Everybody, Tom Woods here. It's episode 25158 of The Tom
Wood Show, and we have the distinct pleasure of being
joined once again by the great Keith Knight.
Keith Knight, long after all Woods is dead and buried.
Keith Knight is going to be holding this 'cause that the the
the flame of this cause aloft for all of you.
He is managing editor at the Libertarian Institute.
He's the author of Domestic Imperialism, Is It 9 Reasons I
Left Progressivism. Yes, Sir.
All right. And I'm that was unnecessarily
morbid, my introduction of you, but welcome all the same.
Keith Knight. Tom, thank you so much for
having me. Well, you're kind of, I don't
know if I would say you're doing me a favor, but you're doing
something kind of interesting today.
We've done this before. This year, it turns out, is is
the anniversary year for two of my books.
So we did a 20 year retrospective on the Politically
Incorrect Guide to American History.
Keith and I did. And Keith reminded me at the
Mises Institute Supporters Summit over the weekend in
Hilton Head that it's the 15th anniversary of Meltdown, my book
on the financial crisis. And I'm just sick and tired of
all these, all, all these, these anniversaries because it makes
me feel old. But you know what?
I'm going to, I'm going to get a visual aid to reward those of
you watching on video. So hang on.
All right, Here we are. This is the paperback edition.
Oh, since you've got your hardcore.
The hardback. You got the hardback.
Yeah, that's good. This is the paperback that
includes a new introduction by the author.
And you will note also that it used to say New York Times
bestseller on a little strip here in the corner.
There's a thing only I would notice.
Now it says national bestseller, which is very lame sounding.
But that's because my publisher got into a dispute with the New
York Times. They believe that the Times, in
its weird undisclosed algorithm for determining bestsellers was
unfairly excluding very, very big selling conservative books.
And so they said, well, to punish the New York Times, we
don't ever want to be considered for New York Times bestseller
status ever again. And I thought, well, that's a
weird way of sticking it to them.
You're screwing all your authors.
Anyway, enough of that, Keith. Let's talk here.
So what? How do you want to do this?
You want more gossip about my publisher or what?
What? What else should we talk?
About, yes, but that's got to be just for the supporting
listeners. Let's get they get the inside
scoop. What I wanted to do was give
people a general overview of the mainstream idea as to why there
was a financial crisis in 2008, and then I want to discuss your
book. Here is Paul Krugman's book
Arguing with Zombies, where Krugman says by 2005 or so, I
and many but not enough others, had grown concerned about what
looked like an immense housing bubble.
It seemed obvious that bad things would happen when that
bubble burst. As it turns out, it was far
worse than almost anyone realized.
Years of financial deregulation and financial innovation, which
often amounted to finding ways to evade regulation, had created
a banking system that was, in a modern high tech way, just as
vulnerable to panics as the banking system on the eve of the
Great Depression. That is Krugman summarizing how
he saw it coming. And he knew what the cause was.
Deregulation and financial speculation.
So I want to go through your book Meltdown.
You list 6 culprits as to what caused the financial crisis of
2008 where you say the median home price across all U.S.
cities increased by 150% from August 98 to August of 2006.
Your first culprit they are the GS ES government sponsored
enterprises, Fannie Mae and Freddie Mac.
What do we need to know about culprit #1?
Oh, I, I, I instead, I want to attack Krugman and, and what he
said. Let me just say a couple quick
sentences about Krugman. I I'm sure we'll probably get
into that at some point, but I have to now that just said it
there, there. Everything that the various
institutions did leading up to this crisis they could have done
at any time. There was no special
deregulation that allowed them, that allowed banks to to hold
securitized mortgages, securitization itself.
None of these things were allowed because of quote UN
quote deregulation. There is no relevant
deregulation that had anything to do with this crisis.
Even the Washington Post admitted that there is no
relevant deregulation that is involved here.
But when you're Krugman it, it has to be that because your
faith is in the idea that if wise people would only be given
the scope they need to manage the economy properly, we
wouldn't have these catastrophes.
So therefore there must have been something somewhere that
would have prevented this. But the stupid rubes repealed it
that, well, that would be nice to believe, but there is no such
thing. And not to mention Greenspan
himself was cheering on lowering interest rates to make housing
more appealing. He cheered that on at the time
it was being done. And so Oh my goodness, he
congratulates himself on realizing that wait a minute,
housing prices might be going up a bit much and this, this could
be a problem. Well, what a surprise.
The guy who calls for the very policy that causes the problem
is now a forecaster of the problem.
I mean, yay, this guy is just hopeless.
All right, so you asked me about the GSE.
So we're talking, in this case, we're talking about Fannie Mae
and Freddie Mac. So these are institutions that
they're like, you know, like the worst of a, they're technically
private, but private, wink, wink.
You know, everybody knows that. Well, first of all, their
purpose was to make home ownership more attainable for
Americans and they were private institution.
But they're private, you know, kind of like the way the Fed is
private. Like, you know, the no really
private institution, you know, has its chairman selected by the
US government. You know, like, can they vote on
them? I mean, there's no company in
the economy that's like that. Well, likewise Fannie and
Freddie, everybody knew and they themselves, I have quotations in
one or two of my books about this.
They themselves knew that if Fannie and Freddie ever got into
any trouble as they supposedly helped Americans become
homeowners, that they had a more or less infinite line of credit
to the Treasury. And that is exactly what
happened. That is exactly what happened on
on Christmas Eve as this was all happening it, it's the the, the
infinite line of credit with the Treasury was officially
established at at a moment when nobody's paying attention, it's
Christmas Eve. But Fannie and Freddie would buy
mortgages from banks. That is to say, once, let's say
an institution like Countrywide makes a mortgage loan to some
family, Fannie, you could get a, you would get a letter in the
mail saying from now on, this mortgage will be serviced by
Fannie Mae. And so therefore you're going to
make the payments accordingly. And so that means that Fannie
Mae by buying this mortgage from the originating bank is buying
the right to get the flow of mortgage payments over time.
And the existence of Fannie and Freddie that we're willing to
buy mortgages and we're willing to buy risky mortgages.
And we know this again, from in from internal documents and we
know what the what directors of the company were telling people
that you got to be you if you get out of this company, if
you're not ready to take risks. So it meant that even though
it's true the private sector made a lot of bad mortgage
loans, they knew they could sell them to Fannie and Freddie.
That's the point. That's the point that somebody
like a Krugman is going to ignore.
So I didn't choose Countrywide at random.
Countrywide sold about 90% of its loans to Fannie and Freddie.
They were Fannie and Freddie or Fannie Mae executives were
caught in counting scandals in 2004.
They were cooking their books to justify bigger bonuses for
themselves. If a private firm had done that,
there would have been consequences.
But everybody loved Fannie and Freddie because politicians
could say, look at these institutions.
They're helping you, Joe Taxpayer and Joe Voter, get the
the home that you want. And so, yes, it's true, there
was no explicit bailout guarantee.
There was a chance that Fannie and Freddie would be allowed to
go bankrupt. But the point is the markets
didn't think so. So even in September 2008,
Fannie and Freddie are on death's door.
They've got all these. They've got all these assets of
their books that are not worth nearly what they were supposed
to be worth. They were still able to borrow
at rates only one percentage point higher than the federal
government itself could could borrow at.
And investors obviously believe the federal government would
would come to the rescue. We have plenty of evidence for
that. So, yeah, So Fannie and Freddie
were creating moral hazard. And there's a lot of moral
hazard in this crisis. Moral hazard refers to the
phenomenon whereby you don't where, where, whereby somebody
else is going to absorb the risk or is going to absorb the cost
of your behavior. So there's a kind of moral
hazard. Let's say when you rent a car,
you're not going to, you're not going to get an oil change for
that rented car. You're not going to wash it.
Maybe you might go 5 miles an hour faster over a, a speed bump
because you don't own the long term value of that car.
You know, the, the, the rental agency does well.
Likewise, moral hazard is present when, for example, there
is an implicit or explicit bailout guarantee from the
federal government. Because, you know, well, if I
take a lot of risk, I could wind up with very high profits.
I also could wind up with losses.
But I I have it on pretty good authority that the losses will
be absorbed by the suckers who make up the tax paying
population of the US. And so that what does that
encourage? Obviously more risk taking than
than would have been taken in the past, you know, in the in
the absence of the moral hazard. Culprit #2 The CRA or Community
Reinvestment Act? What do we need to know about
the Community Reinvestment Act? Well, here's the problem.
I mean, the Community Reinvestment Act had to do with
making sure it was a kind of affirmative action lending,
making sure that banks were issuing mortgages in what the
government considered to be sufficient numbers in the
neighborhood where the bank itself was located.
And a lot of people on the political right pointed to the
Community Reinvestment Act as an example of the kind of thing
that led to the crisis. Because obviously these banks,
if you, if you have to force a bank to make loans, that means
that those loans were unattractive for some reason, or
they would have made them already.
So people would say that legislation like our law, a law
like that, a requirement like that requires banks to make
loans they wouldn't make otherwise.
Why wouldn't they make them otherwise?
Because they're not good loans. And of course, what, what the,
you know, getting past all the stuff about deregulation or this
or that, the fact is this, the crisis occurred because the
banks just made a lot of bad loans.
You know, that's not a sexy explanation.
You know, that's, but that's the reality.
Banks made a lot of bad loans. The, the reason I, I'm not
particularly taken by this explanation is that it is true.
The Community Reinvestment Act goes all the way back to the
1970s. So given that the crisis occurs
2007 into 2008, that's an awfully long incubation period,
You know, for, to, for that to be an explanatory factor.
It didn't help, but it was carrying more of a burden than
it should have by right wingers who didn't know what else to to
say. They they don't want to blame
capitalism because they feel invested in that, but they
haven't learned anything about the Federal Reserve because
National Review wasn't talking about the Federal Reserve.
Neoconservatism wasn't talking about the Federal Reserve.
They had no explanation at hand. Whereas we as Austrian
economists, you know of, of the Austrian school, we can say that
the central bank plays a role here.
And the central bank is not a creation of the free market.
It is just the opposite. But they didn't have that read
readily at hand. So they were forced to to search
around for not very convincing explanations like this one.
And you explain, look, instead of taking a very volatile
example that people know about, could you walk us through why we
might see a disparity between whites and Asians getting
approved for banking loans? Oh, yeah.
So there was a there was some amid.
For all I know, there's still some talk about discrimination
in lending that there were, there are racial disparities in
the, you know, the being awarded mortgage loans.
And because of these disparities, the, the allegation
was the banks are discriminating.
So the banks, on the one hand, we're told that the banks are
selfish and evil and whatever. And look, that this banking
system, you know, a lot of them are, but but this is the, you
know, these kind of woke accusations are never that they
never make the right accusations.
You know, I think that their criticism of the Pentagon is
that it's not bringing on enough trans people.
That's not the correct criticism of the Pentagon.
And likewise, these are not the correct criticisms of our
current banking system. Well, one way you can
definitively determine that these banks are not engaged in
discrimination is simply to look at default rates.
So if it were true that for some reason, even though they're
dying, they're selfish and they want all the profits in the
world, they would rather be racist against blacks than make
profits. OK, well, that seems kind of
unconvincing given that you've all you do all day long is tell
us how selfish they are. Why wouldn't they want to make
money off black borrowers? You know?
So the answer is you look at default rates.
The default is rate is the rate at which people default on the
loan. They don't make the payments.
So if black applicants were being held to an artificially
high racist standard, they should have lower default rates.
But they don't. So it turns out that the default
rates are about the same, and that's because the loans were
being made correctly in terms of of risk assessment.
And so, yeah, it's true that Asians were getting mortgage
loans at an even higher rate than whites were.
Why? Because apparently they were
more credit worthy or whatever factors you want to talk about.
But the default rates are the same, and that's what the bank
cares about. Culprit #3 government artificial
stimulus to speculation walk us through why this is a culprit in
the financial. Crisis OK, so there's there's
actually a lot to say on this. So I'll just pick a little, a
little bit of the story, which is the, and we need to talk
about the Federal Reserve, which is coming up, I think might be
the next one after this one. And that will actually help us
understand this a little bit better.
But we started to see lending standards go way down during
this period because there's there's a, a very, very heavy
push at the Department of Housing and Urban Development,
the FHA, the Fed itself is also pushing this.
Fannie and Freddie are also pushing it to get people into
houses. And that meant all kinds of
novel ways of getting people into mortgages who wouldn't
otherwise be qualified. So that would be, that would
mean things like no doc mortgages, like you don't even
have to show your employment so you don't have to convince us
that you're creditworthy. It was wild the way they were
giving away mortgages, but there was no way to keep these kind of
creative instruments confined just to lower income kind of
mortgages. Everybody wound up getting these
sorts of things. And what's more, the one thing,
the one interesting Alan Greenspan move that is relevant
to this discussion is that when the.com boom fizzled out, he
pushed interest rates down further to try to stimulate
things. And this was the first time in
recorded history in the US that housing prices did not fall in a
recession. They actually went up.
And this LED people to this false idea that was spread by
all kinds of financial gurus that housing prices never fall,
that you can't go wrong in real estate.
Housing prices just go up and up.
And this mentality in turn, coupled with all the various
creative financing schemes, LED people to to get far, far
further into flipping houses than they would otherwise have
done. I'm going to buy this one, this
one, this one. And I just know that I can just
turn this thing around and get a higher price.
And everybody had been a customer or acclimated to that
idea by all these voices they're hearing, and also by Greenspan
continuing trying to continue the party from the.com boom by
not letting the economy just kind of sort itself out
afterthe.com bubble burst. And in fact, Ron Paul on the
floor of the US House in 2001 described exactly what was going
on. Hesaidthis.com bubble has burst
and now Greenspan is pumping up housing bubble.
But get now we'll we'll say more about that when we get to the
Federal Reserve thing. In fact, why don't we do that
now? Fair enough.
Culprit 4 is the pro ownership tax code.
Anything we need to know about that before going?
Into I mean, I mean, you can read that in the book that I'll,
I'll leave one of the six for people to be required to go buy
the book. So we'll have a link to the book
in the description and on the show notes page, by the way.
So culprit #5 specifically is the Federal Reserve and
artificially cheap credit. Yeah.
So during this time, we have the Federal Reserve increasing
credit substantially and then we have all these incentives again
coming from all these federal departments and from the GS, ES
tending to steer that new money into into housing.
And so, you know, there are, we've had the Great Depression,
we've had financial panics, we've had recessions during
various years. And they all have their own
individual characteristics. This particular one happened to
have a major emphasis on housing.
And we can understand why, given all the pressure on the part of
these institutions to just to make these loans to to to build
up the home ownership numbers. Democrats wanted that,
Republicans wanted that, the Fed wanted it, the federal
departments, all of these things.
And so the existence of this Federal Reserve credit makes it
possible. For house prices to just
continually rise away, where would people be getting the
money to keep buying these houses?
Eventually they'd be tapped out, but there's this enormous, vast
amount of credit that's available.
And so it just keeps going and going and going.
And this is something that also, I mean, yeah, we have laws
saying you got to make this proportion of, of, of, of let's
say subprime mortgage loans or you, you've got to make mortgage
loans in the community or whatever.
But we also have the incentive created by Fed credit.
And that incentive kind of runs like this.
And there's a, an analogy in the in the book to a basketball
team. Let's suppose you, you have to
pick five people from your gym class to be on your basketball
team. You're going to pick the five
best you can. But then suppose I changed my
mind and I said, well, you know what, you probably should have a
bench of at least a couple of people.
Pick two more. Well, those two more are going
to be not as good as the first 5, right?
Because you chose the best ones already.
Well, likewise, when the Fed comes along, it increases
credit, pushes interest rates down.
Now the banks are going to be making loans to, I mean, the
banks are going to be loaned up to the extent possible at all
times because they want to maximize their profits.
So that means they've surveyed the market and they've found the
most creditworthy people. But now suddenly there's
increased credit in the marketplace and they have more
to play with. So now when they go back into
the market to try to entice more people into getting mortgages,
we know those people are going to be less creditworthy than the
ones they already attracted. The same reason you already
picked the best 5 basketball players for your team.
So this is another factor contributing to this.
In you walk me through the difference between what you call
artificially low interest rates and interest rates that rise and
fall based on market demand. What makes the Fed interest
rates intervention artificial, and why is that a problem?
Interest rates fall when, when, when we as a society decide to
save more of our resources that that pushes interest rates down.
And when we decide to save more of our resources, we are
basically saying we're not going to go into the economy and claim
a lot of these, these kinds of things that that entrepreneurs
might need for their projects. So if I, let's say, say, you
know, I'm going to save, I don't know, some wild amount.
I mean, this would be considered a wild amount these days, 10% of
my income. That means that I'm not going to
go buying a whole lot. I'm not going to go buying
consumer goods with that 10% for a while.
And so during that time, that's exactly the time when we've all
decided we're going to put a, a little bit of a halt on our
purchase of consumer goods. That's when entrepreneurs think,
OK, well then now's the time for us to do long term projects like
expand our physical plant or do research and development for
future products people might want.
In other words, longer term things because they've got the
time we're saving right now and they've got the time and, and
they have the resources, you know, the, the trucks that might
have been driving retail products to the stores.
Well, if we're saving, they don't need as many trucks for
that. So those trucks are now
available for entrepreneurs to use.
Like we're not stuck in a tug of war with each other.
Like we want the trucks for, for bringing retail products to the
stores, but you want the trucks for your long term investments
that are going to result in consumer products only way, way
down the line. We're not in a tug of war.
It's a natural flow of the allocation of resources.
But if interest rates are pushed down artificially by the Fed,
well, it looks like the general public has saved.
But now when you go to start these long term projects, you're
going to find that you're actually in a, in a, in a tug of
war with consumers. You're going to find that those
complementary products you need to complete your big long term
projects, they're going to turn out to be more expensive than
you thought because they're actually being bid away from you
by people lower in the production process, people
closer to the consumer markets who want them for immediate
consumption. And so now some of these
products are not going to pan out.
Some of these investments are not going to pan out.
And the result is a bust. The result is a waste of
resources, half finished things, unprofitable investments that
should never been begun. And then the recession period is
when we sort this all out, reallocate resources into
channels that are sustainable in the long run, and then we get a
healthy economy again. Walk me through what you mean in
the section Cluster of errors. Why is this significant when it
comes to the Austrian explanation?
OK, so most people listening will know that there's something
called an Austrian School of Economics, which is of course
not a literal building but rather a school of thought, and
that it's main proponents are people.
I mean, from the beginning, Karl Menger, Wigan von Baumbauer,
Ludwig von Mises, FA Hayek, and then many others after that,
Israel Kerzner, Murray Rothbard, many others.
And they have a distinct way of looking at how to do economics,
which is kind of a more old fashioned way, which does not
make it wrong. That makes it much more likely
to be right, actually. And among many other things,
they have a distinct explanation for why the economy moves in a
cyclical pattern. Now, we know that in a market
economy, if you are very bad at pleasing consumers, if you
produce all the wrong things or you produce the right things but
at prices nobody can afford, you are going to suffer.
You're going to suffer losses and potential bankruptcy.
But if you are very good at anticipating consumer demand and
you come up with products people want at prices they can afford,
you're going to be rewarded with profits, which means you'll have
now more resources at your command.
And therefore the people who are the best at anticipating
consumer desires will now be able to command more resources
to continue their good work. So if that's true, that the best
anticipators of consumer preferences are rewarded and
they get more and more resources, and people who are
the poorest at it get punished and wind up being stewards of
fewer and fewer resources, then the question becomes why doesn't
the economy then move essentially in an upward
trajectory? Because the best, the best
entrepreneurs get rewarded and they're controlling more and
more resources, and they're really good at this.
And so the economy should get better and better as this
process continues. But you notice the economy
instead moves in like a sine wave.
It goes up and then it goes down.
It goes that way. You know, we're doing well, then
we're doing badly, then we're doing well, then we're doing
badly. That doesn't seem to be the
story that we're telling here about the the most skilled
entrepreneurs getting more and more resources under their
control. Shouldn't that lead to better
and better and better outcomes rather than up and down and up
and down? So what is the source of this up
and down? What is the explanation for this
up and down? And we're sometimes inclined to
think that maybe there's some localized problem, you know,
like, or or maybe there's some some localized, for example, not
necessarily just to a physical location, but to a particular
industry. Like let's say oil prices go up
very suddenly or there are very suddenly shortages of oil and
that has economy wide consequences.
Well, OK, something like that happens.
Or let's say Martians came and they like to drink oil and they
drank like 9/10 of the supply in one day.
Well, that would of course be a shock to the economy, but that's
not what we're really looking for.
That would be 1 localized, one time shock.
We're looking for the explanation of a consistent
cyclical pattern. And so where Austrians look for
that is in money and banking, because money is half of every
transaction. You know, it's money for a
winter hat or money for some bottled water or, you know, or
money for a new car. Money is always half of every
one of those transactions. So if we're talking about a
systemic problem that seems to affect all markets in the
economy all at once, and it's it turns out that so many
entrepreneurs will have been found to have made errors all at
once in their entrepreneurial calculations, we need an
explanation for this. And the explanation would seem
to be something that affects the entire economy.
If it's a phenomenon that we see in the entire economy, we should
look for the explanation in some phenomenon that affects the
entire economy, and that's money.
And so the the Austrians say now strictly speaking, the the,
their theory of the business cycle can in fact exist even
without the presence of a central bank.
But in our case, we have the Federal Reserve System that
pushes interest rates lower than they would be normally.
And the idea here is that is that entrepreneurs will be
misled into making investments in the light of an interest rate
that's telling them a lie, that's not giving them the full
picture of the availability of resources.
And so this will get entrepreneurs on the wrong
track. And therefore we'll see this
cluster of error that has this institutional explanation the
the Federal Reserve. So that's, and, and not to
mention, it's not just that entrepreneurs become foolish.
It's also, as our friend Lucas Engelhart points out, that fools
become entrepreneurs When it looks like, hey, everybody's
succeeding and there's all this money that's so easy to get on
easy terms and low interest rates, then you fools become
entrepreneurs and they wind up making a lot of mistakes.
And so that is the thing. What is the explanation for that
cluster of error? And the answer is the artificial
interference with interest rates on the part of the Fed.
And on top of sending a poor signal, I guess the chairman of
the Fed could just come out and say there's not as much savings,
so just ignore the interest rate.
They create the incentive on top of it for people to actually
take these loans out. You mean there's also the
concern that if, if my firm doesn't take advantage of the
cheap credit, all my competitors will and they'll use this moment
to expand their capacity. And it's not that every single
person who starts a project during a boom is going to fail.
Some of them will succeed. Some of them will roll the dice
and they'll they'll get their project finished and everything
will be fine. And So what you'll sometimes see
is that there'll be this thought that if we don't also get while
the gettin's good, we're going to come out worse.
So we have to go out and be speculative.
And so in the, it's, it's analogous to what happens with
the money supply and the ordinary person in an
inflationary world, the ordinary person sees his money losing its
value. And so he feels like, OK, I
guess I have to go out and speculate too.
I guess I better get in the stock market or, or something.
It encourages speculative behavior so that people can just
break even. In the book, you differentiate
higher order stages of production and what you call
lower stages of production. So this is differentiating me
going to the store and buying retail versus a construction
company who is looking for places to mine lithium or
whatever. Can you walk me through what
differentiates higher order stages of production from lower
and why that's significant? Now I can, I can give you as I
just did, a, a, a very, very elementary overview of the
Austrian theory of the business cycle without talking about
stages of production. But for people who want a, a
bigger picture here, the idea of stages of production is runs as
follows, that the highest order stages are the ones that are the
farthest from consumers. And so that is to say research
and development or mining, that's very, very far from let's
say a wristwatch in a jewelry store, because that's going to
take a long time. Like research and development,
we don't even know what the product is going to be.
So that these are stages that are that are going to be that
the fruits of those stages will not be consumer goods for a long
time. So we have a stage like that.
We, we might have, you know, we'll have like manufacturing,
we'll have distribution. We're OK now we've so, so
manufacturing itself is going to be a series of stages.
Maybe, maybe the first stage is the production of, you know,
widget A, but widget A isn't useful to people without being
combined with widget B, which is then another stage.
But then once the product is created over the course of
stages, then we have to distribute it.
So we've got to physically transport it.
We have to market it so that people know that it exists.
We have to get it into that retail store.
And so if you think about a bagel in a in a deli, you have
to think about, OK, we're going to, we're going to plant grain
now that's very, very far away from your bagel.
You know, then we have various stages that that grain goes
through to become a bagel that is heated up and handed to you
in a retail store. And the idea of this, this idea
of, of stage of production helps us to conceptualize what's
happening in the business cycle in, in, in a, you know, an
artificially induced boom is that you've got entrepreneurs
now with the lower interest rates, these long term projects
become very, very attractive, very much more attractive.
In the same way that if, if the 30 year mortgage rate for your
house was cut in half, you would go out and buy, you might very
well go out and buy a nicer house, you know, because,
because that that slash in half, let's say, or even buy, you
know, a percentage point or two makes a big, big difference in
the, the payments you're going to be making over time, your
mortgage payment will be way lower because of that.
And so likewise, these long term projects become much, much more
attractive. So you've got entrepreneurs
working up here on the higher order stages, But at the same
time, consumers are just demanding their same pattern of
consumption and saving that they had before.
And so they want resources down here more of existing products.
And meanwhile, because of the mismatch of the, because that we
have artificially low interest rates and not the interest rates
that emerge from the natural patterns of saving and
consumption on the part of consumers.
We have a kind of a competition between entrepreneurs up here
and consumers down here instead of the cooperation that would
ordinarily occur if the interest rates were allowed to set
themselves. And so that's that's the
explanation of what what, what those terms mean.
A lot of the financial terms can make things very confusing.
Ludwig von Mises uses the analogy of a master builder to
close out this section and then I want to go on to the next one.
What is Mises master construction?
I forget what he calls it master.
Can you either use a different analogy to explain this or walk
us through Mises? Well, I'll walk us through the
miserable even though we don't want to.
It is an analogy involving a home builder.
And unfortunately, the 2008 crisis involved housing.
So when we use this analogy, we have to understand he's not
literally talking about houses. He's thinking of the house as
representing an entire economy. So his analogy is this that
he's, he's imagining an economy or he's imagining a master
builder trying to build a house, but he's building a house in the
same way that we're trying to run an economy with misleading
interest rates and mismatches and what everybody's trying to
do. So as a home builder, I'm trying
to build a house. So I'm going to gather resources
together and start building that house.
So in, in the case of, I mean, basically what's happened, the
way I like to do the analogy is that what we have in the case of
artificially low interest rates is a, is a home builder, a
master builder who's become drunk and his drunkenness is
making him sort of like see double.
And he thinks he has more resources than he has.
So when he draws up a blueprint for his house, he draws up a
blueprint for a house that's much too ambitious given his
resource constraints. There's no way you can build
this house with the bricks and all the other supplies that he
has. But he's looking at the supply
and it looks bigger. It looks big enough to build
this house. And so in effect, this is what
we're saying is it's like the economy itself becomes too
ambitious. It's trying to do more than it
actually can do. So the master builder goes about
me, he can build some of it. And he starts building.
And then he realizes, wait a minute, I, I can't finish this
house, though the one in, in the blueprint.
So he starts thinking, all right, well, I guess the, the
only way to handle this is to build a more modest house.
You know, I, I'll, I'll, I, I was too ambitious here.
I'll try to build a more modest house.
So let's see, we'll get rid of the gazebo.
There's no way I have the resources for that.
The second wing of the house, forget it.
We're just not going to be able to build that.
So he tries to think of with the resources I have, what can I in
fact do? And I'll explain how the, this
how this is in fact an analogy in just a minute.
But if somebody said to him, well, what if you continue to
drink, you know, just drink some more, maybe that'll help you
because then that'll make you think there are more resources.
Now nobody could think that's the solution to his problem.
Fool him into thinking he has even more resources so that he
continues to build the original house that we know he doesn't
have the resources to build. If he did that, OK, he would
continue building this. But then he'd realized, wait a
minute, I just wasted even more resources and more labor time
that I could have devoted to the building of the smaller house.
Now this whole thing has to be demolished so that I can rebuild
a house that is plausible given the existing resources that I
have. So the analogy is when we have a
recession, this is, in effect the economy saying we've been
too ambitious. We were trying to start way too
many things all at once. We don't have the resources for
them all. So we got to go back to our
blueprint. We got to figure out what things
we really can do, what things are really sustainable, what
kind of economy we can have that can really work, and we'll go do
those things. But that's the recession period.
So the recession period is actually the restoration to
health. But during that period you have
people saying, well, wait a minute, what if the government
just spent a lot of money or the Fed printed up a lot more money?
Well, OK, so again, we see that there's an analogy here that is
like saying, let's get the the master builder even drunker than
before, and we don't want to do that.
What we want entrepreneurs to figure out.
All right, look, we were misled into doing things we should have
done. Let's step back a minute and see
what we can in fact do now. But if the Fed is going to is
going to push interest rates even lower, that's going to make
it even harder to figure out what we should do.
And that's going to encourage us to persist in the wrong things,
the same way we would have encouraged the Master builder to
persist in building an unbuildable house.
And that's what Alan Greenspan did in 2001.
People persisted in investment and spending decisions they
shouldn't have persisted in. And so we don't want them.
We want that master builder to see the world clearly, and when
we hump the economy with all this artificial stuff, all it
does is is make him fall back into his initial errors.
And So what is true of him in the analogy is true of the
economy and the aggregate. In the face of hundreds, dozens,
maybe hundreds of regulatory agencies, 10s of thousands of
codes in the pages in the Federal Register, thousands of
bureaucrats, the progressive and will have the confidence to say
it was actually deregulation because it's not the number that
matters, it's the quality. And what happened was they've
repealed glass Steagall in the 90s, allowing commercial and
investment banks to merge. How can we falsify this thesis
that repealing Glass Steagall was the cause of the O8 crash?
Yeah, it's just, I didn't, I have friends who take this
position and I think they're just not I, I don't know where
they're coming from on this because so-called glass, there's
the what what we had was the, the, the partial repeal of Glass
Steagall around 1999. The so-called Glass Steagall had
separated commercial and investment banking from each
other. And the repeal of that simply
said that the same holding company can own both a
commercial bank and an investment bank.
That was it. And all that did was make the
United States like every other country in the world.
No other country in the world had that restriction.
So the idea that repealing that caused a financial crisis that
spanned the globe when only the US had that provision in the 1st
place is unconvincing. No other country has had any
problem with that and and neither have we.
And so when we look at like who are three of the major players
that had major troubles during the financial crisis, Bear
Stearns, Lehman Brothers and Merrill Lynch, well, those were
pure investment banks. They never crossed over into
commercial banking. Same with Goldman Sachs,
Washington Mutual and Wachovia, which went under.
They just, they lost money the old fashioned way.
As I said at the beginning, they made bad loans to homeowners.
And AIG is an insurance. Firm is an insurance, right?
Yeah, AIG and, and AIGAIG wound up getting, you know, the, the
bailout thing is the other side of all this.
AIG wound up getting a bailout and then just months later its
former CEO said, you know, in retrospect, probably we
shouldn't have gotten that bailout.
We should have been allowed to go bankrupt.
And then the, the, the, the rest of the US wouldn't have had to
deal with our, our problems. The whole, I mean, I'm, I'm,
maybe I'm getting ahead of us here, but I, I don't, I don't
want to get into all the technical details about credit
default swaps. But the point is that with AIG,
we were told, as with COVID, we don't have time to listen to you
people. It's an emergency.
We have to take action. And so we were told that AIG has
all these toxic assets that, and so that their, their
counterparties are going to go bankrupt if AIG goes bankrupt.
But, and so, and you're not going to get your paycheck
because the Main Street banks are going to get hit by this.
Almost none of AI GS bad assets were held by Main Street banks.
They were held by about a dozen major institutions, and those
institutions alone would have taken a hit, and they could have
absorbed that hit because those institutions had about $20
trillion in assets and they were facing maybe between 60 and $80
billion in losses, which is about the equivalent of one
year's worth of executive bonuses.
But sorry, no, we we have to bail them out.
And then that leads to even more moral hazard because now
everybody knows that if push comes to shove, the Fed will
come along, tell everybody to shut up and make things right
with the federal government, too, will come along and make
things right. And that means that you're
encouraging people to engage in all kinds of risky behavior that
they would have been punished for.
So the Sallie Mae deregulation, alleged deregulation like
they're doing us so many favors. This did not apply to the most
volatile banks who crashed during the recession.
Therefore, to say there's a causal link is nonsensical.
That's your general response. Yeah, It doesn't tell the story
that we lived through. It has nothing to do with that
story. And, and I think I've, I've
heard several people say, but the reason people cite this,
they think is that as with somebody like Krugman and I, by
the way, I don't know what Krugman's opinion on this
particular question is, but it's the same mentality.
There must have been some repealed thing that would, if we
had kept it, have prevented this outcome.
They have to believe that, that the smart people, the experts
running things must have anticipated this.
But the stupid rubes got rid of their their wise regulation.
They have to believe. They can't just believe that
maybe the experts themselves might have driven us into into
this dead end. Yeah, because I would have
assumed that if you had a bank that was allowed to diversify
its portfolio with commercial and investment payments or
investments, I thought that they would be more stable.
So that actually makes sense. All right, so now we get on to
we're in the recession now we got to come up with a solution.
Fortunately, Nobel Prize winning economist has the answer for us.
He summarizes the theory of John Maynard Keynes on page 96 of
Arguing with Zombies. Here it is.
Get a pen, because you're going to want to jot down a few
things. The economy isn't like an
individual family that earns a certain amount and spends some
other amount with no relationship between the two.
My spending is your income and your spending is my income.
If we both slash spending, both of our incomes fall.
In a situation in which many people have cut spending, the
result is depressed incomes and a depressed economy with
millions of willing workers unable to find jobs.
The government is not in competition with the private
sector. Government purchases don't use
resources that would otherwise be producing private goods.
They put unemployed resources to work.
Budget deficits haven't led to soaring interest rates, and the
Fed's money printing hasn't led to inflation.
Austerity policies have greatly deepened economic slumps almost
everywhere they have been tried. Spending cuts and or tax
increases should wait until the economy is no longer depressed
and the private sector is willing to spend enough to
produce full employment. What, if anything, is wrong with
that response? We have come upon the old issue
of idle resources and somebody like Krugman is, you know, I, I,
I want to emphasize people. He's, you can't just go up to
Paul Krugman and say, don't you know about the broken window
fallacy? He does.
And, and he will admit to you that in an economy with full
employment of resources, the broken window fallacy would be a
problem. And for the broken window
fallacy is the boy throws a baseball through the window and
it breaks it. And the home owner is very
unhappy because now I have to replace the, the window.
But the, the, the midwit economist comes along and says,
oh, but actually the breaking of the window will be a stimulus to
the window repair industry because he can only see one
thing at a time. But the problem is like that,
the resources that go into that can't go into something else.
And so if there hadn't been a broken window, I could have had
a nice window and a new sweater. But since I have to spend the
sweater money on repairing the window, now I have only a
window. So it's a, it's a, it's a loss
as a normal person would think. Destruction is a loss.
Krugman agrees with that. So we don't want to think he's
just a dummy. What his, his argument is that
when you're in a recession, the, the, the resources in question
aren't being used by anybody. So it's not like, you know, we,
we have to pull resources away from one thing in order to do,
let's say some government make work jobs.
He's saying people are just sitting there, they're not doing
any work, you know, So he's, he's in effect saying this is a
case where the window repair man was unemployed, you know, so
we're not pulling him away from some other employment.
He was just sitting there anyway.
So we're putting him to work. And this is a net plus for the
economy. So the, the problems with this
are the at least two fold. Number one, when he says that
resources are unemployed, he means like, you know, he means
mostly labor, that people are unemployed, people are
unemployed, but also resources, you know, there are buildings
that aren't being used because the the factory closed or, you
know, and all the machines in the factory are just sitting
idle. And wouldn't it be good if we
could do something with those things?
So let's stimulate them into activity.
The problem with this is they're idle for a reason.
If, if the prices of those things like that machinery of
that building went low enough, somebody would buy it and start
producing something in there. But right now the economy is
trying to price those things and trying to figure out at what
price level is it profitable to use this thing.
And just artificially saying we'll go in there and start
making stuff is not helpful. We need to figure out is it
economical to make stuff? Maybe, maybe this, this whole
building's a total loss for all we know, but we need time to
figure that out. And politicians can't figure
that out. They're going to, they're just
going to say, well, employ some of my local constituents in
doing some random thing of that building that's not making us
richer. So that's, that's one problem.
The other problem is so that other problem is why are the
resources idle in the 1st place? Krugman never wants to answer
this question. Why did the resources suddenly
go idle? Well, because of what we
learned, the Austrian business cycle theory, they started on,
on projects that were unwise and unsustainable shouldn't have
been started. And so we don't really want to
restart them. Why would we want to restart
them? Maybe they shouldn't have been
started again. Entrepreneurs need time to
figure out how to fit these resources now into the new
economy that we have, not the imaginary economy we thought we
had when we were drunk, this real economy.
So that's going to take a little bit of time.
And then finally, when Krugman says we're not using resources,
that the privates, we're not competing with the private
sector, when the government directs the allocation of
resources and employing individuals and jobs, we're just
taking idle things. But that's impossible.
What project could Krugman come up with that absolutely,
precisely uses only those human and physical resources that
happened to be idle at the time? No matter what project it is, it
is going to be competing with real projects that have real
consumer demand behind them. Not just politicians saying,
hey, create these jobs so that I look like a cool guy in front of
my constituents. That only impoverishes us.
Those types of jobs, they don't create anything we want.
If they did, we would voluntarily support those jobs
with our purchases. So Krugman, no matter what he
claims he can do, cannot create jobs and projects that precisely
pull only the resources that are temporarily idle.
He will be competing with the private sector that is actually
currently in the process of trying to produce things we
really need. He equates the involuntary
investment of the taxpayer with things that actually reveal
choice preference of what people actually want.
Exactly. Right.
Just seconding two more questions with regard to
historical narratives. What are some lessons we can
learn from the depression of 1927?
Years after the Federal Reserve was established, there was a
depression. The panics did not end.
What are some lessons from the depression of 1920?
Yeah, so. The that I, I wrote an article
for the Intercollegiate Review on that.
I don't remember the title of it, but that it, it gave my most
thorough overview on it. I do talk about it in meltdown
to about the degree that you know, an ordinary person would
need. But for the nerd, you're going
to want to look for my article in the Intercollegiate Review.
But the long and the short of it is this Joseph Schumpeter, while
great, not not in in the Austrian school, but a great,
very interesting economist, said at the time that that downturn
1920 to 21 was itself evidence that the economy reverses itself
when after there's a downturn that you don't need outside
help, you don't need artificial stimulus, you don't need
anything like that, that entrepreneurs eventually sort
things out. And so you did have a very
severe downturn that year, like production following by the
following, by a double digit percentage, double digit
unemployment, a very, very substantial downturn.
And by the middle of 2000, I'm sorry, not 2000 and 1921, Warren
Harding had as his secretary of commerce Herbert Hoover, who was
not the laissez faire ideologue. We've been told he was something
of a progressive and he was urging Harding to do something.
Oh, by the time it occurred to him to quote, UN quote, do
something, the and the economy had already reversed itself.
The recession was already over. So there is something to that.
And yet we know all about the Great Depression and the phony
story whereby the New Deal solved it.
It obviously did not. But nobody knows about that
depression of 1920 to 21, and it's obvious why.
Final question, Herbert Hoover. The narrative is we had a
depression. Unfortunately, we had this
laissez faire obsessed Herbert Hoover who basically sat on his
hands until we got the New Deal by Franklin Roosevelt.
Fortunately enough, we've already gone over how the New
Deal led to the double dip recession of 1937.
If we just focus on this concept.
Hoover was an economic isolationist or a free market
thinker. What is wrong with that theory,
if anything? Well, the New Dealers themselves
admitted that they're the entire New Deal was just an
extrapolation from what Hoover was already doing.
And in fact, FDR ran against Hoover on the grounds that he
was a big spender and FD Rs vice presidential nominee said that
Hoover was taking us down the road to socialism.
Now what? So how how come they didn't know
that Hoover was a laissez faire ideologue at this point?
The the the good sound revisionism on this has pretty
much come through, just hasn't trickled down to the general
public. But I even saw Apbs special
saying that, yeah, we all know now that Hoover was an economic
interventionist. Well, who's we?
I mean, a few people do, but the general public typically
doesn't. But you look at Bob Murphy's
done great work on this. He has the politically incorrect
Guide to the Great Depression of the New Deal, and he's gone
through the numbers of comparing Hoover's spending and FDR
spending. And, and because Hoover did
spend an enormous amount on public works and not to mention
he had agriculture policies and wage policies, which wasn't a
policy, but it was a strong urging to major companies to
keep, keep wages up at a time when when prices were were
falling pretty dramatically. But to keep nominal wages up at
a time that we know that would just encourage people to hire
fewer people at at that particular moment.
But when we when we go down the line, he raised taxes and he
raised taxes on all kinds of different things, not just
income, but all kinds of particular excise taxes on
particular products. He was lending money to the
states for their for them to do various public works types of
programs themselves. So he intervened over and over.
In fact, he says in his memoir that we might have done nothing,
but that would have been catastrophic.
So yeah, it it, it, it is not so it is.
It is indeed not so. Hoover was a kind of proto
progressive who thought that. In fact, he says repeatedly that
laissez faire is dead, It's over.
It's an old idea. We've now moved on to this new
modern way of of planning with cooperation between government
and business. It's all in there.
One of the great lessons I learned from Diary of a
Psychosis, your book published by the Libertarian Institute, is
ask yourself, what should we expect to see?
So when they tell us, well, we need a mask mandate, well, we'd
expect to see cases going up, mask mandate enforced, and then
cases going down. So when someone says Hoover was
a hands off free market guy, we would expect to see Hoover come
into office and then spending and government regulation slowly
decreasing on top of the Smoot Hawley tariff taxes from
econlib.org. Federal spending in 1929's
budget that Hoover inherited was $3.1 billion.
He increased spending to 3.3 billion in 1933, point, 6
billion in 1931, and 4.7 billion and 4.6 billion in 1932 and 1933
respectively, a 48% increase over his four years.
So that is just another verifiable lie that the
progressives and neocons are constantly shoving down our
throat, ushering in a totalitarian bureaucracy within
our shores for our own good. Meltdown is an absolutely
excellent book, one of the early books I read in libertarianism
after Ron Paul's The Revolution and Frederick Bastiat's The Law.
Thank you so much Tom Woods for talking to me about this.
Well, thank you, Keith Knight, for asking me questions about
it. It is the 15th anniversary.
There is a new introduction bringing things a little bit up
to date. This is one of those things,
like COVID, that if we get it wrong, then the conventional
wisdom becomes the stupid heads wouldn't let the experts take
care of business, you know? And it's like, yeah, how many
these people have no shame. So if any of this interests you,
check out Meltdown. We'll have the link in the
description and on the show notes page tomwas.com slash
2558. Also, I have a big booster and
indeed a member of the board of the Libertarian Institute, and
that is Libertarian institute.org, which I very much
want to encourage you to check out.
So thank you, Keith Knight, and thank you ladies and gentlemen.
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