Predicting Booms and Busts

0:00When I first got into Austrian economics, there were only a couple of dozen Austrian economists in the whole world. And as a student, none of us thought that there would be any conceivable idea that Austrian economics would be discussed on The Tonight Show. And that there was any possibility whatsoever that Austrian economics would be featured prominently in an article in Time magazine. But both of those things happened this week of the Austrian Student Scholars Conference. So I think it's an amazing sign of greater things to come. I want to thank you all for the opportunity to speak with you here tonight on the occasion of the Austrian Student Scholars Conference. Indeed, I consider it a great honor to be asked by Grove City and to be asked back by Grove City.

0:49You have a very beautiful campus here, but you distinguish yourself with your independence. Education must be independent from government funding for it to truly accomplish its goal. Federal money undermines education at all levels and has turned college education into mostly government propaganda and fadism at government and many private schools alike. So I'd like to commend Grove City for their commitment to independence, and you will see that independence looms large in my talk tonight. Furthermore, it is a tremendous honor to be delivering the Hans Sennholz Lecture. I was introduced to much of Austrian economics by reading articles by Hans Sennholz, although I only got a chance to meet him in recent years, especially on the occasion of his award of the Schlagerbaum Lifetime Achievement Award and more recently at the Grove City College Conference celebrating the 50th anniversary awarding the honorary doctor to Ludwig von Mises, Professor Senhold's great teacher.

1:57Hans was a man of immense intelligence and energy, but he was also maybe more importantly a man of unrelenting courage. He was a great example of independence that we can remember for inspiration. So again, thank you very much. The title of my speech tonight is, Our Crisis, and you're wondering, well, what crisis is that? Well, I'm going to get to that and describe the current economic crisis, but I want to explain how economists of the Austrian School view the business cycle, why this approach which is unique and distinguished, and maybe most important of all, why it is a superior approach. This will hopefully provide you with a valuable insight into the economy and to some of our more important economic problems.

2:50First of all, Austrians do not view the business cycle as something that's inherent to the market economy. We identify the source of the business cycle with institutional flaws in money and banking, Banking, in particular Central Banking which you know by the Federal Reserve Bank. The Federal Reserve's policies of inflation, that is increasing the supply of money out of thin air, initiate disturbances in credit markets which can result in booms and bubbles in asset markets such as the real estate market. Once the boom has started, the bust becomes inevitable. Outside of the Austrian School, there are two basic views of the business cycle. The first says that there is no such thing as a business cycle, and according to this view the economy is always in a boom unless there is a major mistake, a major shock or a policy mistake.

3:46Here the boom of the economy is not related to the bust, so that the tech stock bubble of the 1990s was not related to the meltdown in the NASDAQ stock market crash. It was all just a technological shock. The second approach holds that there is a business cycle, but it's all psychological. We the people get enthusiastic about the economy. We begin to engage in speculative behavior, and the next thing you know, we have made the economy boom. At some point people become disappointed in their wild expectations because they have not been met. They become discouraged, scandals emerge, and pretty soon the economy enters a recession or depression.

4:31Both of these views of the business cycle have two important things in common. The first is that they're not economic points of view. They're only psychological or technological. Second, they don't blame the Federal Reserve. They blame the happenstance of technological change and mass psychology. Economists in the mainstream of economics have decidedly different views on methodology as well. Austrians believe that economics should be as realistic as possible, treating people as they actually are in economies as they actually function. Mainstream economists believe that you can use unrealistic assumptions if and as long is they help you make better predictions about the economy and that's very important.

5:24Predicting the future is pretty important stuff and for mainstream economists it's everything. Austrians believe that you cannot make scientific predictions about the future and askew forecasting. We seek to understand how the economy works and how sometimes it doesn't work and then and to use this understanding to make informed guesses concerning the economy. What I'm going to explore tonight is how well the Austrians perform against the mainstream economist using the mainstream criteria of how well each group is able to predict the major swings in business cycles.

6:11The superiority of the Austrian approach rests with its realistic approach to understanding the business cycle by correctly identifying cause and effect. Once you understand cause and effect, you become forward-looking. You are better to be able to anticipate changes in the economy. So while you cannot make definitive predictions, you can make well-informed speculations. The Austrian theory shows that when the central bank, the Federal Reserve, increases the supply of money, it causes the market rate of interest to fall below the natural rate that would have existed in the absence of intervention. This causes investors to borrow more money than they otherwise would, to expand their investments and to undertake riskier projects.

7:01As these borrowers compete for assets and resources, price inflation eventually occurs and Nominal Interest Rates rise. This in turn will negatively affect the economy and some of the riskier projects will be discovered to be bad investments, as well as other pre-existing investments may get caught up in the wake of the bust. According to the Austrian theory, if the Fed simply does not pursue a loose monetary policy, then bubbles can be avoided. If the Fed does follow a loose monetary policy, then bubbles can develop, whether it's stocks, real estate or tulip bulbs. If the new money is directed towards housing, a bubble can develop in housing.

7:48Austrian economists further emphasize that the additional resources allocated to housing are resources that are not available elsewhere in the economy, so that while more resources are allocated towards housing construction. Fewer resources are available to other areas of the economy such as manufacturing, which will experience higher costs for their inputs, labor and materials, and will produce a proportionally smaller amount at higher prices and will be less competitive internationally. It is this mismatching of resources across industries and sectors that has to be resolved painfully in the inevitable bust or correction. And this also allows us to understand why when housing was booming, other sectors of our economy were actually shrinking.

8:40That's all within the Austrian model, although it's kind of a puzzle for mainstream economists. According to the Austrian theory, when the central bank makes loans or purchases government bonds from banks, it's injecting new bank reserves into the economy. Banks now have excess reserves which they can loan. Excess Loanable Funds means that banks not only must reduce the interest rate they charge, they also reduce the credit quality standards they require of borrowers. Some of this may sound familiar to you. The result is a greater quantity of borrowing and investing, particularly in projects that pay off over a long period of time.

9:26Lower interest rates also discourage savings because the return on savings is now lower. In this manner, the Federal Reserve drives the market rate below the natural one. A unique feature of the Austrian approach is that it does not see a need for prices to increase uniformly across markets, or for prices to increase to extreme levels. Many doubters of The numbers of the housing bubble pointed to the smaller price increases in the center of the country compared to the coastal regions, but price is only one dimension of a bubble. Quantity can also increase beyond sustainable levels. In fact, you can even conceptually think of a bubble where prices stayed about the same, but the quantity of houses doubled in economy.

10:21If we had barely budged, we would still have too many houses for the population and all that labor and all that material that went into the doubling of the housing stock would be tied up and unavailable to serve more urgent needs after the bursting of the bubble revealed that these houses were bad investments. The Austrian Theory of the Cycle points the finger of Blaine directly at the Federal Reserve. The facts support the case against the Federal Reserve. They certainly are responsible for the reduction of credit standards that inevitably happen when it floods the market with credit. Inflation by the Federal Reserve is the cause, the business cycle is the effect. Now the weakness of the mainstream approach is that they do not identify a cause of the business cycle.

11:09Business Cycle, and as I mentioned, some even deny the existence of the business cycle. Their models are purely empirical and they are essentially backward looking. Looking backward at the data of the past, they simply cannot determine if the economy is experiencing a psychological bubble or just a change in trend. Most notably, the former chairman of the Federal Reserve, Alan Greenspan, in the late 1990s could not make up his mind if the economy was experiencing irrational exuberance or simply an improvement in productivity. Mainstream economists paint a picture of the economy that falters for psychological reasons.

11:55We the people get overly optimistic, engage in risky speculations and become euphoric during the boom only to become less optimistic when corruption appears until we become downright depressed. We are then to be rescued from our depression by the wise leaders of the Federal Reserve who restore order by lowering interest rates and giving the economy a dose of liquidity. The psychological approach is naturally preferred by the Federal Reserve itself. What happens if you have a psychological problem? Well, you call the doctor, Dr. Greenspan or Dr. Bernanke. They have the cures for you. They can apply shock therapy if the economy to tame the demons of inflation and they can inject the economy with liquidity for depression.

12:45It should sound suspicious that economists resort to psychological explanations for the business cycle when the foundation of mainstream economics is rational economic man. Now on the Austrian side, we don't deny the psychological aspects of the cycle, but But psychology can only help us describe the cycle and the dynamics, it does not explain the cycle. The real story is that people get overly optimistic, highly speculative and corrupt when the Federal Reserve reduces interest rates in the economy. Not only are interest rates too low, but more credit is being injected in the economy and being distributed to less credit worthy borrowers.

13:31People are able to simultaneously consume more and invest more because of this inflation. This not only creates a boom, it inaugurates the bad investments in credit scandals and therefore the bust is inevitable. The truth is that the Federal Reserve is the problem, not the solution. You know, mainstream economists are great at prediction as long as it stays on the trend line and that's the easy thing to do. But they are terrible at predicting changes in the trend, which is really the important thing. I would say don't trust economists when it comes to predicting markets. Their collective record is so dreadful that a monkey in a dart board can do a better job.

14:17And their record is so bad that it even hints at some kind of deception. I'm not suggesting some kind of grand conspiracy here, but you do need to know that the overwhelming Most monetary and macroeconomic economists work for or benefit from the research pork money provided by the Federal Reserve. An Austrian economist Larry White has recently shown that over three-quarters of all the articles published in prestigious academic journals on the topic of money and banking had at least one co-author with an affiliation with the Federal Reserve, and that if you took the editorial boards of those same journals, you'd find that 85 percent of the editorial board had members with affiliations with the Federal Reserve.

15:15In fact, most academic articles on the subject are directly published in Federal Reserve publications, and they do not hide the fact that they openly try to influence research on these topics, and that they are unreceptive to anything critical of the Federal Reserve. Dissent is simply not tolerated. In fact, the Fed cut the research budget of two federal district banks after they published articles that were mildly critical of the Federal Reserve. And you need to know that the Federal Reserve is a very lucrative outfit. They have as much Obviously, if the Fed is able to induce any bias in research, its highest objective would be to deflect blame for the business cycle away from the Federal Reserve and to place Place it on something nebulous like mass psychology or technological change.

16:27The more vague and scary the explanation, the better for the Federal Reserve. And Wall Street economists basically tell the same story, that everything's great because they are interested in having you invest your money in their products. If you sold some of your investments during a bubble and invest them in treasury bills or gold coins, their income from fees would go down. I believe that we have good reason to question the validity of the mainstream approach. In addition to their horrible record, they appear to have a problem with their self-interest. And their psychological diagnosis is at odds with the foundation of psychology itself. For these reasons and many more, I urge you to treat their pronouncements from the Federal Alan Greenspan, the second longest serving chairman of the Federal Reserve, was as revered as he was powerful.

17:26The truth is that he was a political player for both parties, willing to solve problems near and far with various doses of money and credit. His tenure at the Fed is as marked with bubbles and busts just as the moon is marked with craters. Despite his recent denials, he set the conditions for the housing bubble and the preconditions for future economic calamity. Greenspan's semi-annual testimony before Congress was always much anticipated by market watchers, much dissected in the media, and much looked at by market analysts for any nougat of the future they might hold. The reality is that his testimony was usually about deception. On Wall Street, The Theory, they called it green speak, as it was called, referred to as torturous twisting of words with endless assumptions, conjectures and qualifications, so as to basically misinform, but to leave everybody with the impression that all was well, especially at the Fed.

18:29For your own sake, think of his and current Chairman Ben Bernanke's testimony as green spam. about your green money, but otherwise it is an attempt at deception. You should do the equivalent of deleting it and installing a spam filter on your computer. All of his statistics are used to paint a rosy picture. For example, he has recently been insisting that the weak dollar is good for the U.S. economy. But a few years ago he was telling us that a strong dollar was good for the U.S. economy. How convenient. Of course, he does mention regularly that there are some risks in the economy, but that he's always willing to step in to take charge and to make everything better again.

19:17For an example of his accuracy, however, let's take a look at his opening statement of his congressional testimony February 23rd in the year 2000, right before the stock market began to crash and the economy sank into a recession. There is little evidence that the American economy, which grew more than 4% in 1999 and surged forward even faster in the second half of the year, is slowing appreciably. And then after noting that inflation was low and profit expectations were high, Greenspan concluded that he believed that this was, quote, Scarcely an Indication of Eminent Economic Weakness When Greenspan discusses concrete problems in the economy, he is always quick out to point out that these problems are never caused by the Federal Reserve.

20:09And he's always willing to help, but Congress must get busy clearing up problems like the abysmal low savings rate in America, the budget deficit, and the looming crisis in Social Security. He conveniently fails to mention that it is his low interest rate policy that discouraged savings in the first place, and that his willingness to launder government debt encouraged both budget deficits and increased spending, and that he personally blew the opportunity to reform Social Security in the 1980s when the problem wasn't as bad. Let us now look at the Fed pronouncements regarding the recent housing bubble. Two economists from the Federal Reserve researched the existence of a speculative bubble in the U.S. housing market and they found that a housing bubble could have a severe impact on the U.S. economy if it existed and if it were to burst.

21:07But ultimately they concluded that such fears were unfounded. Quoting from their 2004 paper, Our main conclusion is that the most widely cited evidence of a bubble is not persuasive because it fails to account for developments in the housing market over the past decade. In particular, significant declines in nominal mortgage interest rates and demographic forces have supported housing demand, home construction and home values during this period. period. Furthermore, they found, quote, no basis for concern for any severe drop in housing prices. In the past, when the U.S. went into recession or had experienced periods of high nominal interest rate, these government economists found that any price declines have been moderate and that significant declines only happen regionally so that it would have no devastating effects on the national economy.

22:03Not surprisingly, this was essentially the view of Alan Greenspan and his replacement, Ben Bernanke. In particular, Greenspan was aware of the possibility of a housing bubble, but he offered many reasons to suggest that it did not exist and that if one did exist, it would not be a major problem. Now the chairman is very difficult to interpret and sometimes is so incomprehensible as to be misleading, but on this topic of the housing bubble, he was pretty clear and direct. And I think worth quoting at length, quote, The ongoing strength in the housing market has raised concerns about the possible emergence of a bubble in home prices. However, the analogy often made to the building and bursting of a stock price bubble is imperfect. First, unlike the stock market, sales in the real estate market incur substantial transactions cost, and when most homes are sold, the seller must physically move out.

23:02Doing so often entails significant financial and emotional cost and is an obvious impediment to stimulate a bubble through speculative trading in houses. Thus, while stock market turnover is more than 100%, turnover of homeownership is less than 10%. Scarcely tender for speculative conflagration. Whatever that is. Second, arbitrage opportunities are much more limited in housing markets than in security markets. A home in Portland, Oregon is not a close substitute for a home in Portland, Maine. And the national housing market is better understood as a collection of small, local housing markets. Even if a bubble were to develop in a local market, it would not necessarily have implications for the nation as a whole.

23:51As the bubble was reaching its peak in 2005, Greenspan did admit that there was quote some apparent froth in some local housing markets, but overall he found that conditions in the housing market were actually encouraging. Then amazingly in his first speech after leaving office, Greenspan said that quote the extraordinary boom in the housing market is over and there is no danger that home prices would ever decrease, ." Of course, he was dead wrong on all these crucial points. The truth is that if he had recognized or admitted the housing bubble early on and changed course, the housing bubble could have largely been avoided as well as most of the economic hardships that people are currently experiencing and in the future. The new Fed Chairman, Ben Bernanke, admitted in 2006 that there was a possibility of a slower growth in home prices. This was at a time where home prices were increasing faster than they ever had in the history of the country.

25:00So he admitted that there was slower growth possible. But Confully declared that if this did happen he would just lower interest rates. Bernanke also believed that the mortgage market was more stable than in the past. He noted in particular that, quote, our examiners tell us that lending standards are generally sound and are not comparable to standards that contributed to the broad problems in the banking industry two decades ago. In particular, real estate appraisal practices have improved. This is remarkable. Just as the bubble was at its and all the highly risky mortgages were being created. Bernanke reports that he had investigated lending practices in the real estate market and found no signs for concern.

25:49This is precisely when monetary pumping at the Fed was hatching all sorts of mortgage scams. The general lesson here is to not listen to the deceptive testimony of the Fed. they have a monopoly on monetary research and use it to create a spin where the Federal Reserve can cure all economic ills and creates no problems of its own. In addition to the Federal Reserve there was almost a complete denial that a problem existed in the housing market. It was very common to hear things like home prices never go down or that real estate always holds its value or that the market for homes in my city is different because of X, Y or Z.

26:37The Vice President and Chief Economist of the National Association of Realtors, David Lara, could always be counted on spinning any bad news. News. As late as March 16, 2007, he reported, quote, while you should expect some continued volatility in mortgage markets over the next months, rest assured that the National Association of Realtors is working diligently to propose and pursue appropriate solutions so future home buyers can finance their homes with safe, fair and affordable mortgages. Lara left the Association less than a month later, and recently published a book entitled, All Real Estate is Local, which appears to be an attempt to excuse his cheerleading for the housing bubble, just like Greenspan's new book, The Age of Turbulence, is an attempt to whitewash his own record. Few economists noticed, or admitted, or published anything was wrong in the real estate market or did so only after it was too late.

27:44You know, after you see three or four shows, different shows on TV about house flipping, you might think that maybe something was wrong there, but basically the entire economics profession did not see it coming. The economist who did identify the housing bubble and issue warnings came from the Austrian School. Among the Austrians who identified the housing bubble was economist Frank Shostak, who identified He calculated that the median home price was already 73% above trend, and warned again in 2004 that, quote, there is a strong likelihood that the U.S. housing market bubble has already reached dangerous dimensions.

28:32Also from the Austrian camp was Christopher Meyer, who warned of the housing bubble problem resulting from Federal Reserve policy, and in early 2004, I pointed out the ongoing housing bubble to investors, quote, signs of a new era in housing are everywhere. Housing construction is taking place at record rates, new records for real estate prices are being set across the country, especially on the coast, booming house prices and record Low Interest rates are allowing homeowners to refinance their mortgages, extract equity to increase their spending, and lower their monthly payment. As one loan officer explained to me, it's almost too good to be true.

29:20Well, in fact, it was too good to be true. When you hear people talk about new eras, or that this time things are different, or Declaring a new era in real estate simply ignores the historical fact that we've had regular cycles in real estate markets throughout our history. Finally, in the spirit of what goes up must come down, Austrians fully recognize the nonsense of this new era thinking and realize that bubbles necessarily result in busts of some sort. Just as they are alert to the formation of bubbles, so as they are forward looking to the subsequent bust. With the stock market a leading indicator in the economy, it is therefore natural to look at the home building stocks for clues to the unwinding of the bubble.

30:13The Philadelphia Housing Sector Index peaked in January 29, 2005. On August 8th, I published an article on this index that clearly indicated that this is a sign that the housing bubble may have sprung its first leak. Since that time, the index has lost about half its value. In the fall of 2005, there was still plenty of talk about home prices never going down, and still plenty of time to sell your real estate investments at a hefty profit. Profit. These correct predictions led John Desard, the senior economics columnist for the Financial Times in London, to conclude that quote, the best research on real estate is being published in Auburn, Alabama at the Ludwig von Mises Institute. Now let's take a look at the signs of what some of the Austrians were looking at and what the mainstream apparently didn't see as a problem. In the wake of the Nasdaq's dark market crash and the terrorist attacks in 2001, the Greenspan Fed reduced the federal funds rate from

31:316.5% down to 1% and left them there till June of 2004. At this low rate, interest rates were actually negative when price inflation is taken into account. And then And when banks have access to reserves from the Fed at these low rates, they can offer customers lower rates on loans. During the housing bubble, interest rates on 30-year conventional mortgages were at their lowest level ever during the post-gold standard era. The amount of real estate loans at commercial banks first exceeded $1 trillion in November of 1994. Then in fairly quick succession, they exceeded $2 trillion in November of 2002 and $3 trillion in May of 2006. In 2007, they ran into a brick wall at $3.4 trillion.

32:34The increase in the money supply necessary to hold rates down at those levels forced The Federal Reserve to expand the money supply by more than 10% per year during the bubble. In terms of the number of houses built, in 2006 a new record was set with more than 1.8 million new homes started. That is now currently at a rate of less than a million and it's continuing to fall like Like a rock. Like a rock. Dropping a rock. Not like a rock. Although that would fit too, I suppose. During the bubble, home prices increased by 45%, which is 1.25 times larger than the increase in consumer prices.

33:29So, all of the indications, all of the measures that you would look at in terms of the housing market, if you looked at any of them, or if you looked at all of them, you would find them all beeping red, that these are very unusual conditions. Now, were the Austrians just lucky with the housing bubble? Was it just happenstance that several Austrians published on this subject, and of course it was common discussion amongst Austrians, particularly on blogs. I went back to check the historical record and found a consistent pattern between the Austrians and the mainstream economists. The Austrians called every major turn in the business cycle in 20th century America, while mainstream and Wall Street economists almost always missed the boat.

34:20In fact, instead of issuing cautions, mainstream economists were usually serving as the head cheerleaders of the boom, particularly right before the bust. With the tech stock bubble of the late 1990s, I found academic economists were completely at a loss of even understanding bubbles. Likewise, central bankers from around the world and government forecasters were completely ignorant of the bubble. And when we turn to Wall Street, we find basically the same thing. The forecasters tracked by the Wall Street Journal were actually fairly cautious as the tech stocks were growing bananas. But then they got incredibly bullish right before the Nasdaq market crashed. If we look at some of the books published at the very height of the bubble, we find James Glassman and Kevin Hassett's book, Dow 36,000, which basically was predicting that the Dow Jones was going to triple in value.

35:19Their favorite stock pick, by the way, is still down one-third in nominal terms seven years later. We also had David Elias's book, Dow 40,000, and then not to be outdone, Ralph Akampura's book, Dow 100,000. I found 12 different Austrian economists who published articles in the late 1990s identifying the bubble and its cause, and among them was Hans Sennholz. The Japanese stock market bubble of the 1980s also had mainstream economists completely confused. Most economists and commentators were complaining that Japan was taking over the world economy by using government management of the economy to dominate, and if we didn't start copying the Japanese, that we would be buried.

36:10Writing at the peak of the bubble, Laura DeAndrea Tyson, President Clinton's Chairman of the Council of Economic Advisers, was nearly hysterical that Japan was surpassing the U.S. and that we needed to have the government more involved in managing the economy. I haven't found any Austrian who predicted the Japanese bubble in print, although it was a common topic of conversation, but we did provide an explanation in the aftermath, most notably by Professor Jeffrey Herbiner of Grove City College. If we go back to the stagflation of the 1970s, your parents might be able to tell you something about that, when we had both high unemployment and high price inflation, we find a similar scene.

36:56Professor Arthur Oaken, who was then chairman of the President's Council of Economic Advisors, published a book, unfortunately, during the same month that the economy slipped into recession. He declared that the business cycle was dead in his book, and he ridiculed those like the Austrian who believed the old fiscal religion about business cycles. Oaken believed that Keynesian-style scientific management of the economy had created another new era. Quote, the activist strategy was the key that unlocked the door to sustained expansion of the 1960s. Unfortunately for Oaken and the economy, the unemployment rate would more than double and would stay above the historical average for the next two decades.

37:45The rate of inflation for consumers would more than triple. Things grew so bad so fast that the Bretton Woods monetary system broke down. Richard Nixon took the U.S. off of the gold standard in 1971 and imposed nationwide comprehensive wage and price controls. Like the dot-com bubble of the 1990s, The high-tech companies of the 1960s would lose 80 to 90 percent of their value. Austrian economists Murray Rothbard and Henry Hazlitt confidently called the bubble and the impending bust in 1969 in print at the very top of the market. Now let's go all the way back to the Great Depression.

38:31Mainstream economists today saw no bubble in the stock market and no reason for concern. Business press, industrialists, government bureaucrats and political leaders saw nothing to fear in the roaring 20s. They were highly optimistic at the peak and continued to be optimistic even after the stock market crashed and the economy went into recession and then depression. One political party official complained in late 1930, Quote, persons high in the party circles are beginning to believe that there is some concerted effort on foot to utilize the stock market as a method of discrediting the administration. Every time an administration official gives out an optimistic statement about business condition, the market immediately drops.

39:25As I detailed in my paper for the 50th anniversary conference, the leading mainstream economist of the day was Irving Fisher and he basically invented modern mainstream macroeconomics as well as central bank policy guidelines. He was the lead cheerleader of the boom in the late 1920s for the stock market and in particular the scientific management of the economy. Fisher was completely blindsided by the Great Depression. He wrote on the eve of the stock market crash that in America it was now the case that, quote, stocks have reached a permanently high plateau of prosperity. And he continued to be, continued to be bullish and to recommend stocks month after month after the crash had occurred.

40:17In the process, he lost his own considerable fortune, his wife's family fortune, and a considerable portion of the endowment of the university until they finally had to kick him off the committee. On the other hand, the great Ludwig von Mises clearly saw the problems in Fisher's system and wrote an entire book-length critique of Fisher and his system that was published in 1928 that describes the flaws of Fisher and warned that the bust was inevitable if Fisher's policy guidelines were continued. Mises students such as F. A. Hayek similarly warned of a crash. So I think the historical record here between the Austrians and the mainstream are very clear. All of the major turns in the economy were predicted by the Austrians. None One of those major turns were predicted by mainstream economists or even Wall Street economists and as a matter of fact, the government economists and the mainstream economists were cheerleading on those economies as the crash or crisis came about.

41:30Looking at current economic statistics, one would be puzzled as to the direction of the economy. On the one hand, the stock market, indeed stock markets around the world, are near all-time highs. Unemployment is low and the consumer price index is at relatively low levels. China, Russia, India and other countries are doing extremely well. Statistically, things look almost too good to be true. On the other hand, the dollar is at an all-time low. The price of gold went over $800 an ounce today for the first time in 27 years, and oil is over $90 a barrel. In debtedness in terms of the national debt, consumer debt, mortgage debt, the personal savings rate, and the future liabilities of the federal government are all at unsustainable levels.

42:21But looking at all the statistical facts, one would really not be able to develop a A clear indication about the future direction of the economy. However, if we look for signs of economic imbalances, we do find the makings of an economic crisis. First and foremost is the housing bubble, which is now in a freefall downward in terms of building permits, building starts, housing starts, foreclosures, bankruptcies, as well as the number of houses being sold. The housing prices, despite all those predictions by the Fed, are actually declining. The real estate bubbles typically do not crash, like stock markets.

43:08The Japanese real estate market, for example, declined for 15 years after the bust. The housing market is related to the mortgage market, which has seen dozens of firms go out of business already. This market is where the subprime mortgage problem took place. Subprime mortgages, along with a variety of new mortgage products, including interest only loans, adjustable rate mortgages with teaser rates, and no-doc loans where customers don't have to document their income, they just have to tell the bank what their income is. Our products represent an economy-wide reduction in lending standards.

43:54Just like the Enron fiasco where banks were pushing loans on an unworthy and poorly documented consumer, a reduction in lending standards is the natural result of Federal Reserve inflation and a classic indicator of future economic crisis. How will our crisis unwind itself? Well, this is a question that we cannot answer with scientific certainty. Economic theory is not capable of predicting either the magnitude or the timing of a crisis, because first, it is not equipped to do so, and second, much of that is going to rest with the future actions of individuals and government policy. We do, however, in recent days, have seen one indicator based on the interest rate cuts by the Federal Reserve.

44:45These cuts by the Fed were encouraged by the high finance industry, the big New York City banks, the hedge funds, and none other than Secretary of the Treasury, Henry Paulson, who is the past CEO of Goldman Sachs. I believe that the cuts were not made to help mortgage payers, but the mortgage holders, and that any future bailouts will be similarly motivated. Now I say this not to necessarily impugn their reputations, but to indicate that there are well-placed special interest groups who will seek and probably receive future bailouts. This then gives us an indication that the bailouts associated with the housing bubble will lengthen the unwinding of the crisis.

45:32Bailouts do not serve to solve a crisis, they only make them longer and ultimately more painful. Bailouts are also a subsidy to bad investments, hazardous entrepreneurs and unproductive activities. They are attacks on sound investments, stable entrepreneurs, and productive activities. They necessarily make the crisis worse in an economic sense, even if they appear to be politically popular. We already see signs the U.S. economy is contracting and probably headed for recession. Foreclosure rates, bankruptcy rates, and delinquency rates are all rising, and there are hundreds of billions of dollars of mortgages that are set to reset their rate over the next two years.

46:23All those teaser rates are basically going to go up to market rates. In addition to housing, the domestic automobile industry is in contraction. The state of Michigan is in recession. And so while the unemployment rate is low, it is rising. The economy is currently benefiting from a surge in non-residential construction as businesses, churches, universities and other institutions try to make up for the backlog that developed during the housing bubble. There has also been a surge in exports due to the falling dollar. Neither of these surges is over, but no one expects them to be permanent. The imbalances indicate that the possibility of a recession in 2008 is much larger than currently anticipated by market forecasters.

47:13And if you stripped out government spending and properly accounted for inflation, we would probably already be in a recession. In addition, there are plenty of political hotspots, as you know, which could ignite at any moment and bring down markets around the world, including the bubbles that exist in China and Russia. One indicator that I work with has already signaled a major economic crisis in 2008 and along with a real estate bubble in the US and elsewhere could make for a very painful and drawn out affair. However, there are policies which could in part mitigate much of the economic pain for the crisis. In addition, crises usually can present opportunities for policy reform.

48:00We would start by allowing markets to set interest rates rather than the Federal Reserve. Next, government spending would have to be greatly reduced, both to eliminate the budget deficit and to allow tax cuts. With the budget deficit eliminated, the trade deficit would move towards a balance and stabilize the value of the dollar. Third, rather than providing bailouts, the government should allow liquidation to take place. Fourth, by moving to a sound monetary system where you have a gold standard and 100% reserves on checkable deposits would restore stability in money and banking and prevent future economic bubbles. Yes, the pain would remain, but it would not be as bad as other policy alternatives.

48:49The names of the holders of mortgages and collateralized debt obligations would simply change. Homeowners would become renters. Employees in the finance and construction industry would have to move to other industries like manufacturing, service and infrastructure. All of this is going to happen anyways, but the Austrian approach would make it much quicker and less painful. The Austrian approach might seem like it's pie in the sky. After all, in this battle, Austrians are outnumbered by mainstream economists by more than 100 to 1. We are like David to their Goliath. But like David, we have a slingshot or a secret weapon, and that we have some scientific truth to back up our case and our remedies.

49:36And we also have a track record that I presented tonight of knowing and anticipating what many people consider of utmost importance, anticipating the business cycle. and we have a remedy for the business cycle. Meanwhile, the mainstream has a terrible record and questionable motivations. I believe we have a grand opportunity to place this nation back on its original foundations of peace, property and natural rights and to once again be a shining example for other nations that they may follow our lead. In the late 19th and early 20th century, Austrians dominated the debates over economic policy, a position we lost during the Great Depression and the rise of fascism. But I believe that in the early 20th century that we can once again retake that position of leading economics and economic policy around World. Thank you very much. Any questions? Yes.

50:49What do you think about the time and economic policy of the President of the United States, Ron Paul, to advocate time on the road?

51:19The Theory of Money and Credit The Theory of Money and Credit The Theory of Money and Credit brought Austrian economics out into the mainstream for the first time in a very long time basically and that is really driving his campaign is really driving a lot of renewed interest in Austrian economics and I can tell you working at the Ludwig von Mises Institute you can just feel the increased volume of interest based on the traffic on our websites, the number of phone calls we get and things like that.

52:19and things like that, he's a tremendous drive for reform and I think that he's really helped to spread the word about Austrian economics and what good it can do for all of us.

52:35Yes? What do you think of the Austrian economics? Do you ever think that they will overcome and something like that would be destroyed or social security would be removed? These are big economic issues that are deeply rooted in too large America for the past 15 years. How would a big thing like that happen?

53:06and prominent financial press, including The Wall Street Journal, The Financial Times of London, The Economist Magazine, Investor's Business Daily, the list goes on, Barron's. I mean, so we're being found out to have the right answers and these guys never report on the entire mainstream economics unless you're just a bond fund manager or something

54:04to solve long-standing problems and people know that Social Security is a problem. And more and more people realize that inflation is a problem. They're certainly gonna realize the housing bubble is a problem. And that the Federal Reserve and other institutions are not really telling the truth. And when people find out that they've been had and somebody's not telling the truth, Do you think that open integration is a more open integration policy than the integration of drug additives as a counter-competitive act, given by the use of travel?

55:01because it was sort of tangential. Much of the illegal immigration from Mexico has occurred precisely because of the housing bubble. There are four major categories in which illegal Mexican immigrants work. Three of those are directly related to housing. The big run-up in all that illegal immigration flow I see as basically being directly related to the housing bubble because the Mexican immigrants worked in housing, construction, road building, new landscaping, and a variety of other related industries. And I've just checked the figures before I came up here to Grove City. The Central Bank of Mexico keeps a statistic on how much money is being sent from the U.S. back into Mexico.

55:52It's called remittances as these people send money back to their family. You might see this at the grocery store where they wire money back to Mexico. Those remittances have increased dramatically during the housing bubble and they have, over the last six months, leveled off and actually we're starting to see negative numbers for the first time. So my guess is that illegal immigration from Mexico has not only on net stopped but may may actually be reversing itself. Not to the point that Lou Dobbs is going to be off his blood pressure medicine, but there is a sign. These things can be explained. Lou Dobbs doesn't want it explained, but that's the explanation for the problem of illegal immigration from Mexico.

56:44Okay, thank you very much.

56:50Thank you very much.