Ben Bernanke: Loose Talk and Loose Money

0:00as you can see by your program, if you have a program, and hopefully you do, that I am first up and you'll see that I have this sort of clever title to my talk which involves Ben Bernanke's Ben Bernanke's Lips and Ben Bernanke's Money but before we get into all that I wanted to talk about money period because it's a very important subject that for those of you who are going on to college, and I think most of you probably will, or maybe some of you are in college already, that we ought to talk about money and talk about the way it's taught and talk about the way it's mistaught.

0:46Now, the way it should be taught is through Ludwig von Mises' regression theorem. And he was continuing the work of Carl Menger, and Carl Menger was the founder, really, of Austrian economics. And through his money regression theorem, he found that according to which the price or purchasing power of money is determined by its supply and its demand. Simple enough, right? which in turn determine not by its purchasing price today, but by the knowledge the actor formed on purchasing price, its purchasing price yesterday. At the same time, the purchasing price yesterday was determined by the demand for money which developed based on the knowledge of its purchasing price the day before.

1:42Well, we can trace this pattern back over and over and over again when for the first time in history people began to demand a certain good as a medium of exchange and we've all kind of heard the stories about how seashells and ox and tobacco leaves and all those kind of things served as money and we won't trudge through that today, but that's how it happened that the market created the money. So therefore this theorem reflects Menger's theory of spontaneous emergence in the evolution of money. Spontaneous urgence in the evolution of money founded around individual action. Now the cumulative development of a medium exchange on the free market is the only way that money can be established.

2:33Money cannot originate in any other way, neither by someone suddenly deciding money can be created out of some useless material, nor by government calling bits of paper money. The reason I emphasize that is you're going to go to college and some professor is going I'm going to tell you that money is whatever the government says it is, and sure they have legal tender laws and that kind of thing that use force to force us to take paper money, but that's not how money developed. Money is a commodity, and Murray Rothbard, who I studied under at the University of Nevada at Las Vegas, said that learning the simple lesson is one of the world's most important tasks, just learning the idea that money is a commodity.

3:38because so often people talk about money being so many other things, much more than what it is and much less than what it is. It's not an abstract unit of account, divorceable from some concrete good, it's not a useless token for good for exchanging, it's not a claim on society, it is not a guarantee of a fixed price level. It is simply a commodity. Now it differs from other commodities in that it is demanded mainly as a medium exchange. You trade money for other things, for other goods and services. But aside from this, it is a commodity. And like all commodities, it has an existing stock. It faces demands by people to buy and hold it. Like all commodities, its price in terms of other goods is determined by the interaction and its total supply or stock and the total demand by people to buy and hold it.

4:42People buy money by selling their goods and services for it, just as they sell money when they buy goods and services. So if I ask you to, well, I've got a wonderful shoe shine from Paul out in the lobby, by the way. Highly recommend him. If you need your shoes shined, Paul traded his services for, as it turned out, eight bucks. On the other hand, then I sold my money for his shoes shined for that eight bucks. And that's how this exchange takes place. Now, the reason I bring this up and start kind of at the beginning here is that there's a guy named Paul Samuelson wrote a book in its 11th edition of economics.

5:38I think there was a total of 19 editions of the book economics and if you're not studying in this book now more than likely in your college years you are going to get stuck reading Samuelson about economics. Most kinds of money tended once to be of some value or use for their own sake. Thus, even wampum had decorative uses, and paper money began as a warehouse or mint receipts for such metal. So far so good.

6:24Samuelson's doing great. But the intrinsic usefulness of the money medium is now the least important thing about it. Samuelson writes that money as money is wanted not for its own sake, but for what it will buy. We wish to use money by getting rid of it. Money is an artificial social convention, is what Samuelson says. Now remember, we just, I just talked about Menger and Mises and Rothbard saying that money evolved from the marketplace, and here Samuelson says that it's an artificial social convention. Samuelson writes paradox, money is accepted because it is accepted.

7:12Well that's not terribly enlightening there, but that's the kind of analysis that you're liable to get. He says by the printing of more or fewer zeros on the face value of the bill, A greater or smaller amount of value can be embodied in a light, transportable medium of little bulk. So he must have been talking about this bill, which you guys can't see, but I can describe it to you. It's for a hundred trillion dollars from the Bank of Zimbabwe. So this must have been what Samuelson was talking about, printing as many zeros on a bill to create as much value as you could have in this very lightweight piece of paper.

8:10It's very well done, it's nice, it's crisp. You've got three stones here that are balancing and on the back you have an ox and a waterfall and it's signed by my favorite central banker, Gideon Gono. So a hundred trillion dollar banknote is what he is talking about. And so presumably he was saying that a hundred trillion dollars sounds like a lot of money, doesn't it? I mean, if you had a hundred trillion dollars, I mean, you probably wouldn't be sitting here right now. You'd have had it already figured out. But the question is whether a hundred trillion dollars was worth anything. Well, this is a camera phone picture about the time that the $100 trillion note was created.

9:04And this was outside a restroom in Zimbabwe. And it says, toilet paper only to be used in this toilet. No cardboard, no cloth, no Zimbabwe dollars, no newspaper. So, as much as Professor Samuelson may say that adding zeros to a piece of paper adds value to it, doesn't mean the marketplace is going to accept that value. Now, Samuelson goes on to write that he envisions a day when anything so crude as a poker chip, a coin, or bill will be dispensed with in favor of records that automatically balance each other out, a person's in-payments and out-payments over the whole of their lifetime.

10:02So really what Samuelson is looking for is not money in its physical form at all, he just thinks that this should be a kind of like your credit card statement and that's what money should be. But Samuelson goes on to say, he says, by careful engraving, the value of money can be protected from counterfeiting and alteration, adulteration. The fact that private individuals cannot create it at will in unlimited amounts keeps it scarce, i.e. an economic and not a free good. So what Samuelson is trying to say is that as long as you can, the government is in charge of creating money and not individuals like you and I, that they are going to keep money scarce.

11:01It didn't work out that way in Zimbabwe and it's not exactly working out that way in the United States as well. Money scarce? Well, Paul Samuelson was born in 1915, and he died at the end of 2009. And when Professor Samuelson was born, the money supply in the United States was 17.6 billion dollars. 17.6 billion with a B. When his first economics textbook was first published, 1948, M2 money supply, the money supply was $148 billion with AB. When Samuelson died at the end of 2009, the money supply was $8.5 trillion with a T.

11:55Now remember, please, that a trillion is a thousand billion. So the money supply in the government's hands has grown exponentially, despite the fact that Samuelson makes the case. And Samuelson, by the way, was the Nobel Prize winner and he was the first American Nobel Prize winner in economics. So he's claiming that government keeps money scarce and the facts would prove exactly otherwise. Now there is no way that gold and silver money could have been produced at or pulled out of the ground at nearly this rate for that long and of course to create this money it takes a central bank and in the United States the central bank is known as the Federal Reserve and the guy in charge of the central bank is a guy named Ben Bernanke and hopefully most of you, if not all of you, know who Ben Bernanke is and hopefully all of you follow every word that he says.

13:12That's probably not right but you know humor me a little bit. So anyway, our guy running the, our money, keeping money as an economic good, keeping it scarce, is Ben Bernanke. And Ben Bernanke was first interviewed on CBS's 60 Minutes back in 2009. And nobody really, the press really hadn't been invited into the Federal Reserve offices This is in Washington D.C., the Eccles Building. It's very secretive. They don't let people in there. They don't want people to know what they're up to, but they had this little dog and pony show where Scott and Pelley from 60 Minutes, which is a very highly watched program on Sundays, was brought in to interview the chairman of the Federal Reserve back in 2009, and Scott Pelley did an interview.

14:16And he started the interview with saying, you know Mr. Chairman, I think the Federal Reserve for most people is a mystery. And the Federal Reserve may be a mystery to many of you here, most people on the street, the Federal Reserve is a mystery. And Bernanke replied, well, it's an institution that people don't hear so much about, but it is a very important one, Bernanke said. It manages monetary policy for the country. it is one of the main tools we have for stabilizing our economy and keeping prices stable stabilizing our economy we've had a tech bubble, we've had a housing bubble, we've had a commodity bubble, we've had price inflation, we've had stagflation, we've had boom, we've had bust, we've had recession, we've had depression and this is what Mr. Bernanke calls Stabilizing. And as far as prices being stable, since 1913, when the Fed was founded, the value of a dollar has fallen over 95%. It's not exactly price stability. And besides, there's no man or group of men or group of women who have the tools to do what he's talking about.

15:37F. A. Hayek, who won the Nobel Prize in 1974, an Austrian economist, said, man will have to learn that in this, as in all other fields where essentially complexity of an organized kind prevails, he cannot acquire the full knowledge which would make mastery of these events possible. So it's just not possible to do what Bernanke said that the Fed is doing. Now during this interview, Pelley asked about the Fed bailing out AIG. Hopefully some of you at least have heard about AIG. They're a big insurance company that was bailed out during the financial meltdown of 2008.

16:25And Bernanke says, it makes me angry. I slammed the phone more than a few times on discussing AIG. I understand why the people, American people are angry. It's absolutely unfair that taxpayer dollars are going to prop up a company that made these terrible bets that was operating out of the sight of regulators, but which we had no choice but to stabilize or else risk enormous impact, not just in the financial system, but on the whole of the US economy. Now notice that he said AIG was operating out of the sight of regulators. It's not true. AIG was regulated.

17:12Scott Polikoff, acting director of the Office of Thrift Supervision, which was AIG's primary regulator, told lawmakers in March 2009 that his office did have oversight of AIG's operation. AIG's main business insurance was regulated in every state they did business with. So they probably had fifty regulators in the United States. They had probably had dozens of regulators overseas. They were regulated every which way but loose. And of course the Office of Thrift Regulation or Thrift Supervision monitored all the other businesses that AIG was involved in, including financial products such as credit default swaps which is ultimately the problem that AIG had.

18:03Now Pelley tells the audience, in the midst of the crisis, Bernanke had freedom to act independently. He didn't need permission from Congress or the president. While they debated on Capitol Hill, Bernanke cut interest rates nearly to zero. Then he used Depression Area's emergency powers to launch a dozen rescue programs of his own. And he was asked if it's tax money the Fed is spending. Bernanke said it's not tax money. The banks have accounts with the Fed, much the same way that you have an account at a commercial bank. Probably most of you guys already have accounts at commercial banks.

18:50So, to lend to a bank, Bernanke says, we simply use the computer to mark up the size of the account that they have with the Fed. That's much more akin to printing money than it is to borrowing. Pelley asked, you've been printing money? Well, effectively, Bernanke said. And we need to do that because our economy is very weak and inflation is very low, he said. When the economy begins to recover, that will be the time that we need to unwind these programs, raise interest rates, reduce the money supply, and make sure that we have a recovery that does not involve inflation. So again, in 2009, Bernanke said, yeah, we're printing money. So what? We need to do it.

19:42First, James Grant, who writes a publication that happens to be probably my favorite, Grant's Interest Rate Observer, he writes that he doubts the Fed will be able to say when to say when, so to speak. He says, the trouble with living authorities in money and banking is the ideas they absorbed in school, like, say, Samuelson. For instance, that a central bank can calibrate the rate of debasement of its currency at prints by adjusting the speed of the printing press, or that the Federal Open Market Committee can pick the interest rate that will cause GDP to grow and payrolls to swell, prices to levitate by 2% per annum, give or take a basis point.

20:32Such things are impossible, Grant writes. Bernanke got a Ph.D. in economics from MIT. He chaired the economics department at Princeton, where his specialty was of course the Great Depression. He believes it was the Federal Reserve itself that turned a recession in 1929 into a global calamity that is of course is known as the Great Depression. Bernanke told 60 Minutes, they, meaning the Fed then, They made two mistakes, basically one, that they had let the money supply contract very sharply, prices fell, deflation, so monetary policy was in fact very contractionary, very tight during that period.

21:19And then the second mistake they made is that they let banks fail. They didn't make any strong effort to prevent the failure of thousands of banks. And that failure had terrible effects on credit and on the ability of the economy to ride itself, according to Bernanke. Now Murray Rothbard in America's Great Depression, and if you want to read one book about the Great Depression, read Murray's America's Great Depression. He wrote that the federal government had tried hard to inflate, raising controlled reserves by $195 million. largely in bills bought and bills discounted, but uncontrolled reserves declined by 302 million, largely due to a huge $356 million increase in money and circulation.

22:18So what was happening? The inflationary attempts of the government were thus offset by the people's attempts to convert their bank deposits into legal tender. If you take your money out of a bank, the bank can't lend it. And if the bank can't lend it, it can't, through fractional reserve banking, create money out of nowhere. And that's what happened during the Great Depression. But it didn't mean that the Federal Reserve was tight. Federal Reserve was as loose as it could be. And it was the people acting very rationally that stopped what the Fed was doing. Now banks were failing, people were rightly scared and they were pulling their money out.

23:06Now as far as bank failures go, Rothbard explains in probably one of my favorite books of Murray's is the mystery of banking. If you ever want to know how banking works, fractionalized banking works, The Mystery of Banking is the book to purchase. Of course, it's free online, and Bob Murphy is teaching a class out of The Mystery of Banking, a class on the Fed, actually, in the Mises Academy. He explains in the mystery of banking, bank failures are a healthy weapon by which the market keeps bank credit inflation in check. An absence of failure might mean that the check is doing poorly and that inflation of money and credit is all the more rampant.

23:58So Bernanke thinks saving banks and creating money allows the economy to right itself, but it's exactly the opposite. The malinvestments created by the easy money policy in the 20s had to be corrected and the malinvestment of the 1990s and the 2000s must be cleansed. The extra houses, the extra shopping centers, the extra whatever that have been built, these These uneconomic malinvestments, as we call them in Austrian economics, must be cleansed through a recession, depression. Standing in the way of that depression only prolongs the agony.

24:44The Fed stood in the way of that correction, and that's what made a recession back in the 20s, the Great Depression. And it is, in fact, exactly what Bernanke is doing today. Now Bernanke appeared again on 60 Minutes this past December. I'm sure you all saw it. After all, unemployment's still high, even all the things that he's done, nothing's really gotten much better. So he rolled out the red carpet again, Scott Pelly was called in and they had another interview. And he had just announced that the Fed was going to buy $600 trillion in treasury debt, otherwise known as QE2 or Quantitative Easing 2.

25:29Quantitative Easing means the Fed creates money out of nowhere and buys government bonds with it. That's what QE means. It sounds a little more clever when it's called QE, but that's what it is. So Bernanke told Scott Pelley, the unemployment rate is just not going down. Unemployment is just about the same as it was in mid-2009 when the economy started growing, so that's a major concern. And it looks that at current rates, that it may take some years before the unemployment rate gets back down to more normal levels. Bernanke thinks that by lowering the 10-year treasury bond rate from say three to say two, the Fed will provide this enormous boost for business.

26:21Suddenly government bond rates are going to go down, so immediately the businessman running the yogurt shop on the corner is going to run out and see the light and hire people and borrow money and so on. But the fact is that the Fed funds rate, controlled by the Federal Reserve, has been at 0 to a quarter percent since December 2008. And what have been the results? Well, the prime lending rate, and most people don't borrow at Treasury rates. The average business person borrows at the prime rate, prime plus something. Prime rate has gone down from 8.25 down to 3.25, so there's been a huge drop in that.

27:08And what's happened? Well, banks aren't lending and borrowers aren't borrowing. Total bank loans are down. Commercial and industrial loans are down by 25%. And no matter how low rates are, business people aren't borrowing. And consumers aren't borrowing either. Households have slashed a trillion dollars from their balances, their debt balances since the peak of the third quarter in 2008. Now, Bernanke responded to this with, he says, a lot of small businesses are not seeking credit because you know, because their businesses are not doing well, because the economy is slow. Others are not qualified for credit, maybe because the value of their property has gone down, And so then the next question that Scott Pelley should have asked would have been, since you can't really make rates go any lower than they are now, and it hasn't worked for spurring job creation in the last two years, then how do you think it's going to work now?

28:26But Pelley didn't ask that question. Bernanke talked about the banks, and he said we want them to take risk, but not excessive risk. We want them to have a happy medium. And I think banks are back in the business, he said. But they have not yet come back to a level of confidence or overconfidence that they had previous to the crisis. We want to have an appropriate balance, he said. Well, Happy Medium, Happy Medium, I'm wondering what he means by Happy Medium because in 2005, when Ben Bernanke was questioned about the housing market and maybe whether the housing market had gotten ahead of itself, Bernanke said, well, I guess I don't buy your premise. It's a pretty unlikely possibility. We've never had a decline in house prices on a nationwide basis.

29:21So what I think is more likely is that house prices will be slow, maybe stabilize, might slow consumption spending a bit. I don't think it's going to drive the economy too far from its full employment path, though. Concerning inflation, Bernanke told Pelley, well, this fear of inflation, I think, is way overstated. We look at it very, very carefully. We've analyzed it every which way. Okay, so the trick is to find the appropriate moment when to begin to unwind this policy and that's what we're going to do. So the folks at the Fed think that they will know the exact right moment when to tighten monetary policy. Now this not might work in the physical sciences, but as Hayek explains, such complex phenomenon as the market, which depends on the actions of many individuals, all the circumstances which will determine the outcome of a process, will hardly ever be fully known or measurable.

30:24Pelly asked, can you act quickly enough to prevent inflation from getting out of control? Bernanke says, we could raise interest rates in 15 minutes if we had to, so there really is no problem with raising rates. Tightening monetary policies, slowing the economy, reducing inflation at the appropriate time. Now that time is not now, he said. And Pelley said, well what degree of confidence do you have in your ability to control this? Bernanke said 100%. Bernanke is 100% sure that he can control this process, that he can control inflation, He can goose the economy and make it go where he wants to and then shut off the tap at the precise exact moment.

31:15After seeing 60 Minutes Society Generals, Albert Edwards wrote this, very little surprises me anymore in this business. But even I was surprised by Ben Bernanke's comment on CBS's 60 Minutes that he has a There is a 100% confidence that he can act quickly to stop inflation getting out of control. Surely, if there is one thing Ben Benenke should be 100% confident about, it is his own fallibility. Remember, this is the man who was not only adamant that U.S. house prices would not decline, but refuted the very notion that there was even a house price bubble in the first place.

32:01I realize these guys have to pretend that they know what they're doing, but you would have thought that having been at the epicenter of the greatest economic and financial crash since the 1930s, he would show a little humility and uncertainty, apparently not. Mr. Bernanke is very sure, he is very confident, but then again Mr. Bernanke was equally sure, not only in 2005, as Mr. Edwards points out, but also in May of 2007. Bernanke testified, given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles of the subprime sector on the broader housing market will likely be limited.

32:52and we do not expect significant spillovers from the sub-prime market to the rest of the economy or the financial system. The vast majority of mortgages, including even sub-prime mortgages, continue to perform well. Past gains in house prices have left most homeowners with significant amounts of equity and Growth in Jobs and Income should help keep the financial obligations of most households manageable. That was back in 2007. Now you remember I quoted earlier Mr. Bernanke from 2009 and 60 Minutes where he admitted to Scott Pelley that the Fed was creating money.

33:37A year later, Bernanke says, one myth that's out there is that what we're doing is printing money. We're not printing money. The amount of currency in circulation is not changing. The money supply is not changing in any significant way. What we're doing is lowering interest rates and buying treasury securities. Well, of course, technically, Fed isn't printing money. I mean, how could we be so naive? I mean, we're not making that case. The days of printing money are long gone. Now the Fed, all they have to do is push a button and, as he said in 2009, credit the bank's accounts at the Fed.

34:23I mean, it merely buys U.S. government debt from the banks, not printing money. When they buy these bonds, they don't print money and drop a pallet load over at Citibank. But how does he pay for the bills and notes and the bonds he buys? They do it electronically. And the banks are then supposed to lend it out once they do it. Once they buy these bonds, the banks are supposed to lend it out. And for every dollar they get from the Fed, Collectively, they can lend 10. Not the individual banks, but collectively, they can lend 10, and that's how it works. So, if anyone wanted to borrow money, and if the Fed had bought, say, a trillion dollars worth of US government debt, the banks could lend out 10 times that amount.

35:17And the supply of money in circulation could increase to 10 trillion dollars. Does that sound like money printing to you? And if you said yes, well, you'd be right. In fact, the Fed has created $1.5 trillion in money supply since the summer of 2007, when the financial breakdown started. And that's a 20% increase in the money supply. So indeed, the Fed is printing money, and Money, no matter what, Ben Bernanke wants to tell the folks on 60 Minutes, but I just, I want you to remember what the Austrians say about how money is created, I want you to remember and compare that to what Samuelson says and what Bernanke is telling you on 60 Minutes.

36:12I hope you carry this with you a long time, it will serve you well, and thank you for Thank you for your attention.