 Talk is the great crash of 2008 causes and consequences. I Fear that it will very soon be called The great crash of 2009. Maybe when I crash on this podium I'm a little bit exhausted by our Wonderful evening yesterday where which was then extended throughout the night and this morning our good friend Joseph back I took me out for tennis And then I realized now I realize I'm no longer 22 or 30. I'm not even 32 anymore So I'm having a hard time Standing here, but the voice is still working In any way, so we I have a I have a relatively easy subject talking about the financial crisis to this distinguished group of Austro-libertarians is like carrying owls to Athens. Okay, so it's it's a home game. I Gave similar talks to other audiences that were not as well-informed as you are which allows me to step over some parts of the argument rather quickly and So I've some some experience with the reaction to this one of the Aspects of the present crisis that started in July 2007 and still extends to the present day one one thing that intrigued me was It's it starts already, right? was between that the the Austrian Interpretation is a well-received can be communicated to a lot of audience even in France as which is the country which I am presently living and teaching and if you know something of about France as Far as economics is concerned France is distinguished by the fact that it's the only country in which the economists are to the left of the general population Okay, or the other way of another way of saying this would be where economists know less about economics than the average Frenchman so Let me first give a Brief definition of a crisis a crisis is a situation in which many Investment arrows become apparent at the same time So when when I fall of this podium, that's not a crisis it shows that I've done something wrong because I can no longer stand on my feet But which which is an individual error if an individual company goes bankrupt. That's not a crisis either It's an individual investment error and this happens of course all the time We constantly have what you said Schumpeter once called process of creative destruction the market economy renews its itself my Knowledge of biology is rather limited which I have to admit. It's a professor deus back But even one thing that I remember was that within the human body also cells are constantly renewing themselves So part of the cells are dying other cells are being created in the economy. It's a little bit the same thing So this process is not done to mount your crisis a crisis is in a situation in which we have particularly high number of Bad investment decisions that become apparent by the bankruptcy of the firms So the question then is what explains the crisis what is the is there a common cause? Is this just a poor pure coincidence could be a pure coincidence from a logical point of view but of course that we Interested in finding a common cause and Austrian economics and Austrian business cycle theory in particular Gives us such an explanation of a common cause of all these failures so what I will do now in my talk is First talk about the causes of the the present crisis And I'll explain to you that we can distinguish Two main aspects or two main causal chains One runs through the fragility the general fragility of financial markets and the other one runs through a malinvestment And both causes of an ultimate cause which is the same namely the presence of our current monetary system which is based on paper money or fiat money and central banking and Then in the second part of my talk I'll come to talk about the consequences of the present crisis and here I will limit myself to discussing the political reaction that has taken place so far and then Also address some Light on the horizon some libertarian inroads that have been taking place In in the context of the crisis So what are the causes again? We can distinguish two main chains on the one end We have the fragility of the financial markets and then we have malinvestment The fragility of the fun of the financial markets has been known for a long time So it's not something that became apparent only in July of 2007 when the crisis broke out on the subprime market And this fragility has two symptoms one is extremely low cash balances At financial market participants And the other is extremely low equity ratios So if you're extremely low cash balance Then of course you run into trouble whenever you need to make a current payment or an unexpected payment And you don't have enough money in your In your balance and on your bank account or in your pocket So banks do have extremely low cash balances investment firms same thing always tell my students if you ever Complete failure in your studies You won't get your degree and you have to become a robber or something else At least you're strong or something you can handle a gun you will become a robber. Don't try to rob banks, right? There's no money in the banks. Don't go to go to the banks go to the next grocery shop or some other place with There's still some well bank notes and so on so banks don't hold much much cash Which makes them vulnerable to? liquidity crisis and this Fragility or vulnerability of any individual bank then tends to spill over to other banks if one bank has liquidity problem it Will then I try to absorb liquidity from other market participants thereby reducing The money supply available elsewhere creating liquidity problems for other market participants And so on so there can be a chain reaction or snowball effect same thing for The low equity ratios as soon as one market participant goes bankrupt The the value of the debts of these firms will will fall so for example if you have given a credit to General Motors here you have bought as some of my relatives have done General Motors bonds And General Motors goes bankrupt. Well, then the bonds will fall in value because bankruptcy means that General Motors is unable even by selling all of its assets its assets the entire other the plans and The products the stocks that they have accumulated and so on if they sell everything they will not be able to pay back the entire debt Now so if this happens, then some other market participant Whose assets are the liabilities of General Motors? So you have an investment firm for example who has given a credit to General Motors about the General Motors bonds Will now have a reduction of its asset size so the assets have a lower value And therefore this firm in turn will not be able to pay back all its debts even if it liquidated if it sold on the market Whatever asset it has on its balance sheet. So there's again a snowball effect coming from this fact and this is Exactly the snowball effect is exactly what we observed in the months after July of 2007 and we had a crisis that broke out on Rather narrow set the segment of the the market in the so-called a subprime market and from there on it spilled over to the rest of the market and it spilled over very quickly and with dramatic Dimensions because of the general fragility of financial markets. So do you give you give you an idea? We have several entrepreneurs here and a typical Firm that is not operating on the financial market would hold equity ratio Anywhere in between 30 and a hundred percent Okay, which means that out of all the money that the firm has invested 30 to a hundred percent is financed by The money belonging to to the entrepreneur and only the rest Comes out of debt on the financial markets a typical German firm Deutsche Bank converts bank Operates with an equity ratio of 2% Okay, and in the US it's similar There's been much talk in the media about hedge funds and so on is it's true that hedge funds Also operate with very low equity ratios But it's less dramatic in the in the case of hedge funds for reasons that I explain can I explain? I can explain to you if you if you bring up the question later on and As a consequence there there was no problem on the hedge fund market But we did have big problems with banks in Germany and in the US in particular And of course cash balances are extremely low is less than 1% of the balance sheet is held in form of cash So we have great fragility here and there's a loan I mean even if we didn't bring in Austrian business cycle theory would explain all essential facts about Some of the main facts at least of the of the present crisis and the question then is why Do we have these symptoms why do we have such fragility precisely on the financial markets Why don't we find it in the shoe industry? Why don't we find it in the hotel industry? Why don't we find it in the lamp production or whatever or microphone production? Why is it on financial markets? So here we have then have a couple of non-Austrian typically wrong explanations and we have the Austrian explanation Typical wrong explanation that we have been offered in the media for the past 18 months was greed. Okay, this is the five letter explanation greed and Sometimes one could get the impression that just uttering these five letters was seemed to be sufficient as an explanation why Banks and other investment firms were brought to such excesses why they reduce their equity ratio why they reduce their Their cash balances and indeed so from a technical point of view It is some sort of an explanation right because the the reason why we hold equity and the reason why we do hold Cash balances is to protect us against the risks of business We hold cash balances to protect us against unforeseen payments that we need to make and We hold equity to protect us against fluctuations in the demand for our product of macroeconomic fluctuations that Affect the value of our assets the values of our products and so on Let's say you have invested you have a battle sheet of a hundred Million euros, which means that you expect that you could sell all your assets your planned and your machines vehicles and so on for a hundred million euros in a reasonable period of time and now There is a fluctuation in the demand for your product, which means that you have to Downgrade the monetary value of Your machines and so on and you have to cut cut from let's say a hundred million to 80 million if you only have 10 million of equity on your balance sheet that is if you have financed these hundred million out of 90 million debt and 10 million equity and then you have to reduce your balance sheet by 20 so from 100 to 80 you are bankrupt Okay, because the value of all your assets is only 80 million and the value of all your debts is 90 Okay, so even by selling everything you you could not stay in business So that's the reason why we hold equity we hold equity in order protect us against unforeseen fluctuations In the demand for our product and therefore in particular unforeseen macroeconomic fluctuations that determine the overall price level and therefore the overall aggregate value of assets so if We therefore neglect to hold sufficient equity if we neglect to hold sufficient cash balances In some sense, it's true. It's it's a sign of greed Okay, because reducing our equity of course we can increase the return on our own money We can the increase the return on equity Let's say we might make for this balance sheet that I just mentioned that we make 10 million profit Okay, so we have 10 million for a hundred million of capital invested 10% return on investment Now that's not the the figure that an entrepreneur is mainly interested in the our main interest goes to see what's the return on equity What's the? Return on our own money If we it say finance a hundred percent of this investment of our own money. We have 10 percent return If we finance only 10 million out of These hundred million out of our own money, then of course we would have a hundred percent return Okay, so there is a monetary incentive to reduce equity as far as possible There is also monetary incentive to reduce the cash balances as far as possible because cash balances are not Do not earn any money, right? So we rather than keeping the money in our Bank account we can spend it and buy an asset that earns us a return so we can increase our earnings So it's true then just greed as a is an explanation, right? Certainly, we've been greedy if we reduce our equity will use our equity Our cash balances in order to increase the return on investments or greed is an explanation But it is a very superficial explanation It is superficial because it doesn't we still haven't explained why this greed comes to be concentrated in particular on the financial markets Why aren't you producers greedy? Why don't you produce us produce? With 2% equity ratio. Why don't land producers have 2% equity ratio? Why do we find this only on the financial markets? Yeah, then of course we get various pseudo psychological explanations According to some economists and this species is very widespread in France The financial markets people who are having to deal with money. They are particularly prone to be greedy And so if you do produce nice things such as glasses and And watches and water cans and so on you're a nice guy and you're just producing whatever is natural As an Aristotelian philosophy, but as soon as you touch money You turn into the vampire So you forget everything else But but there still would not be a sufficient explanation because there is some other element here too Then because this is a risky strategy right is of course we can increase our monetary earnings But there are also greater risks. So on top of this we need to postulate that suicidal tendencies Are particularly widespread on the financial markets. So you see I mean we were drawn into all kinds of Psychological or pseudo psychological explanations or hypotheses rather because there is no Thorough psychological comparative psychological study of Financial market participants as compared to other industries. It's maybe some people Research will come up with this but so far. It's just a hypothesis. It's not a not an explanation One of the more sophisticated wrong explanations stresses asymmetric information between Market into intermediaries and the customers. I saw the ultimate question then is why do the customers? Why do private capitalists who? Have money on hand with who have savings. Why do they invest on the financial markets? Why do they buy stocks of companies with very low equity ratios? Why do they hand their money over to investment firms that pursues that risky investment strategies and Here the explanation that they we often find Economic literature stresses that the customers are relatively less informed about the risks of the products as Compared to the financial intermediaries, right? So we have the vampires that really guys and son Who do all these nasty things in order to pop up the their return on on investment and the customers are the poor sheep not just have a few billion dollars spare and Put this on the market that they don't really know what's going on and They're so their ignorance is being exploited by the financial market professionals Now it to some extent this explanation is true, of course because we do have asymmetric information Certainly as in all fields the professionals are better informed or tend to be better informed then the lay people then the final customers But this we have of course also in other industries, right few of us understand The precise operation of our computer still we use computers few of us can repair their own cars Or even understand how a car works precisely and still we buy cars. We sell cars. We're not being ripped off So why should this be fundamentally different on the financial markets? the Austrian explanation solves these logical problems and stresses the impact of monetary policy and Of the monetary system more generally speaking, so we have a monetary system based on fiat money Which is that is the money that is being imposed on the economy Which profits from monopoly which profits from legal tender laws and The whole point of having a fiat money is of course to facilitate Public finance It's easier for the government to get additional credits if You can produce as much money as you want and hand it out in the form of credit to the government That's the historical reason why we have created the system Other explanation are other rationals have been created a little bit later And we need monetary policy for the macroeconomic management of the economy We need monetary policy to promote Employment and therefore economic growth and so on but these were rationals that were invented later So we have monetary policy our monetary systems are based on Fiat money that is cheap to produce typically paper typically electronic money and Which therefore from a technical point of view can be produced in unlimited quantities and can be Produced at virtually no notice So it's from a technical point of view. It would be possible to increase the money supply from one day to the other By a hundred fold or a thousand fold. There is no technical limitation And there's also no commercial limitation in the central bank which produces Paper money and electronic money cannot go bankrupt You can go look up The website of the European Central Bank or the Bundesbank very well done with the wonderful website They give you also their balance sheets So you get the impression that it's a regular company because I have a balance sheet, right? There are assets on the one hand. I need to show it for you the assets on the one end and their liabilities on the other hand So they could go bankrupt, right? I mean there are debts if the debts are higher than the assets they would be bankrupt. Well, the problem is that this is Accounting hocus pocus. Okay, it's the it's it's it's it's an illusion the debts of the central bank are the in fact the bank notes and the Demand deposits issued by the central bank. So it's it's these things in fact, right? This is this Turkish money. This is the liability of the Turkish central bank But what does it mean can you Turn this in something can you can you claim a payment for this if you show up at the the counter of the Turkish Central Bank? So well, I want to have my money Well, they first of all, they will not understand what what you want And then if you insist a little bit well, they might hand you over another ten lira Banknote right or five do you want to five? They won't cut in half at 20, but yeah, so That's the nature of paper money that you cannot redeem in something more fundamental if you can redeem it in something more fundamental You don't have a paper money it's the characteristic feature of paper money or of electronic money that you cannot redeem it into something more fundamental Therefore the bank can never go bankrupt and it can therefore produce as much of those Without ever encouraging commercial problem. So in the presence of this Central bank then which produces a paper money it is There's a strong incentive for all financial market participants to reduce reduce their cash balances They can be in fact no more liquidity crisis because the central bank can lend at a moment's notice any amount of money needed to make the bridge needed to fill up the Cash balances of the the companies and therefore prevent a financial Liquidity crisis which they have done and as a consequence financial market participants have to use their cash balances So that's the explanation of the low cash balances and it but it also explains the low equity ratios Because what central banks do is to pursue the mission of stabilizing the price level, right? That's enshrined in the Constitution of the Federal Reserve of the European System of central banks and of the each national central bank They pursue a policy of price level stabilization and often in the case of for example the Federal Reserve There's a second objective which is macroeconomic stabilization So what this means ladies and gentlemen is that the central banks? Well because they have the power to stabilize the price level in particular. They can prevent downswings of the price level and therefore downswings of the aggregate Monetary value of assets being held with the companies This implies that for each individual company therefore there is a reduced incentive to hold equity and that's what we said before the The only reason why we hold equity at all rather than benefiting from leverage the leverage effect to increase the return of our equity is because There is the risk of Down downward movement of the value of our assets if this risk is reduced by the presence of monitor macroeconomic Monetary policy then of course there's a reduced incentive to keep as much equity as in other industries So central banks have the mission to stabilize the economy that we have here a classic case of unintended consequences Right the objective result of their policy of stabilization is to destabilize financial markets So we have here destabilizing stabilization policies Why does nobody see this? Why does nobody talk about this as this is an interesting question Therefore, I also found Professor Duesberg's talk on Friday. So interesting in the case of economics monetary policy in particular nobody talks about this because The debate is from the outset confined Under to the hypothesis that we need to keep a central bank So we cannot question the the necessity of a central bank the entire debate that takes place in the professional journals concerns technical issues of Monetary policy given the presence of a central bank and we need a central bank again historically as I've said because government It's a very important instrument for government finance So nobody talks about the elephant that stands in the middle of the room It's the central bank in the professional journals nobody talks about this because most people Writing on monetary economics in the US for example, I actually employed by the Federal Reserve Okay, the Federal Reserve's employer a reserve employs as many economists Some writing on monetary policy issues as the top 50 departments economics departments in the US combined okay 75% of all Scientific papers and published in the professional journals have been either authored by a Federal Reserve employee or have been funded by Federal Reserve money or Directly or indirectly so I Give these figures not to say well they all our colleagues in the US are corrupt But it's also naive to assume that Such a massive financial presence would have no impact on the kind of research That is being conducted in the kind of conclusions that is that are being reached so our monetary System destabilizes financial markets, so he explains the fragility of the financial market It explains therefore the snowball effect that we have observed in the in the past 18 months But the problems that we had were not only a problem relating to the fragility of financial markets. We also had a problem of Mal investment and that's the subject of course of Austrian business cycle theory which explains to us that policy of easy money that Decreases the interest rate below the level it would have reached in equilibrium Tends to create To to inside investment more investment projects than would have taken place otherwise and that this must result ultimately In an economic crisis So the idea is from a macroeconomic point of view that the number of investment projects that we can Successfully conduct that we can bring to completion therefore, which will turn out consumer goods depends on the availability of real factors of production real resources, so In particular labor The amount of people laborers available in the country there their knowledge and so on Human capital, but then also real factors of production like vehicles and streets Plants machines, etc. So this different determines how much we can produce What the monetary policy of easy money does is to inside the Launching of more investment projects then can be ultimately Realized can be brought to completion with the available real resources, so we get mal investment That's the great subject of the Austrian business cycle theory that has been first formulated by Ludwig von Mises in 1912 And certainly we had mal investment of the sort also in the present crisis, which had a few particular features In particular too, so we had on the one hand the length of the the preceding boom so the length of the period during which the interest rate was too low and It started with the dot-com boom in the late 1990s and then immediately after what we had a real estate boom in the United States and the second particular feature is The international international dimension of the crisis, so it was not confined to an individual country We had something called globalization in the past 25 30 years as a consequence is an international division of labor It has been created and from which we have greatly benefited But which makes also that the the mal investment that have been taking place That is the investment that should not have been made but were made under the impact of easy money Concern all countries all over the world So as a consequence then we have now the situation in which we have a scarcity of capital There's not enough real risk and not enough real resources available now to come to bring to completion all the projects that have been started and this on an international level, so that's the basic Fact that one needs to keep in mind about When it comes to addressing the present crisis and which unfortunately has not been kept in mind By virtually all economies except for the Austrians and the Austrians are the The reason is that only the Austrians have kept up the tradition of Analyzing the capital structure of the economy. Okay, it's simply a question of a neglect of an important subject by most of the other economists so what are then the consequences of the Financial crisis in the light of this fact We have the political reaction on the one hand and then the some libertarian inroads The political reaction will be very brief because I'm running out of time and as mobilized the two traditional tools of macroeconomic management, namely monetary policy on the one hand and Budget the deficit spending on the other hand Monetary policy turned out to be very quickly to be inefficient For a simple reason that traditional monetary policy at least Consists in giving short-term credit to market participants Now if you're faced with a widespread or large-scale bankruptcy crisis which companies are Simply bankrupt so their debts are larger than their assets It doesn't help them if you give them an additional credit And if your assets are of the value of 50 and you're you have to pay debts of a hundred It doesn't help you if the central bank comes along gives you another credit of 50 right I mean your your assets grow up but the balance your your debts go up as well You're not really being helped so this became especially obvious last summer Late summer September and October 2008 Traditional monetary policy was hapless So there was a glorious return of Cajunism right Cajun Cajun Deficit spending and from a technical point of view Cajun deficit spending can address the bankruptcy at least of individual companies Because what this deficit spending allows the government to do is either to buy the products of the company Therefore propping up the value of their assets or it allows the government to buy shares in the company so Popping up their their equities now this Was then presented as a macroeconomic approach for solving the crisis But it is not and one of the main criticisms that can be made of Cajunism is precisely that it's not macroeconomics. It's partial Industry level economic analysis the problem is that we don't have enough capital on an aggregate level So if you're propping up individual companies and you can do this with deficit spending You don't solve a macroeconomic problem. You just take capital out of other companies So by solving the situation solving the bankruptcy problem for some companies you are Creating additional problems for other companies. So that's the situation in which we are being right now There were a few libertarian inroads Our our staunchest ally as always was the real world, okay reality And that's the reason why Austrians have been heard in the media Even in France so even I at some media presence in in France. I was in the radio and Bought a couple of newspaper articles and so on it's been invited to do this and some of my other colleagues have Regulatory appearances and so on and the reason is that Austrians are able to explain what's going on Whereas most economists most other economists don't have a clue And the remedies that they recommend don't work So we have a foot in in the door and I can spread Austro-libertarianism, which is a good thing And one of the most encouraging aspects of this foot in the door and spreading the message is the burgeoning debate on the gold standard the reintroduction of the gold standard So about a year ago Austrians were the only ones who are calling for some sort of a reintroduction of a commodity monetary system And we are of course we were being laughed at meanwhile Amazing things have happened At the divorce economic forum. There was a workshop on precisely this problem reintroducing the gold standard The economists the financial times have been publishing articles on this subject manager magazine in in Germany and even in France In the Swiss press there have been articles on precisely this problem So there there are signs of hope We can therefore conclude that the the great crash of 2009 could be avoided I've not fallen on this on this podium the great crash of 2008 contrary to the Presentation that usually left-wing economists give is not a sign of a market failure. It's a manifestation of a gigantic political failure In the course of which we are now experiencing a certain institutional deterioration because well, we are nationalizing the the economy government pumping money into companies buying companies to prevent them from going bankrupt therefore thereby Turning the economy into a totalitarian scheme and on the other hand. Well, there is some light on there on the horizon and some There is a possibility for for us to spread the message and that's what I have been doing and many others as well some in this room and I think that's what we need to keep doing in the coming months in the coming years to prepare the public for the next crisis And in 2030 See you then