 This is Jeff Deist and you're listening to the Human Action podcast Ladies and gentlemen, welcome back once again to the Human Action podcast One of the few if not the only podcast where you can actually learn substantive economics just by listening And as you may know, we have been working our way through slowly Murray Rothbard's Magnum Opus Man economy in state and that's primarily what this podcast is all about the great books Particularly those in the Austrian tradition and over the past few weeks. We've gone through chapters one through five and most recently We've gotten into this large section of the book About production the structure of how we get goods and services into the economy and so Rothbard Spent a lot of chapter five going to the sort of the vertical structure of production. You and I see Consumer level goods and services, but we don't see all the various stages of Capital investment along the way in the form of higher order goods unless we happen to be involved in a particular industry So chapter five was really all about the temporal nature of production and higher and lower order goods But as we move into chapter six It is all about interest rates As part of the the structure of production because people oftentimes need to borrow capital They need to borrow money to make this happen. Now if you've been listening along throughout the show a Long time ago probably more than a year or so ago We worked our way through Bombay everk's second volume of his three volume treatise and we got really an understanding of interest rates that we had not received from necessarily from Carl Manger and as we went through human action Mises is great book. We of course again worked our way through interest rates, but this time we are doing it in the From Rothbard's perspective I'm very pleased to have with us this week in studio to help me do this our great friend Christopher Hansen Who is at the University of Angers in France with Dr. Guido Halsman, but it's also one of our summer fellows and originally from Shakespeare's Denmark So welcome Christopher. It's great to be here. Thank you Now that doesn't mean I think Shakespeare was from Denmark See like to talk about princes and kings and that sort of thing So great to have you in studio just finished a wonderful week of Mises you Going through man economy and state and you know, you and I had spoken offline earlier about the the way the books organized and laid out and it struck me that most Economics treatises would have a section on interest rates in the in the money and banking section Whereas Mises puts it in in the part of the book that is about Production of goods and services. So you you had some thoughts on that Yeah, it's very interesting when we just look at the layout of man economy and state That in a sense, we cannot come to the question of interest rates earlier than this and we are already on page 360 or something But it's also we cannot come to it later because Rothbard sets out in the beginning chapter one is just Man acting in isolation So we get the basic concepts of means and ends time preference and so on chapter two we introduce a society prices chapter three a Really good discussion discussion of price formation in a chapter three and chapter four and we the introduction of money and all these elements and then chapter five with this With the structure of production and all these elements unnecessary in order for us to be able to even Speak about the rate of interest and I had a brief look through the index and through the first chapters and he doesn't mention interest rates at all until Section seven in chapter five when he gives us the first little teaser of interest rates And I think it was the reason that he does this in this way is that we need The basic determinant of interest rates of the rate of interest is time preference the universal fact that we all prefer Satisfaction of our of our needs sooner rather than later, but this alone Is not enough to explain to to give us the interest rate in isolation from other Economic factors that is I mean the rate of interest is not a price for waiting or price for time in some sense We need both. We need prices. We need a good understanding of what a price is because in Rothbard's understanding and in Mises's we Interest rate is not a price in itself, but a ratio between prices and we need money introduced Because we can only understand the rate of interest in money terms. There is no such thing as an own rate of interest of Potatoes or apples or cars or whatever. So that's why only now after waiting through 360 pages can we come to this key ingredient in understanding the structure of production So Rothbard's writing this in the 1950s if we go back to then you know this this chapter and The Rock you know Rothbard's economics in general are generally thought to express a pure time preference theory of interest now How radical of an idea is that the 1950s as opposed to the prevailing orthodoxy at the time? I mean there's it's still highly highly debated today If we look at just at the footnotes in this chapter, we see that Rothbard draws a lot on first of all on Mises, but also on Böhm-Bawerk and Hayek and Federer So the pure time preference theory was I mean it was sort of well known and well established But it was was by no means the dominant position You could still find Marxists around much more than today who would despite the demolition job that Böhm-Bawerk already had done on Karl Marx and on all exploitation theories of interest back in the 18 1890s They'd still insist that any interest payment at all was just a deduction from the just wages of of labor So that's kind of the It's by no means the dominant interest theory in the 50s or since for that matter But it's kind of out there when Rothbard is writing another approach that he doesn't really tackle in this part of the book is Keynesian liquidity preference theory, but it basically explains interest rates as as an outcome of liquidity preference And while I think that we can make good use of a well not necessarily of a concept of liquidity preference But of a concept concept similar to it. It has nothing at all to do with the rate of interest So one thing I got out of this chapter Which I think we forget about sometimes is that we tend to think of interest rates as being charged to Borrowers by capitalists and then they go out and produce things with them and hopefully make a profit and they pay repay the Interest and then they're happy But what what Rothbard takes pains to point out is that there's even though there's value added at each stage of production Between consumption and production there can be multiple stages multiple levels on that vertical ladder that we've been discussing and That somebody needs to be paid interest at each stage along the way That in other words these tend to be different firms involved all the way along and so the whole thing is more complex maybe than we imagine Yeah, rough but it's a pains to make clear that the producer's loan market is really almost irrelevant to an understanding What the rate of interest is? To Rothbard the rate of interest is the price differential between the prices that the capitalist pays for his inputs and The prices that he in turn get in return for the output for the final output. Okay of his Product and there has been some debate among Austrians that it is problematic to talk about Exchanging present goods versus future goods because you can never know that it'll be the same good in the future But Rothbard although there's a little ambiguity in the way Rothbard phrases it at times Rothbard is is a pains to make clear that what we are exchanging in a time transaction There's always present money against future money in some a set that is against the present expectation of acquiring money in the future and This is the reason Why there must be a positive rate of interest that is that the present money must be valued higher Than just the present expectation of future money simply because that a present good is always due to the law of Time preferences always valued more more highly than the same future good now Rothbard says that we can conceive of this time exchange in two ways the first one and the one that I think it's People mostly think about when we talk about interest rate is that you exchange present money for a claim on future money So basically loan transaction This is so you get a house today and and as a result the mortgage company has a claim against your future Payments. Yeah, exactly exactly. I mean it's it's probably the way that most of us encounter the phenomenon of interest rates is that we pay our mortgage we pay car loans Consumer loans etc. But the fundamental or rather the primary time transaction There's not this loan transaction. It is rather when the capitalists at the outset of production hire the services of original factors laborers and landowners and Buy other inputs that they need for their production process now These capitalists pay present money to the factor owners and in return. They get the factor services of laborer land and so on which will eventually mature into Whatever product they are interested in and this final product can then again be sold either to the consumers if it's a consumer good or to Capitalists in the next lower stage of production and it is this spread This between the output price and input prices that is the interest rate There's again a little ambiguity here because what the landowners and laborers give to the Capitalist is not future money as it would be in a loan contract But the future good which can then in turn be sold for money Now since we are talking about the pure rate of interest as it would be in the evenly rotating economy There can never be any doubt to the capitalists that the appraised value of the final good That is his expectation of what he can sell it for will also be the actual Sales price when he arrives at the end of the production process But in the real world, of course, this is very uncertain so we can already here see that the as rough but will elaborate later on in When he deals with change in entrepreneurship in chapter 8 That the capitalists is always in reality is always an entrepreneur and to a much greater extent Than the other functional categories So if we're thinking about interest rates in terms of time preference ideally between savers and borrowers Everyone's time preference is subjective Everyone's is different But yet a rate of interest manages to arise on the market at least when that market is left relatively unhampered but Rothbard takes pains a couple points in this chapter to sort of go after this mainstream idea Well, there's got to be some sort of objective rate of return in other words He doesn't specifically spend a lot of time going after neoclassicals or Marxist or Keynesians in terms of their faulty Conception of what interest rates really are and how they arise But he does give this sort of general criticism that there's no such thing as an objective rate of return And so help us understand that now forget the page number, but he does have a critique of the idea that Of the neoclassical idea that okay We have the supply of savings That is determined by the time preferences of of the savers But the demand for savings cannot be determined by this factor It is rather determined, but the marginal efficiency of capital that is the value productivity Of all the investments and Rothbard says well, if you look at the economy from just from the point of view of the individual businessman this Kind of makes sense because the individual businessman is confronted with on the one hand The possibility of borrowing money at a certain rate of interest and on the other hand various investment projects That he expects will yield various returns will have various degrees of value productivity so to speak So he will obviously confronted with these facts. He will borrow Money at interest rate x assuming that he can make a return at interest rate with a rate of return of y y being larger than x But the problem here is that this this way of phrasing assumes What is to be proven namely that the investment projects will Will yield a more valuable Product and that there will be this spread between input prices and output prices So we never really get to the final explanation of interest rates in this way of looking at it Well, so you you know, you mentioned marks earlier and the the Marxist conception that interest is almost per se exploitative I thought one of the most interesting Parts of this entire chapter is that actually it pays 373 374 where me we're Rothbard's talking about capitalist advance Uh, basically goods present goods for future goods and in a sense Employees exchange future goods for present goods. So I I thought that in just a couple of pages in a sense Rothbard gives us a mini course of where he demolishes the entire concept Of marks of capitalism being exploitative. No, no, no, you you are getting something Of value today something certain something in hand Whereas the capitalist who is advancing funds is getting something uncertain in the future There's a a element of time in there. There's an element of uncertainty. There's an element of risk of loss And so workers are getting paid today now. So I thought that that was just as an aside A demolition of Marxism in two neat pages. Oh, oh, oh, yeah, I mean definitely. Um, that basically goes that Birnbavak's final refutation of Marx that we Think it's the final chapter of Carl Marx and the close of his system Where Birnbavak says that okay the laborers insist on being paid The full value of their labor And let us just assume that there are no other factors for production. So it's just labor But in a sense, there's nothing stopping them from being paid the full value of their labor They just have to be willing to wait until the final product is produced So what when they say this This Marxian slogan all they have to do is wait and if they're not willing to wait if they Time preferences are so high that they'd rather prefer the money The discounted value now rather than the full value later When there's no exploitation in the capitalists providing them with this Well in a part because this has such a textbook feel and because Rothbard is writing in somewhat of a dry technical fashion here. You don't always get the sense of How damning What he's saying really is In other words, he brings up the old neoclassical trinity of land labor capital and says well, that's that's pretty much bunk There's actually capital is actually much more heterogeneous than stated and it in profit for the capitalist doesn't come from land or capital equipment It comes because we prefer present goods over future goods and the capitalist is taking a risk So as you're reading this sort of dry description of all this you might be missing That he's actually laying waste to entire schools of thought along the way Yeah, well at some points robert sets out to consciously refute opposing doctrines But most of the time he's just concerned with elaborating correct theory integrating the contributions of mesas bem barwerk hayek and so on But that in itself obviously provides the best refutation possible because Once you have a correct theory then all the false theories kind of fall by the wayside but In the case of marks, I think that's a good example because I don't think he ever really mentions marks at all in in this book But when we're thinking about workers, there's always this labor versus management thing Which is so tedious and so played and especially in the information age All of this has become far more murky than it was Let's say even 150 years ago when there was sort of a factory owner and a factory worker and one person was doing Real physical labor and the other person was sort of doing blue collar Excuse me white collar work in accounting or something like that And of course all that is is blurred today But I just want to stress here that rothbart is making the point that in a sense The the laborer owns his or her labor and is exchanging that For a present good a paycheck And the product of their labor is going to be a future good with some level of uncertainty later Enjoyed by the capitalist who's either selling it as an intermediate or as a final good So the the worker has some say in his life The worker is engaging in a an entrepreneurial activity of his or her own and making a choice Yeah, definitely. This is perhaps jumping a bit ahead to the next chapter But rothbart is at pains to stress that labor in general is the most non-specific factor of production So the laborers are free again in general that will obviously be specific highly trained workers who are very specific To one particular line of production But labor in general will be free to move to where they can get the highest Return on their labor. This doesn't mean that I don't know unskilled workers in texas Will move to vermont as soon as they're here. They can get one dollar more per hour But it does mean that maybe unskilled workers in new york will move to vermont And unskilled laborers in pennsylvania will move to new york and so on And it also means that as soon as say There are higher wages to be made say in engineering Some people who had considered training to become a doctor will shift to engineering And in this way again, there's a general Connectivity of all labor markets as well as a general connectivity of all prices in the market economy Now I will say this In defense of the workers here Rothbart's talking about understanding interest Is something that's expressed in the pure rate of interest expressed via time preference now When we talk about present goods and future goods really rich people Have lots of present goods In other words, they have lots of money. They have a good house cars food all that sort of stuff So in a sense is easier for them to have low time preference because their their present goods are satisfied And so they can sort of think more long term put money away for their kids Invest in some sort of long-term investment, whether that's a factor or something else So it's a little easier for them to have low time preference to be fair than it is for someone Who's living very close to the bone very very paycheck to paycheck very hand to mouth So in that we you and I and I think our listeners understand that in a sense Low time preference is actually a process of civilization. We want that structure of production Vertically to be extended. We want lots of lots of higher order goods. That's what makes a society wealthy greater productivity But when when you get to to poor countries A lot more people almost have to have high time preference because they just have to survive Yeah, I mean it's uh Again, if we go back to the basics time preference means that you prefer Present satisfaction of your needs to future satisfaction Now, obviously if you are very poor either because you live in a poor country or because you just haven't Inherited or accumulated any wealth of your own You won't be in the same position to save and invest As you would be if you lived in another country in a richer country or Had a higher income or just had a higher inherited as some of cash Now this doesn't mean that we or poor people should Look down on on rich people for saving and investing. I'm thinking that this is just the privilege of the wealthy Or like the frivolities of playboys and stuff like that The benefits that wealthy people get from saving and investing The only yield you can really expect is the going rate of interest more or less The market rate of interest that is it'll come down to the Pure rate determined by time preference Most of the benefits from investing capital accumulation and so on will return to the workers Because investment and capital accumulation the invention of new production processes and so on Will all serve to Greatly increase the productivity of labor again because labor is the most non specific factor of production So the laborers can always move to where their employment is most highly valued This by the way is why Mises again and again would stress that There's really only one thing That poor countries are lacking in order to become wealthy countries and that is capital accumulation So that is the only way for them to Raise their standard of living So alluding again to a conversation we had offline We were talking about how in sort of the conceptual Nature of interest rates, there are there are people who want to save money Who want to consume less than they produce and then there's people who want to borrow money Who want to consume more than they produce now and and pay interest down the road as a result And so there ought to be a meeting between lenders and borrowers that where they kind of get together and based on their particular time preferences on either end Come together and agree on an interest rate or a price a ratio but A lot of austrian critics today and there are many Say no, no, no, this is not how the real world works anymore, jeff And you know, we can just use modern monetary theory to produce money at the treasury level And we can use tax policy to constrict it and pull some out when we need to if inflation overheats and that Interest rates are in effect a policy tool And they can be commanded by fiat rather either by a central bank, which is targeting through its Purchases and that sort of thing its rate setting function or it can literally be commanded by a legislature by a treasury in a country so Talk about this tension. They're they're an awful lot of Economists today who think that what the fed does is just And something that we all have to accept. It's sort of like the weather. Of course, there are central banks Of course, they have an interest rate targeting function And that you austrians are crazy to think that that all this can be done sort of naturally Yeah, I mean, yeah, I mean it's worth pointing out that all rough by this really talking about here in this chapter Is the natural rate of interest the price spread between input prices and output prices Now as I mentioned earlier interest is always expressed in terms of money Either because it's a money loan or because you appraise both input and output in money terms Now it must be stressed that there's nothing How should I put this the interest rate is purely natural integrated in the economic system So it doesn't depend on any kind of rate of inflation any kind of money production at all So long as we can just express it in money terms, that's all we need But obviously it is possible for Central banks and legislatures To have a lot of effect. Let's just call it that on how market interest rates are formed Precisely because you can pour in a lot of money into the financial system And thereby affect the contract rate of interest which will again Have effects on the real structure of production Now this doesn't mean that central banks or governments can just have whatever rate of interest they please Right because they they still have to work through the institutions of the market economy At the end of the day the federal reserve can only set a specific interest target And have the rest of the economy adhere to it if they are willing to To do whatever it takes as Mario Draghi said a few years ago And do whatever it takes at the end of the day basically means pumping in money Being willing to buy to buy up financial contracts and and stuff like that Right so the interest rate will tend to rise if if they if they're not suppressing it certainly in the environment the last 10 years Yeah, yeah, and the the final outcome of any kind of inflation And by inflation we of course means increases in the money supply Will always be a tendency for prices to increase to a higher level than they had before And this will also Have an effect on the rate of interest But only during the inflationary episode Just an easy Exposition of how this will take place is if Let's say businessmen expect that in the future Prices will increase they'll be willing to borrow money now in order to make their purchases now at the lower prices But since they then have an increased demand for loans, this will push the interest rate on loan contracts up And we will thus see the emergence of an inflation premium in the loan rate of interest But this will obviously only endure for as long as inflation takes place If money production ceases and once all the effects on prices have taken place Then we'll go back down to the natural natural rate of interest But this new natural rate of interest is not necessarily the same as the old one Not only because people in the interim may have changed their minds they have may have changed their value scales but also because the inflationary episode is Redistributes wealth often. I mean the larger the inflation the more extreme the redistribution And there's no reason to think that the new wealthy people will have the same time preference rates As the people who were wealthy before So let's think about this in terms of so-called negative interest rates now even in the united states Adjusted for inflation. We arguably have negative interest rates now But we don't have nominally negative interest rates like we do With european sovereign debt and also with a lot of european corporate debt Mises goes out of his way to say that Originary interest will always be positive and can never be negative rothvard doesn't stress that as much but clearly What we think of as a pure Rate of interest based on time preference by definition is positive. So what what are negative interest rates and how did they come about? Again, it's we shouldn't be fooled by what people call Various phenomena in the market So the market rate of interest On some government bonds have turned negative. Yes, but that doesn't mean that the rate of interest As we understand that the pure rate of interest is negative precisely because it can only be positive So the real question we have to ask ourselves is why are some financial institutions willing to buy and own Government bonds that not only doesn't yield anything But they actually have to pay a percentage each year just to hold it And for the most part that this is institutional investors very few individuals do this. Yeah Yeah, I I don't think many individuals would be willing to make that trade But I mean there are a few Reasons we can suggest why institutions would be willing to do this The first one is that even though the yield the nominal yield on the bond is negative As you said yesterday The value of the bond might go up in the future So they might just speculate on reselling it down the road and in that way they'll have a positive yield Right. So that's a capital gain potentially a separate from the interest question. Yeah But still in our terms they hold the bond in the present because they expect to be able to resell it in the future So it is explained by our theory by time preference by time preference. Yeah A second possibility is that there are very stringent capital requirements on banks and financial institutions and so on So they are basically if they want to operate they are forced to hold a certain part of their assets in in government bonds again or various other kinds of high quality Or what are deemed high quality assets, I should say And in this sense, I think we should just say that well when the negative yield is just a tax They have to pay it in order to be able to operate A third possibility is that these Government bonds are all deemed to be Very high quality AAA rated and they are therefore usable as collateral in In further financial operations and in repo contracts and so on And can in this way form the basis of what we are not the basis But rather an an important part of what we Usually term the shadow banking system So based on this good collateral in quotation marks banks can leverage up and extend loans And in this way because these loans will then have a positive interest rate in this way they can make money So there's an appendix at the end of this chapter appendix 10 about schumpeter And it talks about the even in Even in an evenly rotating economy the construct which we talked about earlier in the book where Technology and markets and and supply and demand Are fixed and knowable That even in in this case The austrian conception of pure time theory would posit a positive rate of interest whereas schumpeter argued That the net that interest rates would tend towards zero. So what's the why is appendix 10 in here? What's what's rothbard Teaching us about schumpeter's error in his view Yeah, rothbard had a couple of engagement with Let's call it schumpeterian economics throughout his career. He has this Short appendix and later on he wrote a critique of schumpeter called breaking out of a valresian box But what he's saying is that again that schumpeter is not although he was an austrian economist In that he was from austria. He wasn't really an austrian school economist Uh and schumpeter is an austrian austrian. Yeah, that really austrian exactly And schumpeter is operating in in the framework where time preference is optional It's not a fundamental category as we perceive it and since therefore Time preference, I should say has no relation to the formation and maintenance of capital of the structure of production Minute just falls away by the wayside and and therefore schumpeter comes to the conclusion that we don't really need interest rates Or we will not have interest rates rather in equilibrium. It is uh talking of schumpeter it is uh interesting to note that schumpeter has a theory of economic cycles that we need not go into the details here, but about how Entrepreneurs make new innovations new inventions that upset the valresian general equilibrium So we have I have creative destruction. We have the emergence of interest rates of rates of profit Until the economy until all the innovations have been Adapted into the system and we settled down into a new equilibrium now the interesting point to note is that there is That schumpeter's theory of of business cycles is not really an entrepreneurial theory Because there is a sort of shadow partner in schumpeter system And that is the banker who is willing to extend new credits uncovered credits to the Entrepreneurs and who are willing to finance this again out of any Not out of any previous saving but just out of extending credit so it's it's a point that a professor hülsmann has has made in some of his lectures and it's That there is always a monetary aspect to these business cycles theory and it's a point that mesis also made at some at many points in his own writings that Nobody has ever really refuted the monetary theory of the business cycle because they all at some point either explicitly or tacitly introduce credit expansion in their own theories Well, ladies and gentlemen, if you read chapter 6 of man economy in state And in the second scholars edition, this is pages 367 to 451 You're going to know everything you need to know about interest rates and so much of what Christopher Hanson and I have been talking about today relates to time I mean so much goes back to the temporal nature of economics And so oftentimes what you're taught in so-called mainstream economics time is not a factor And that's why henry has its famous dictum You have to look at the effect of an economic policy not only on every one not just a particular group But over the long term and I think if you read rothbard if you read mesis If you follow the austrian school you will come to understand that interest rates Just like other currencies just like other commodities just like wages just like prices Just like economic activity in general do not need to be engineered. They don't need to be commanded We don't need a central bank to create interest rates for us We don't even need fdic insurance. So there's all kinds of things that the market can do With without these guiding hands, and that's really what the overriding lesson I think you can take away from this chapter now I've mentioned a couple different times that this book is available for free at mesis.org Just type in man economy and state and you're going to pull up a very beautiful searchable html File format that you can read this book and you know crystal clear as an e-pub Or on your kindle or whatever kind of device We also have a beautiful hardcover available from the mesis Institute bookstore which with the code hapod takes five dollars off I believe it's only 20 dollars and we have a Paperback which you can slip in your backpack which comes down to only 10 dollars with the code hapod So this is one of those four or five. I think seminal books In the austrian literature that you're going to want to own in physical form And we're going to be back next week as we continue going through this whole concept of production and how How goods and services come to the economy rothbard gives it several hundred pages And we are going to get into the role of the entrepreneur and all the various factors But this week we had to take a little bit of diversion and just talk about interest rates because as christopher hanson points out This is the stage in the book where we need interest rates to explain Subsequent development. So this book is laid out in a sense chronologically. I don't know if that's the word But certainly in a way where each chapter builds upon the last and so we you know, we're setting the stage for All kinds of interesting things to come especially power and market at the end Where rothbard takes on the the central idea that we need a state to among other things run our economy So all that said christopher hanson. I want to thank you for your time today and ladies and gentlemen I hope you have a great weekend The human action podcast is available on itunes soundcloud stitcher spotify google play and on mises.org Subscribe to get new episodes every week and find more content like this on mises.org