 Okay, it's my distinct pleasure to introduce the Rothbard lecturer. I was sent a book last year, maybe two years ago, maybe a year ago by Robert Higgs to review for the Independent Journal of Political Economy, and it had the great title, The Global Curse of the Federal Reserve. So of course I wanted to review it, but then I saw the subtitle that said, A Second Monitorist Revolution, I think the subtitle was, but which was explained in the book in a way that made it more innocuous than it initially sounded to me. So the 2013 Murray N. Rothbard Memorial Lecture is sponsored by Helio Beltrao and will be presented by Dr. Brendan Brown. Dr. Brown is a widely followed market economist. He has authored many books on international financial topics including monetary problems in the U.S., Europe, and Japan, and asset market pricing in a global context. His most recent book, which has just been published in its second edition, is the aptly titled The Global Curse of the Federal Reserve with a new subtitle. It's a wonderful read and I highly recommend it. Copies are available in our bookstore downstairs. Dr. Brown was awarded a Ph.D. by the London School of Economics and an MBA by the University of Chicago. He is currently Executive Director and Head of Economic Research at Mitsubishi Securities International. So I present to you Dr. Brown. Well, thank you very much for your kind introduction, Professor Solano, and for inviting me here today. And your previous talk is an excellent introduction to what I have to say today, which really is how could a Second Monitorist Revolution gain from the insights of the Austrian School and make up for the flaws of the First Monitorist Revolution, which I think we would all agree has failed by this point. And I hope you don't find what I have to say heretical in any way, and it's very much drawing on the Austrian tradition. So the subject for global curse of the Federal Reserve, first of all, what do I mean by the curse? At first blush, you might think for curses the fact that the dollar today, compared to what it was worth when the Federal Reserve opened its doors in 1913, is only about 3% of a real value. So the world has been deprived of what could have been an ideal global standard and global money, a hard US dollar. But at second blush, I'm not dismissing that as a curse, but for curse, which concerns me in this book, is a second one. And that is the waves of irrational exuberance and depression, which the Fed has simulated through its life. And these waves of irrational depression and exuberance, or what has some similarities to what Austrian economists call asset price inflation and asset price deflation, but they're not identical, has exerted or caused huge destruction economically and in some senses politically. There's two main forms of destruction that have come from these waves, one well known to Austrian school economists, which is malinvestment and I don't have to spell out here. The second one, it has actually been touched on in some of the earlier sessions today, and that is the form of destruction in the form of creating sick appetite for equity risk. The fact that these waves, which create big booms and depressions occur. First of all, mean that investors over time require higher risk rewards to go into investments of risk. Secondly, in looking at the future, they perceive more risk than we otherwise would have done if we had a more stable background. So this ailing of equity risk appetite exerts a cost on economic welfare. I mean, if you consider two capitalist economies with the same endowments of labor and capital and natural resources, the one economy in which there's a healthy appetite for equity risk compared to the one in which there's a sick appetite for equity risk, the society in which there's a healthy appetite over the long run, not necessarily the short run because mistakes can make, Columbus can go to America and discover the wrong continent, but over the long run, you would expect for society which has the healthy appetite for equity risk to become the more prosperous. So I come next to what do I mean by waves of asset price inflation and asset price deflation or irrational exuberance and depression. I want to go one stage further back and quote J.S. Mill and Milton Friedman, of course, picked one phrase out of J.S. Mill and made it famous where Mill said that most of the time, if a machinery of money doesn't matter, but when the money machine gets out of control, then it throws a spanner into all the other machinery in the economy and causes them to go out of control also. I think in modern idiom, you would probably translate that or rephrase it as saying most of the time the software of money is unimportant, but if the software of money becomes corrupt, it infects all the other software which controls the prices in the economy and direct for market signals for the invisible forces, it infects those that causes them to go out of control and give the wrong price signals, especially in the capital markets which leads to a lot of economic pain and misallocation and non-optimal outcomes. Then going back to Milton Friedman, when he interprets this line from J.S. Mill, as Professor Solano said, I would guess that he very much meant goods and services inflation. What I try to add in my book to this is the second form of virus attack which comes from money getting out of control or being corrupted and that's asset price inflation. So it's two diseases, two monetary viruses that may be linked, that may both appear in the same cycle and they may not. One is for disease of asset price inflation, the other is for disease of goods and services inflation. When I talk about asset price inflation earlier on, I did talk about irrational exuberance and depression and I'm sure you're all aware of behavioral finance literature where these terms are used quite freely and by Professor Schiller in particular. I don't have any problem with, in fact I enjoy reading Professor Schiller's work very much in behavioral finance theorists, but what I'm constantly taken back by is that their analysis of how these irrational exuberance comes about, they completely miss out any monetary factor and I would argue or try to argue that the main factor behind these waves of irrational exuberance which Robert Schiller talks about is in fact monetary disequilibrium. And to describe what we mean by irrational exuberance or asset price inflation, it's a bit different from the Austrian's concept, you're all aware of here of whether it's capital to goods prices getting out of line with consumer goods prices. What I'm talking about here is more in terms of asset price inflation, irrational exuberance and I could describe this in two ways, one simplistic, one a bit more complicated. A simplistic way of describing asset price inflation is where investors are putting on some rose-colored spectacles which filter out for dangers and exaggerate for size of expected returns. If I was putting this more in terms of a sort of arrow state preference theory, I would say that irrational exuberance is where investors systematically are putting too much probability on the states of the world with good outcomes and too little probability on states of the world with bad outcomes. Friedman refers to the long lags between monetary disequilibrium and the monetary virus appearing in a form which can be diagnosed in the form of goods and services inflation but that lag is indeed even more serious when we come to a second monetary virus. I argue that by the time anyone can confidently say that the monetary virus of asset price inflation is there and demonstrated in a positive way which would be accepted unambiguously, the disease is probably long present and already had a very serious negative effect on the economy and by the time central banks or anyone else can make a definitive positive test to demonstrate that asset price inflation is present it's probably well on the way to turning itself into asset price deflation because asset price inflation unlike goods and services inflation does tend to mutate back into deflation without any action being taken and the reason why asset price inflation tends to go reverse itself is because of the features which are so well known to Austrian economists that you tend to get over investment, profit margins come down or if people are wearing rose colored spectacles and ignoring risks when any of these risks do occur they have a much more profound effect in shaking market prices back down to a very low level and that exerts a shock effect on the economy and you know the idea which we have so much in modern Federal Reserve thinking for the team of regulators or anyone else can somehow judge when asset price inflation is there and do something about it I think it's just totally pie in the sky and the history is full of examples of where asset price inflation by the time the central bank recognizes it's there they only make matters worse I'll quote you a few examples 1929 is one obvious example by the time of Federal Reserve in 1928-28 is confident about being asset price inflation it's already been there a long time Florida boom already moved into bust 18 months before the real estate cycle in the United States was already peaking in early or mid 1928 so by tightening policy by the time they recognize asset price inflation it was already bound to move on to asset price deflation and they only made the consequent recession worse you can quote the same example in Japan in the late 1980s where the Bank of Japan eventually starts tightening policy in 1988 well not 1988 the end of 1989 early 1990 when already golf course prices were beginning to tumble and the early signs of asset price inflation going to deflation were there and they end up turning it into a serious recession and I would argue the same thing actually happened under Bernanke in 2007 2008 and but I think was a strong case to say that the oil price going up to $150 in the summer of 2008 was actually the last dying feature of asset price inflation which had already generally died in a whole lot of other markets and by acting against all prices at that level was just a classic case of panicking central banks responding to asset price inflation when it was already dying and making the subsequent recession even worse now I want to at this point just look at three from three channels which I suggest run from monetary disequilibrium to these waves of irrational exuberance what what's how does monetary disequilibrium create waves of irrational exuberance and I suggest three main forms now some of these may involve a degree of irrationality some of them may not the first the first channel is Sam and I think in many ways the most robust again challenge against challenges but you're assuming a lot of irrationality is Sam pegging and forward guidance of short-term rates modern central banks and the Federal Reserve by pegging short-term rates and announcing or implying where short-term rates are going to be going in the future have a very big effect on long-term interest rates that's quite different as I mentioned this morning from the situation under the gold standard where short-term rates pretty well oscillated around violently and long-term interest rates had a life of their own and were very much influenced by this sort of decentralized information effect which Austrian economists would applaud that all that's all broken under the sort of pegging of forward of short-term interest rates which reached a which became more and more or at certain times in the Federal Reserve history in the last 100 years has become very very substantial now when you have when the result of this is to bring long-term interest rates below neutral and below equilibrium level you get into an area of what Schiller describes as positive feedback loops the fact that there's a lot of froth and asset prices because the long-term rates are below neutral in turn tend to validate a speculative hypothesis which is out there you know I could borrow from minceki for example the idea or professor alibar University of Chicago the idea that at various times in markets there is speculative stories in some some I mean I can give you examples in the late 19 mid 1920s there was speculative hypothesis for Germany in the Weimar Republic was in a miracle economy we had the speculative hypothesis in the 90 in the 2000s that European monetary union was a miracle in which financial banks were going to have a huge new profit opportunity from this integrated European market now in normal rational mood these sort of speculative stories nobody would probably give more than 20 or 30 percent probability to them being true but when you have the central bank holding interest rates down and long-term interest rates getting below neutral then those speculative stories tend to get an inflated life of our own through through through the feedbacks of the positive feedback loops so that's one that's one that's one channel of monetary virus attack leading to asset price inflation the other the other two channels involve desperation at low real yields if interest rates are being held by the central bank at very low levels in real terms even if in line with neutral if investors have had no experience in the past to make up for that of price level falls as they normally would do in a monetary stable world where you had periods of price falls and price rises but all they can look forward to is price rises and income famine out of desperation they look for speculative stories to derive real yields and the third for third monetary channel is what I describe as inflation scare if central bank policy today isn't actually creating inflation but there's a danger that there may be high inflation several years in the future then investors again may respond in somewhat irrational way to seek out real yield now I would stress one other point that asset price inflation isn't affecting all markets at all times there has to be a speculative story so you know it's going fast forward to the present under the Bernanke QE policies after 2007 you know the the first speculative stories that emerge are those related to China because you have a coincidence of the QE policies starting off at the same time as China itself is having a massive massive monetary expansion so expect for speculative stories which catch on are those related to commodity prices emerging markets Brazil all the country's doing well out of China for none of them that in turn may fade and then the speculative story moves on to somewhere else so you do get you do tend to get these rotations of asset price inflation rather than all markets being affected at all times during this phase now I want to I want to review those ideas somewhat more in terms of the hundred year monetary disorder we've had under the Federal Reserve since 1913 asset price inflation to be accurate did not originate with the Federal Reserve and I must stress maybe at a point at this point you know many of you may be saying given the sort of views I'm expressing here why are we talking about monetary isn't coming back or anything else but I'm I'm putting this in the context of yes the international gold standard before 1914 may be the best although imperfect order that the world's come up with but once the world comes out of that semi-golden garden of Eden the cost of going back in again may be so exorbitant but it's impossible ever to get back in and of course one can argue about that but I suppose that's the sort of background hypothesis to some of what I'm writing about but so so the point I would stress here is that asset price inflation didn't originate with the Federal Reserve but the size of the waves and their frequency has got much larger under that institution's hundred-year monetary history and if you go back to the gold standard days there was although there were some large booms and busts I mean most most particularly there was that of 1907 of course you can trace for boom and bust of 1907 and the asset price inflation of a 1905 1906 period to the fact that you had a very rapid growth of gold gold stock in those years related to the new technology of mining gold so that was a form of disequilibrium growth of the monetary base which was feeding this asset price inflation process but in broad in broad terms through the gold standard world the gold standard world was a monetary system which had important checks and balances against the progress of asset price inflation I think one can essentially look at the gold standard world a pre-federal reserve system as a monetary base control system it was a monetary base control system where the fixed price of gold regulated for supply of monetary base aggregated across all countries which were on the gold standard there was free determination of interest rates price level fluctuated considerably up and down for a purpose and when I say for a purpose you know many people lose sight of a fact but one of the equilibrating mechanisms under the gold standard to all which guided the invisible hands towards creating business cycle recoveries was the perpetual expectation of prices going back to a constant level so if prices fell during the recession there was the expectation that prices would go back up again in the subsequent recovery and so combination of low prices now with high prices in the future meant that in fact you got for negative real interest rates which Bernanke so desperately tries to create today through hyped up inflation expectation so and the the the white noise that you got in the short-term interest rate markets through go temporary gold shortages helped insulate for long-term bond markets from getting infected through any manipulation going on in short-term interest rate markets so all of us all of us helped restrain asset price inflation waves from coming about although nonetheless it did sometimes come about but I would argue and this is an empirical assertion I guess that the waves will have been much more violent since the Federal Reserve opened its doors no sooner of course did refed open its doors in 1913 when the gold gold standard disintegrated somewhat paradoxically if you look at for history of a Federal Reserve during the First World War Brian who had been I think one of the leading opponents of gold in the US immediately advocated in 1914 during a crisis for the Federal Reserve or the US should leave a gold standard whilst people like Benjamin Strong and Warburg who were in the Federal Reserve were very much of opinion that the dollar should be still be backed by gold and it was very dangerous to go over to fiat money one of the paradoxes of monetary history of course if the US had followed Brian and the taken the dollar temporarily off-gold there probably wouldn't have been the high inflation and asset price inflation that actually occurred from 1914 to 1917 because these gold inflows essentially the on-tone paths dumped their gold in the US and basically levied in inflation tax in the US through creating inflation to pay for the war so if instead they followed the example of Switzerland in Europe at the time which actually in similar circumstances of neutrality broke for link of a frank with with gold and had much less inflation than the United States but I don't want to get way late into that it's a fascinating description for any of you want to look as to what how the Fed operated during the First World War and in some in some degree affected the possibility of peace being reached in 1916 or not but I want to go fast forward to the 1921 to 1929 period and we sort of covered this this morning where Friedman and Schwarz described that as a high tide of a Federal Reserve it's a it's a very important historical episode because it's critical I think in examining that period to draw out the lessons for monetarism which weren't drawn out by the first generation of monetarist because quite evidently as the Austrian schooled make make very clear and Rothbard in particular the the it was a fixing of manipulation of interest rates and the too rapid growth of monetary base during that period which contributed to the waves of a huge wave of Russian exuberance and of course the biggest asset price inflation of all was arguably in the German credit market from because from 1924 onwards Germany was part of the dollar area having fixed the Reich marked the dollar in 1924 and with interest rates well below equilibrium levels in the United States US investors were very keen to get a higher yield which they did in Germany and the speculative hypothesis which went along with that was Vivaima Republic and the economic miracle which was taking place if you look at real estate prices in Berlin going up by a factor of five or six during just five years from 1924 to 2029 it's fairly evident what all all this where where where where this was leading and then inevitably the asset price inflation turns to asset price deflation and and the second largest economy in on the earth Germany at that time goes into default and that creates for feedback and that so intensifies for great depression in 1931 my next example of asset price inflation is actually in some ways closer to the situation we have today although I would stress and I later on if I have a chance I'll go into a bit more there was some dissimilarities this is in a period 1935 to 1937 1935 to 1936 if you look at it the monetary base in the US went up in pretty similar fashion to what it's done under Ben Bernanke in the last two or three years but of course it wasn't an explicit policy action it was in response to gold inflows coming in and being monetized but but this period of exceptionally low interest rates together with the big rise in prices and concern about inflation ahead did drive a process of asset price inflation stock markets doubled in about 18 months from 30 late 1935 to the end of 1936 investors put on their rose colored spectacles they ignored the fact that that geopolitical skies were darkening and that's an actually one interesting point in Lionel Robbins book that he mentions already that in mid 1930s many firms were holding back on investment because they were concerned about the risk of World War something which Keynesians completely miss out when they describe World War two as a saviour of a US economy it's quite the other way around but and they were they were the investors were also ignoring the fact that the gold block broke up in Europe in 1936 meaning that the dollar was suddenly shooting up again in the devaluation come to an end but by the time we get into early 1937 and the Supreme Court rules in favor of a Wagner act and rules votes one is landslide victory at the end of 36 eventually reality catches up the the spectacle the rose colored spectacles break and in about four months from spring 1937 you get a 40% fall in the stock market and the rules felt recession which is even more severe than that of 1929 to 1930 so that's an example of which bears some similarities to present situation now I'm going fast forward here I'm not going to spend much time on the World War two situation but I think it's possible to look at the Martin period of the Federal Reserve Martin becoming Fed chairman in I think 1952 or somewhere there around and this was a period of just before I do that I'll just make one comment you know many people say or the point's been put forward now how how is the Fed going to extricate itself from this extraordinary monetary policy it's been followed and how can it decontrol the bond market after this long period of manipulation and some optimistic commentators say well look the Fed managed to and the government decontrolled long-term interest rates in 1953 and yet there wasn't any great calamity but of course what you had in 1953 onwards was an economic boom an economic miracle with Germany growing 10% per annum Japan growing 10% per annum and a huge productivity growth spurt in the in the United States and you would think that given given this growth spurt everywhere and productivity miracle on any Austrian view of monetary stability of course the price level should have been falling in the United States through through the 19 late 1950s and early 1960s instead of which it was rising at around 2% and briefly somewhat lower and to give credit where credits do you actually if you go back in that literature and I'm not sure whether it's on the von Mises Institute website or not Arthur Burns did write a book in the late 1950s attacking with that for pursuing an inflationary policy and saying what price level should be stable but of course for corollary of that the Fed under Martin pursuing inflation in the middle of once in a century economic miracle was asset price inflation this was a period of this was a period of Buffett making his fortune the real estate Titans making their fortune it was the period of the the huge equity market speculation equity markets tripling and as you would expect this asset price inflation merged moved on to asset price deflation in 1969 with the fantastic fall in the market which and in real estate markets which then Arthur Burns was called in by Nixon to try to reverse which he did for a few years but then ended up with an even bigger crash in 1973 you then you then go further forward with that history to currency war machine being very much part of the Federal Reserve apparatus once you have a floating exchange rate currency war machine becomes very much a feature and I would highlight the example which maybe is very often glossed over or maybe not recognized but one of the biggest courier currency warriors was none other than Paul Volcker you know Paul Volcker started as Treasury under its secretary in the Nixon administration going around all the capitals in Europe arguing and and implementing big dollar devaluation which leads on to the inflation of 1970s then he comes in in 1980 81 runs basically two-year so-called monetary policy and then abandons it and of course the pressures by the mid 1980s 1985 were huge on trade protection and essentially Volcker goes along with the idea that the dollar has to be devalued and there's a trade and currency war against Japan and Germany but in doing that of course we fed had to do its bit in implementing a currency war machine of keeping interest rates way below neutral which is what happens and you get the great asset price inflation in the United States from late 1980s the real the the equity market bubble and bust of 1987 real estate markets and of course all of this rolls on to Japan and as a separate note on Japan I would say if you look at a 40-year history of Japan since 1970 Japan has essentially had to deal in very difficult circumstances with the Federal Reserve curse you know and the and each time they each time they each time they respond to the curse by deciding the best way to bring the end down is to copy what the Fed's doing but by copying what the Fed's doing we end up with an even bigger economic calamity in our own countries so in the early 1970s the Bank of Japan follows with the reluctantly the the Nixon and Burns fed into inflationary policies and end up with 30% inflation in Japan by the mid 1970s they follow Volcker into lower interest rates in the late 1980s and end up with a gigantic credit bubble and then of course in the early 2000s with the with the Clinton war not not to the sorry the bush currency war and they end up bringing interest rates down to zero and monetary base expansion and we end up with a gigantic yen carry trade bubble which leads to an overextension of an export sector malinvestment and it all comes apart in 2007 2008 so in the time I have left I want to maybe stop the history and come on to two big questions how to cure the curse and what to is it going to be cured is very prospective it really is going to be cured and I suggest for six step six steps towards curing the curse one inflation targeting has to be dropped altogether in faith in favor of a general aim of price level stability over a very long run such as one had such as one had under the gold standard secondly no more deflation phobia monetary rules in so far as they are adopted as part of a second monetarist revolution must be designed so as to mean a fall in prices during bouts of productivity growth such as one had in 1920s or 1950s or in the 1990s with that matter third we have to stop all manipulation of long-term interest rates and the benankeite bond market manipulator has to be smashed up fourth restore monetary base to a pivot of a monetary system now restoring monetary base to a pivot of a monetary system means abandoning paying interest rate any interest on reserves and getting back to a fairly high level of reserve requirements because you have a trivially low level of reserve requirements then having a stable x percent rule for monetary base expansion doesn't really give you any assurance of overall monetary stability fifth eliminate Orwellian monetary history especially the chapters and the Great Depression and Japan's great deflation which never existed I mean if you look at Japan's deflation so called price level in 2010 or sorry 2012 in Japan is pretty well the same as what it was in 1992 on some measures and if you look at the hedonic price adjusted series it may be down 10 or 13 percent but if you'd had a hedonic price adjustment during with gold standard years the price level would have been falling over time so Japan hasn't had any great deflation its problems lie elsewhere which is beyond today's talk but six six step and a key step in how to cure the curse is to acknowledge asset price inflation as a deadly virus of economy which can only be spread by monetary disorder the only way you get to large asset price inflations is by monetary disorder and the best way of preventing these waves of irrational exuberance and depression getting very large you can't eliminate them all together is to stick rigorously to a monetary stability order you can't having teams of regulators thinking they can spot it in advance is just completely futile and lastly I come to when when will the cure come well I think a key point here is the cure is not going to come from within the Federal Reserve Federal Reserve now is a more than possibly any time in its hundred-year life packed by political appointees who are all there or ignoring one or two members who really don't have any power so if it's going to be any monetary reform it has to be led by political forces which regain ascendancy in the widest scene and are then able to reform or abolish or whatever the Federal Reserve second point is the second monetary revolutionaries have to learn what went wrong with the first monetary revolution and I would suggest that unfortunately as Professor Salerno started to outline some of these routes misleadingly some of these routes do go back to Milton Friedman's teachings bananquism has to be obliterated you know the three the three the three for three features of bananquism currency war machine bond manipulation machine and virtual monetary helicopters they have to go and and when I when I'm talking about virtual monetary helicopters that's actually quite an important point because today's monetary base expansion by the Fed is not real monetary base expansion what we have today is the Fed is essentially the government US government is essentially issuing two forms it's financing itself by issuing two forms of Treasury bills one is to be Treasury bill for an Anki which is issued at a gift bonus rate for the big banks to buy and there's another category of Treasury bill the ordinary Treasury bill which is just for you and me which is issued at zero so of course for banks are going in to buy the B Treasury bills at 25 basis points and issue deposits of zero to everybody else that's fantastic arbitrage so the government's basically funding itself by issuing these B Treasury bills and the rest is just funny bookkeeping the fact that the Fed may be buying long-term bonds and using B Treasury bills who really cares the government is financing itself with floating rate Treasury bills but in the process giving a bonus for banks that's that's that could all be unwound tomorrow if B Treasury bills came to an end and the interest rate paid on B Treasury bills was the same as for everybody else you would get massive disintimidation from the banks it probably wouldn't affect the outlook for credit or anything else very much although it might have some psychological effect because the the second component of binankeism which is a bond market manipulate it does depend on a whole lot of psychological effects included amongst those is a lot of investors believing that there is a lot of money printing going on the and this brings me to a last point talking about second monastery's revolution I think it was Napoleon who said for the biggest for the main quality he looked for when he chose generals or field marshals was luck much it's much better to have a lucky lucky general than a excellent general so clearly you know whether it was ever a prospect of a second monastery's revolution taking place depends on luck and I mean by luck does for scenario of 1937 which is a very lightly scenario for how this is all going to end up happened before or after an election and then you have to ask you know even if it happens before an election is is the way when the next crisis happens in the next depression or recession is it going to lead on to a monetarist revolution or is it going to lead on to rb economics and the road to socialism and I'm not going to answer that question because I have to remain optimistic and thank you very much for your attention