So Where’s the Inflation?

0:00And we are back on The Peter Schiff Show. Tom Woods in for Peter today. Very happy to welcome to the program right now Mark Thornton. Mark is a senior fellow with the Ludwig von Mises Institute, holds a PhD in economics from Auburn University, which is one of the universities where he has taught economics over the years. He's the author of The Economics of Prohibition. He's co-author of a book called Tariffs, Blockades and Inflation, The Economics of the Civil War. He's book review editor for the quarterly Journal of Austrian Economics. and we're going to talk today about a lot of current events. Mark, very glad to welcome you to the Peter Schiff Show. How are you doing? I'm doing fine, Tom. It's great to hear you. It's great to be on the show. Thanks a lot. Now let's jump right in here because I asked you before we went on what sorts of things have you been writing about but on your mind. I read your article on inflation, so we'll get to that in a minute. But what is the deal here? Peter's had some commentary on this, but what's going on with the German gold repatriation?

0:56Patriation, why do they want their gold back and is the response to this request just normal? I mean, is this just a matter of, well, we need to ensure the gold going from one place to another and it takes a lot of time and that's why we're taking all this time. Is there an innocent explanation? What's happening here? Well, we're not giving out a lot of information, Tom, but the German people are very uneasy about their position within the European Economic Community because they're viewed as the big Bailout Nation, and so they're worried about the Euro, they're worried about the economy, they asked the Federal Reserve for an audit of their gold holdings, which the Fed then refused, and so Germany made this request to get back some of its gold. It asked for 300 tons, which is a small percentage of their overall holdings at the Fed.

1:46The curious thing though is that, you know, mainstream economists dismiss this whole thing is just silly and that it's unimportant and that gold is just a relic of history but the interesting thing for me is that the New York Fed is not going to deliver those 300 tons until 2020, seven years from now. So the Fed is not exactly like Domino's Pizza. Right, now that is true. So do you think, Now on this issue of refusing to do this audit, it's not like Germany is like a small player that you could just treat with contempt. Can you conceive of an innocent explanation as to why the Fed would not consent to such an audit?

2:33No, I can't. It's just preposterous, the idea that it would take seven years to move a mere 300 tons of gold, Gold, even given security concerns and things of that nature, that's not a humongous amount of gold. That would still leave more than a thousand tons of German gold at the New York Fed. So there's no logical or logistical reason why they couldn't get that gold within, say, one year period of time. So that leaves us thinking that there's been some funny business going on at the Federal Reserve. You know, they run a fractional reserve banking system, and so it's not too much of a leap to figure that they might be using a fractional gold holding system as well.

3:23And people have speculated that what's going on here is that the Fed and other central gold banks have been selling gold or leasing gold to gold banks who in turn then sell the gold and buy bonds so that they can make money on the interest on the bonds and by selling the gold into the market, at least temporarily, that has a depressive effect on the price of gold which makes, you know, which is something that central banks like. They don't like to see rising ever higher gold prices. And so one way of suppressing gold prices, people have speculated, is that the central banks would sell some of their gold holdings, which then gets, excuse me, they lease their gold holdings to people who then sell the gold and that depresses the price of gold.

4:13Do you think we can expect more requests of the nature that we saw from Germany now in light of how Germany's request was handled? I think so. I mean, you know, our enemies have already requested their gold, like Venezuela and things The Germans have requested most of their gold held in England to be returned, and they've requested all of their gold in France to be returned, and we see other central banks around the world adding to their gold holdings, particularly countries like China has added significantly. Some believe that it may have even surpassed Germany as the second largest holder of gold.

4:58India has made some large purchases, so the whole game has changed here and central banks, even though they loathe to admit it, realize that real money is gold and that the paper money that they're dealing in is losing face value. All right, let's switch gears now. Let's talk a little bit about something you wrote a few weeks ago. We were more or less weighing in on a discussion that's been going on between, well if you can call it a discussion that would I think dignify it too much, but Paul Krugman has been highly critical of people who predicted that the price level would rise to a particular height because of what the Fed has been doing and the CPI hasn't risen to that extent and so Krugman is claiming this is a vindication of his whole approach and it's a devastating How do you sort this out? Is it a mystery as to why prices haven't risen, or have they not risen? How do you make sense of this?

6:04No, there's no mystery at all. I mean, the quantity theory of money tells us that if you increase the supply of money, that prices will go up. There's nothing particularly Austrian about that. So the idea that Krugman is somehow unseating the Austrian economist The Austrian economist or condemning the Austrian economist just isn't so. In fact, we're the only ones that can actually explain how prices have actually turned out as a result of this massive inflation of the money supply and the monetary base. It hasn't gone into consumer prices. Consumer prices are up, as measured by the government, about 2% using older measures. CPI is up 6, 7 or 8%. But where the money is really going, that's what you have to find out, is where is the money really going?

6:50And if we look at markets around the world, other than consumer goods, we find that the price of oil is over $100 a barrel, gasoline in Auburn, Alabama went up 5% last week alone, the price of gold is very high, near historic high levels, commodity prices in general, The things we build houses with, the things we consume as corporations and businesses, all of the prices of those things are at or near record high levels. And so if you look at the financial markets, what we see is government bonds and corporate bonds and junk bonds are at all-time record highs. The stock market is at an all-time record highs.

7:36We see real estate markets higher significantly in some cases, all-time record highs in real in New York City, in Washington D.C., in San Francisco. We see art prices at the Sotheby's and Christie's at all-time record highs in terms of the size of the auction and record prices for particular artists. So if we look outside that narrow consumer index of prices, what we find is prices are exploding across the board and are at or near all-time record Well, can you describe the mechanism by which that would be the case? I mean, it would seem to the untrained mind that all prices should just rise. Like, why would there be this kind of segregation of goods in financial markets or commodities, whereas toothbrushes would just rise?

8:29Why would there be this kind of segregation of goods in financial markets or commodities, whereas toothbrushes are roughly the same as they've been? Why should that be? Well, because of how they're injecting the money into the economy. The money is going into the hands of banks and financial firms, and the money goes from there into capital goods and into assets. and so the money is flowing from the Fed to the banks and the financial firms where the money is then put placed into government bonds, corporate bonds, junk bonds, it's placed into the stock market, it's placed into real estate and things of that sort so the money is flowing exactly the way the system works and it but it's not going to the consumer. I just saw a study out yesterday that showed that the overall cost of the government bailing out our economy was $12 trillion dollars.

9:30Eleven of that $12 trillion dollars went through the banking system and less than a trillion of it went actually to American citizens. And so the money is flowing to the banks, to financial firms and then to financial markets. The reason our prices are high is because all those hedge fund managers, all the mutual Fund Managers and Dealers in Securities in New York City, they're making tons of money. And so they're using that money in terms of consumption in buying contemporary art and modern art. And so you see those auctions exploding because there's just so much money there. Now that money doesn't get to Auburn, Alabama or Kansas or Des Moines for a long period of time.

10:19Now, the time it gets to us, the prices of those consumer goods will already have been bid up, so eventually it'll get into consumer goods. It's not going to be a good thing, obviously, but eventually it'll end up there. Isn't it the case though that if the banks aren't... obviously we know there's a huge unprecedented amount of reserves that the banks are sitting on and that they're holding at the Fed, excess reserves, and if they are not going to lend this out, they're just going to sit on it, this obviously does limit the amount of the price inflation that we see. So, wouldn't that also be another reason that we don't see prices exploding to quite the extent, like proportionately to the money supply increase, if the banks don't lend it out, then it has no way of getting out into the general economy, so it's not exactly, you don't have to hire a private detective to figure out why prices aren't going through the roof for consumer goods.

11:18That's correct. The money that the Fed has given to the banks, most of that is being held as excess reserves and traditionally the banking system as a whole did not hold any excess reserves and now they hold an amount of excess reserves that equal the entire deposit base of the banking system so this is really unprecedented and they're not lending that money, they're keeping it on the books at the Fed, earning interest, the Fed is paying them interest to not lend the money. And so, under normal circumstances, if the bank started lending that money to people for mortgages and cars and business loans, then the money would actually get into the hands of the average American, and then you would see that process where the money is lent, it's spent into the economy, the money multiplier effect means that the actual amount of money circulating in the economy and even greater than the amount of money that the banks currently hold and so Americans would be starting to bid against one another for lumber and for car parts and the normal things that are in the consumer price index and so that's when the consumer prices would really take off is once the banks start lending that money.

12:41Alright, we're going to take a quick break right now and when we come back we're going to continue our conversation with Mark Thornton and I'm going to ask him about the housing bubble, how he spotted this so early, what was he seeing that other people weren't seeing, and frankly, why weren't they seeing it? That's coming up next on The Peter Schiff Show, the gold standard in talk radio. Well don't try to change the subject again, hide and seek with yourself, it ain't a game. All right, everybody, we're back on the Peter Schiff Show. Tom Woods, In for Peter, joined by Mark Thornton of the Mises Institute. Mark, you were one of the first people to start talking about warning about the housing bubble. First of all, can you tell us when did you start talking about this and what exactly were you saying? What were the particular aspects of the housing market that alarmed you or made you think that maybe there was something out of whack there

13:34Well, Tom, you'll remember that the Federal Reserve cut the interest rates to 1%, which was historically the lowest level it had ever gone to at that point. So we were on guard. We were looking out for where is the bubble going to form. And it wasn't too hard to really figure out that it was going to be a housing bubble because very often the Fed creates real estate-related bubbles. and so we were on looking out for this and then I finally in early February of 2004 wrote an article about the housing bubble for lewrockwell.com and the response to that was kind of interesting because people were enraged that I would suggest that there was a housing bubble in the economy everybody was saying you know you can you always make money in real estate housing prices never go down and you know things of that nature you can't lose money in real estate and and what I was saying was just you know against all that I was saying that yeah

14:33people are going to lose money because housing starts, housing investment, housing prices, housing inventories, all of the indicators in the housing sector were suggesting that housing was being way way overdone and that there were too many houses being built, the housing prices were going up at a much higher rate than they had ever done in the past and so it was clear to me that there was was a housing bubble and I got a lot of speaking engagements actually which were more like ambushes where I would make my presentation about why there is a housing bubble, why this could be dramatically difficult for the US economy going forward and you know people hated that because I was you know taking away the punch bowl so to speak and so people were very upset but the you know the housing bubble continued on for about another year and a

15:54readers and listeners about that fact. And I think one of the greatest things I've ever experienced in my career as an economist was I got some telephone calls and some emails, I think four or five of them at least, where people thanked me for keeping them out of the housing market, that they would have been financially ruined in 2007 had they bought a house in 2005. And so that was very rewarding and endearing and makes it all worthwhile. Well, actually, Mark, I ignored your advice completely because I moved to Auburn in 2006. And I said to my wife, I know we're at the top of this bubble, but rental opportunities were very, I mean, practically non-existent for a family of our size.

16:40And I just said, well, I'm not planning on going anywhere for a while. So we'll just sit on this thing and do our best. But I know this is going to happen. And of course, it did. So I was one of these people who didn't want to hear what you had to say, but I sat there Why do you think people missed this? The things you're describing to me are not features of the housing market that one would need a crystal ball to see, or would need special access to confidential statistics to see. It can't just be wishful thinking on the part of other people. Well, when you're making money, like people were making money on housing, flipping housing, selling housing, building housing, everybody's making money, everybody's consuming more, they're taking money out of their mortgage and buying speed boats and RVs and worldwide trips around the globe and having so much fun and making so much money and everybody's doing it and it seems so easy and you get so euphoric that all of the reality

17:46Statistics just go out the window. I recently wrote an article two weeks ago about the housing bubble in Norway where I show that housing prices in Norway are completely out of control and you know it's just obvious that what's going on in Norway and I was criticized in Norwegian financial press that you know that this is that Norway has a good economy that we have lots of oil revenues and you know we have low unemployment and we have this that the Well, the reality is their housing sector is way out of control. The housing prices are up significantly and a lot of the explanations of looking at the fundamentals. They always say, well, just look at the fundamentals. Well, naturally, the fundamentals are going to stay in line until it's too late.

18:32And that's the key is you have to look beyond the fundamentals like the unemployment rate and things of that nature. you have to look at what is the Federal Reserve doing, what is it doing to the supply of credit, that fundamental fuel of the economic process, they can artificially expand that credit from what it should normally be and as a result they're throwing in jet fuel onto the economy and you're burning through resources and prices are inflated as a result of all the heat given off from the Federal Reserve's action. So you have to keep your eye on the Fed. It's the fundamentally destructive factor in the economy. And when they're active, as they are right now, you've got to look out for trouble because that's what they do. They create trouble. They like to be seen as the solver, the institution that solves all things and keeps everything stable, when in reality, they are the source of economic destruction Well, Mark Thornton, I knew the time would fly by, and indeed it has, so I much appreciate

19:47your taking the time to talk to us today. I'll look forward to seeing you at the Austrian Economics Research Conference at the Mises Institute next month, and thanks once again for talking to us today. Thank you, Tom. I enjoyed it. Mark Thornton, everybody, author of The Economics of Prohibition. Check out his articles at Mises.org.