 Okay, so the the title of this particular talk is why capitalism needs losses, too And you know, this is something that I think even a lot of big fans of the free market a trap they fall into where You know when we're defending capitalism in the way that free market lays a fair economies work There is this tendency where we we just focus on Profits and we say that oh, you know that this is great the entrepreneur is Profitable and that's sort of a noble thing again if he's he or she is earning it through voluntary market transactions and not by as Peter talked about running to the government and getting special favors and privileges and and that's certainly true and that's that's an important component of the story but We don't describe the market economy as a profit system It's one way to describe me is a profit and loss system and it's important to focus on the flip side Because then that in a sense underscores what it is the profits do right? So if you understand what a loss is and why that's undesirable Then that sheds more light on why a profit per se is a good thing and why you want to encourage that now And so going along with that mere not merely just looking at the government sort of Crippling the earning of profits and the profits in the in the good sense And why that could be a bad thing so just to give you an example of what I'm talking about If the government has what's called an excess profits tax Okay, so some of you may be familiar with that term and that's something that politicians a lot of times will recommend and on the face of it it seems like well How could that be a bad thing right that if they need to raise money somehow in excess profits tax and those they put that That word excess in there to make it look like you know someone who's earning more profits than he really even needs You know so who could be against an excess profits tax? Well as an economist you can walk through the logic of why that's not a good thing or at least what the downsides would be to that and It goes back to those things that Peter and I have been talking about so remember How do you earn profits? It's when you forecast the future better than other people And I may have given you the impression that the successful entrepreneur You know knows it's gonna happen But of course in the real world nobody knows the future for sure They could be wrong And so if you're gonna be an entrepreneur and take a risky venture if you're gonna do something put up your money or your Shareholders money you're gonna borrow money from people in the bond market or whatever and Take a chance on something it could go right and it could blow up in your face Right and so if the government comes in now and and says we're going to have a very high tax rate Uncertain activities that we're gonna classify as the earning of excess profits It's not correct to think well in the grand scheme. That's not gonna hurt anything because if somebody makes a Million dollars off of something and he only gets to keep half of it Well, he still made 500,000 so he's still gonna do it no one's gonna turn away $500,000 right and that's that's the way some people think about it and even if you're familiar with Warren Buffett You know he makes jokes about that in front of the press or whatever to make it look like he's just an average guy like you Or me Saying things about you know, oh come on I've never looked at a business deal and thought I was gonna earn 18% But then because of taxes I'm not gonna earn 14% or whatever and so I walk away But you're not guaranteed you're gonna earn 18% 18% right you might lose a bunch of money too And so that's and he knows that that means I think that he's being coy there with it with his audience And so that's the problem just to give you a concrete example I mean suppose There were you know a pharmaceutical company that had millions of dollars in its research budget and it had you know And I realized okay, we're gonna fund research for 15 different types of drugs to Fight certain diseases treat certain illnesses or so forth and maybe develop a cure for them And we're gonna spend I'm obviously making up numbers here we're gonna spend $200,000 on each one and You know, we think that one of them might hit probably most of them We're gonna be duds and we're gonna spend that money and get nothing back for it But one of them we might hit a home run and on that one once we get the thing up and running and we're selling it in the marketplace You know if you just looked at our investment in that one particular drug in the rate of return on our investment it would be huge and So if the government comes along them and sees that and then taxes us and says you don't need to be earning that much All you need to earn is 15% on your capital and that's plenty and that should be enough to encourage you to develop drugs Well, you'd realize well that that wouldn't be the right way to look at it if they thought going into it that if any of these Takes off we hit a home run on it Then the government's looking to let us keep a little bit Well, then the whole research budget as a whole now is cast in the doubt and maybe we don't want to do that We don't want to put up millions of dollars because we know even if one of them does hit You know pay off. We're not gonna get to keep that all right So that's just one example and of course those numbers might not be realistic, but I just want to get you to see How it can be that the government coming in and putting in a so-called excess profits tax Would cripple things okay, but going back to what I said the beginning of this second talk I Don't want you merely to focus on that kind of thing It's not simply that the government distorts the market in the operation of the price system If it sort of mutes Successes right if it doesn't let you keep What you've earned in terms of profit Yes, that deadens your incentive to go do the right thing and to stick to something that's safer All right, so that's that's one aspect But let's also not forget that the government does the opposite they come in very often and they subsidize losses so you get the worst of both worlds that They're taking away what the market normally would give is a reward That's the way you want to think about it to people who see the future better than others and at the same time the government comes in and compensates people and sort of Cushions the blow when they really screw up and then and it takes the pain away from that And so it takes away the fear of doing something silly as well And that's also not the right signal you want to give so in terms of What's the right balance between those things? Well, I think Peter and I would certainly say and many other Austrian economists that the right mixture of the possibility of gain but also the worry and the fear of a giant loss and how do you adjust your behavior accordingly is Exactly what the market gives you and let people in the market determine what the appropriate Degree of risk taking ought to be so it's not that we want to encourage people to be risky But we also don't want to discourage them either let people judge for themselves whether a certain Gamble if you will is justified or not now Let me take a step back here and just give you some examples historical examples because I think even a Lot of us we might not realize How things in the market? It's not obvious. We can see something in retrospect a very successful corporation Certain business venture certain products innovation and it's oh, yeah, of course And then someone's making millions of dollars because of that or the shareholders who got lucky and People can say well, you know, why should they have that sort of? advantage over the rest of us and I think part of what's happening to the reason people think like that is they don't realize how often even big businesses make mistakes They don't realize that You know, why is it that a corporation wants to bring in a CEO? To do a certain thing and a lot of times it's because they think this person has a vision And we want someone to come in and make these decisions. So my point is it's not Just clockwork. It's not just going in and punch in a clock and everyone just goes about their daily business And that's what a giant corporation does. No, there have to be people at the helm Who make decisions about what what what's our new product line going to be? You know, do we want to push our engineers and our production staff to get this thing out in next quarter? Or do we want to just, you know, do more internal testing to make sure that, you know The quality assurance is there but then release it the quarter after right and so this is a trade-off they face and as Peter was mentioning that, you know, there's no Obvious answer to that. You got to leave that up to people in the marketplace and they might make the wrong decision So, I mean, that's you wonder sometimes to look how come when software comes out It's all buggy the first version and then in subsequent versions they fix it Sometimes you might wonder why don't they just get it right the first time and the answer is well Because then they would never release new software, right? There could always be something wrong with it and you just at some point on the margins Economist would say delaying further is not worth it that it makes more sense to release the thing knowing full Well, it's gonna get out there your customers are gonna be using it and they're gonna start complaining And then you're gonna have to start working on a fix For you know, the next version or a quick patch if it's a really a serious problem that sort of thing All right, so that's the constant trade-off that there is just to give you some Historical examples so your parents are Will recognize some of these that but then later I'll give you ones that are perhaps more relevant to the students here So there was famously this line of cars called the Edzel that was a big flop All right, and this was not some you know Poad Uncle Corporation with the giant corporation released this new thing They thought it was gonna work if it had been a home run, you know They would have said the people involved were geniuses, but it was a flop And so now that's sort of just like a joke the the Beatles right the musical band the Beatles you guys are familiar with them, right? You guys first be okay. I gotta check They Their first, you know, they went to a record before they were famous They went to and did an audition for a record label to try to sign them and they turned them down the record label said no You know your guitars that sound that we think is on the way out. Thanks for coming in Can you imagine if you were the people involved in that decision when the Beatles went on to become you know The biggest band in human history and then somebody at a record company turned them down They had the chance to sign them the Beatles would have been their band and they said nah, we're not interested all right There was something called it you guys might not read you guys familiar with the new Coke You guys remember that okay So there I actually never knew that the specifics of that So what happens you know Coke unveiled this thing to call the new coke and then they just quickly got rid of it And you know did we don't we don't ever speak of that again and what happened was and I didn't know this until recently I was just reading this book about various, you know these sorts of marketing flops and things like that and what happened is apparently they had done a bunch of taste testing and In small doses you know is given consumers and it was you know and they were scientific about it Right, they didn't want to make a dumb decision. They had lost the millions of dollars at risk You know so they did all the proper double-blind studies and so in other words, you know, they didn't They made it sure that the people didn't know what they were drinking and so they honestly were reporting and This they tinkered with the formula and the sugar content whatever from from the old original Coke to what they were calling the new Coke and It was just beating the pants off a Pepsi right and all these blind taste tests And so they were there you know their marketing guys were sure this this thing is gonna be awesome And so let's build the campaign let's call the new coke to make sure people distinguish and they realize this is a new thing It tastes even better than the old and they went through and then what happened is people said just they wasn't selling and They figured out what the problem was If you're just having a little sip you want it to be sweeter, right? And so drinking it you know just a little sip at a time the thing that's sweeter Just people said I like that better, but if you're drinking a whole can That after a while gets overwhelming and you don't want that right and so, you know If you just think about like original classic Coke It's not as sweet as some other types of drinks, but you know if you want to drink a whole can of something Coke's pretty good. I'm not getting paid by coke by the way, but if they want to send me a check if you're watching this online feel free Okay, so you understand so that was the mistake that they made that they Incorrectly extrapolated from the results of these blind taste tests to thinking we sell this thing in terms of six packs and two liters It's gonna fly off the shelves and they just they made the mistake It was an honest obviously an honest mistake that wasn't in their interest to lose millions of dollars I don't know how much they lost but it was certainly embarrassing and they quickly recovered Okay, so the point of that one is just to show you you might think that oh Coca-Cola's this giant behemoth they have all this ad I mean these marketing people that they can do whatever they want and the consumers are helpless because you go to the store And there's coke coke all in your face. Well, no in a market economy a corporation can't force you to buy anything Ultimately, it's up to the consumer and you can do what you want with your money And it's true with clever marketing and they pay sports stars or whatever to do things and you know beer commercials Make it look like oh, you just you want to start a party just pop open one of our drinks and all of a sudden you know people are dancing in your living room and It doesn't work by the way just so you guys know But the point is you Everyone can do that and Mises made that point too in his writings So he said that you can't that a bad product or a good product, you know They both have those means at their disposal and so in the long run a product that really isn't good and consumers don't like You're not gonna trick them into consistently buying it from you time and again And also the companies that make genuinely good products They can also hire, you know the spokes models to come in or to get Michael Jordan to give it an endorsement or whatever And so those things should wash out and then you would think the thing that in the long run is actually the superior product is gonna win Out all right, so that's just another example One more recently similar to the Beatles fiasco I don't know the exact number, but JK Rowling, you know the author of Harry Potter She apparently sent that manuscript To dozens I believe, you know publishers and agents or whatever and they all just nope. No, no You get rejection after rejection until finally somebody gave it a shot and then we all know what happened there I mean, she's incredibly wealthy She could be I don't know she a billionaire. Does anybody know she's certainly a hundreds of millionaire I don't know if she's okay, so and that's in pounds. So that's really that's saying something, right? Okay, so What's the what's the point point is go out and write a novel and just keep shipping it to people until it hits No, the point is that people make mistakes people in you know the business world and so it's not obvious what the right thing to do is and You need to understand it and this ties back into what I was saying about Mises critique of the socialists Mises pointed out that he said that part of the problem here is when these guys referring to the socialist academics When they think of what it is that happens in a market and what it is that the leaders of a company do he said they're They're actually not thinking of the entrepreneur. They're thinking of the manager. They're thinking of somebody who walks in Has his daily routine already structured who knows, you know, what what are we doing today? Oh, we're making you know Drill presses or something and he goes to a factory and he's a mid-level manager and he's part of a factory that cranks out drill presses They know who their customers are and he comes in and just sits down has the figures and then just tweaks little things and oh Gee if some, you know, John didn't show up her for his shift. We give him a warning if he doesn't come again We fire him and we replace him and it's a very narrowly constructed thing We know what we're producing. We know that the factory is supposed to be there And the question is just oh if the electricity bill rises, maybe we should Change our operations a little bit and use less electricity and use more or something else Okay, but you're just making little tweaks within the parameters that are established And Misa's point is in a market economy Somebody had to make the decision that we're gonna get into the business of making drill presses Someone had to decide Investors had to be willing to give money to build the factory where it happens to be it could have been a shopping mall Right. It's not it's not set in stone It's not a knowledge that we get from nature that says there should be a drill press factory right here It could have been a parking lot. It could have been a shopping mall. It could have been Something else a hospital, right? So somebody has to make those decisions or some group of people And Misa's point was that's the important thing that profits and losses do in a capitalist Market economy is they guide people in those decisions and it's precisely that that the central planners and a socialist framework Wouldn't be able to do so. It's true Misa's pointed out that on the the eve of such a transition, right? If if there was a revolution or just a peaceful Democratic thing and we all of a sudden had a socialist group put into power They could just continue to do things the way that had been done under Capitalism and so, you know if the revolution happens on a Tuesday Wednesday They could just say to everyone just keep doing what you were doing yesterday Just go back to work wherever you were and then we'll just start tinkering with the plan But the point is over time You know the relevance of what the market had been doing on that Tuesday under capitalism and then the transition occurred That relevance would die off over time and so 20 years out in the future The socialists really would have no idea of gee What would the market economy have been doing with this in this situation and they would have to sort of from Scratch be deciding. What do we do with our resources here? What do we where do we tell these workers to go? What should they make? You know this plot of land right here Should there be a hospital or should there be a factory cranking out drill presses and again? The point is those are not merely technological questions They couldn't just ask their engineers and their chemists and their physicists Tell us everything you know and then we'll the answer will pop out because it involves Consumers valuing things and that's a that's a crucial part of the equation and that's precisely what they wouldn't have without Something analogous to what the market economy is the profit and loss system okay, let me talk a little bit about Specific example of how the government can come in and Subsidize losses and sort of chop the knee chop the market economy off of the knees in terms of the normal operation of the profit and loss Mechanism so specifically it's I want to talk about tarp The troubled asset relief program you guys you at least are you vaguely familiar with what that is or was okay? so This was back in the and I like talking about this also because this happened under The the Bush administration is when this thing went through and so what happens a sort of hazard of my occupation is if If there's a Democrat in the White House and you write stuff against the federal government You get all kinds of emails, you know saying where were you when you know George Bush was in power? And I can send them articles of me criticizing George Bush and I was right here, you know That's that's where it was and please send your contributions to the Mises Institute, but And then by the same token of course when George Bush was in power And I would write something critical of the federal government intervening in the market economy and get all these things You know what you liberal lovers don't don't realize it such and such and you know again so What happened other the Bush administration was remember there was this big Housing bubble this big boom in certain asset prices and the collapse and then a lot of financial institutions if the government and the Federal Reserve had just state stepped back and done nothing would have gone under and People were telling us. Oh, that's that would be the end of the world or at the end of the financial world We couldn't possibly contemplate that horrible outcome and so the federal government came in and Effectively nationalized a lot of these banks in a move that if some Latin American dictator had done it You know the American public would have easily been persuaded that that was fascism or socialism or something But since it was the free market bush administration, it was a necessary move According to what we were told so Whether you know a lot of people didn't like that because of the unfairness of it all Right that here we have all these millions of homeowners who are underwater people are getting foreclosed on And then a lot of the people who lost billions of dollars in terms of their bad investment decisions They get bailed out either from the federal government or the Federal Reserve sort of a backdoor channel So yeah, of course just in terms of common sense and our everyday notions of morality that that seems kind of unfair But in terms of just the operation of a market economy and just not being not making a moral judgment one way or the other Just being neutral about it that is is bad or because it cripples the ability of the economy to allocate resources effectively so you know what What is the argument in favor of unfettered Financial markets where we don't have the government coming in and regulating everybody in telling them You know, these are the capital requirements you need to if you want to do certain investments The government's going to have a list of guidelines for what's safe and what isn't is free market economists You know, we're not in favor of that. We don't want the government micro managing investment decisions We don't want the government telling firms. This is what you can do with your money and this is what you can't do But the only way that works is if when a firm screws up, they're allowed to fail All right, that that that model doesn't work if you reward profits by letting people keep a bunch of money But then if it blows up in their face, you come in and bail them out with taxpayer taxpayer money Or when the Fed does it basically with Everybody who who uses us dollars with their wealth because by printing more money it dilutes what everyone else is holding Okay, so so that's um That's the other side of that argument So it's not simply just the sort of populist anger that's justifiable about why is wall street getting bailed out when Everybody, you know, ordinary folks are getting laid off and getting foreclosed on and that's certainly a legitimate gripe But beyond that it's that it's It's difficult to Say the free market can work when they don't Uh Allow losses to do what losses are supposed to do in a market economy and it's sort of ironic because the the interventionists Who you know were for tarp They they cited the whole episode as an example of why see we can't have just unfettered markets because look what happened But the way you know that that's sort of odd because The the business people involved Many of them knew or at least strongly suspected that if things ever really did get bad The fed would come in and rescue us and so that's why they were During the heady days of the boom period like 2003 to 2006 When a lot of these firms were making a bunch of money as housing prices kept going up And the executives were all making hundreds of thousands or even millions of dollars in bonuses It was easy for them to sort of overlook the fact that well, you know, what if what if housing prices just collapsed? Wouldn't we be in trouble that maybe we want to pull back and not be so aggressive? And it was quite rational for them to think well if that were to happen You know the fed's not going to just sit back and let and let the whole financial sector go down That would be crazy and they were right in thinking that uh now Just to give a little more flavor to that let me mention I I did after that, you know after the the blow-up and everything I called some people I talked to Analysts who worked at Ratings agencies you like Moody's and Fitch and standard and poor because there was a lot going on there. So I'm certainly My point is not to say The everyone in the free market or in the market economy Just a bunch of angels fluttering around and then the government came in and screwed everything up And that's why we had the housing boom and bust. That's not what I'm saying There certainly were greedy people who were myopic and made what in retrospect were awful decisions but again the point is The market economy doesn't require having flawless individuals to work What what you need though is accountability where yeah, if people make the right call then they Earn profits and get to keep it whereas if they make a horrible decision and they aren't suffer losses Well, you have to let that result stand as well if you Sort of nullify that result. Well, then that's excuse things and leads to situations like we saw So there were firms Financial institutions that were less aggressive during the housing bubble where their internal analysts or just their CEO or whoever Said, you know, these these home prices are ridiculous. This this can't last We're not going to get into this as heavily as some of our competitors And in a market economy, what would have happened is they would have ultimately been justified So yes, their returns that they reported to their shareholders During those housing boom years Would have been less impressive than their competitors But they could have, you know told their investors and their other clients Just stick with us. We think that this is a mirage and trust us, you know, you'll be glad when the when the Roof caves in on these other guys. You'll be glad you stuck with us Whereas now they they can't say that as much because the other people, uh, you know, we're partially rescued So what happened just to fill you in a little bit on the details of that is there was Partly an intellectual mistake Like I said, I've talked to some of these guys and they said partly the problem was These these things that were called derivatives Um, they were based on it was basically you take a little bit of thousands of different mortgages from around the country and put them in this one thing And so then all the the homeowners would make their mortgage payments every month They would all flow into this thing and then you'd sell off pieces of this To various investors and so depending on the rules of who gets to dip into that pool of money first Those things appear to be very safe. Like if you were drawn from the very bottom You know, if you were an investor who bought a slice of this pool that was getting funneled by thousands of mortgages from around the country The idea was in order for me to not to miss out on my payments And that's what i'm paying for right now is the right to earn this flow of payments It would take, you know Homeowners from across the country would have to start defaulting and so the bottom of that thing was very safe Whereas the top piece of that pool was very risky and that's how they were priced accordingly. So that was That was what happened. That was part of the intellectual Um mistake that these guys at these rating agencies, you know, they had fancy computer models And the one guy was telling me on the phone This was this would be like in 2000 middle of 2009. I was talking to him asking them You know, what happened like did did you guys know there was going to be a blow up? I thought you'd get bailed out because that seems kind of implausible and he said no, it wasn't so much that but it was more That these things were so complicated barely anybody understood them You know, we had a bunch of physicists down the hall and they built the computer models And they knew how the things worked and the rest of us didn't really even know how they worked And so that was a problem And specifically the computer models assumed That all real estate was local So they so yes the computers knew Home prices in tallahassee florida could go down 10 percent in a year. They knew that was possible And they had you know, they looked historically Movements and prices to figure out what's the chance of that happening and they knew the same thing could happen in vegas And the same thing could happen in sacramento But they thought those would all be independent events Statistically so they thought if we're building this derivative product from mortgages all over the country and put them in this one pool The chance of them all dropping all those real estate markets going down 10 percent one year is infinitesimal That's like an event that'll happen once every million years So that was the intellectual mistake So the point is you know, is that good or in retrospect we can say those idiots But at the time, you know, they thought this is inconceivable that the home prices across the country would all drop simultaneously And so there's no, you know beforehand, you wouldn't know what's right or wrong But the point is in retrospect, well, they were clearly wrong And so in a market economy with genuine profit and loss where the government and fed don't bail people out Those people would have all gone out of business where they would have suffered greatly And those ratings agencies would have taken a huge hit in their credibility And we would now probably be, you know, turning to other ratings agencies But we can't because those are ones are locked in Based on government regulations that say if you're a financial institution You need your bonds to be rated AAA by So-and-so ratings agencies and that those big ones are listed, right? You can't get your Your brother-in-law to say yep, your bonds are AAA by me. Go ahead that that doesn't count Right, so I'm just saying a lot of these things that people these need your reaction You guys Peter Klein and Murphy you guys are nuts. Look what the market did for us Well, look at all the host of government regulations that cripple and neuter the sorts of mechanisms we're talking about so again You got to have a balanced approach We're not saying somebody who earns profits per se is necessarily a good guy Because there's all sorts of interventions, but it's important To realize the function of profits and losses in a genuine market economy Okay, so now we'll open up to the general q&a. Thanks