, reduce the interest rate below the equilibrium interest rate. So again, let me draw this one diagram. We have here money and interest rate, shift of the supply curve, the influx of additional money, and then as of necessity, we get a lower interest rate.

26:34Now this, ladies and gentlemen, is not true, is not necessarily true, that an increase in the quantity of money, if so facto, leads to a decrease in the interest rate, that depends again on the expectations of the market participants. If entrepreneurs realize what's going on, if they know that the money that is offered on the credit market comes from an increase of the quantity of money. Alan Greenspan spent an extra night shift at the printing press. Next morning he pops up at the stock exchange or wherever else and then he offers all these new tickets. Well, the entrepreneurs know, oh, yes, Alan, well, he has had a hard night, the eyes are a little thin and so, yeah, they know what's going on. Okay, all right, so he's offering all this quantity of money now Now on the market, it will increase money prices below the level we would have expected otherwise.

27:37So what they will do, they will bid up interest rates. And because they can count on higher selling prices for their production processes in the future. What that means then is that also the demand curve shifts, right? And the interest rate will in any case be higher than it would otherwise have been. It might be, of course, there are various difficulties here, too, while guessing what is the right interest rate. It might be lower, but it might actually also be higher than the interest rate that would otherwise have come into existence. So there's no systematic reason to assume that in this scenario the interest rate will of necessity drop only because the quantity of money has increased.

28:22So, demand, the demand curve, the fundamental point is the demand curve and the supply curve are not necessarily independent of one another. In the case of most other goods, we can assume this with a good degree of confidence. In the case of money, this is much more problematic and actually we always refuse to believe this when we have a situation of hyperinflation, for example. What happens in a hyperinflation? Well, at the latest then, the market participants know that the purchasing power of money will decrease ever more. As a consequence, they will have a higher nominal demand for money. So they overcompensate.

29:07What you then observe in such a situation is that interest rates go up. We call this the price premium and so on. That's exactly the scenario that I have illustrated in this case. So again, the point is the story that Mises has offered, which Hayek has developed, is a little bit too mechanistic. It's not a theory of error, therefore it is not ultimately a theory of an explanation of the business cycle. and it does not explain really why it comes to the cluster of errors it starts from the assumption well and in this scenario people will not anticipate I will not realize what's going on but that is of course a petition of the principle and you assume to be true but would have to be explained in the first So, what's the way out? What can we do instead? We can pursue what I've called an essentialist approach, and rather than pursuing the question, what are the consequences of events in the material world on the quality of decision making of the entrepreneurs?

30:34of the entrepreneurs. We can raise the question, what are the institutions that are inherently inviolable and which error is so to say embedded? And I think there are such institutions which might then serve as our examples in the following discussion. The first one is fractional Fractional Reserve Banking, FRB. I will not go into much detail here because I have another lecture to give on this subject. But the point is what we do in fractional reserve banking is as I have explained the banker lends out a certain quantity of money tickets, money substitutes, not necessarily a form of bank notes but can also be bank deposits, which which are backed up by a smaller or much smaller reserve of money.

31:28So, for illustration purposes we can assume a reserve ratio of 1 to 10 and we illustrate this whole thing by an inverted pyramid. Now, where is the illusion, where is the inherent error in such a situation? Now the error is that the market participants believe they can rely at any moment on the use of 10 ounces of gold

32:01because they have tickets giving claim to 100 ounces of gold And it is of course clear that not all of them can have, can redeem their ticket into real gold at the same time, right? The whole thing is possible only because only a part of the market participant chooses at any instance to do this. So what we here have then is a dissociation of the beliefs of the market participants, the belief they can rely on 100 ounces of gold, right? In the aggregate, this belief informs their plan making, it therefore determines their behavior. The marginal utility of money, marginal value of money for each of these bank customers is lower than it would have been if the bank had not issued these tickets.

32:58The additional quantity of money is lower than the marginal value of each unit of money, therefore they tend to spend more of this money, therefore prices are higher than they would otherwise have been. Therefore the redistribution within society or the market process is different from what it would have been. So this whole business has a real impact on the market and it is in one important respect based on an illusion. Illusion that each of them has to be able to rely on the ownership of the aggregate, 100 ounces of gold whereas there are only really 10 ounces of gold there. Well, we know for fairly certain reasons that it must with great regularity come to awareness of this error and the point of time when it comes to awareness of this error of this illusion is the time of the bank run.

33:56For what happens in a bank run? Well, people say, oh, I might not get the money that my ticket gives me claim to. So they rush up and try to be first in line, because otherwise they might not get their money. And at that point then, the tickets become valueless. They're no more accepted, because there's no more confidence among the market participants that they can in fact be redeemed against gold. So, fractional reserve banking leads to this kind of cyclical movement without any consideration for inter-temporal misallocation of resources. We don't even have to go into the Austrian story, Mises and Hayek, Rothbard and so on, in order to arise such a movement.

34:46and Nominal GDP over time, and it increases because the quantity of money tickets increases, thus popping up the price level, and thus GDP in the course of time. And then here we have the bank run, and thus a great part of the quantity of money becomes valueless, namely all the money substitutes, quantity of money shrinks, nominal GDP shrinks, adaption phase, and then it goes on again when the banks again start issuing fractional reserve tickets, and that is by and large the pattern that we observed during several decades in the 19th century and when we did not have central banking. Okay.

35:37What we, what is the impact of the impact The Institution of Central Bank and of Fiat Money on the cyclical pattern Well, it's roughly speaking, it's the following Let's say we have here the 19th century until 1913 Now I'm talking about the US, right? Again, that's a simplified version of events, right? So we have this pattern Okay, and now here we have the establishment of the Federal Reserve. What happens So, what is due to the existence of the Federal Reserve? Well, we have a central bank, as we have pooling of our reserves, pooling of the money hoards, which allows the central institution to bail out individual banks that otherwise would have gone into bankruptcy, if they had relied only on themselves.

36:31So, what we get is an extension of the cycle and it becomes more violent, right? So the phases become longer, but also more violent, okay? Now, that is, so that would be, let's say, 1922, and that would be 1929. And then we have this long upswing, because what happened in 1944, well we have the establishment of an international central bank. The Federal Reserve became an international central bank.

37:18So we have reserves streaming in from other countries and you have no more exchange rate volatility which contributes to this scenario. so you have a very, very, very, very, very long upswing and it would have led to a terrible crash again, we're not talking about inter-temporal misallocation that's only about the fractional reserve principle it would have led to a crash of the bank around 1968, 1971 If we had not again changed institutions, which institutional innovation had we this time, well we abandoned banking altogether and we introduced money production.

38:06We dispensed the Federal Reserve with the necessity to redeem its tickets and allowed it just to go on printing money without redeeming it. And through this decision of President Nixon at the time, we had roughly, that was roughly the equivalent of what one could call economic transubstantiation. You know the Catholic doctrine of transubstantiation, the priest consecrates the wine and the bread and then it becomes the body and blood of Jesus Christ. So in this case, when President Nixon uttered his famous words, we close the gold window. The physical appearance was still the same, right? You still had the bank, right? The building.

38:52It looked very solid with columns and so on. Still the same bank written on it and so on. But it was no longer a bank. It was a money producer. A bank deals with money that it does not itself produce. But the Federal Reserve today is the money producer. It produces dollars. Dollars are no longer money substitutes, they are money. and the dollar bills themselves, talking about these pieces of art, this looks exactly the like, maybe not exactly the like, but roughly the same, to be confused alike, dollar ticket in 1967. What's the difference? Well the difference is the ticket in 1967 could be redeemed, not by you Americans and other lower beings of course, but by foreign central banks, After closing the gold window, the physical appearance is exactly the same, didn't change, but it's no longer money substitute, that is money.

39:59It's not a charming prospect, but that's how it is, and so we had then in 1971, this whole thing went further up still, and that's where we are roughly now, so we are still in the expansion path, And of course we know that although nominally everything gets higher, our incomes become higher, GDP grows and so on, well there's some discounting when we calculate real GDP and so on, but still, all these other things grow up, nominal quantities, but that is not growth, it's just inflation, the result of inflation. Okay, can it go on indefinitely? That's the interesting question. It's a question that Mises raises in The Theory of Money and Credit.

40:49Can this scenario go on indefinitely once we are on a fiat money standard? And I think there are good reasons to believe that it cannot. First of all, because we have a credit bubble. It has become possible through the institution of fiat money. and even governments are confronted with the necessity of paying back money, meanwhile of course they have for several years already abandoned the doctrine that debts need to be paid back, well in any case not by government, so there's a problem here, right, so enter the phase of moral hazard, that's very dangerous, but then of course you have also something, moral hazard works itself out not only in public debts but also in entrepreneurial behavior, Those with good connections to the central government, to the Federal Reserve, rely on these connections to be bailed out.

41:48That's something that we have observed in the past 10 years at several occasions. I think, for example, of the bailout of the Mexican government in 1974, long-term capital management, Several players involved in the Asian crisis of 1997 have been bailed out, not all of them, because you have to punish some, right? But so, I mean, this force, of course, what it does is to encourage overly risky behavior, this wasting of resources, and forces the central bank to engage ever more in bailing out, which can only be done by such an increase in the quantity of money that it comes to a hyperinflation. So that's one scenario that lies ahead of us. I don't say it's of necessity. There are several other scenarios also.

42:35For example, you can just regulate the whole economy as you regulate the banking sector, thus preventing overly risky investments. In the banking sector, we've done this in the past 70 years in all countries, all Western countries, but it might come also in the other sectors. Okay, but I will not go into this, so the point is only, this certainly cannot go on indefinitely, it will have a terrible ending, sooner or later. Okay, so now, our starting point was, whereas the illusion of fractional reserve banking, illusion of fractional reserve banking consists in the fact that the bank customers think in the aggregate, They can rely on higher quantities of a certain resource, money, than really exist in the economy.

43:27And that, sooner or later, becomes revealed as an error. So we get the cyclical pattern. But of course that's not the only institution, as I said, fiat money entails very similar consequences. Now that does not mean that the standard Austrian story, as we have heard it in Mises, Rothbard, Hayek, no longer applies, but it is just one part of the story. So the the cyclical pattern would exist independent of inter-temporal misallocation and story that is the subject matter of the traditional Austrian business cycle theory but this traditional theory still applies to certain cases and certainly applied to the 1920s great boom which ended in the great great depression so here we had a case of inter-temporal misallocation we can raise the question and that's an interesting subject maybe for doctoral dissertation and and so on, in how far the present investments in the welfare state would also count as inter-temporal misallocation of resources, right?

44:50Okay, further problems, a few remarks on other questions.

45:04The area which the Austrian business cycle theory is least enveloped is the bust phase. So we have really no, I mean the picture that we have of the bust phase is by far not as detailed as the one that we have of the phase that leads to the bust. Professor Garrison has emphasized that the Austrian theory is ultimately a theory of the crisis. How does it come to the crisis? Okay. So, I mean the bus phase is interesting and we have, it's probably worthwhile to take a closer look at this.

45:49Let me give you just one example why this could be interesting. In the account that Mises gives us, what happens in a bust if the banks, commercial banks, central banks, or maybe also the money producer, bail out the market participants. Now here, Mises tells us, well, they do not really solve the problem, they only amplify the problem. They pump more money into the economy, again reduce the interest rate below the equilibrium level, and thus increasing inter-temporal misallocations of resources. Now, in the light of what I've explained before, that is not necessarily true, right? It's not necessarily the case that this additional influx of money decreases the interest rate below the equilibrium level.

46:35What it certainly does is to bring about a distribution of resources different from the one they would otherwise have obtained. So what we certainly have in such a situation, and that's also what we can almost patently observe, And the empirical record, if you look at things like Mexican bailout, LTMC bailout and so on, is that we have bailouts. So some market participants are saved by the monetary authorities at the expense of all other owners of money whose money cash balances have now a lower purchasing power. So it's not necessarily the case that we have to say, well, what happens in such situations is that we amplify the problem that existed before.

47:21It could be, okay, we liquidate our investments in the midst of an increase of a quantity of money. Think of the last bust that we had at the end of 2001, when the stock market boom collapsed, certain investments had to be liquidated and were liquidated in the midst of an enormous increase of the quantity of money. I might leave okay so has this really amplified misallocation of resources I would say yes but not necessarily in the way Mises describes the process as an investment in additional projects commercial projects that are understandable I would rather say okay my impression is that the record is we have additional investments in welfare-safe projects we have bailing out of certain market participants and the bill is paid by the great majority of other cash balance holders so there are there seems to be a great variety of possibilities of what can happen in a bust and what we would need is the much more detailed theory of the bust that goes through case by case all the

48:45and various possible scenarios. That's also a very nice subject for a doctoral dissertation. Another problem that we, now I will conclude with this, is the problem of, well, how do we evaluate the meltdown, the financial meltdown, the deflation depression from a political point of view? In his lecture this morning, Professor Garrison has pointed out that, Well, it's a bad thing to let all these prices drop, and it's even worse if you try to prevent them from dropping. Once they are dropping, I try to reflate the economy. Now, I agree entirely with him on the second proposition.

49:31Once prices are in the process of dropping, it's very bad to re-inflate from another side, because you prevent this liquidation process, you prevent, in any case you make it much more difficult for entrepreneurs to act in this business environment which is characterized by the intervention of two violent scissors. On the one hand you drop off the market prices as a consequence of the inflation depression, on the other hand you have this huge influx of money, it's difficult to calculate the overall effect of these two things. and I would disagree with the first proposition that it is necessarily a bad thing that prices drop and that you have this meltdown and so I think that the meltdown has many charms in particular from a political perspective in that it threatens the positions of the economic power base so to say of the political establishment and I don't think that that is a cynical attitude I think it is It's a very realist and healthy attitude. It certainly brings about a very violent change of the elites.

50:43In a market economy, if you had a free society, democracy or any other political system, maybe no political system at all, elites would constantly change as the entrepreneurs in a market economy. Economy and only those who provide the consumers with the most important goods at any point of time stay in business all others go bankrupt and thus have to become employees again and in politics is very similar only the leadership that is really capable of leading making wise decisions and so on they stay so to say in business all others are crowded out what our present system does in particular not only the existence of fractional reserve banking but also the and the existence of fiat money is to entrench the positions of the present leadership.

51:35There's not enough fluctuation, not enough fresh wind coming in from competition. And what the deflation does is to cut the power base of these people. It brings about a violent decrease in the price level, destroys the debtor position of most of these people. There's no hope that they then can ever pay back their debts and so on. So they go bankrupt, and their creditors, many of their creditors with them, and I say that's not necessarily a bad thing, right, because this whole credit and well, relationship between creditor and debtor is in many ways only a nominal property layer over a layer of real factors of production that ultimately determine the well-being of a society In other words, it's not because we have a violent deflation that we are necessarily poor.

52:31It's not because prices drop dramatically that streets disappear and hotels and cars and factories and so on. These all still continue to exist and therefore they can be used, can continue to be used, even though their present owners and those who have given credit to them go bankrupt. And all that happens is that there's a new management, there are new owners, and they continue to manage these production facilities just as they have been let before. So the deflation is not a very, from a mere pure economic point of view, the deflation is not a great problem, it's not a great deal. It's a big problem from especially a political point of view, but I say that does not concern us very much here.

53:22and it is of course also a problem from a legal point of view but we had in the past we had such situations and even in countries such as Germany to the very bureaucratic legal apparatus they've been very flexible and have been able to accommodate this problem within a few months so there's no reason why the same thing should not happen in the US which relies to a much greater degree than Germany at the time on private arbitration and so on. I'll leave it at That's all for now. Thank you for watching.