Gold is Free Market Money

0:00While the young people are distributing the interest rate tables, the reason I'm doing that is because nerds are us. You know, if you don't have an interest rate table, you can't be a nerd. So I'm trying to promote nerddom here and geekiness. While it's being passed out, let me make a few comments about what Ron Paul said about Arthur Burns. Here's an inside story that perhaps people don't realize, that Murray Rothbard had a lot of trouble getting his PhD, dissertation approved, because Arthur Burns didn't like it, the panic of 1819, and while Arthur Burns was at Columbia, Murray wasn't getting his PhD, it took him like 8 or 9 years to get his PhD, which is a lot longer than usual.

0:50It was only when he, Arthur Burns, went to the Fed that Murray snuck in while the cat's away, the mice played, and Murray got his Ph.D. So I guess it's a very ill wind that blows no good. Now I don't want anyone to say, well, Block came out in favor of the Fed, on the other hand. If I were to summarize all the speeches that went on before, I would say it was a bunch of symphonies. It was Mozart, it was Bach, it was Handel. These are my favorite composers. Telemann, Vivaldi, Beethoven. What I'm going to do is something very different. I'm going to do scales.

1:32I better shut up, otherwise I'll lose my audience because I'm not a very good singer. But I think that it would be very important to understand Austrian business cycle, not theory, but Austrian business cycle explanation. I stand corrected by Ron Paul, although it'll be hard to get the theory out of me because I'm so used to seeing it that way. In terms of interest rate tables, interest rate tables are very important for an understanding of Austrian business cycle theory or explanation. Looking at money through time dimension is a crucial part of Austrian economics. I think it would be too much to say that the only Anything that Boehm-Bawerk did in undermining the Marxian system is use interest rates. He did much more than that, but surely interest rates are crucial to the Boehm-Bawerkian analysis of Marxism and the utter annihilation of them.

2:27I have to apologize to my colleagues because we learn from each other, and I doubt that my colleagues will learn much from this because it's very, very, very basic. On the other hand, not everyone in the audience is a professional economist, and as a sob I can offer this that this is perhaps the best way that I've ever been able to convince my students of the veracity of Austrian business cycles. And so even if my colleagues won't learn from this, perhaps they can use it for pedagogical reasons. Okay, we have several interest rate things going on here. Can I still be heard when I'm away from the microphone? The first one, the amount to which one dollar will grow, is the basic, easy interest rate table.

3:12This is the table that when you were six years old and your parents told you, well, if you put money in the bank, you'll get more later. For example, if you put a dollar, and I'm assuming that you'll get the money back for sure, and that there's no inflation, namely we're abstracting from reality to the essence of what interest rates are. For example, if you put a dollar in the bank at 4% for five years, you'll get $1.21 or $1.22. Everyone follow that? If you put a dollar in the bank for 10 years for 24% interest, you get $8.59. Okay, so that's the easy stuff. Now, the more difficult stuff to understand is this thing, the second table, The present value of a dollar and what's going on here is I offer you a dollar and I say look here's a dollar I promise to give it to you in one year for sure and no inflation how much will you bid for it now and you would be silly to bid more for it than you could get from the bank and according to this let's take this right here if the interest rate is 2% you could

4:30You could put $0.98 in the bank right now, and we assume that the bank is secure, but let's assume. You could put $0.98 in the bank at 2% and in a year get a dollar. So this table gives you the maximum that you would bid for any future money. Or we sometimes say that the present discounted value of money receivable in a year from now at 2% is $0.98 now. You have to have this way of conversion because if you're going to invest 98 cents, you want to get at least a dollar and if you're not going to get at least a dollar from a commercial enterprise, you wouldn't do it, you would put the money in the bank. So the interest rate sort of serves as a barrier under which you will not voluntarily sink.

5:16If you don't think you're going to make more than that, you wouldn't invest it in the widget that you might think of investing in, you would just put it in the bank. Notice that the first two rows, or the first row of A and the first row of B are reciprocals. So if you multiply, say, this number, 102 times 98, you'll get 1. That whole row is the reciprocal. Namely, if you put money in the bank here, the present discounted value of it, you multiply it, you get a 1. Okay, so now we have a whole bunch of exercises as to what is the present discounted value of money receivable in various years at various interest rates.

6:02In this table you'll notice, table A, that as the interest rate goes up, the numbers go up, goes from 101 to 1.3 on the first row, and as the years go up, namely down the columns, also the numbers go up, namely the higher the interest rate at any given year the more money they'll give you, Notice that things are very different in Table B. In Table B, the higher the interest rate, looking along the first row from 0.99 to 0.73, the higher the interest rate, the lower the number is. Why is that? Because the higher the interest rate, the more heavily you're discounting the future. Because the higher the interest rate, the more heavily you're discounting the future. At a 36% interest rate, money you receive in one year isn't worth all that much.

6:52It's only worth 73 cents. Why? Because if you put 73 cents in at 36%, you'll get a dollar. So at a high interest rate, we heavily discount the future, even a year away. At a lower interest rate, we don't so heavily discount the future. and also notice here that as you go down the columns, the numbers get lower, namely the further away in time, the more heavily you discount it. Not because the odds are less of getting the money, because we're assuming perfection here that you'll get the money for sure and there's no inflation. It's just that because the more number of years away, 50 years away from now, well if you put money in the bank for 50 years you're going to get a ton of money.

7:37So you're going to get a ton of money, so you have to discount it by that amount. Okay, so let's do some quick exercises. What is the present discounted value of a dollar receivable in 10 years at 9%? 42 cents? Everyone follow how to do that? Now, the third table is the present value not of a dollar receivable in the future, but of an annuity. And what an annuity is, is a dollar a year for a certain number of years. So what's an annuity of one year? Well, an annuity of one year is the same thing as a dollar receivable in one year. So the two rows in B and C are the same thing, they're identical.

8:22Everyone with me on that? And what this is, is a cumulation. C is a cumulation of B. So, for example, let's take, I don't know, a dollar receivable in one year from now is 97 and 94. Well, if you take 97 and 94, you get 191. Namely, these two numbers here add up to that number and so forth. Okay? Oh, I'm sorry. I zigged one. I should have zagged. Namely, this number here, 1.193, is the same as these two. So if you take any two numbers of present discounted value, in other words, what this table B is doing is saying, well, what's the present discounted value of a dollar receivable in a year from now?

9:17And that's 97 cents. Then it says, what's the present discounted value of a dollar receivable in two years? In two years, that's 94 cents, and what this one does, sort of the lazy man's way out, it says, well, what's the value of an annuity of a two-year annuity, and a two-year annuity is a dollar receivable in the first year and a dollar receivable in the second year. Okay, let me take a few more examples. For example, what is the value of a four-year annuity at 6%? It's that. And how do I get it? What I do is I add up these four numbers, which are right here, and they add up to 3.465.

10:06Or I can go to table C and also get $3.465, $3.465. And if it was $10, I would just move the decimal point over a little bit.

10:22Let me do one more. Suppose I wanted to get an annuity. This is a little complicated. I want to get the present discounted value of an annuity going from the years 10 to 19 at 12%. What would I do? Well, first I'd get an annuity of the years 1 to 19. And annuity of the years 1 to 19 at 12% is, if I've done this right, yes, 7366, right? And then what I would do is I would subtract an annuity of 1 to 9 because I want the years 10 to 19, right?

11:07And 1 to 9 is 5,328. And where is 1 to 9 at 12%? 5,328. And I would subtract that. And when I do it, I get $2.38. Okay, so these are just exercises that I give to students to get them familiar with the analysis, with the analytic interest rate tables. Okay, now we should have a little drum roll. Oh, thank you, thank you. We have a little drum roll. And now what I want to do is I want to illustrate what happens when the Fed... When the Fed increases the money supply, and when the Fed increases the money supply, what it does is it lowers the interest rate.

12:01Whoops, I've got to get back down here. Okay, so this is very mainstreamish. When the Fed increases the money stock, it lowers the interest rate. Okay, well when the Fed increases the money supply and lowers the interest rate, What I'm going to do is illustrate this with a decrease from 4% to 3%. Before I do that, I have to introduce the Austrian Structure Production Triangle. Now, my buddy Bill Bonnet and I have a long 95-page attack on this, mainly used by Hayek and Garrison and Murray Rothbard and others. I believe that it's a very good heuristic device, so I like to use it.

12:48And what the Austrian business cycle theory structure reduction triangle is, it's got money on this vertical axis and time or stages of production, and time is measured back this way, so that the longer the period of time, the further to the left you are. And the interest rate here is the angle of that triangle, namely, I'm going to illustrate a lowering of that interest rate angle. But think of the first, the closest one, one year away or three years away is consumption, retail, wholesale, manufacturing, mining. Namely, the further you go to the left, the further away it is in time. So think of the linkages between the interest rate table, which is very denominated in time, and interest rate, and this triangle.

13:38Okay, so that's the first triangle that I want to use to illustrate. And let's assume that the triangle that we get when we have a 4% interest rate is like that. Sort of a short, fat triangle compared to this longer, skinnier triangle that we get when we go to 3%. you got the difference here is a shorter fatter one with fewer years if you can look at that you can see that the 4% has got fewer years and the 3% stretches out the years because it makes investments in the long run more valuable and here what I do is I compare the two triangles and what I'm saying in effect and like here is consumption here are these other stages what I'm saying is is that what the lowering of the interest rate does is it makes the 3% triangle more viable.

14:38In other words, had the Fed not done anything, I'm assuming that our time preference is such that we would have been right here at the 4% triangle. And that represents the decisions of the electorate or the society or the economy. that's based on our voluntary saving and investment decisions but when the Fed lowers the interest rate it leads entrepreneurs as if by an invisible hand says Adam Smith to engage in longer run production processes which are not justified by the saving and investment and time preferences of the the folk now let me illustrate this in a very dramatic way very dramatic for nerds In other words, that is, in terms of the interest rate tables.

15:24So what I'm going to do is I'm going to say what happens when we go from 4% to 3%. And 4% to 3% is not really a big number. Namely, what we do is we go from the value of a dollar of 9.1, we go from 8.89 to 9.15. Namely, we make a dollar receivable in the year 3 worth a little bit more. How much more? 3% more. Namely, if you divide 9.15 by 8.89, you get 102.9 or 3%. Is everyone following this? This is the crucial part, this is where we had the drum roll.

16:14I'm now on this line, and what I'm saying is that when the government perverts the interest rate, it makes a dollar receivable in three years worth 91 cents instead of 88 cents or 89 cents, and it increases the value of a dollar receivable in three years away by 3%, which is not much, only by 3%. However, when it does it for 60 years away, and here is the 60 year number, it increases it from, wait I'm confusing, annuity and present value. Let me get back to this number right here. Take a dollar 60 years away, and this is the key number right here.

17:03It increases the value of a dollar receivable in 60 years from now, just from a stinking lousy 1% interest rate from 4% to 3% from 09% to 17%, namely, it increases it by 79%. And here is the crucial number, and that's why I put three red marks under this. So this is the key element. What the government does is it says in effect to people that if you invest far out, 60 years out, namely a mine or a coffee plantation or something, or eucalyptus trees or redwood trees or something that will take 60 years away, it will increase the value of that by 79%, which is way more than 3% for a short term.

17:52This is why what we have is this triangle, which I'm going to get back to, namely, what it's saying is that it's making stuff over here very valuable and it's deprecating this. So what the Austrian analysis of this is, is that the Fed is lowering interest rates. It's making long-term investments more valuable, artificially so, because it's not compatible with people's desires. It's making them more valuable, and it's making this stuff relatively less valuable. So what we do is we shrink this, and we increase this, and this is the bad stuff. Here is my next illustration.

18:44So what I'm saying is that what we do here is we have a misallocation theory of the business cycle. It's not that we have too much or too little, it's rather that we have investments in the wrong places in the structure of production. We don't have them, in other words the 4% triangle is the good triangle, and the 4% triangle would include B. But when the government artificially lowers the interest rate, what it does is it encourages businessmen to invest in the A area which is unsustainable. And what's out here in the unsustainable area? I'll give you one guess. Houses, autos, long run things. I mean it takes a long time not to just make an auto, but to make an auto factory and to get all the steel and the rubber and the plastic and this and that together and houses not only takes a long time to build but also houses last a long time so if you compare the Austrian and the mainstream views

19:49the mainstream, what they have, they have this crazy idea that the economy is sort of like a car And if the car is stalled, what you do is you hit the gas. And if the car is going a little too fast, you hit the brake. Now the differences in the mainstream are between the Keynesians and the Friedmanites. They're all Keynesian-Friedmanites. There's no difference. The only big difference is these guys think that fiscal policy is a better vehicle to put on the brakes and the gas, whereas the Friedmanites think that monetary policy is a better way to do it. But between the two of them, There are no great differences as to the understanding of what's going on. So what you have is whether it's done through fiscal policy or monetary policy, the way these people are operating is, well now the car is stalling.

20:42So what we've got to do is kick-start it, or kick it, or turn the crank or something. And what they're going to do is bail out. Now it seems a little strange how you're going to improve things by taking money from Peter and giving it to Paul, and you're going to say, let's look at Paul, he's increasing, He's kick-starting the economy, and we forget all about Peter. I mean, if you'd read Hazlitt's economics in one lesson about the seen and the unseen, everyone, let's look at Paul and forget about Peter. But Peter's got less money, so he's reducing the car, even if we admit that the car analogy is sensible, which it's not. But even on their own terms, if you take money away from one guy and you give it to another guy, why do you expect anything better? Now, you might say, well, he'll spend it. And he wasn't spending it on consumption.

21:30But this is the idea that what really drives the economy is consumption. But I've got a bit of news for people. Before you can eat, you have to produce. Production is first in line. You just can't... You know, I'm a good eater, so I'll have a good economy. Whereas you're a good producer, so you'll have a lousy economy. No, the whole thing is ludicrous. Now, another Arthur Burns story, Murray tells this story, or told this story, and Arthur Burns was once asked, well, you know, you guys say that if the economy is doing badly, you have to increase it, and if it's doing, if it's doing very, too well, if it's too exuberant, you have to slow it down, you will have inflation, if it's doing poorly, you have to boost it up.

22:21Well, what about if it's doing both? Namely, stagflation? And Arthur Burns said, ha ha ha ha, then we'd have to resign. Well, too bad. Now, this business over here of homes and autos, there are certain parallels between what's happening now and what happened in the Depression. During the Depression, you had the same sort of triangle situation. Joe Salerno made a very good point that it was masked in the 20s, the inflation, for Austrians inflation is just an increase in the money supply but for the mainstream it's the price level but they pumped a lot of money in and the price level didn't rise in the 20s because of certain improvements and Joe mentioned that there were certain improvements in the more recent period with efficiencies and computers and other things like that so it's a little masked but there's inflation for the Austrians even though the prices don't rise but there are ominous parallels to use the title of a book of some random between now and the 20s depression, one of them was not only the same triangle story, not only the same structure production story, but in the 20s you had the smooth holly tariff, which just screwed up things royally.

23:36And you also had this thing, keeping wages up, and you had the inception of unions to keep wages up because, God forbid, any wage should fall. fall. You see, the point is that if you're going to solve this, you've got too much of this stuff out here. You've got to have those prices fall. Namely, the solution is laissez-faire capitalism and the way laissez-faire capitalism would work is to deprecate the prices of investments that never should have been made in the first place. Complicating things nowadays is not so much the smooth-holy tariff, although if Obama gets in, we're going to have more tariffs I presume because, you know, we have to buy American or whatever. But instead what What you have is the CRA, the Community Reinvestment Act, where you have ninja loans, NINJAA, no income, no job, no address, no assets.

24:27You know, there was this wonderful Eddie Murphy skit, Eddie Murphy is one of my favorite comedians, and he dresses up as a white person because he wants to show racism. And he goes to the bank and he goes to this bank teller who's a black guy And the black guy is saying, well, you know, do you have any assets? Do you have any collateral? What about your payment history? What about your credit record? And Eddie is sort of looking, you know, very unhappy And then the white banker comes and says, okay, black banker, you know, go away, I'll take care of this client He says, you need money? Here, take it, you know We don't need any proof or anything like that You have this, there's a whole new lexicon of liar loans I'm not making this stuff up. I mean, I could argue that it would be preposterous to make it up, because I guess Murray used to say, you know, you're not going to make a lot of money, you're not going to make a lot of money, you're not going to make a lot of money.

25:35You can't improve on reality in terms of making fun of it. The other thing is with bailouts. Look, I used to teach in Holy Cross and Worcester Mass where they made metal ball bearings and ball peen hammers and things like that. There were vast factories there, seven stories high, a quarter mile by a quarter mile where they'd make these factories. They're all empty. They're trying to yuppify one or two of them. Why? Why do we have the Rust Belt? Because of unions. Unions are like a tapeworm. They just sort of seize everything. They don't allow for expansion. So instead, what happened? All those companies came down to Birmingham, Alabama or Mississippi or places like that. Well, Detroit is now hurting. Why? Because they've got unions. And they're also here. So it's sort of a double whammy.

26:25We shouldn't have as much investment in housing and cars as we do. Plus, we shouldn't have unionized ones. What the government is now planning to do is just the exact opposite of the Austrian public policy analysis. Thanks for your attention.