Bubbles Made of Paper: Then and Now

0:00Hey, y'all. I've been working on that for about a month, trying to get the lingo down here for Auburn. I know we've all been kind of sequestered here in this great conference, and you probably don't keep up on bank failures, but I have this sort of morbid curiosity about it. Bank number 17 was seized yesterday in Florida and interestingly enough, it was a bank called Freedom Bank. It works out wonderfully for this speech. But Freedom Bank probably did not have any gold deposits, probably practiced fractionalized money, of course, and paper money.

0:53For a bank of only $287 million, so that's a relatively small bank, what's interesting per the FDIC release on this is that the FDIC is going to be responsible from $80 to $104 million, is going to be the loss that the FDIC takes on this. And when you start doing the math that the FDIC only has $48 billion and when they were insuring deposits up to $100,000, they were insuring $5 trillion. Now at $250, presumably, they're insuring $9 or $10 trillion, and if they're going to lose $100 million with the failure of a $287 million bank, well, you can see pretty quickly that the FDIC may go the way of the FSLIC, if anybody remembers that entity.

1:57Now, you might quickly say, well, why didn't they go to that TARP money? You know, they got that TARP money out there, they're buying equity in banks. And in fact, there was a newspaper in Florida that speculated Thursday that the TARP might save Freedom Bank. And then the very next day, Freedom Bank failed. And I think from what my sources tell me, and believe me, I don't have sources inside the FDIC. The FDIC is not a big necessarily a fan of me and for whatever reason but what I'm told is that the only banks that can really access the TARP or the new equity money that's being made available by the government are banks that are rated one or two The FDIC doesn't release those figures but banks that are one or two are fairly good shape. Banks that are three and four are in bad shape, banks five are on the verge of being closed.

3:143 and 4 are in bad shape, banks 5 are on the verge of being closed, so it isn't any 3, 4 and 5 banks that are going to be able to access the TARP money, it's what I'm told, it's only banks that are Camel 1 and Camel 2, so what you'll see is relatively healthy banks get money from the government to turn around, probably not to lend the money, but to go ahead and buy out weaker competitors. So you'll just see a consolidation of the banking industry, and unfortunately for Freedom Bank, they probably didn't have any friends either at the government or at Goldman Sachs, evidently. So unfortunately, they are the 17th bank failure of the year.

4:07I, of course, as Lew mentioned, I used to be a banker, but I was carried out on my shield back in May and had resident fairly high in this bank, little bank in Las Vegas and we were very active in construction lending. In fact, that's what I did for a living was make construction loans. In fact some people considered me very good at it. In fact, kind of an idiot savant, if you will, at being able to structure real estate loans. Of course, at the end, they just considered me an idiot, because it wasn't working out. And it's been mentioned to me by a few people who are here.

4:55They've made kind comments about some of the articles I've written for Lew about what was going on in Las Vegas. And I would just tell the students in the audience that writing about the market, if you're a banker, is not good for your career path. Telling the truth in print really doesn't do you a whole lot of good if you're working for a bank. Now, it's okay if the market's good. If the market's good, they kind of look by it, and that's okay. But when the Las Vegas economy began to spiral down very quickly in the spring and early summer, I remember a particular piece that I wrote about an auction.

5:44One of my customers was having an auction of some homes. He had about 50 homes around Las Vegas that he was trying to auction. And he held the auction on Derby Day, so it had been the first Saturday in May. and they had this auction and I stood off to the side and you had these fancy auctioneers and they're all wearing tuxes and they're young guys and they're energetic and they're saying yes there's a bid and all this and they're banging gavels and all this stuff so I thought from my vantage point they were actually selling homes my customer called me up had me sit next to him at the podium and And he said this is all fake. These aren't real bids. And as I watched these guys go through this kabuki dance that they were doing, that's exactly what it was.

6:37There were actually no bids. And they had 50 houses that they needed to auction. They actually only got live bids on about two or three. And of course, silly me, I decided, this is a pretty good father for an article. We put it on lewrockwell.com and a few people picked it up and our CFO started getting calls from New York. And they said, gee, Doug, you're tanking our stock today. I said, well, what tanked it for the previous six months? But anyway, that's what happens at the end.

7:25You know, you go from being a genius to an idiot and then a scapegoat. And ultimately at the end, I used to be a member of the management team that would be on the earnings call for the bank. Because I was the guy that knew the Las Vegas market, and they would have me spew out all this stuff about the Vegas market. Well, when the Vegas market started doing nosedive, I felt compelled to tell the truth. Well, the truth didn't really serve the purposes, and by the first quarter earnings call, I was told that I didn't need to participate anymore. Such are the things that happen in booms and then in busts.

8:12And what I wanted to talk about today is not necessarily recent bubbles, but as Lew mentioned, the title of the speech is early bubbles, modern bubbles of paper and early bubbles and now the various kinds. The speech could be called, things may change, but they always stay the same. I mean, we keep doing these things over and over again. And what's interesting is that I wrote a thesis for Murray Rothbard and had that tremendous privilege. But how did I know that I would directly participate in one of the biggest bubbles in the history of the world? But the title of my thesis was actually Early Speculative Bubbles and Increases in the Price of Money And one of the guys that I wanted to talk about today is a very interesting gentleman named John Law A lot of people haven't heard of John Law, a John Law fan right up front here and some people view John Law as a genius certainly at the time when he was

9:25creating money out of nowhere they thought he was a genius course later he was considered a madman and a swindler and I tend to think that Bernanke is kind of going the same way that's the way this thing's working out so so again the the more things change the more they stay the same but the The interesting thing about John Law is that he wasn't your old fuddy-duddy economist type. His father was a very sound banker, actually he was a goldsmith banker in Scotland, and John Law learned the banking business from him. John Law was very good with numbers, so he learned economics.

10:13and Economics. His mother made sure that he got a good grounded economics education both in theoretical and applied economics. So, John Law was very well equipped in the banking area, very well schooled, and then his father died. His father died in his teens. There's some dispute as to exactly when his father died. But after the death of his father, law's interest in the banking business kind of waned. And what contributed to that was the fact that he got a little inheritance from his father. And he liked girls. It's the darndest thing.

10:58And in spite of the fact that his face was deeply scarred, he had smallpox as a kid, his big strong strapping guy and he was very much the ladies man in fact the ladies called him Beau Law fortunately the men called him jesumy John so they weren't quite as impressed with him but he he took his father's inheritance and he decided that he wanted to go see the world so he He stopped in London and decided to just gamble, and he was a pretty good gambler. He was good enough at math that he had these systems that he was able to work and made good money gambling at night.

11:45And, of course, a fair amount of womanizing in there. He had all the choice of the best looking women in London. Of course, I don't think we can really say that our current monetary cranks are those kind of ladies men. I'm not sure if Hank Paulson or Bernanke or... I guess Greenspan kind of had his time there. Anyway, Law had a life of leisure for nine years, but he got addicted to gambling. So he had to give it up, and about the same time his love life got in trouble.

12:30He fell for a woman named Elizabeth Villiers. Unfortunately, Ms. Villiers had a jealous suitor named Wilson. But law was as good with a gun as he was in bed, evidently, Because they fought a duel and he shot Wilson on the spot Now it's really hard to imagine Alan Greenspan or Bernanke in a duel. I mean Now Hank Paulson, yeah, maybe, I don't know, but anyway, law was, it was good with a gun and and normally this was, those are considered a fair fight, so wouldn't have been that grave of an offense, but But this Wilson character that he killed had some influential friends, so Law was put on trial and he was actually sentenced to death.

13:30But on appeal it was lowered to a fine and then he was able to bribe a guard, he was a pretty enterprising guy, and he was able to bribe a guy and the guard and escape to the continent. So, he actually spent 14 years gambling his way across Europe. He couldn't stay in Scotland because he couldn't get a pardon for the murder, but he gambled his way across Europe. But during the day, he studied banking because he had this training in banking. He was a big fan, initially, of a very sound bank, the Bank of Amsterdam. The Bank of Amsterdam had a free coinage policy around the time, early 1600s, of coining any money that was brought to them and had a huge influx in their money supply based on sound money.

14:31They attracted sound money because they had a very good system in place, at least initially. So he was a big fan of that, he studied that, and he also, when he was out at night, he made friends with the Duke of Orleans, amongst many other princes and influential people. So John Law not only studied banking, but he made influential friends. So John Law attempted to put what he thought was a system in place to help the economy. and he first went to Scotland, which is his native land and they were in the depression and he said he went to pardon moment and he said I know how to fix your problem and of course the way to fix the problem is what we've been hearing about all weekend you need more money and so he thought that the best way to increase the amount of money was not the way that the Bank of Amsterdam did it.

15:40He decided by that time that the way the Bank of England, which we heard about earlier in earlier speech, was a better idea. And so he changed his system from maybe being fairly soundly based to money that was backed by land. So imagine if all of our currency was backed by the public lands of the United States. Well, that was his idea. And of course, this falls apart rather quickly. Because if you go into the treasury and take your treasury note and, well, give me some of that dirt out here in the garden, this doesn't work very well.

16:27And so ultimately, John Law had the idea that he wanted unbacked currency because that's really how the Bank of England had paid for England's previous wars and that's really what he thought was the best way to revive an economy. It's interesting that Law, even though he advocated a system of fractionalized banking, he wasn't ignorant to its harmful effects. And it's very interesting that Yuri had that quote from Keynes, where Keynes understood that expanding the money supply was essentially a tax on the people, but let's go ahead and do it anyway. John Law was the same way, and this was back in 1705, he wrote this.

17:17Raising the money in France is laying a tax on the people which is soon paid and thought to be less felt than a tax laid on another way. This tax falls heavily on the poorer sort of the people. So even though he advocated for these systems, he was very well aware of their very harmful effects. But he was all in favor of that in expanding the money supply in just an unbacked paper. And he was able, finally at age 45, after he'd shopped this monetary system all over Europe, Again, he's gambling at night, and he's meeting princes and studying economics.

18:16But he finally finds a taker for his system, and it was in 1716, and it was France. His old friend the Duke of Orleans was able to put him in a position to where he could put his system in place. So this was 1716, and Law was 45 years old at that time. So you might ask, well, why would France want this? Well, as we've heard from Ron Paul and a number of speakers, the reason you need to create more money is to pay for war. And France had been devastated economically, they had fought the War of Hispanic Succession, they had piled up huge debts, and Law's plan was to refinance this government debt to lower interest rates and stimulate the languid French economy.

19:10Something that we hear day after day after day, if we can just lower these darn interest rates, all will be well. So Law began the Company of the West, he started the General Bank, this became the Royal Bank in 1718 and then he merged the companies into what was called the Mississippi Company, whose only asset, by the way, was trading privilege with Louisiana, essentially. And so, for that, he was able to capitalize that company. So while that company's shares were traded, the Royal Bank increased the money supply and not only did he know that increasing the money supply would flow into the price of these shares, the higher the shares go, the more he could refinance the government's debt. And he also put people on a payment plan. Very low money down.

20:22Low money down, extended terms, kind of a sub-prime way to market stock. So then the shares essentially rose tenfold in the case of over the course of two years and ultimately he tried to support the price of the shares with increases in the money 1720 supply and unfortunately in the spring of 1720 the system began to unravel and this led to a series of decrees. He didn't go down without swinging. Legal tender laws, people wanted specie by this point, they wanted silver, they wanted something real for their money, but he didn't give them that choice and go out and confiscate silver. The government He had the power to do that, he put in place legal tender laws, he did all he could do, anti-hoarding laws, maybe that's where FDR got that idea back in the early 30s.

21:28But law did all of these things to keep the system alive, but ultimately the Mississippi shares fell 86% in a year. And so you had this huge bubble and this huge crash. And you may wonder, well, were these just a few people trading shares, some rich people that lost out? But that's not the case. The commodities went up in that four-year period, 64 percent. And real wages for real people went down, went down 19 percent. And similar to today, law's success was envied.

22:15It was envied across the British Channel, the Bank of England, of course, we know as very instrumental in creation of paper money. But they also wanted a vehicle to refinance that government's debt because they had been involved in wars. And so the South Sea Company was formed by a gentleman by the name of Sir John Blunt And he was given the monopoly rights to trade with South America It was the only tangible asset this company had But they capitalized this company And for doing that and being given that monopoly They turned around, refinanced the government's debt And ultimately refinanced 40 million of it but that system unwound as well.

23:10Ironically, in the South Sea case, the South Sea Company was upset because promoters in Exchange Alley saw the success of the South Sea Company so they started creating what were known as bubble companies and they were so unhappy about the competition they were taking money away from their shares that they had the government come in and have an anti-bubble act and it was because of this bubble act that eventually unwound the South Sea Bubble as well and those shares fell 80-some percent in one year and again inflicted tremendous pain on that economy.

24:02So what's going on now is really just a repeat of what we've seen as far back as the early 1700s. I mean, Hank Paulson and his crew from Goldman Sachs may think they're doing something new, but they're not. This was known as a lifeboat operation back when Robert Walpole put an operation to bail out the banking system in England in 1721. Of course, it takes a little more than a lifeboat now. I mean, we've got the whole fleet employed trying to keep this thing afloat.

24:50In fact, you can just imagine all the captains of these little boats work at Goldman Sachs, it appears. But, of course, we have the TARP and we have other things, all these acronyms nobody understands. Somebody put it best, they call it YAP, which is Yet Another Program. So, every day. Of course, my favorite term for creating more money out of nothing is, I think I heard this on CNBC the other day. It's called a systematic policy response. Now, that sounds pretty tame. Yeah, it sounds like something you'd go on a routine procedure at your doctor's, possibly. But that is called creating more money out of nothing to try to bail out the system.

25:41But, Mises wrote about this, he wrote about this a long time ago, and explained how this would happen, really at the end. He says, if the crisis were ruthlessly permitted to run its course, bringing about the destruction of enterprises which were unable to meet their obligations, And that's exactly what we have today, and thus we live from one speculative bubble to the other.

26:33Another, I wish it were different, but the people who can make it different over time are the people in this room and the Mises Institute. Thank you.