Theory Meets Praxis: The Austrian Business Cycle Theory in Today's Economy

0:00Discussions of high theory among intellectuals will not by itself win the day for liberty. To convert others to the truth, theory must prove its merit and application. The Austrian School has a long tradition of public intellectuals who have dedicated themselves to bearing the fruit of Austrian thought. Men such as Ron Paul in politics, Benjamin Anderson in finance, and Henry Hazlitt in journalism. To commemorate their efforts, we offer the Henry Hazlitt Memorial Lecture. We are very pleased to have Mr. Sean Corrigan deliver this year's Hazlitt Memorial Lecture. Mr. Corrigan received his M.A. in natural sciences at Magdalen College, Cambridge, before doing postgraduate work on aerospace structural engineering at Cranford Institute of Technology.

0:49He started as a financial trader in the city of London as the Japanese bubble was expanding In the mid-1990s, Mr. Corrigan became head of G7 Market Strategy and Research at a major independent London research house. With his partner, Judy Matthews, Mr. Corrigan founded Capital Insight in 1999. Capital Insight is an economic and financial market advisory service based on Austrian economics. Economics. He is an advisor to the Eidelweiss fund run from Zurich by another devotee of Murray Rothbard and a regular contributor to lewrockwell.com and mises.org. Mr. Corrigan's topic is theory meets praxis, the Austrian business cycle theory in today's economy.

1:42Well, it's theory to practice anyway. I don't know about today's business cycle theory. When I was asked if I'd be willing to deliver this lecture, I contacted Lew to see if he'd give me a few pointers as to what sort of material would be most suitable for the audience on the occasion. And Lew said it was quite easy that Henry Hazlitt himself was very big, pouring over official statistics and showing how they could be supportive of very different conclusions from those which the mainstream tended to draw from them, and he said, why don't I do the same? Well splendid, I thought, after all this is a big part of what I do for a daily living, so I ideally set off downloading data, compiling a number of very large Excel spreadsheets and drawing copious graphs to illustrate yet another bromide on the failings of the global fiat dollar hegemony.

2:31Well thinking to enliven these, I dug out a few copies of some of Hazlitt's work to look for some passages I could quote, only slightly out of context, in order to affect the usual subterfuge of the struggling politician of the hack lawyer, and add somebody else's intellectual stubsence to my own special pleading in this PowerPoint kaleidoscope. But on re-reading works like The Inflation Crisis and The Failure of the New Economics after a gap of a number of years, it became more and more apparent that the power of Hazlitt's writing and the clarity of his analysis are timeless, and that the problems of today are are of course therefore the same ones which he so effectively disposed of in his own time. So rather than bombarding you with the mind-numbing profusion of billions of this and trillions of that or subjecting your aesthetic sensibilities to the chromatic enormities of my charts, I decided instead I'd provide a run-through of the way in which the logic of Austrianism

3:23can be applied to make a practical difference to traders, investors and businessmen at large. Now before we start, I need to lay a little groundwork by way of challenging the preconceptions I want to look at the fundamental question of how we characterize something called growth in the modern economy. Here we immediately run into the fact that the familiar usage, coupled with a dull complacency of thought, has allowed the idea to arise that any increase in prosperity is to be measured strictly in terms of that macroeconomic entity called gross domestic product, or GDP for short. Of itself this has led to a horrible inversion of means and ends, such that it encourages ever more monetary and regulatory violence to be visited upon the free economy by the ranks of self-serving politicians and bureaucrats from Collectivist Central, who have come to believe that keeping this statistical artefact expanding by some arbitrary minimum during their term of office is their primary function, no matter what the long-term economic or social

4:22harm they are occasioning along the way. Indeed, the collectivists have successfully deluded both themselves, and most of the uncritical electorate over whom they reign, that were they to desist, or even to relent a little from this interference, the intrinsic flaws in the capitalist free market would self-evidently lead to an implosion under the weight of its own contradictions. It should be noted that this whole business of national income accounting intrinsically enshrines Keen's perverted and patronising view of the economy, and so it condemns those of us who reject its premises to an Orwellian struggle to articulate heretical thoughts within the narrow framework of an alien language and an antagonistic epistemology. The very origins of the intellectual effort and the financial resources devoted to the compilation of the GDP numbers are rooted in the efforts of King's contemporary Simon Kuznets to provide Roosevelt's statist brain trusters with a template on which to impose their Mussolini-inspired fantasies of how the nation's affairs should be ordered.

5:21Now given that their efforts were largely responsible for prolonging, if not intensifying, the dislocations associated with the pricking of the inflationary bubble of the late 1920s for more than a decade of lost hope and retarded progress, and given too that once the seeds of conflict and extremism had taken root in this otherwise barren soil, the second great extension of their statistical efforts arose out of the need to try to coordinate the totalitarian wartime command economy, you might feel we should treat this whole approach with a deal of suspicion. But even if we were to suspend our questioning of the simplistic algebraic formulation of the Keynesian economy, intrinsic to the data, the fact remains that even the author Kuznets of this series admitted of grave qualifications. The statistician, he wrote, who supposes he can make a purely objective estimate of national income, not influenced by preconceptions concerning the facts, is deluding himself.

6:14For whenever he includes one item or excludes another, he is implicitly accepting some standard of judgement, his own, or that of the compiler of the data, and there is no escaping this subjective element. Something a lot of people should bear in mind today. A few numbers might help flesh out this idea. In 2001, GDP, measured in the depreciated dollars of the day, was reckoned to stand at just about $10 trillion in the US, broken down as to $7 trillion of personal consumption, just under $1.6 trillion of private investment and $1.9 trillion of government outlays, less what was then only $300 billion to account for the surplus of imports over exports registered that year. Now, even as thus boldly stated, there are problems aplenty. One obvious fact is that fixed investment is measured on a gross basis, but inventory accumulation is measured net.

7:07More importantly, there is the issue of just who gets to determine what is a consumption expenditure and what is an investment, much less whether this distinction is a valid one to set in place of the classically correct separation of resource use into productive and exhaustive spending categories. Software, for example, used to be treated as an intermediate business consumption item and was thus excluded from the final reckoning. Its subsequent reclassification in the mid-90s, in essence, was a move akin to the sort of manipulation of revenue recognition that Worldcom and the other corporate miscreants of the bubble used to practice. A third problem inherent in the GDP numbers is that in order to add apples to pears, each of the myriads of different commodities and services being exchanged in the economy have Money is the obvious candidate for this task, but money itself fluctuates in the speed at which it depreciates in value, the rara avis of its appreciation being a very elusive fowl indeed these days.

8:04This gives rise to the calculation reams of what are called implicit price deflators through which to allow for the changes. The backflips to which this gives rise are enormous. For instance, just if you have time in the inclination, compare the entries for the nominal and the real inflation-adjusted versions of the high-tech component of private fixed investment, PC, software and the like. So embarrassing here have become the distortions that the sub-entries in the columns have been left blank, apart from monetary footnotes of the effect that the admission arises because the numbers are not to be trusted. Ask yourselves next whether the near 20% of GDP accruing to the activities of the state has any place at all in the reckoning. Though one cannot deny that some benefit is to be derived from the activities of the 21 million or so souls employed in the public sector, there is also much that the apparatchiks, the senses of political correctness, the price fixers, quota monitors, box tickers, environmental inspectors, dull dispensers and tax gatherers,

9:01not to mention the secret policemen, uniformed paramilitaries and galactic storm troopers is complete with a commissariat and armourers, through that he's openly destructive. In any case, where even some genuine benefits can be identified from public sector workers, since the provision of government services is often a matter of either direct or indirect compulsion, and is anyway never subject to the disciplines of the market, the need to satisfy willing consumers in a sustainable financial fashion under conditions of competition and choice, Attaching to even these a value of any sort is still problematical. That this is far from being a pedantic distinction can be seen in the fact that around one in four of the more than three million manufacturing production workers lost in the past three years have ended up conceptually, if not individually, on the bloated payroll of the state instead, where the new drones enjoyed salaries a third higher than the metal bashes had been paid and received benefits one sixth greater.

9:55All of which implies that each member of the shrinking number of manufacturing workers has now had to become over 8% more productive per year of value just to support the monstrous regiment of extra-bureaucrats in Silowiski, a legion of the dams whose muster is burgeoned from 169 to 214 per 100 manufacturers just since 2000 itself. It should not be a matter of dispute that much of this game of Keynesian piggyback, rather than being some sort of augmentation to the common will, can in fact only be doing the nation harm. Leaving this behind, yet another glaring inconsistency in the facts, involves the disparate treatment we've noted already of what may be loosely termed fixed and circulating capital. In the case of the former, the choice to ignore the effects of depreciation adulterates the composition of this identity, identity since it implies that a peasant who keeps buying sickly donkeys which die after only two years hard work is adding more to national income than is his prudent brother who buys those which can endure for four. The upshot is we're

10:54now left wondering whether even the nominal national product should be reckoned as 10 trillion as it is presented or is the 8 trillion after we subtract government or the 7 trillion after we deduct the estimates made of private capital consumption. But in fact we're still not finished for we find a Now, a good deal of the expenditure in these numbers is not monetary at all, but takes the form of something called imputation, which the Bureau of Economic Analysis tells us are, quote, transactions recorded in the national income and product accounts that are not transactions of the market economy, i.e. they're numerical phantoms purporting to adjust for the implicit services rendered but not charged to their recipients. Now, to give a flavour of the vast sleight of hand being undertaken here, Let me just briefly show how the magic of imputation helps solve the mystery of how a citizenry increasingly in hoc and whose net financial assets for the first time in at least fifty years are falling

11:47can still be enjoying year-on-year net interest receipts of around nine hundred billion dollars roughly ten percent of the unadjusted total income they're supposed to receive What we do is we deduct from the interest paid column three hundred and fifty billion dollars in mortgage interest payments because these are made not by the homeowner but by an imaginary corporation set up in the accounts to buy his house for him and hence to prove that somehow it's an investment. Next we add $260 billion to the interest received column, which is reckoned to be the value of the free checking services your bank gives you and the net difference now in interest soars 225% from an actual monetary total of $275 billion to the published $900 billion. Hey presto! Incidentally, do you not consider it a touch risable that the implication of the second of these adjustments is the next time you go overdrawn, you can always just hand your checkbook into the bank and tell your account manager that the balance is quits?

12:46The blizzard of numbers here means that GDP ends up being swollen by perhaps 16% from the published number, a gap incidentally which has widened appreciably from the 1964 to 1973 So is the economy in 2001 10 trillion in size, 8 trillion ex-government, 7 trillion ex-depreciation or 6 trillion ex-imputation? Clearly giving the yawning two-thirds differential between the lowest and the highest of these, any collectivist central planner should be asked to adjudicate on which is the most representative of economic reality before he proposes to trample on our property rights or to infringe upon our sacred personal liberties in order to achieve his arbitrary target for what he likes to think of as growth, but which is usually only spending.

13:35In fact, even the foregoing does not come close to providing a full view of the controversy with which we have to deal, but this has still been framed in Keynes and Kuznets' own terms. But conversely, if there is one thing the Austrian School teaches, it's the fundamental importance of the division of labour. Another is the crucial element of time and of the instrumentality of capital in mastering this. Another is the role played by the individual entrepreneur in disposing of scarce resources to meet current and prospective consumer demand and a final one is the function of saving and facilitating this role. With this in mind we can recast the official statistics with all their provisors and precautionary notices in a radically different way, maneuvering them using an approach first outlined by Professor to give us a feel for what Hayek depicted as a right triangular arrangement of production in the modern economy.

14:25To achieve this, we take the official input-output tables, which show, in addition to the now familiar GDP numbers, all the intermediate business-to-business flows, which are then later simply cancelled out. Adding imports to the domestic total of these, we are left with a sum of business revenues, whether derived from sales to other businesses and consumers, to government or to foreigners. If we subtract appreciation and profits from the revenues, we are left with above the line business costs, to which we can add the entries for net inventory, accumulation and gross fixed investment which represent the below the line outlays. We now have identified a total of all domestic productive spending, to which we can compare the sum of personal consumption and government expenditures, plus the total of residential real estate investment, to determine the scale of domestic exhaustive spending.

15:15In our year under consideration of 2001, the productive outlays came to a grand total of $18 trillion, against which was lined up around $9.3 trillion in the exhaustive category. Thus it could be argued the circulation of money and hence the transfer of goods and services through the real economy amounted not to the $6 trillion, the $8 trillion or even the $10 trillion above, but to a whopping $27.5 trillion, of which some two-thirds represented is not the final consumptive exhaustion of wealth, so over-emphasized in the orthodox approach, but a series of exquisitely intertwined, mutually reliant, highly contingent and purposely undertaken non-automatic entrepreneurial expenditures. Even now, however, after we have tried to expand the scope of our mental imagery, we are still all too prone to succumb to the temptation to describe the economy by a single number or a single series of numbers.

16:08This insistent urge keeps leading us back to a narrow conceptualization, very much like the one of trying to capture the complex geology and fractal topography of the Rockies by measuring the total volume of rock contained in them. The Romans, it is said, had little concept of cartography. There is apparently no word in Greek or Latin for map. Instead their worldview was what is called odological. It was based predominantly on milages set out in periploi or linear itineraries. In fact, when the Rooseveltian tyrant who thought he could cue a rampant third century inflation by fixing prices, the Emperor Diocletian, came across a man who had constructed a two-dimensional map of the world, he had the poor unfortunate summarily executed, lest his enhanced knowledge made him a danger to the Imperium.

16:54The Keynesians and the other macromances, with their fetish for monolithic aggregate numbers and their reliance on predetermined coefficients of mass behaviour, share a similarly blinkered outlook, while their vituperation towards the more deductive and individually centred schools of thought makes them and their masters all mental diocletians. In contrast, we Austrians always strive to attain a wider purview and to preserve a sense of the variability and complex interrelations which characterize the world of acting men and women laid out before us. Armed then with these growing insights, let us try to dispel in sequence the falsehoods nested in the simulation of the mainstream view set out before you in the handout. We started with the phrase, America is recovering thanks to the courageous actions of the Federal Reserve in slashing interest rates.

17:44To assume that lower interest rates, when imposed by monetary manipulation rather than arising spontaneously on the free market, are a panacea for all ills is a very old delusion indeed. If low rates and a cheap currency were a solution to hardship, then we should have to impeach Alan Greenspan before the Court of World Opinion and the world opinion for being too pusillanimous in ending want and for not allowing his colleague Ben Bernanke the full access to the printing press which he so patently desires. If this were the case, John Law would never have gone bankrupt. To be worth a continental would be praise indeed. And the legendary wheelbarrow wielders of Weimar would have secured command over all the riches of the world. But President Bush's visionary tax cuts have helped us. Reducing taxes and reducing them on producers rather than consumers is a laudable aim, but refraining from funding these by an equal and opposite assault on the spending side of the ledger is but to substitute the government for the private agents with the beneficiaries of the tax deductions as the party liable for the extra-inflationary debt so brought into being, and that this is inflationary has particularly been true over the past six or seven months when US commercial banks, foreign monetary authorities and the

18:58and the Fed itself have bought such prodigious amounts of government paper, simply by expanding the entries on their balance sheets, that they have more than accounted for the whole increase in marketable public debt in that time. This is a process called monetisation, and it puts the US on the same inflationary road to ruin as has been travelled by all those previously practising this subtle fraud. Besides, lower taxes are one thing. The higher subsidies, renewed tariffs and the threats of quotas, more burdensome legislation, more expensive welfare programs and the pervasive threat of arbitrary legal assault are quite another. And there is little enough sign that the Bush White House has done any more to lighten these crushing impediments to wealth creation than has any other progressive administration of recent times.

19:43But the US has weathered a shallow recession and is now growing strongly again, the fastest rate in two decades according to the numbers. Well, this shallowest of recessions has actually seen manufacturing payrolls plunge to their lowest level since before Pearl Harbour, and total hours worked have suffered such a steep decline that the fall has barely been pipped for the title of worst post-Second War depression by the trough registered in the savage worldwide recession of 1982. Net non-residential fixed investment has fallen by its greatest extent in over 50 years, as is the proportion of total net investment to GDP. Cumulative non-financial profits, now admittedly on something of an upswing, also fell by their greatest extent in that period. But the US of A is once again the locomotive of growth for an ungrateful world.

20:33This is only the case if you subscribe to the 400-year-old errors of the mercantilists, as all Keynesians do, of course. If you confuse money with wealth and credit with capital, only then could you see the present-day Anglo-American role as a benign one. Asian labourers, mostly though not exclusively with lower standards of living, are sweating in their factories to sell us Westerners cheaper goods than we can produce here at home, and they're accepting nothing but our irredeemable and largely unenforceable paper promises in return. Thus, rather than being a locomotive, the more apt metaphor is that of a surly and aggressive brother-in-law who arrives not only to eat you out of house and home, to touch you for the odd 50 bucks here and there until a payday which never seems to arrive and a horse which never gets to finish first, but who also reviles you before his pals in the local bar room for the sake of your long-suffering charity.

21:25The heroic American consumer who makes up 70% of the economy has gone out and shopped for victory. She's released some of the wealth contained in her appreciating home for the purpose. Well, yes, the consumer is 70% of GDP. But that particular map, as we've just been at pains to describe, is not the territory. The personal consumer may exercise the biggest part of that final $1 a vote franchise, which is the free market. But remember, her spending amounts to no more than a quarter of the overall invoices raised and the bill settled up and down our cone of production. And besides, it is saving, wisely utilised by honest and far-sighted entrepreneurs, and not spending founded largely on the inflationary collateral credit spiral that is the US housing market, which will lead to our material enrichment.

22:11Anyone with a basic grasp of accountancy, much less economics, must see that monetising a notional gain in the value of an unproductive asset by borrowing more against it, are against it and then dissipating the proceeds on instant gratification can hardly be construed as liberating wealth, only as destroying it. But now as uncertainty subsides and revenues rise businesses too are spending their money on investments. What it is true there has been a pick-up in some of the indicators of capital goods spending but given the size of the O'Neill tax incentives and the highly accelerated obsolescence of much new era equipment, Not to mention the scale of the preceding drop in that investment, this is largely unremarkable. It is also true that the inflationary effects of the aggressive stimulus policies being enacted at home and abroad, coupled with a decline in the value of the dollar, have helped corporate cash flow.

23:03Indeed, it would be a singular event if there was not at least a temporary and unevenly distributed boost under the prevailing circumstances. But how much of this will be revealed as capital consumption? How many of these newly coursing streams will dry up and even reverse if this deliberate inflation either accelerates or switches channels, and how soon costs will rise again in line with or faster than prices is something we cannot know in advance, but are developments for whose signs we must be ever vigilant. Another feature often overlooked is that all this easy money flows straight to the bottom line of corporate America in a very different manner than in the past, since even nominally Non-financial corporates now have more financial assets than tangible ones on their balance sheets, meaning that these days they are half machine shop and half consumer finance house and pension fund manager combined.

23:54Thriving on the proceeds of a steep yield curve, soaring especially speculative bond prices and rapid asset growth, officially designated financial corporate profits have climbed to a record $60 for every $100 earned by their ostensibly non-financial brethren. Now if we were only to assume the latter derived the same amount of mileage from the same type of activities as the former, returns from the credit bubble alone could therefore amount to between 65 and 70% of all corporate profits earned, a complete and inherently disquieting inversion of the ratio typical of the 60s and 70s. As growth picks up though, the absence of inflation, especially core inflation as measured by the Fed's indexes, and the existence of so much idle capacity worldwide means the Fed can be patient about raising short term interest rates and can keep the present accommodative settings.

24:47While inflation, no Austrian will need to be told, is not synonymous with rising prices, but it's the prime causative factor in those prices rising. And inflation is a situation where more money exists, however we define that term, than and is required by individuals in their own subjective judgment, so that it is ever more eagerly exchanged into goods, services, other financial assets or the monies of other polities. With the broad M3 measure of money and credit up by over a quarter since the end of 2000, a gain of getting on for $3 trillion, which is an increment greater than the total stock of money called into existence in the first 208 years of the Republic, you have to have With mortgage debt up nearly 40%, financial debt up a third, state and local government borrowing up 30% in these past three years, for an aggregate increase of over $7.5 trillion, and a climb of 50 percentage points from 370% to 420% of private domestic product, the size of this officially sanctioned Ponzi scheme and the scale of its expansion in the last three years,

25:58is hardly unnoticeable for those who care to look. As for the spare capacity argument, this is another old canard. If you reflect for a moment, it must be obvious that those businesses presently with a glut of capacity are precisely the ones whose managers during the late boom most misread the true state of consumer demand vis-a-vis the costs of all the inputs they needed to try to meet it. Therefore, there is little choice but for as many of these as possible to release these It seems unlikely in the extreme by artificially pumping up consumer demand in this general indiscriminatory fashion, the authorities will, for example, call many of the hundreds of millions of miles of unlit fibre optic cable back into employment.

26:48It is often overlooked further by the aggregationists that one sector capacity is another sector shortfall. Resources misdirected towards the first, during the phase of feverish malinvestment, were inevitably also directed away from what many may now be revealed as more deserving outlets. You only have to consider that while semiconductors and servers went on building to unsustainable levels, natural gas and oil refining was sorely neglected, not to mention the steel mills now making the nightly news. As Hazlitt himself put it, capacity is reached when And we have fully employed our most scarce resource or complementary productive factor, whether that is an important key industry, specialized labour, plant or some raw material.

27:34When this situation occurs the price of the scarce factor will start to soar. This rise will soon force increases in other prices and wage rates. If you read the business pages of today's newspapers you'll see this is very much the case. In fact the irony was that this morning the USA Today on the business page in the left The right hand column had a little item saying that Wall Street was heartened by the fact that the February CPI numbers were low and were below consensus and there was no inflation. And on the right hand side it had a big column, because energy costs were down. And on the right hand side it had a big long column saying natural gas prices hit record highs as crude oil soars. In any case, businesses, the problem in our economy is they're too productive.

28:19They don't need any extra workers to meet all this demand, but maybe that'll pass as they begin to exhaust the possibilities of applying all these new technologies. Let's take that last phrase, one of our venerable Fed Chairmen's, first. Since when did investment depend only upon the technological possibilities open to man, rather than upon a careful weighing up of the returns achievable by deploying available savings to put it into operation? And even if it did depend on this, and NASA was the most profitable entity on Earth, why should we ever look to exhaust such possibilities? Have we already applied all the techniques of which we are already aware? Has every economic entity taken advantage of them? Has the well of human ingenuity suddenly run dry so we can no longer look forward to more advance?

29:04Sorry Mr Greenspan, that explanation doesn't fly, even if it does employ all the aerospace marvels that the skunkworks has to offer us. Less frivolously, we are forced to concede that an individual business, or even a group of businesses, may well find it profitable to substitute capital for labour. But is it really likely they've all suddenly decided this is the best course of action? And even if this were the case, would it then be telling us not that labour is too productive, but rather that it is not productive enough of economic value? In all the interminable talk we get from the Fed of a productivity revolution, overlooked is the fact that its own oft-cited numbers are aggregative, hedonically manipulated, which means they over count notional quality adjustments, they count things made, not the value received for them, that by the BLS's own admission they under count hours of work, and that also they ignore those non-labour costs, which can amount to as much as 50% as wages on top of the

30:05Bill that firms face for labour. Even by their own rather dim lights, it should also be noted, they artificially and arbitrarily ascribe the bulk of all productivity gains to labour, thus pushing the increase in this quantity in the late 1990s to a 2.5% annual pace, the best since the early 80s. But ignoring the fact that simultaneously negative returns on capital of nearly minus 2% was the worst showing since the 1979 to 1983 recession, And their own officially calculated multi-factor productivity numbers, which combine these, fell to its most anemic level of growth since the troubled 1989-1993 stretch. Increased productivity, the employment of more useful capital per head of population, is the route to riches, not mass redundancy.

30:56But only if the markets are unhampered, if prices and costs are allowed to adjust to to reflect the new plenitude of goods being made, and thus they speed the useful re-employment of the labour released from all its former drudgery. But where these jobs are being created, we're told, they're moving offshore. And this is only possible because the perfidious Chinese keep buying US dollars and suppressing the value of their own currency unfairly. Well here again we see the glaring paradox that we, who are supposedly so effortlessly superior in terms of technology and productivity, can't compete with the newly hired factory hand fresh from the paddy fields of Hainan or Hanoi but then economic rationality was never much of a match for cheap populism the contradictions are manifold for the Chinese these days actually run very little by way of a trading balance when we measure it across all their partners and so naturally they see little incentive to unplug, unplug, unpeg the one potentially upsetting the entrepreneurial calculations of all those involved in

31:56The US, by contrast, racked up a record goods deficit of over $49 billion in a single month last month, a shortfall which amounts to nearly 30% of the total trade in goods. This is rather impressive, given the fact that the US has been doing business with them. Indeed, their surplus over the past year on the trade account amounted to around $20 billion out of a total global two-way trade volume of $800 billion, a disproportion of some 2-3%, which given the reliability of the statistics is nothing. The US, by contrast, racked up a record goods deficit of over $49 billion in a single month last month, a shortfall which amounts to nearly 30% of the total trade in goods. This is rather a lot to be blaming on a single bilateral currency distortion. But if the Chinese keep cheating the rules, of course, we should limit their ability to send us their exports, and we should compel American businesses to buy goods and services here at home instead.

32:40Yes siree, let's punish the American consumer by denying her the full benefits of the International Division of Labour. That'll show those pesky Chinamen. And if Fu Manchu wants to give away his Nike sneakers, we still won't take them. We'd rather make the citizens pay some unionised, over-regulated, inefficient good old boys from the cotton belt to make them for $120 a pair, and we'll be grateful for it when they vote for us afterwards. Besides this sort of illiteracy, sadly becoming written into the electoral platforms for both of those Yale alumni Tweedledum and Tweedledee, we should ask what rules precisely are the The Chinese breaking by seeking to keep their unit of accounts stable against the world's reserve currency, the same currency by the way for which they were lauded for selflessly shadowing throughout the crushing collapse of the 1997-98 Asian contagion.

33:33Moreover, if we consider that the Chinese run an export surplus with the US, receive reserve assets in exchange and then allow domestic credit to increase on the base which these provide, thus driving up both internal prices and the demand for goods on either on the other side of their border, this is only a simulacrum of the workings of the classical and internationally munificent gold standard. Where it breaks down is that the reverse should be happening in the United States, where the withdrawal of these reserves should serve to contract credit deflate prices to the point where balance is once more achieved. Only under the rules of what Jacques Reff scathingly termed the childish game of marbles, by which the winners, the Chinese, return their spoils, the excess dollars, back to the American losers at the end of every round by buying US Treasury and Agency bonds in the main.

34:23And as a result of what that great Frenchman also dubbed the monetary sin of the West, the fact that the dollar hegemony allows the US to go on mindlessly inflating and then blaming others for its own lack of financial virtue, can the Chinese be held culpable for what is at work here? And then their crime is only that of being an accessory after the fact. While the main perpetrators are to be found inside the beltway, not in the People's Congress in Beijing. But these wily orientals are now gobbling up all the world's natural resources and their spare energy capacity. They're pushing up prices. Well, they're damned if they do, and they're damned if they don't. If they accumulate dollars and return to the US Treasury, they're not allowing the market to determine the value of their currency, which is political speak for they're not accommodating the GOP and devaluing the dollar more broadly.

35:09If instead they buy real assets, whether for immediate use or, as some suspect, by way of building strategic stockpiles, thus transforming their work for the importunate but ungrateful Occidental customers into tangible wealth of their own, they are to blame for the fact that they've highlighted there isn't quite as much idle capacity in the world as the Fed would have us believe. In the unlikely event that the US were to stop inflating, Or under the less fantastical scenario that China's very real and very Austrian style bubble were to implode of its own accord, the pressure on these scarce factors would of course cease to soar forthwith. But this is not inflationary anyway. No central bank needs to restrict credit yet. This is cost push, not demand pulled.

35:57To see the fallacy of this one, if you imagine you only had $10 left in the world and you were going to treat yourself to a final two beers at $2.50 a bottle and a $5 hamburger meal before you went broke. If when you got to the store you found the price of beer had doubled, you would have to rearrange your preferences. Perhaps you'd make do with half as much booze and a little more beef, maybe you'd stick to your original quota of two bottles of beer and down them on an empty stomach, or maybe If you'd find a substitute beverage or alternative snack, so this price rise would assuredly not be inflationary, merely the holy, natural and welcome functioning of the price mechanism, signalling to entrepreneurs everywhere that beer was now more relatively urgently demanded than before and that production schedules should be adapted accordingly.

36:44However, if your fairy godfather, a septuagenarian figure with receding hair, bulging bespectacled and a confusing and somewhat tedious turn of phrase appeared in a flash and simply conjured up the extra $5 you needed, you could have beer and beef and economise on nothing. That would be inflationary. This is what career central bank chief Mr Park, the man responsible for the preceding quote, as well as his well more well known peers clearly intend to do should raw materials prices like the beer of our fable continue to rise, less some real life producers, like In fact, in Korea, the interesting thing was that the small businesses, who were hampered by the fact that the overarching kai-bol conglomerates, kind of like a non-military industrial complex over there, get all the goods and services and all the finance, the small manufacturers complained about the price rises, and so they asked the government to intervene in their favour by extending them cheap credit, so they could buy the beef in half a tail.

37:51and Federal Materials. It's interesting how economic literacy works in this world. Things are going up because there's too much credit, so give us some of the credits so we can push them up even more. An ever-increasing part of our economy, Alan Greenspan told Congress the other week, is becoming conceptual rather than physical. All of the items in these standard commodity indexes, well they're physical, they're not intellectual. Good old Alan may well have been able to will vast effusions of money into existence, frustrating the market process and underwriting the speculations of the money trust with our effort, but he clearly has fallen into a folie de grandeur if he believes that he can will a gallon of gas into our tank or a loaf of bread onto our table. Such dangerous flights of whimsy only serve to show those involved in the painstaking business of building and cultivating the capital by which we will all be enriched have all too Rising personal indebtedness is nothing. It doesn't matter when we look at the increase

38:52in household wealth, and if debt service becomes a problem, people can always refinance their homes once more, apparently now using adjustable rate mortgages according to Mr Greenspan. As noted above, cashing in some of the gains in an asset price spiral, not by selling some of it outright, but by increasing one's leverage against it, is hardly the soundest of financial Practices. And as for the reliability of the household wealth measure itself, we shall have more to say. Governor Bernanke, for his part, tells us there are risks associated with deflation, though they thankfully receded very substantially. But even so, trend inflation is rich levels that are too low, to the point where the benefits of low inflation are lost. Quite what the benefits of even low inflation are, aside from providing an insidious transfer And as for prices, well, the highly dubious consumer price index may still be behaving modestly by today's rather lax standards, but prices of homes rose at their fastest in 30 years last quarter, and the nation's residential real estate is now valued at an aggregate $16.5 trillion, even if this is something of a total nonsense.

40:12Caveats notwithstanding, at this stippling level, the RE capitalisation figure represents an unprecedented 205% of private GDP, where it is 20 points up from the zenith of the late 80s boom and is also at a record price to estimated replacement cost of 170% premium. Significantly, despite having risen 30% in 3 years and having doubled in 10, these house prices have still allowed home earners' average equity to languish at a record low of 55%. And no wonder, when they've extracted what Alan Greenspan calls wealth to the tune of $600 billion from their homes since the end of 2000 through mortgage refis and home equity loans.

41:01The rise in the stock market needs little comment, of course, if we're looking for prices, except to note that its aggregate price to book, price to trailing earnings and capitalisation to GDP among several conventional metrics are back at levels still only seen during the post-95 bubble itself. All other manner of financial assets, especially the more exotic denizens of the bestiary, junk bonds, emerging market debt, structured products replete with risky derivatives, the least substantial stocks such as those trading on the hot house which is the OTC bulletin board, all these have made new highs in price and lows in absolute or relative yield in recent weeks. Back in the real world you need no reminding that medical expenses, insurance premium and tuition fees are rising by double digit amounts and that it costs ever more to fill up your The National Federation of Independent Business agreed in its January survey, quote, price hikes were pervasive in the service sector and it appears that things are looking up

42:05in agriculture. Providers of professional services also managed to post price hikes fairly frequently. Their bigger brethren at the ISM revealed that prices paid were the The highest since the bubble peaked in March 2000 and the second highest in a decade. And on top of this last month, the well-regarded Philadelphia Fed survey came complete with the second highest forecast for prices to be received in 15 years. Look to the prices of widely traded commodities for confirmation and we see that though some of them have slipped back in the past week or two, they are characterised by rapid, double and even triple-digit percentage gains. For example, the Journal of Commerce index of commodities has risen by 50% annualised since last spring, the fastest ever such rise. Steel prices are up perhaps 160% from their lows, aluminium is 50% above its 2002 nadir, copper is 120% and tin is 88% higher than their 2001 bottom, and all of these are at 8-9 year highs. We could go on at length quoting

43:04prices and multi-year highs for lead, nickel, zinc, gold, platinum, silver, palladium, lumber, Flywood, oil, gas, coal, cotton, soy, corn, palm, rice and rubber, among others. You'd be glad I cut that down. Emphatically, the only risks associated with deflation are those which come from clinging too long to the naive faith that the value of one's money will be preserved by a central bank which can still talk about such an eventuality while the malign effects of its inflationary policies are everywhere increasingly undeniable. The next myth, Democrats will address the deficit by taxing the undeserving rich once more, while the Republicans will look to plug the gap when their policies begin to shift more of the undeserving poor off the welfare rolls.

43:49Well, the ballooning budget deficit may not presently be obvious in crowding out investment, for as we saw, it is being monetized so effectively that interest rates remain subdued and that bond prices remain elevated. But the government is still commandeering too many resources to the detriment of those private endeavours which could be accessing them at a commensurately reduced cost and it is demoralizing thrift, enterprise and self-reliance into the bargain. In a West already displaying symptoms of the extirpation of the middle classes in favour of the governing military-political elite and at the cost of buying off its feckless urban proletariat with a higher dole and more spectacular circuses, The more the state expands in this way, the more success it will enjoy in the only one of its wars on abstract nouns, which it wages unremittingly, and at outrance, its war on capital.

44:40But don't fret, even if the deficits did count, as President Cheney apparently doubts, we owe it to ourselves. Well, yes they do count, and no we don't. Some of us owe it to others, which is a very different species of animal. And in any case, not having been invested in anything worthwhile, but merely payable in future in depreciated dollars out of general taxation, in practice out of rolling over principal and interest as they come due at the expense of some future dupe, this is hardly an asset in its strictest sense. And furthermore, the abiding evil of a funded and permanent public debt is exactly that it teaches people to count as assets, the exactions to be forcibly visited both on themselves and others on the day when that incontinent monster of public administration comes to pay its slaves once more for the labour of making their own shackles.

45:34If no less than Jefferson fulminated against transplanting this medium of the great Whig corruption from the metropolis to the infant republic and if Hamilton cynically espoused it as a means to bind the interests of those ruled to that of their patrician rulers, and rulers, I think we can safely set their opinions above the amoral braggadocio of the good Mr. Cheney. So where does this all leave us? Well, hopefully with the healthy distrust of bald macroeconomic statistics as they are typically presented and spun, and also with heed to the lesson of caution needed in drawing conclusions from the prevailing vapours of optimism coming from the likes of Mr. Greenspan and his acolytes. In the real world, it is a simple matter of logic to predict that jobs will be added only in those industries where the costs of hiring, and all the costs, including the monetary ones of benefits as well as wages, and not to overlook the intangible ones of regulation and legal jeopardy, seem not to preclude but rather to enhance the profitable production of goods and services.

46:36Services. Conversely, if the present environment makes the hiring of American workers seem too expensive and or too risky for any given firm to hire, be assured they will not be hired, but the capital will be substituted for labour where possible, and that this will take place overseas if need be. Since adding capital per head is the only sustainable way of enhancing productivity and thus the general standard of living, and at this those improving is still well below its recent best in quantitative, if hopefully not so much in qualitative terms, this still means we have quite a hill to climb. Moreover, where materials and energy inputs rise so as to preclude that too, for as Hayek pointed out, capital and labour compete with one another but raw materials compete with both, not even those higher order industries which might otherwise benefit from equipment orders will be able to flourish.

47:33This way, both the direct and the indirect take-up of the unemployed may be aborted by these higher resource prices, these prices you remember which have arisen to a considerable extent because of the very reflationary policies being undertaken to supposedly insure full employment. Thus, notwithstanding the artificial boost delivered by a 25% currency devaluation, negative real interest rates, a half trillion dollar budget deficit, this might yet dissipate itself In a variable and inherently unpredictable rise of costs incurred, which may serve to dash the entrepreneur's hopes of securing unmitigated gains from the rising prices he expects to receive. If so, it will usher in a renewed stagnation in production, an inhibition which, remember, will nonetheless be partially disguised by the inflationary effects of government fiscal and monetary policy upon some few fortuitous industries.

48:29If this is not to lead to a commensurate reduction in consumption, to the policymaker's horror and the banker's imperilment, however much its balm is actually needed to soothe our fevered brows, it can only be offset by recourse to yet more credit, credit presumably built upon further asset price inflation, especially if the Fed is lucky in the housing market. Indeed, to keep this game going will certainly require a good deal of finesse, another large dose of disingenuousness regarding inflation and, you may want to underline this, a further period of inordinate laxity in setting interest rates. The overwhelming imperative to avoid a housing implosion, coupled with the self-imposed erosion of America's competitive edge on the world labour market, seems almost a guarantee that Policy both here and abroad will stay too loose for too long in the vain belief that this will ease the problems caused by a previous spell when policy was too loose for too long.

49:30The likelihood is that the development of full-blown symptoms of an inflationary excess across much of the globe is as much of a certainty as anything in this ever-changing world with its top-heavy, distortive and intrinsically unstable financial and monetary system can Pessimists, especially the foreign variety who have so many investments tied up here in the US, will find a resonance in the words of Treasury Secretary Henry McCulloch, quoted by Hazlitt in The Inflation Crisis, It is corrupting the public morals. It is converting the business of the country into gambling and seriously diminishing the labour of the country. Men are apparently getting rich while morality languishes. Upon the demoralizing influence of an inconvertible government currency, it is not necessary to enlarge.

50:17It is not to be expected that a people will be more honest than the government under which they live. And while the government of the United States refuses to pay its notes according to their tenor, It practically teaches the people the adoption of repudiation. McCulloch should know he was the Yankee secretary in the Civil War. Optimists, however, and we have to have an optimistic note in a speech this long, will turn for comfort to the voice of Adam Smith, who has it, cites, in The Conquest of Poverty. The uniform, constant and uninterrupted effort of every man to better his condition is frequently powerful enough to maintain the natural progress of things towardsivid the extravagance of government and the greatest errors of administration.

51:02While you decide to which camp you belong, some of you might also recall Hazlitt's own scathing summation of Keen's general theory to the effect that I have been able to find in it a single important doctrine that is both true and original. What is original in the book is not true and what is true is not original. In fact, even much that is fallacious in the book is not original, but can be found in a score of previous writers. If, having paid kind attention to my talk tonight, you feel the same way about me, I offer my apologies. I can only assure you it has nonetheless been a singular honour to have been asked to commemorate such an unyielding champion of liberty and a tireless expositor of the truth as Henry Hazlitt. May his example, as well as those of the many others associated with the Mises Institute, always be before us. Thank you.

51:52Morgan. If you want to solve the GDP statistics, which is well deserved truly, but how would you How would you address the choir argument, offsetting errors and musicality, or in the labor statistics, you have the idea of unemployment, which is a far softer concept than having a job, but goes the argument that we may not have the level right because of all these discouraged workers and what not, But the changes really are reliable. So, goes the argument, changes in GDP, despite all these grievances underneath the data, seem to tell us something.

52:59Well, I think the lesson to be drawn really from this is that we presented with this one number as if it was an absolute, it's calculated to several decimal places. In fact, in Belgium, for instance, they quote the CPI number, I think, to two, if not three decimal places, as if it meant anything. The point being is that you shouldn't take these headline numbers as they come in isolation. You should look at them. You should be intelligent about interpreting them. You should corroborate them with other numbers. And, of course, you should have a well-founded intellectual basis on which to look and ask the right questions. questions you can't do good science unless you have a good scientific methodology and the same thing applies to economics the point here is is that nobody number there are two points your number one is that people take these numbers on trust because they're supposedly compiled ridiculously and that's a nonsense secondly is that even if the numbers even if we attach some

53:50caveats you have to know or understand how an economy works which the Keynesians What would you use the second guess for the CPI number?

54:25What suggestion would you offer, for example, would you offer a gold standard with a 100% back and forth? So there's no simple answer to that. What we do know is that there is a vast diffusion of money and credit being created and we now know that not just financial asset prices, not just residential real estate, not just domestic services, but also raw materials are going up in price. So clearly the effects are there. What suggestion would you offer, for example, would you offer a gold standard with 100% back and forth? Well, that would be nice in an ideal world, sir, but in the famous words of the person who got lost in rural Ireland, who pointed to the little, who asked the little guy sitting, smoking a pipe on the wall, how do I get from here to Skiverine? If there's a burst in the credit bubble, how do you feel that affects inflation and the prices of different countries?

55:21Depends where it happens first, I guess. As I try to point out, I think one of the vulnerabilities at the moment is that the children are not getting the money they need. Yes. As I try to point out, I think one of the vulnerabilities at the moment is that the Chinese have had unfortunate experiences with credit inflation in the past, twice in this generation. The Tiananmen Square business was largely about unrest created by an inflationary problem. There are enormous real-size strides obviously being made in China, in China, but we also have the problem that credit growth seems to be out of control and that too much of the investment and production decisions are made by bureaucrats trying to hit growth targets rather than by the decisions of entrepreneurs. So it's very hard to unpick the good from the bad there. But what we do know is that the Chinese government are now supposedly going to try to slow this down. And if history teaches us one thing, you can't

56:23slow a credit bubble. It either collapses or you reinflate it quickly. So I think that's That's a critical element. If it happens in China, then we'll probably see a revulsion in foreign markets which will lead money flooding back to the United States. And we'll, just as we did in 97, 98 with the Asian contagion, we'll have another period where we in the West, by the way I pick on the United States, we Brits are guilty of all the sins that you are and some more as well. The numbers and the imbalances and the distortions in the British economy are at least as bad in many instances if not worse. So this isn't me Preaching from the pulpit here in that sense. If Asia goes first, which will probably be through China, then we'll have another couple of years, possibly, where we get to eat everybody else's cooking again, because they'll all look for safety.

57:10If China manages or indeed continues to inflate at the signs of problems, I don't know. I must admit, I'm skeptical of this. I think that any kind of collapse, if the housing market goes, it's more important than if the stock market goes, because it's much more critical for banking balance sheets and therefore the general monetary mechanism of the country. But we also know this government, any government, would stop at nothing to socialize that problem. So I think that any dislocation there is unlikely to be permanent. There would clearly be enormous attempts immediately to reinflate. Now, what form that takes is another question. Of course, the Argentinians ended up with inflation, but only after they'd had a complete collapse of the monetary system. Could a country like America or Great Britain go that way?

57:56I don't know, but I find it hard to believe that we will slow the inflation willingly here and that if asset prices look like they're going down, there will not be huge measures taken to keep the party going. For the benefit of students and some of us who are not that economically sophisticated, when you say the economy collapses, what does that mean to the average person? I mean Cisco trades at nine cents probably but no sure well well that's a very broad question which I'm sure you're trying to ask me for a pithy answer to I mean the positive side to all this of course is that even in the Great Depression 80% of people who wanted a job still had one and that life did go on for people and as we saw in periods of distress in the 19th century when There were classic liberal mechanisms that work in the markets or to a greater extent.

58:59Times of hardship for some were times of prosperity for others. We shouldn't fall into the aggregative problems here that I've been reging this Philippic against. There will be people who do well in any situation. There will just simply be relatively less of them than there would be if we'd been allowed to get on with things ourselves and hadn't had these distortions visited upon us. I don't know if that answers your question, but it's a very broad question to take up in this space.