A Monetary Vietnam

0:00Thank you very much. What I'd like to do is sort of outline to you what I'm going to be talking about, give you a quick overview of what I'm trying to say, and then give you a chance to ask me some questions, then I'll get into the bloody details. Okay. First, why do I call this a monetary Vietnam? What am I trying to convey to you when I say monetary Vietnam? Well, I'm trying to convey two thoughts. One, that recently we've had a very serious economic disaster in the conduct of our monetary policy. And for some reason, the public is not fully aware of how bad it's been.

0:46And second, I want to convey another thought, which is that the error that the Fed made was very similar to the error that was made during the Vietnam inflation. So in that sense, the title is intended to convey two different thoughts. One, that we came very close to a very serious disaster, and we're still not out of it, but I think we probably will get out of it. And two, that the analytical era is very similar to the era made during the Vietnam inflation. And I also, and I try to go into that and explain that. So that's one part. Second part is I want to talk a little bit about monetary pragmatism.

1:32Our policy, I think, can be described as monetary pragmatism. You can think of the Fed as the monetary equivalent of the zero we have in the White House. We have a pragmatist in the White House, and you have a pretty good idea of what he doesn't stand for. Well, I believe that the Fed were dealing with the monetary equivalent of that pragmatism. So this part of my paper will deal with monetary pragmatism. Then I'll talk a little bit about precisely what the error was that the Fed made in the in the last two years, why it's a very serious error and why we came so close to a disaster. And finally, if there's some time, I may talk a little bit about why the people that are supposed to be watching this have not said very much about these mistakes.

2:23Okay, so let me explain what I mean with the title when I say monetary Vietnam, and as I indicated, I mean two things. I mean that the era is very similar to the era we made during the Vietnam inflation and then I'm going to talk about monetary pragmatism, what's wrong with it, what it is and what's wrong with it and why it's very, it's almost like this Fed, Bush you might say deserves this Fed, they deserve each other, they're very, they're like the gold dust twins and then I want to talk about the actual mistakes made, so let me start first. What kind of a disaster I'm talking about? Now here what I have in mind is, I don't know how many of you know that the monetary growth, that is the rate of growth of the money supply in 1991, was the lowest in 30 years.

3:19In other words, it was lower yet than when Volcker went out explicitly to break the back of inflation in the early 80s. Then he explicitly followed a policy to break inflation and went to very low growth of money. What we did last year was even harsher than that. And more importantly, as I shall try to show you later, it was unintended. In other words, they didn't really intend to follow... But because of the way they operate, that's what they did. So that's what I'm talking about. That in the midst of a recession, the Federal Reserve followed a policy which turned turned out to be the toughest, the most stringent in the last 30 years, even more stringent than the one Volcker chose to break the back of inflation in the early 80s.

4:08Now the other point I want to make is that the error, now this was clearly an error and in fact the Fed has practically admitted this error. They admitted it, when you recall, in Greenspan in December, lowered the discount rate by one full point, which is four times the usual dose, you remember that in early December? Then they admitted it again about a month ago, and they cut the federal funds rate again. So they came as close to admitting they made that mistake. The other mistake is this confusion about money and credit. And let me tell you what I'm getting at here. If you go back to the 1960s, anybody looking at it now knows that during the 1960s when we had the inflation, the Federal Reserve was actually following an inflationary policy.

5:05By that I mean they allowed the money supply to grow at a very rapid rate, and a very rapid rate will cause inflation. However, if you look at the credit markets, when you get inflation, you will typically find that interest rates are rising. That is, nominal rates will rise above real rates. For example, pretend you're living in a world of a stable price level and say interest rates are, say, roughly 3%, 4%, 5%. Now pretend you go into a world where If you had an interest rate of 4 or 5% with stable prices, what kind of interest rates would you expect to have if inflation now is 5%?

5:50Well, roughly speaking, you'd expect interest rates to reflect that inflation. So one of the things you can be absolutely sure of is if you follow an inflationary monetary policy and you allow inflation to develop, you're going to get high interest rates. Now, when you get high interest rates, if you look at the credit markets, you will get the manifestations of tight credit markets. That is to say, interest rates are rising. During an inflationary period, everybody wants to borrow because you figure if you're borrowing, you can buy something, you're going to make money. So the demand for credit rises faster than the supply of credit and you get continuously rising interest rates, tight credit markets. Therefore, when you look at a tight credit market, you have no right to assume that you're dealing with tight money.

6:40In fact, more often than not, a tight credit market is the consequence of having had very easy money. See, very easy money, that is inflationary monetary policy, will lead to tight credit. Unfortunately, the way the Fed operated in the 60s, they took the rising interest rates and the tight credit markets as evidence that they were following a tight policy, and therefore they couldn't understand why they're having the inflation, and they thought unless you have a big tax increase, you couldn't stabilize the economy, so they kept worrying about the tax increase. In other words, to repeat, the big mistake then was that following an inflationary monetary Policy, you generate inflation, that causes interest rates to rise, that causes tightness in credit markets, and if you're not very careful, and if you confuse money and credit, you can often take the tight credit markets as evidence that you're following a tight policy, when in fact you are following an inflationary policy.

7:46So now that's what I mean when I say the mistake of the 1960s. Now what is the mistake in the 1990s? The mistake in the 1990s is the exact same mistake except completely reversed. In other words, what we're doing in 1990s is following a tight monetary policy which generates the manifestations of easy credit. And they're looking at the easy credit and thinking they're following an easy policy. Let me repeat that. I hope you understood that if you follow an inflationary monetary policy and you cause Because of inflation, you're going to create tight credit markets. Because of the inflation. Now, turn that around. Supposing you follow a very tight monetary policy, i.e., as I mentioned before, the lowest rate of money expansion in 30 years, you're going to kill the economy.

8:39When you kill the economy, the demand for credit falls. And then you often will find that in the credit markets, interest rates are falling. And when interest rates fall, you think it's going to be easy, if you look at the credit market. So, tight money can give you some of the appearances of easy credit. And therefore, if you gauge the thrust of monetary policy by looking at credit markets, you look at the easy credit and you say, ah, we're following an easy policy, and if the economy is weak, it's something wrong with the economy. You understand? So, just as in the 1960s, The era of following an inflationary monetary policy led our experts there, because of inflation and rising nominal rates and tight credit markets, to conclude that we were following a tight policy.

9:31So it was in the 1990s that following a tight monetary policy, evidenced by the lowest rate of Monetary Expansion in 30 years led to falling interest rates, and these experts looked at the falling interest rates and figured, money, FED has done as much as it can do to revive the economy. This must be something else, okay? So you see, in the 60s, there was easy money, which led to tight credit, which was interpreted is tight policy. In the 1990s, tight money leads to easy, leads to the manifestations of falling interest rates, which they're interpreting as easy policy. So that's the second sense in which I mean a monetary Vietnam. Now, now just to show you how serious it is, but I'm not kidding you, I wonder how many of you remember that not very long ago, a hundred Economists, including six Nobel Prize winners came out and they were saying that things are so bad that we have to introduce WPA projects like the 1930s to revive the economy in spite

10:49of the fact that we're running a $400 billion deficit. That's staggering. Now I wonder how How many of those people knew that unwittingly and unknowingly the Fed followed the tightest monetary policy in over 30 years in 1991 in the midst of a recession? Now let me just put it down in plain English to hope you understand. Here we have a patient and we're thinking of using bone marrow transplants because the man is sick and he doesn't respond and then I'm telling you the man hasn't been fed in nine months. There's nothing mysterious about his disease. He hasn't had a meal. They're starving him. And all these great experts are talking about bone marrow transplants. They're doing fancy things. I'm saying this poor SOB hasn't been fed. That's what I'm saying. It's an unbelievable error. And I'm talking about a hundred economists, including six Nobel Prize winners.

11:47So I hope I've convinced you that I'm talking about a monetary Vietnam. It's an unbelievable era and yet it's interesting how few people are aware of the fact that the Fed unwittingly, and I will show you later that it was unwitting, followed the tightest monetary policy in over 30 years. Now I thought I'd stop here if you have any questions of my thesis before I go on to the next. So to what extent does the Fed really control the total quantity of money? Because the federal reserve is only 260 billion, deposit currency, money that is given to the banks is 3.8 trillion, it's like 16 times greater than the face. And is that really – in terms of what the banks do and don't do in the final analysis, if the banks don't make the loans, regardless of what the Fed does, the money is provided by the bank.

12:45That it's not our fault. It's their fault. If I have to give you a quick answer, I'd say the Fed can't control that, and you will see if they pour in the monetary base, you'll get the deposits forthcoming. In other words, it may be they got to push a little harder to get it. But if you keep your eye on the ultimate product, not on the intermediate step. You see, let me put it this way. To put it in technical terms, what you're asking me is, is the money multiplier a constant? If the money multiplier is a constant, then for every dollar of monetary base, high-powered money you inject, you'll get a certain amount of final dollars. Now, supposing I say to you, no, it isn't always a constant. So what does that mean? That you may have to put a little more in or a little less in.

13:30But that doesn't mean that you can't get the final result if you're looking at the final result. See, the Fed was handing out that line that it was the banks' fault. They were doing all they could. The banks just didn't want to make money or whatever it was. I'll talk about it a little later, but I think that's a good point. So my answer to your question is, if the money multiplier is constant, then for every dollar of high-powered money, reserve base or base money you put in, you get a certain amount of deposit money. If it's not constant, you have to put in more or less. But that shouldn't affect the final outcome, if you keep your eye on that outcome. Any other questions? Yes. What is the patient that is looking at feeding?

14:15Well, I'm using an analogy. These 100 economists, incidentally very prominent, who say that we need a WAPA project today like the 30s, are acting like the poor patient is, you know, we've got to use a bromanoid transplant to revive it. Right this time, if they were to ask you to focus on something and do something, what would you do?

15:02using money growth as the equivalent of feeding a patient. Yes, Murray. I can't hear you. In other words, they want a bigger, you see, in other words, they're saying we've got to have a bigger government to save us. Yes. That is not letting the money supply grow is like not feeding the patient. You mean you're talking about what should we do to get out, you know, how do we get out of this problem?

15:47No, no, no. You see, the gold standard, you have a mechanism that takes care of this. But we don't have that today. We've got a committee that meets once a month to decide what to do. I'm going to talk about, when I talk about monetary pragmatism, I'm going to explain that. What function does that committee serve? Do they have such enough to do that?

16:31To grow or not to grow in function of what?

16:56When is the rule of thumb? Why? How do they do it? I don't think they have a rule of thumb. That's what... remember I said that the Federal Reserve is like Bush? He doesn't know what he's doing, and they don't know what they're doing. They read the newspapers and the side. That's the problem.

17:18Any other question? Any other question? Yes.

17:28I don't know if I'd go that far. I mean, I, you know, they may have, their main agenda may be to stay in office. You know, they like, you know, a lot of people like the perks. You know, it's not a bad job. And so maybe it's as simple as that. But I don't know, I'm not a psychologist. What their other agenda? I'm not even, I think, in fact, I'm going to make a comment. When Murray was talking last night, he kept, he made the point about the House of Morgan. When I look at these guys, I seem more like homeless. I'm not... I don't see a house or more.

18:10Okay, now, now I want to explain... Now, I just wanted to give you an overview of what I'm talking about. Now, let me talk a little bit of what I mean by... I'm going to try to convince you that when these people The Federal Open Market Committee, that's the committee that meets once a month, meets every month for a policy decision that selects a policy. This committee makes the decisions for the central bank and I'm going to be arguing that they are governed primarily by pragmatic considerations. Now what do I mean by that? I mean to say that this committee, it's called the Federal Open Market Committee, is not committed to any policy. Thus, we do not know whether they want to stabilize the price level. You see, some people think a central bank should be concerned with the price level.

19:26That's their main objective. We do not know whether they're trying to achieve a certain rate of employment. We do not know whether they're trying to maintain a certain kind of exchange rate. Every once in a while, if you notice, if the yen goes up or the mark goes down, they get nervous. They go to a meeting and is worried about that. So some people think they're worried about exchange rates. some people think they worry about the rate of growth of real output and some people think they're very much concerned about unemployment or at least they give that impression and then again there are a lot of other things that come up like Los Angeles rise who knows what else the fact suggests that the FOMC the Open Market Committee it meets every month reviews a wide range of monetary and issues and after discussions they arrive at a set of decisions. Now I think it would really be very, I've studied this for a long time, I think the clearest

20:26image you want to have of these people is think of them as a fire department. They meet every month and if there's a, they see something that looks like a fire department, they've got to do something about it. That's, I think, comes as close as I can get through. In other words, when you say does the fire department have a policy, well Now, you can say that policy is to put out fires. If you ask me, what's the policy of the Open Market Committee, it's like to fire the public. The general public is thus pretty much in the dark concerning the central bank of the Federal Reserve's monetary policy. Indeed, I believe, and here I'm going to make a stronger point, not only are we in the dark, but I'm going to try to convince you they are in the dark too. I believe that even the Federal Reserve Governors and other members of this committee do not know the precise contours of monetary policy.

21:20What they are doing each month is responding to a brush fire that is raging. Individual members may believe that they have some idea of how they would like to respond to a fire. By a fire, I mean if the exchange rate is moving, if unemployment is moving, if inflation is moving, you know, anything that's happening. Individual members may think they know what they would do, but they do not know which fire will be burning next month. They don't know what's going to be happening three months or nine months. So what I'm trying to tell you is not only do I not know what the policy is, they don't know either because they don't know what fire is going to be raging next month or three months from now. One can go a little further and argue that individual FOMC members...

22:06Incidentally, the FOMC members consist of seven governors, the seven governors of the system, plus five bank presidents. There are twelve Federal Reserve banks. Each bank has a president, and five are selected to serve on the open market, and the five rotate. So you've got seven governors and five presidents, and that's the twelve that make the decision. Seven governors of the Federal Reserve, yes, they're appointed by the President and confirmed by the Senate, and so you got the seven governors of the Federal Reserve plus five Presidents, the five Presidents are chosen of the 12 banks, okay? Indeed, one could argue that individual FOMC members, now I'm talking about the governors themselves, may not know for certain how they will respond to a particular crisis.

23:02Individual members may be under great pressure at a particular time so that they may not vote the way they would like to vote. For example, suppose you're a governor and the president calls you up and he says, Joe, Especially if you're appointed, you say, I'm very worried about the employment. You may think inflation ought to be what you're worried about. What do you think you're going to do? You're not going to tell them, get lost. Because if you do, you'll find that you don't have a secretary next week. You know, there are problems. This means that the FOMC members do not know which crisis will be raging. They do not know for certain how they will vote. In this sense, the present fiat money regime can probably be called a random walk monetary standard, random walk monetary standard.

23:51This is an expression that was coined by Professor Leon Helvud and I think it's a very good description. Under this standard, that is under a random walk monetary standard, the uncertainty of The monetary policy grows rapidly as we look into the future. There is less uncertainty concerning the thrust of policy this month or next month, but we are more in the dark concerning policy, say, three months or six months from now. And when we look at what's going to be happening nine months from now, it becomes darker still. And there isn't even a ray of light when we consider what policy may be a year from now or two years from now.

24:37Many people, anybody that studied this will tell you that the uncertainty of policy grows exponentially as you look ahead in the future. To summarize, the random walk, monetary standard, leads to what I call monetary pragmatism. This means we do not know the content of the FOMC's monetary policy, we do not know What commitment they have to the policy and we do not know their longer term policy goals. What we do know is that these officials are seeking to come up with the best short term solution to current problems without having any long term objective or a clearly articulated policy. Now, I'd like to elaborate a little bit on monetary pragmatism and incidentally, I think this is the equivalent of what Bush is in the White House.

25:29So as I said, they fit each other. In the present environment, and now I'm talking about what the FOMC does. Monetary authorities decide each period, that is when they come each month, whether to accelerate money growth, maintain the same rate of money growth, or whether to decelerate. And they do that by affecting the reserves of the monetary base. The officials focus primarily on current economic conditions and immediate political pressures. The future money growth rates are left unspecified. They let the next guys worry about that. This will be decided by the monetary officials who will be in charge when the time will come. The only rule governing this process is that at each point in time, those who are responsible for monetary policy choose the convenient and expedient thing to do.

26:24There is no, now here is the important thing, there is no scientific way to forecast price valuation or price level in this kind of monetary regime. The uncertainty attached to any forecast of future prices grows exponentially as the number of months increase. A 12-month forecast is a lot more variable than a 3-month forecast, and a 10-year forecast is hopeless. To think of what's going to be going on in 10 years when these turkeys are operating for 10 years, you can see it's an impossible task. Operators in the market, that is, people have to make a living, that is, people work for a living. Operators in the market guess differently as to the state of expectations, and the market is apt to be somewhat incoherent.

27:12In this environment, the value of a dollar 10 years from now is not really a fit subject for economic analysis. See, it really isn't economic analysis. It's like saying if you're analyzing Bush, you're not dealing with analysis. You're dealing with a fish flopping around the water. You know, there's nothing there. You can't, you can't forecast that. It depends, it depends on the cost of, for example, what does it depend on? It depends on how big government's going to get, how much mercantilism we're going to have, what kind of protectionism, International geopolitics, turf battles between the Treasury and the Federal Reserve. This is going on all the time. How can anybody forecast that? Unfortunately, in our economy, people are constantly forced to make decisions involving future price levels.

28:03Every one of you has to make that decision when you decide to buy a house. And yet, we know that these are the guys making those decisions every month. Monetary pragmatism has several notable consequences for the economic system. Long-time bond markets will thin out and markets for some instruments may disappear. In fact, most people in the market will tell you that the long-time bond is used as a trading vehicle. In other words, it's the way, if you want to go to the casino, that's how you do it, with a long-time bond. It's not an investment. Price valuation puts noise into the relative price mechanism and makes it more difficult to allocate or coordinate resources.

28:48Anybody who's had any connection with Mises or any kind of economics knows that the reason we have been successful and the Russians have failed is that we have a price system and a price system signals resources. Now, think of it. If you start fooling around with inflation, you distort the price system. Because a price system is really a system of red and green lights. It tells you where resources should go, where they shouldn't go, and so on. Now, when you start fooling around with a bad monetary policy with inflation, it's as if you start confusing the colors. So you get resource allocation mistakes because we're fooling around with the signaling system. frequent changes in monetary policy will cause more and more costly mistakes in output decisions. That is you see a price rise and you think it's a signal that there's a demand for something but it may be only an inflation rise and not really an increase in relative demand. Output mistakes adversely affect current

29:54profits and reduce the incentives to invest in long-term capital. Long-term Modern nominal financing subjects an entrepreneur at a great risk. Under these considerations, productivity and capital accumulation are negatively affected and monetary pragmatism is likely to give rise to stagflation. The ability to forecast inflation and to hedge against it becomes more important to firms, obviously in this environment, than efficiency and competitiveness. Merger and acquisition experts and LBO specialists will be at a premium relative to marketing Income of lawyers will rise relative to product designers, and MBAs and accountants will be favored over production managers. Ambitious people will therefore reallocate their resources and their ingenuity.

30:43Since the late 1960s, guessing about inflation has been the way for many entrepreneurs to achieve great wealth. but all individuals cannot improve their living standard by playing the inflation game, in other words, it's a zero-sum game. Who therefore will focus on productivity and investment if real estate deals and tax shelters appear more profitable? This is again a recipe for stagflation. In this monetary environment, the real outcome of private contracts becomes very uncertain. Private agreements arranged through contracts become a less effective and less reliable method for reducing the risk of long-term ventures.

31:35And when contracting fails, many groups resort to political lobbying as a substitute strategy. Monetary pragmatism will bring about general conditions in which many groups seek to obtain many groups seek to obtain through political, they seek to obtain by political compulsion what private cooperation has failed to achieve. In other words, they feel they've been robbed and therefore they start putting up a lot of Political Pressure, and so they try to accomplish, in other words, contracts lose their force and people resort to political, in other words, you remove the markets, you bring in politics.

32:25Legislators will be swamped with demand to control prices and rents, to regulate ways of doing business and to tax and subsidize. The nation becomes less efficient just as the economy becomes less efficient in carrying out ordinary business. The political system loses legitimacy. This trend will continue until the public demands new institutional constraints on government. Okay, so I try to talk a little bit about monetary pragmatism and the random walk monetary standard. Remember, I started out by saying in what sense this was a Vietnam and I made the point about that it was a Vietnam in the in the sense that it's a major disaster, and it's also a Vietnam in the sense that they're confusing money and credit.

33:13And then I talked, I tried to explain a little bit what I meant by monetary pragmatism and a random walk, a random walk monetary standard. Now let me come back to this point I was making about tight money and easy credit versus the easy money tight credit. Because I remember I made the point that the mistake in 1990 is the mirror image of the mistake in the 1960s. Now, in monetary economics, there are two relatively well-defined approaches. One approach focuses on money and monetary aggregates. Another approach focuses on credit and interest rates. One approach can be viewed as incorporating a capital theoretic portfolio approach that views money as a capital asset and seeks to analyze the consequences of monetary changes through portfolio analysis.

34:12The other approach looks at the demand and supply for credit in particular markets, looks at the availability of credit, and focuses on interest rates and expenditures in particular markets. The former approach, this money portfolio capital theoretic approach, can be identified with the quantity theory, you know, Irving Fisher, you might say, Chicago School, those kind of people. The latter approach, you know, interest rates, credit markets, is Keynesian income expenditure macroeconomic approach. Okay? So those are the two approaches. Now these two approaches sometimes give significantly different answers to questions. Let me illustrate. In the 1960s, during the Vietnam War, we had a situation that I have characterized as easy money versus tight credit.

35:04By easy money, I mean that the rate of growth of the monetary aggregates, that is, the money supply growth was very high, and an excess of that which could be maintained at a stable rate of prices. In other words, we had inflation. This high, thus, a high rate of monetary growth in the 1960s, which leads to inflation and which was, which was an inflationary monetary policy, will also cause interest rates to rise. Remember, we went, if you start out with a, if you start out with a situation where you have, say, let's say, five percent interest rates and zero inflation and now you go, say, to five percent inflation, You'd expect roughly to find that the interest rates are now 10%.

35:49So interest rates will rise. Viewed from a credit market point of view, rising interest rates could also be seen as a situation of tight credit. In other words, let's look at this carefully. Suppose you had relative price stability, no inflation. And now, for one reason or another, we have, let's say, five or six percent inflation. Now, I'm telling you we have the inflation because the monetary authorities allow the money supply to grow too rapidly. In other words, it was caused by an inflationary monetary policy. But suppose you're a Keynesian, you're a macroeconomist, you look at credit markets, and you're seeing rising interest rates, tight credit markets, people not being able to get credit, everybody's complaining, I can't get credit, the banks, it looks like tight credit, right?

36:46It's very easy to confuse tight credit with tight money. So you'll find that if you go back then, at the very midst, when we had this inflationary monetary policy resulting in higher interest rates and tight credit, the economic report of the president was talking about a tight monetary policy because they were confusing the rising interest rates and the tight credit as evidence of a tight money therefore they thought the only thing that could save us is a big tax increase because they saw inflation with tight money then obviously you need a big tax. So in other words there was a clear-cut case of of easy money that is inflationary and accelerated vision, causing nominal rates to rise above real rates, causing tight credit markets because in an inflationary environment, the demand for credit rises very rapidly, even faster than the rising supply, and so you get tight credit.

37:43So, tight credit markets can be very much the case of an inflationary monetary policy. But if you're oriented towards the macroeconomic income expenditure Keynesian approach, looking at the credit markets and interest rates, you could easily have confused that as thinking. In other words, you could say it was a tight credit market, but it was not tight money. And that's the confusion there.

38:16Okay, let me recapitulate and then I'll go back to the 90s. Let us assume we start with a relatively high rate of monetary expansion, sufficiently high to cause an inflation. In these conditions we will find that interest rates will be rising if not escalating. Interest rates escalate because the demand for credit rises faster than the supply of credit In other words, in such a situation, it is not surprising that the demand for credit rises faster than the steadily rising supply of credit, and thus we get the manifestation of tight credit evidenced by escalating interest rates and the demands for credit that exceed the supplies and result in credit rationing.

39:03This was very much the case during the Vietnam War when those economists who focused on the income expenditure approach thought that money was tight when they really meant credit was tight. While monetarist economists saw this as a situation of inflationary monetary policy leading to inflation and therefore to the appearance and the manifestation of tight credit. So that was the mistake in the 1960s. Now let's look at the 1990s. In 1990 we appear to have the reverse of what happened in the 1960s. The central bank appears to be following a tight money policy. And as I indicated several times, lowest rate of monetary expansion in over 30 years.

39:51That certainly is tight, even tighter than anything Volcker did in 82. This tight money policy was inadvertent, and I'm going to try to explain that. They didn't know what they were doing then. They didn't realize how tight they were. ...of failed financial institutions, which, in conjunction with the Federal Fund's target, leads the central bank to effectuate a relatively tight money policy, although this is not intentional. Tight money weakens the economy, and as the economy is weakened, the demand for credit falls. Indeed, the demand for credit falls faster than the supply of credit, which is also falling as a result of a tight money policy. This is precisely the reverse of what happened in the 1960s.

40:36The easy money then led to the manifestation of tight credit and credit markets. In the 1990s, tight money led to the manifestation of ease in the credit markets because interest rates were falling. But interest rates were falling because the demand for credit was falling faster than the supply of credit because the economy was so weak. As already mentioned, the tight money policy followed by the Fed in the 1990s was unintentional. It was not their desire to follow a tight money policy in the midst of a recession. They simply did not recognize that their policy targets that they were pursuing led to this result. And several months ago I met Murray in New York and I said to him, I was thinking of writing a little article saying, is Chairman Greenspan a secret agent of the Democratic National Committee?

41:32Because in effect, if you just looked at the record, you could make a case for it. that in the midst of a recession, and prior to the election, he follows the tightest monetary policy in 30 years. Now, I don't think Greenspan is a secret agent, in fact, I think he probably thinks he was working 24 hours a day to re-elect the Republican. But I think it was a mistake they made because of this apparatus, which I'll explain. I want to now talk about precisely what the error was and why they made it. I also have something about why the people that are supposed to be watching the Fed haven't watched, but I may not have time to get into it. Okay, what precisely is the Federal Reserve's error? The editor of monetary policy that the Fed committed in 1991 is related to the fact that there have been massive bailout operations for failed financial institutions.

42:29Now, everybody knows, in the 1930s, a lot of banks failed, and everybody knows when banks failed in the 1930s, the money supply contracted sharply, and many of you who read Friedman's study know that there was a 35% reduction in money supply. So, we all know that was a disaster. Now, everybody knows that happened in the 1930s, but everybody also thinks they know that in the 1990s, we have insurance, right? We all know that. We all know that. Therefore, everybody assumes that when a bank fails today, its deposits are insured by FDIC or Fislik or RTC. The temptation is therefore naturally to assume that a bank failure does not cause deposits to decline after the advent of deposit insurance.

43:19But this is not entirely correct, as I will show you. Now, I'll show you that the public is only half right on this. When a bank fails today, the deposits in the failed bank will be made whole because the Federal Deposit Insurance or the Resolution Trust Company or FISLIC, somebody, will make this failed bank whole. But in the process of making a failed bank whole, the FDIIC or RTC has to sell bonds to the public. They don't print the money. The individual who purchases the bond from the RTC or FDIC therefore gives up his deposit and receives a bond in return.

44:05Now, let us see what is the next step. As financial institutions fail, in order to make a bank whole, the initial effect is therefore that deposits decline by one million. Not the deposits in the failed bank, but the deposits of the guy who's buying the bonds that the FDIC sells to make the bank whole. Now, when those, this decline is not in the failed bank, but in the bank where the individual bought the bond, held the deposit. of the Deposit. The decline in deposits therefore leads to a decline in required reserves, since deposits have come down, and an increase in excess reserves, and therefore a fall in the federal funds rate. In other words, the mechanism is a decline in deposits, as deposits decline, required reserves decline, as required reserves decline, excess reserves go up, and as excess reserves go up, there's additional money in the federal funds market, the federal funds rate goes down.

45:17Now, since the Fed is operating with a federal funds target, that is, the way they conduct monetary policy is when that committee meets every month, they give instructions to a guy in New York, he's called the systems manager, to do certain things. They tell them keep the federal funds rate at a certain number. Now as the federal, since they have that target and that fund rate decline, the Fed will necessarily take reserves out of the system because they, it's going down, will cause money supply growth to be very sluggish because they're taking money out of the system. And the sluggish, and furthermore, now let me add one other point. The reason this was confusing to the Federal Reserve and unintentional is we never had bailout operations on such a massive scale. They're now up to, if you start adding them up since 1987, we're up to 300 billion. In other words, we've had a lot of, if you add up the savings loan, all these things, there's a lot of it. So in other words, they've never

46:24run into this problem on the scale they're running into it now. So that's why, remember Remember I said that the mistake was unintentional. I think this was what threw them off. They just didn't have any idea the extent to which this is going on. Thus, if this is continued on a sufficient scale, it will... Money supply... In other words, the Fed, instead of adding reserves or adding monetary base or adding high-powered money into the system, is pulling it out steadily. And that's why we had the lowest grade of monetary expansion in 30 years. And if this scenario is correct, the sluggish growth in money is completely unintentional. This was not the Fed's desire. Greenspan is not a secret agent of the Democratic National Committee.

47:11He may be a bit of a fool, but not an agent. It is an error due to the fact that the Federal Reserve, the FOMC, did not make sufficient allowance for the fact That the bailout of failed institutions, up to 300 billion, will cause a temporary decline in the federal funds rate. We therefore feel that the monetary restrictiveness, that is the monetary sluggishness in the 1990 and 1991, was completely inadvertent and unintentional. I really believe that. It reflects the fact that the Fed has become the victim of a mechanism it uses, namely the federal funds rate, as a target for monetary policy.

47:59And a lot of people have written books about why it's dangerous to use a federal funds rate, and on this there are a lot of agreement, but for bureaucratic reasons, which I don't fully completely understand, they insist on operating monetary policy. Policy, and this is not the first time that they made a very serious mistake, and I think here we practically have admissions from the Fed that the monetary restrictiveness the last two years was unintentional. But they're still not prepared to give up the Federal funds mechanism. In other words, what I'm saying is if instead of operating monetary policy, instead of telling the guy in New York to keep the Federal funds rate at a certain level each month, they gave him instructions to add reserves by a certain number each month, He wouldn't make this error, but they won't do it that way.

48:48Later on, the cocktail part, if you ask me why, I'll tell you my private reasons why I think they don't, but I don't have enough evidence to say it publicly. So anyway, this is what I think happened. So here's what I see. I see a situation where we have literally been starving the patient for a year. No food. And all these 100 economists are thinking of super, you know, bone marrow transplants, brain transplants, everything, because they think they're in a very unusual situation, and nobody is beating away at the fact that maybe there's a simple explanation, the poor guy hasn't been fed for a year, they've been starving, and that's why he's acting so funny.

49:37Money. Okay, so that's what I'm saying. Now, let me recapitulate. Let me recapitulate what I was trying to do today. I try to point out that I believe we've had a monetary Vietnam in two different senses, that these poor guys may have produced a real disaster, and I hope we pull out of it. are clear that we are, and that they made the same mistake that we made in the Vietnam inflation. They confused money and credit. So in those two senses, I pointed out, I try to call to your attention that a hundred prominent economists, including six Nobel winners, are convinced we need brain transplants. It's such a serious, and nobody's talking about the fact that we We had this tight monetary policy, tightest in over 30 years.

50:37I try to talk a little bit about monetary pragmatism, why the Fed today can be viewed as the equivalent of Bush, which is sort of a zero, a hollow shell. I try to indicate that in maybe some difference with Murray, where as he thought about the House of Morgan, I think of these guys as homeless, homeless types. I try to explain a little bit about the random walk monetary standard, which is I think what they're doing. And I try to explain that this terrible tightness we've had monetary policy, which is a disaster, was very likely inadvertent and a result of the massive bailout operations of the financial Institution. Okay, I close with that.

51:33Okay, sure. Murray.

51:42That was the last part of my paper, but it's very complicated. Let me, if I have I have to give you a quick answer. A quick answer would be what we say in Washington, NIH, not invented here. I think they were very upset that all these high-powered thinkers meeting in this, you know, every month to review, and some lowly researcher at the Chicago Fed figured it out. And I think they were very embarrassed that they made such a big mistake. So they're trying to convince themselves that it didn't happen. And you know what they're doing? They're doing something that every crooked lawyer will do. They're now saying, they're now talking about inflation. You know why they're talking about inflation? Because for the Fed to get out of this mistake, they're going to have to overdo it on the upside.

52:29And when you overdo it on the expansion side, you very likely will cause inflationary problems later. So they're now writing things worrying about inflation, and two years from now say, you see, we warned you about inflation. But the real thing is why they were asleep at the switch the last two years.