Only the Austrians Understand Interest Rates

I did want to mention our sponsors more than half of which have have chosen to remain anonymous but three actually they have have have chosen to to be recognized and one is up here on the front front row mr. David theis mr. mark Hart who is not here today that he's back in Fort Worth bettin against Greece or something like that according to paper I think and the Conant Family Foundation so I want to thank our sponsors I want to thank Lawrence Parks who got us into this fine facility today he's right up here on the front row because not just anybody can walk into the University Club it's a private club by the way I've heard a couple cell phones go off and normally you wouldn't make a an announcement about turning off your cell phones but according to Club rules you're not even supposed to have them on you right so anyway be careful with those cell phones wouldn't want you to lose them today our next speaker is adjunct scholar at the Mises Institute a faculty member at Mises University he's written the study guide to man economy and state study guide to human action he's written the politically incorrect guide to capitalism politically incorrect guide to the Great Depression the New Deal he's working on a new book for us that's called lessons for the young economist that we think will be a great hit with with young people and with home schoolers and he's also an instructor in the Mises Academy which is a program we just started and he's teaching a course online about the business cycle and amazingly he has over 200 students from all over the world so he's the one who's broken ground with that and he's talking about only the Austrians understand interest rates please help me welcome Robert Murphy well thank you Doug Thank You Evan for being here I'm it's it's a pleasure to be here this is one of the nicer places I've ever stayed normally when the Mesa circle travels around the country doug puts us up in a motel 6 so this is a very pleasant surprise and i'll joke is it really is impressive when we go out and do these things and just fill up these rooms of you know hundreds of people who come out I was I have some family on Long Island so I got in yesterday I was out with them and and they knew I was in town for a conference and then when I was talking to them and they realized it was gonna be today they said people turn up on a weekend to hear that kind of stuff and I yeah it's an interesting I mean of course what they didn't realize is that when you come to these things you hear Doug French talking about dopamine and financial pornography so that was the little inside secret that allow the outside world doesn't realize it's not all just about interest rates so speaking of interest rates though that's what my topic is for you today and it's it's a bit of a presumptuous title will admit that only Austrians understand interest rates but I think by the time I'm done I hope you at least see where we're coming from that it's it's really even you know it's a Chicago school types you watch CNBC and you see certain you know Larry Kudlow where we get free market guys or you read Thomas soul and things like the free market guys that they would agree with the Austrians on many things like if it were price controls or deficit spending certainly any aspect of Standard Keynesianism we're both on the same side but yet when it comes to interest rates even if we have the same conclusion on something the reasoning is different so that's what I want to try to elaborate on right now in this talk and then later on Joe Salerno when he's going to talk to you about Austrian business cycle theory in the relation to the overconsumption boom you'll see the same lesson applied so I just want to make sure you understand what the Austrians think of when it comes to interest rates now to do that to motivate it let me just give you an analogy suppose that on Monday Ben Bernanke has a press conference and he announces a new Fed policy and he says you know I am the other policymakers here we've been monitoring the situation in the Gulf with this oil spill we know that people are concerned if that continues you know oil prices might go up and that's gonna just choke off this this recovery in its infancy and we also know that people are struggling I've been talking with President Obama he's very concerned about you know the middle class and and the poor and how you know rising gas prices this summer would really just be devastating to a lot of households who are already you know struggling and so what we're gonna do this new Fed policy is we're gonna start buying oil from all the major producers around the world and then we're going to set up arrangements with US oil companies so that will sell the oil to them at $10 a barrel and we're gonna do what we can you know within limits you know gauged by the the takers we get when we auction it off because presumably we're expecting we're gonna have heavy so a few people show up if we're selling oil at $10 a barrel that's just our guess and and well as much oil as we can get from these producers around the world you know well they will go up to capacity and pump as fast as they can and then we will just transfer and sell oil for $10 a barrel to select US oil companies so that will of course push down the world price of oil significantly in particular you know it'll push down gasoline prices for US consumers and so that's what the what the feds gonna do we know everyone's in this together and that's our contribution to help make sure the recovery goes forward now if they did announce that I mean you can imagine some people of course are gonna think it's great just because by definition anything Bernanke says is genius right but beyond that you could imagine a lot of the free-market type analysts and commentators would say that sounds like the most insane recommendation I've ever heard in my life and they would and you know the commentators well why what's wrong with that and they say well we're even begin first of all that's gonna cause massive inflation right that I mean the Fed is gonna have to just print up all kinds of new money or technically just write checks on the Fed to give to you know these OPEC countries and other producers to buy the oil from them at what currently is the market price and again those if they'll sell as much as they can if the feds willing to buy it and then but but suppose that didn't happen suppose they put the plan in place and these OPEC countries and other producers just keep piling up the dollars in there bank account you know they just had accounts with the Fed just get huge you know over a trillion dollars in six months I mean I'm just being crazy that would that would never happen you know that that the Fed would just create a trillion dollars in six months but imagine this is a thought experiment okay so suppose that were to happen and then you can imagine people looking at you know going to the st. Louis feds website and looking at the spike and and the dollar reserves at the Fed and they say you know we're all gonna blow up how can I be possible but you know prices at the grocery store haven't gone up and they say oh I guess maybe it's okay and then you could say alright yes maybe massive inflation didn't hit from this but still that's I mean just all the corruption that of course you know the Federal Reserve picking certain US companies the ones to get these sweetheart deals and get oil sold them at ten dollars a barrel and you of course their profits would be going through the roof you know if you're an oil company and you get to get oil from the Fed at ten dollars a barrel and then yeah it's gonna push down prices but certainly the people who are really gonna reap the benefit are not the ones who drive cars and get slightly lower gas prices it's gonna be the ones who are getting the ten dollar barrel oil and and then you know and people could be looking into it and they're probably will have a funny coincidence is about which particular oil companies got selected and which ones weren't the ones who got in on this deal but again people would say all you conspiracy theorists I mean if you can't trust central bankers and the heads of oil companies who can you trust right and we and again you see the I miss filling I'm sure like everyone but two people here understands the analogy but just make sure I'm not losing anyone of course in our time again you know major heads of major investment banks or whatever people in and out of Goldman Sachs I mean those are the salt of the earth right so I mean sometimes they make mistakes but it's only because it was an intellectual error and they had our best judge or you know our best interest at heart okay and then but now you that was going on so that would be like the 30-second sound light stuff in terms of the the CNBC but in terms of people writing op-eds or you know various think tanks writing longer pieces summarizing just how insane this new oil policy was I think a lot of them eventually would come around to the fact that look this is supposed to be a market economy and prices actually mean something that the world price of oil being whatever it was at the time of the announcement $75 $70 a barrel that meant something that had something to do with supply and demand and if the Fed pushes that down so maybe the new world oil price after this new policy is putting a affect gets pushed down to 40 let's say and that some companies of course are getting it at 10 and other ones aren't but the on average the price gets pushed down to 40 they say that's gonna screw things up and maybe gasoline prices get pushed down to $1 a gallon I'm gonna say that those are the wrong prices that doesn't accord with supply and demand and you say well so what what's were the consequences you know can imagine someone thinking you know I'm driving my car and I like the fact that gas prices are lower and you warned about inflation I didn't see that yet at the grocery store so what's the big deal and an economist you know very stuffy economist could explain matter-of-factly well now those prices mean something and it's screwing things up for example we're using far more oil now than we otherwise would have and the oil a finite resource there's only so much of it in the ground and we're burning more now that leaves less available for future use whereas in a market economy with if the prices aren't interfered with one thing that the current spot price of oil does is it sort of regulates the use it rations it right and if people expected there to be a shortage in the future the price would go up now to make us cut back on our current consumption and so you screw that mechanism up that rationing approach up if you push down the prices and the president makes you more oil now than you ought to be using so it's not a question of doing a favor for the consumer while you're doing now is benefitting people now and hurting them down the road because now they're using up too much oil and it has other effects too that the artificially low price of gasoline is gonna cause people to buy less fuel-efficient cars and they otherwise would if so people are gonna be more likely to buy SUVs and so forth then the otherwise would have and if this if it were the correct market price that would be fine but it's not the right market price and in particular what's gonna happen eventually the Fed when inflation kicks in or some other reason kicks in the feds gonna abandon this policy and then when prices shoot up people are gonna be stuck with these gas guzzlers so to speak and they're gonna see gasoline prices a lot higher alright and so you can imagine then just talking through all of the different problems and of course there'd be all the issues of arbitrage and the companies getting the barrels at ten dollars and then just selling them to somebody else I mean you could just imagine it would be a nightmare there would be so many economic distortions introduced by this policy all right and I think not just Austrians but other free-market economists would see that and they would go ahead and spell these things out now the policy might go through it I'm not actually concerned that if you know if the Austrian school gets more popular and this lecture is on YouTube that you know somebody and Bernanke staff might say I just heard a fantastic idea you know let's let's have a meeting so it's sort of like you know if you're a novelist if you wonder that like that like the guys that it like come up with with crimes thrillers and they have like ways that serial killers get away with so if you wonder sometimes if they think I don't want to give somebody an idea well that's that's what we have here when we talk about hypothetical Fed policy so the so that would be the problem and then but again this the same thing carries over with interest rates and yet the Austrians are really among the few people although I was pleased to see the previous speaker mentioned that to when he was saying you know interest rates at 0% what does that even mean and I and I had a guy call me bill Barnett who's an economist down at Loyola in New Orleans and when the Fed first had pushed interest rates down you know between zero and point two five or whatever the official range was and he was calling me talking about some issue of the Fed's balance sheet and he just said you know Bob what what does that even mean that interest zero that he said did they abolish scarcity you know and and I was Bob's plaintiff I was like well I don't know did they you know and but it's I mean that that's part of it so what what is that what are interest rates well first of all their prices all right I mean that's a price and in the market if the Fed didn't intervene the interest rate in a sense in the Austrian view is a signal if you will sort of regulating people's inpatients all right and it's it has to do with what's with the ostrich is called time preference meaning the trade-off between being able to consume now or postponing the consumption but with the reward that you get more down the road right so that's what the interest rate serves to regulate if you will just like the price of oil controls or rations how much we consume now versus how much you leave in the ground to be available down the road the same thing interest rates do that for capital funds in general and there's so it's not just about money and and you a unit of account that as the previous speaker has mentioned we're sort of we've lost in our age right that I think before back on the gold standard people really thought of money as sort of a metric yardstick or a ruler whereas now people really don't think that money is anything like it's it's not even real anymore and just like I don't know if you guys notice this but you don't have to the bail out the first tarp went through and jokes would circulate like you'd hear people you know saying what do I get my bail out or people would say like yeah I'm not gonna pay my credit cards because I'm gonna wait for my tarp or or there would even be ads on the radio about you know you know it's come down to crazy yetis where the prices are insane to get your own bail out you know and that kind of like that was just the marketing so it was just sort of like the running joke and I was talking about bailouts but I think was beyond just a humor I think that really did influence the way people looked at the world and that when you're running your business or just a normal person trying to do financial planning I mean just to see a bunch of guys change the rules in the middle of the game when they were losing I mean I think that really shocked a lot of people and makes them less confident playing this game going forward and I think the same thing happens with fiat money that when the government can just when the Federal Reserve can just create money out of thin air you know quite literally that that sort of shocks people and they start behaving differently just because that's a different game now that we're playing and it's funny I think even members of Congress have just slowly started to realize just how insane this process is I don't know if this is true but the the anecdote going around was that when the when they first bailed out AIG and I think the Fed came in and stepped in and advanced eighty five billion I believe and that first injection and they were Bernanke was in a committee meeting with some members of the Congress and Barney Frank I think asked Bernanke well do you guys have eighty five billion and I think Bernanke was like you mean do we have it you know and you say yeah you guys went into the business where you have to tax people and take their money and spend it we just create it you know so in terms of professions you chose poorly so it's a good crowd for my anti Bernanke jokes all right so when it comes to interest rates though I mean there again the the Austrian view if you had a free market and you had a real sound money system based on gold or some some market chosen commodity there we what the interest rate would do is sort of signal and I'm dumbing it down a little bit here but this is basic spirit of it is signaling society's willingness to postpone consumption or there need to have consumption sooner rather than later and so it's not that there's a good interest rate or a bad interest rate in the interest rate is what it is and based on people's preferences and so if people really are impatient then the interest rates should be high and it's the the Fed isn't doing it anyone any favors by pushing it down that's just messing up the signal that's in a sense not allowing people to communicate with each other that's partly what market prices do is it allows people to communicate so Friedrich Hayek has a famous passage when he's talking about market prices and how they help people in the economy coordinate with each other and he says that you know suppose there's I don't know an exact example but there's a tin mine in some other country that collapses right and so for a short period the supply of tin being brought to market is lower than it normally would be and so Hayek's is what happens in a decentralized market of course the price goes up because the supply gets shifted to the left and the short-run and then what happens every business around the world that uses tin economizes on it they cut back on their production because up the price went up so any business where there's some substitute ability where you can use a little bit less of tin and more some other input that's what they're going to do not because they want to make sure the world economy allocates resources effectively but because they want to make money they want to minimize cost and one of the their inputs goes up in price they cut back on it and so Hayek's point is that what the price mechanism does in that scenario is it transmits the barest amount of information everyone needs in order to respond to the collapse of the tin mine that the people back on their use of 10 in Idaho they don't even have to know what happened it's not that someone needs to tell them oh by the way the tin mine collapsed and so you guys better use less of it they don't need to know that they all they need to know is that the price went up alright so that's what that's what interest rates do as well but they're what they serve to regulate is the in the Austrian view is how much the production structure is geared towards present consumption versus future consumption so and here the the reason Austrians are the only major school of thought to focus on this stuff it has to do with the Austrian approach to what what's called capital structure capital theory meaning when the Austrians look at an economy and make a model of it if you will they don't just say as other schools of thought do they don't say okay well imagine there's a big bunch of Labor and there's a big glob of capital and then they get mixed together and produce output and that it best if other schools of thought want to talk about saving and investment they'll say oh well if the society invests more well then next period that the glob of capital increases like this your capital was a hundred and next year it'll be 110 and that's the way other schools of thought typically deal with thinking through issues of capital and savings and investment and interest rates whereas in the Austrian approach it's a lot more realistic the detail given to the capital structure is a lot more intense and so the Austrians picture there being what's called stages of production and there the idea is the furthest from concer the further stage from consumption is something like mining whether it's getting the materials from the earth right or harvesting raw natural resources and then those things will move down the stages of production so if you just think about it like you go into an electronics store and you see a plasma screen TV if you went back in time and just looked at the life cycle of that thing it probably would be years in the making if you just traced it back and looked at all the materials that went into that particular physical thing on the Shelf you would have to go back years just to get the starting point if you will and then trace that forward and see how those materials and resources just got passed along from person to person that you know one factory somewhere would have semi finished goods come in the front door the workers would use machinery and other inputs transformed a little bit and then it would go out the back door and then it would get passed on to some other process all right and so that the Austrians view the economic system if you could see it like from from space and you had a really good eyesight then you would just see like some people on the earth would be you know taking resources out of the ground and giving it to other people and all these things would just go through really complicated chains of transformation where each person put some more finishing touches on it before it finally comes out is the finished consumer good and that those chains of production or transformation could take years all right so what the interest rate helps to coordinate is that whole structure right it's a very complicated thing and so you see it's not just an issue of oh gee we'll have interest rates get pushed too low well then we might get more inflation right that that's really the one thing even if a mainstream economist or someone from the Chicago school for example if they do criticize the feds decision with interest rates usually all they'll say is Oh interest rates are too low right now and we're gonna get inflation right that's that's the problem that they view it merely as interest rates are sort of a Governor on total spending and that's what the what the Keynesian think of it to and that's what they want they're saying right now we're in a recession people aren't spending enough so what do we need to do we need to push down interest rates because in the Keynesian view that's what the interest rate does that's its sole function is it regulates how much total spending there is all right but again go back to that oil analogy I mean it would be you'd be missing out a whole lot of what's going on if what you thought of the oil price was that regulates how much people spend on you know when they fill up their car like if that's the only thing you thought that it did and you didn't realize that when others actually physical barrels of oil and how much we consume is partly influenced by what the price of oil is so the Austrians think it's the same thing with interest rates that it's not just these arbitrary numbers in a checking account somewhere that it corresponds to real physical things so what happens I think it's easiest to see it if it's a market-based process that if you have initial situation and the interest rate is the correct market rate let's say it's 8% and then people in the in the economy decide they want to save more that because they want their kid to go to college or something so what happens is everyone starts saving where they spend less on restaurants they spend less on going to the movie they spend less on Ferraris and so forth so they're saving money and then they put it in the bank let's say so in a normal market where prices are correct and there the market prices what happens all those other industries they see their revenues fall they you know theater owners and the restaurant owners they see their sales plummet and so they cut back right they have to lay off waiters and lay off the guys who rip your ticket at the movie theater and so forth and the people who make Ferraris they have to cut back their production lay off staff and buy fewer resources and then the banks have more savings come in so they can afford to lower their interest rate they charge on loans and then what happens so long as the people running the college's know that that demand is gonna be there in the future well then they can afford to borrow more at the lower rates and then you know build more buildings in their faculty campuses and people who want to go get PhDs can afford to borrow money to get student loans and so forth and so the idea is it's it's not that a production fell and now we're in recession no it's just it gets read averted instead of resources going into making dinners and Ferraris and showing more movies around the country those same physical resources and workers get redeployed into making stuff that's not gonna yield its fruit until years in the future all right so that's the Austrian view of how interest rates serve to coordinate all that stuff right so it's a very complicated thing of course I'm boiling it down for you but that's the basic idea and so what happens when the Fed comes along and just pushes interest rates down arbitrarily that screws all that up it makes entrepreneurs start acting as if people had saved more but there aren't more resources to go around and so it's a boom period it seems like there's prosperity because it's you're getting the same signal as if there's also more capital but there really isn't all right so that's that's the the Austrian view on interest rates and that's why I and you know previous speakers as well are so concerned about the future because for the last two years basically we've been in limbo what's interest rates being pushed down to basically zero or certain key interest rates being pushed down that low that what does that mean the economy has been without a major corrective signal if you will like they're there without that important signal to regulate how much should we invest I know how much funds are there available to be borrowed and in particular certain investment banks and other financial institutions they should have gone under right that when they make bad investments as they did during the housing boom that caused real physical resources to go to the wrong places right so it really was the case that too many houses were built that it really was the case too many smart people who maybe should have gone into theoretical physics ended up going into you know options trading or you know making up models like that and society lost opportunities that society right now would have been in a much more solid more solid footing had those mistakes not been made during the boom and so the point is you can't just undo that you can't just take a mulligan by having Bernanke by everyone's toxic assets and say okay okay let's try it again you use the mistakes were made you know though you can't just turn all those houses now into you know virgin pieces of wood again and then use them for something else I mean those mistakes have been made and we now have to suffer the losses so the point is those losses did happen someone has to bear them and when the Fed comes in and just buys up all these toxic assets there does other tricks to sort of rescue the banks it didn't undo the mistakes it just meant now the people who made those mistakes don't have to eat the loss and it's gonna be spread now among everyone else who holds dollar bills all right and as far as that issue of price inflation just to have a few minutes left me just talk a little bit about that so one thing I want to point out to people and there's this and I do it too when I'm trying to explain to people you know when they say do you think is gonna be massive inflation and they mean price inflation that well technically the and they'll say things like and I can I've said it to that well wait till that money really gets into the economy because of course is I'm sure most of you in here know most of those excess reserves are just sitting on deposit with the Fed that the banks legally speaking have the right to advance new loans but they're not for various reasons and you know there's this tendency to think like oh so that money really hasn't gotten into the economy yet but in a sense it has I mean those banks whose sole assets in exchange for checks written from Bernanke I mean that that was real money to them those dollars are just as much legal tender as a ten dollar bill in your pocket and so that money really has been created but what so when you talk about will so what are the distortions so far everything's seems trite well the distortion is crisis first of all should have been collapsing that that's normally what happens when there is a boom and then a bust as prices come down and so what like when it comes to the stock market or the housing market I think the conventional wisdom is things were going great and then the market got crazy and crashed and now finally we're pushing you know we're we're allowing it to recover to where it should be where's in the Austrian view it's know things were crazy you got prices pushed way up here in the stock and real estate markets then people realize the mistakes and prices started to come down back to a more sane level and then Bernanke and the federal government came in and then did their best to inflate it back up and now they're doing their best to keep them up at these crazy levels and so that's partly why a bunch of us think that another crash is coming in in asset prices and so that that's part of it that the inflation in a sense is already there it's just the baseline would have been much lower prices so we already have seen re inflation of the asset bubble but then again as far as the prices of things in the grocery store and so forth I personally do think that that's coming and that's why so many of us are telling people you know buy gold and silver and things that are gonna at least allow you to get through this it's not that we're gonna be able to avert the coming crash but at least if enough of us survive sort of a Darwinian sense then you know when we emerge from it the Austrians be the only ones left standing the yeah austin ben bernanke so I'll stop it there thanks a lot

Channel: misesmedia

Views: 29,292

Rating: 4.9233718 out of 5

Keywords: Robert, P., Bob, Murphy, Ludwig, von, Mises, Institute, Circle, Austrian, Economics, Financial, Markets, Banking, Recession, Depression, Interest, Rate, Money, Debt, Fed, Federal, Reserve, Bernanke

Id: tDkNPNSgiaY

Length: 30min 3sec (1803 seconds)

Published: Tue Jun 29 2010

Reddit Comments

[u/[deleted]]

I want them set free

There's a boom and bust cycle

... reason to fear it

[u/Lightfiend]

So do any of the 21 downvoters want to explain what they don't like about the Austrian theory of interest rates?

[u/hyp3rVigi1ant]

See Chapter 6 - Production: The Rate of Interest and Its Determination in Man, Economy and State with Power and Market by Murray N. Rothbard (free download or readable online) to get an idea of the "Austrian" view of interest rates. (You may need to read prior chapters for some background.)

[u/guy231]

I don't think any of it was silly or wrong, but there were two points I found misleading:

He suggests that only Austrians make certain predictions about interest rates and prices, but the same conclusions can be made within mainstream schools.

The parable about the television monitor might lead to the conclusion that the monitor was fated to exist, and that the economy had a grand plan for it's construction. He encourages this thought by saying that signals get passed about anticipated future demand, and that these signals are important because the production schedule can be lengthy. In practice, long production schedules can cause enormous uncertainty - you can do some planning, but entropy is probably the dominant factor regardless of of the presence of signals of future demand.

Disclosure: this isn't based on any economic theory. I'm totally armchair.