Current Market Conditions: 2 Oct. 2008

0:00Have you been following today after the Senate vote? No, I didn't see what happened to the stock market today. Last I checked, it was down a few hundred points. But nobody's blaming the fact that the Senate passed the bill. Right, of course. In fact, they were saying that when the stock market went up after the initial 777 point drop the next day, they were claiming, well, it went up because the Senate was going to pass the bill. And now, right? I mean, they expect it to be revised and it will be passed eventually by the full Congress. But now, of course, they're not attributing this latest drop to anything that happened today.

0:50today. Yeah. Why do you suppose that Washington seems to have a problem understanding economics? I guess this is the eternal question, but it's been terrible to watch this day after day with these idiots running around saying stupid things all the time, you know? Yeah, this even seems to affect and infect even economists like Ben Bernanke who, when he was at Princeton, seemed to have a pretty good grasp of how the economy worked. of course he was not an Austrian but he had done some decent work on the Depression so you know it's what Murray Rothbard would always say and that is that that the closer you get to power the more power you want and the more you have to tailor your views to to the state itself which is always sort of at the center okay in a political sense okay everybody moves towards the center where the power is yeah I think everyone is still more or less enthralled to basic Keynesian error, that spending drives

2:01the economy and that if you have any sort of credit crunch and if it worsens, there's is going to be less lending by the banking system and other financial institutions, and people are going to have less money to spend, and businesses will have less money to invest, and that's going to slow the economy down. I think every senator, every congressman, all their aides, they've all more or less absorbed this view. I mean, this is when you get to Washington, this is the view that's the fashionable view, and that everyone more or less absorbs to survive. Yeah. It does, you know, and graduate students have been told for two decades now that Keynesianism is dead, but it doesn't seem to be dead at all. No, no. What I call a vulgar Keynesianism, a policy-driven Keynesianism, still exists.

2:49Because as Murray Rothbard pointed out in a very interesting article, Keynesianism is dead from the neck up, but it's still the economics of power. It still gives the state credibility in using these so-called macro tools to manipulate the economy. So, if you're non-Keynesian, you're on the outside because you're basically denying power to the state. The Keynesian economics, even though it's dead from the neck up, is the great enabler of state power. Yeah. How does this affect people's view towards the existing credit situation? I think what's happened there is that, again, because of the connection between credit and spending, everyone's extremely fearful of any sort of drawing up credit.

3:42We hear this hysterical statement that credit markets are frozen. This is total nonsense. What has happened is that things have become more risky in the short run, and therefore there is a higher risk premium on all types of loans. But in that sense, you do want credit markets to be more circumspect, to be slower making decisions. In other words, once you're heading into a recession and all of these malinvestments and mispricing of assets have been revealed, at that point, the market has to work to sort things out. And so you don't want people making precipitous loans. So you want some freezing of the credit market while the real economy is restructured.

4:28So I see there's as much credit as you want around if you're willing to pay the price. And every once in a while in the flood of articles that have been written in the last couple of weeks about this, you see people mention, well, if you're willing to pay this high price, then the firms can get, meaning high price, high interest rate, then the firms have access to credit. So bank credit is still growing, it's growing at a slower rate. It's more expensive and the banks are doing the right thing and other lenders in taking to account the greater risk and being reluctant or more reluctant to make loans at this point. Now once prices return to reality for both real assets like houses and for financial assets, you're going to see the credit markets becoming unfrozen, meaning that what Mises is called the risk premium, the entrepreneurial risk premium coming down on the interest rate.

5:21Then it's not to get ahead of ourselves, but at that point, banks are going to have tons of new reserves and lending is probably going to go out of control again. Yeah, it can. I mean, and that's a very likely scenario unless the Fed reverses things and tries to sop up some of the reserves that it's been injecting into the system. Now, it's very difficult to follow all the polemics and the rhetoric here, but I vaguely recall that within the last couple of months, there's been a lot of complaints that lenders were too loose in the past and they were reckless. Am I right? Yeah. That's what we hear. Right. I mean, so people have been saying this, so why then isn't there a celebration taking place? And people have been calling on government to regulate these guys, so they won't get any more reckless.

6:09Right. Question that the lending markets are tightening, achieving exactly what the politicians claim should have happened already. Do you see what I mean? No, no, absolutely. It's very interesting. People are now saying that, yes, yes, credit was way too loose in three or four years leading up to the full housing price in 2006, but now the pendulum has swung the other way. But it's been only a few weeks, or maybe a few months, and they're saying the pendulum has swung the other way. And that's because of this great fear of a reduction in spending, driving the economy into recession. In other words, they do not want the market to do its job. It's not that the market's frozen and not doing its job. It's precisely that the market has reacted in the correct way and made credit less available in this time of recession when there should be sorting out of all the past mistakes that were caused by the loose credit.

7:01And by the way, again, they blame the banks and they don't look further into it, which of course goes back to the Fed. How did credit become so loose? Banks can't create credit on their own, they can't create their own reserves, only the Fed can do that. Yeah, it can be very difficult to understand the political dynamics here and how it interacts with the economic realities, but one of the things that's really puzzled me is this, what It seems to be like this apodictic position that the economy must never go into recession. Do you know what I mean? It's almost a hysteria. Oh my gosh, economic growth is not going to take place at the same rate that it did in the past. We must do something.

7:48Yeah, that seems to be taken as a given. That's the starting point of any plan to deal with this crisis, that we cannot have a recession. But the point is that we've had recessions before. We'll have recessions in the future because we do have a central bank that can and Expand Credit. But right now, I mean, we're in a recession. I mean, we're descending into a recession. The point is, are we going to have a grinding, let's say, depression like Japan did for over 10 years because the government interfered and made the economy more rigid and didn't allow prices to adjust to reality, or are we going to have the usual quick recession of, you know, a year to two years in which things are sorted out and we get back on track. And by the latter can only come about with the government taking a step back and allowing the economy to adjust.

8:39It seems like there's things going on that remind you of the New Deal. I mean, there's stuff about expanding deposit insurance. I mean, this is going exactly in the wrong direction, right? Yeah, absolutely. What's happening is that they're introducing even more moral hazards into the banking system. What kept the banks somewhat responsible in the past is the fact that people who have a lot of money and want to put them in CD's, jumbo CD's for more than $100,000, can easily move that money around the country to different banks. And so banks that were more or less irresponsible, relatively irresponsible, would be the ones that would be losing their reserves and their assets would be shrinking so that as an institution they would shrink.

9:25So keeping it at $100,000 was a way of getting the private sector to monitor bank's behavior because those people's money was at risk, the deposit is above $100,000. So now we're taking away sort of that last oversight by the market on the bank's behavior. Yeah, so it's again on the one hand claiming that the credit was too loose in the past So there's no illusions that increasing deposit insurance is going to increase moral hazard, right? I mean, people understand this. Well, you know, it's not clear. I mean, certainly all economists understand this. Moral hazard is sort of a buzzword in money and banking and macroeconomics.

10:13Whether or not the policymakers completely understand this is another question. ." Again, they may understand it on some level, but the point is they are all very short-run oriented. They want to keep the economy out of recession. They want to stop the so-called credit crunch at all costs and as quickly as possible. So they feel that in the short run, this does that. And as I understand it, that's supposed to be only a temporary measure. That's what I've read. Now, we know that when government increases taxes or when it Increases Regulations, those new higher taxes and the new regulations are never repealed or reduced. Yeah. You know, it's terrible the way this whole crisis has affected my own sort of perspective, maybe all of our perspectives on what the heck is going on in this country, but you know, you're describing a financial system, a banking system, almost an entire corporate sector that's just insanely addicted to credit.

11:12I mean, does that sound more or less true? Yeah, I mean, this tremendous expansion of debt was brought about by the loose money policy first in the 1990s leading up to the dot-com boom and then in the present decade, okay, that has led up to the bursting of the real estate bubble and that was just the Fed shoveling money into the economy, okay, because for various reasons, including the globalization, prices, consumer prices didn't respond as quickly to the increased amount of money in the economy. that money was being held by foreigners, that money was being used by foreigners to buy investments in the U.S. and so on. So they felt, well, there's no inflation, we can just keep shoveling this money in. But money, as we know, newly injected credit, what's called fiduciary media, distorts other things in the economy.

12:03It doesn't just raise consumer prices. Right. Yeah, it does seem as if all the events these days are conforming almost exactly to the Austrian script, doesn't it? I mean you read Mises from 1949 or even you know the Hayek book that you edited right this is the classic I mean it is a classic unfolding of the Austrian business cycle and people like Mark Thornton and Lew Rockwell have been writing about the coming housing crisis since you know at least 2003 yeah so the Austrians were not taken by surprise by this right what do you think Hayek okay this book Prices and Production Areas, all throughout the 30s he's desperately riding to stop these attempts at stabilization.

12:50What do you think is in there that could help us today? Well, Hayek's whole point that the stabilizers had been in control by the early 1930s. Their policies had dictated the Fed increasing the money supply in the US, certainly, to stabilize the price level. and because prices would naturally have fallen so much because of the great technological advances we were having at that time, as we did in the 90s, you had a lot of money being injected to stabilize prices and this distorted financial markets, which in turn, we have to always keep in mind, are intimately related to the real structure of production in the economy. So we got real distortions also. This is the same thing that, I mean, so this lesson of Hayek applies, applied in 1930s and applies today.

13:40Which is the part of that book that you think that is most revealing, most pertinent for us today? I mean, it's a big book, right, and we're looking at whatever, 600 pages or something. Yeah, the New Hayek, the actual monograph entitled Prices and Production is very important And as a preface to that, or as a prelude to that, I would recommend highly the article in there called The Paradox of Saving. And in Mises, you get something similar in his Causes of Economic Crisis, right? Yes, Mises called the prolongation, or the prolonging, of the Great Depression not a normal business cycle, but what he called a crisis of interventionism.

14:27and so what I'm fearful of mainly is that what the government bailout policy is going to bring us into this sort of crisis of interventionism which will cause a grinding stagflation in our economy as happened in the Japanese economy so the attempts to end it will only prolong it and deepen it so this is the problem okay do you think that that the congressional efforts on the on the fiscal side if it is indeed on the fiscal side I mean it's still unclear to Post any kind of unique problem that is different from what the Fed is doing? If the bailout takes place through fiscal means, through borrowing, they're not going to raise taxes to finance it.

15:14If they borrow and they don't sell their bonds to the Fed, directly or indirectly, Then what we're going to see is a large increase in interest rates, which is what precisely is not needed during a time of recession. So we're going to have even less growth, less saving and investment, less productivity gains because of this bailout. But I have a feeling that as interest rates go up, the Fed is going to react by buying up these treasury issues, and so a large part of this so-called rescue package is going are going to be financed by money creation, by monetary expansion. Okay, I can only handle so much despair. What is the plus? What is the upside? I suppose one good thing is intellectual in a way.

16:01I mean, surely the Austrian business cycle theory is going to achieve a new level of prominence. Oh, I absolutely think so. I think that people are going to become more and more aware of an alternative explanation, which gives a satisfying explanation of what the causes were. No one is talking about the causes of any of this. Remember, greed is more or less like gravity. To say that all of a sudden, the bankers and people in financial institutions became more greedy than they were the day before and so they started recklessly lending in seeking higher profits and higher returns is ridiculous. It's no explanation whatsoever. So what we want to know is where did all this loose credit come from, okay?

16:46And the Austrian theory tells us that it has come from the Fed's actions. In fact, you can date it almost to the day back in November of 2002 when Ben Bernanke gave an infamous speech to New York bankers in which he said, we will never have a deflation because the Fed has the tools necessary, all the tools necessary to prevent that. And what he did is he went through a list of the ways that the Fed could expand the money supply, okay? It's really a chilling speech and I recommend that people read it. Now Krugman has this book, Attacking Hangover Economics, I mean there's been lots of people around for many years that have been saying, oh the Austrian theory is all wet. I suppose we're going to at least be able to say, you were wrong, we were right, I mean there's got to be something to that.

17:33Yeah, well we're going to be able to say that, but in the short run it's going to be hard to talk over the hysteria that we're hearing now. But we have to remain on point, give them more message, and I think eventually as things get worse, if this rescue package actually passes the full congress, we will have a hearing. So I'm very, very optimistic. I'm also very optimistic that people will eventually see, or see pretty quickly, that it's the Fed. And maybe, as one step away from what we have now, we'll have a call for Congress and the Treasury overseeing Fed operations. I mean, the Fed's so-called independence has to be taken away because it's not really independent, but it has a veil of objectivity because it's supposedly independent.

18:22So I would like it just to become what it really is, and that is a political tool. And when people see it as such, then maybe even a return to the gold standard in the longer run will become more likely. Thank you so much, Joe. Okay, thanks, Jeff. www.fieggen.com