 This is Jeff Deist, and you're listening to the Human Action Podcast. All right, ladies and gentlemen, welcome back once again to the Human Action Podcast, and we are continuing our walkthrough of the book itself, Human Action. Mises is Magnum Opus, and we have been working our way through part four of that book, which is very long and which commands more than one one-hour podcast at any rate. So today we are working through chapters 18, 19, and 20 in part four, which is a little more than a hundred pages, and these are rock solid core pages. I mean, especially chapter 20. I was telling Joe Salerno offline that I wish we could get our politicians and central bankers to just read the 50 pages in chapter 20, and they would have a much better understanding of what's going on today in markets and why what the Fed is doing can't work. So all that said, as I alluded to our guest is Dr. Joe Salerno. We're all sort of on lockdown here in Auburn, Alabama. But for those of you who we've whipped into shape and gotten reading this book, in a sense with everything going on in the world, it feels a little counterintuitive to go read some 900 page tome, some treatise when the news seems so ephemeral and we have to keep up on what's going on with this terrible virus and what our government's doing to us. But really counterintuitive or not, this is an excellent time. I'm going to argue once again for getting back to first principles, getting back to original understandings to going back and looking at some of the masters, the great masters from the past, whether that's in art or literature or history or economics because a lot of their wisdom would serve us quite well now. And Mises is certainly in that category. And so we've been highlighting as we go through the book, not only some of his passages which are particularly applicable to what's going on today. I mean, it's just amazing sometimes you can pull a sentence or a paragraph and it absolutely perfectly describes what's happening, but also his language. Mises is the stylist. It's really, I mean, this is a gentleman who's later in life. He's writing this in the 1940s. He's writing this in the English, a second language upon his arrival in New York City. So it's really a tour de force and a pleasure. You know, you think that a 900 page economics treatise is not necessarily the most pleasurable thing to read. And it isn't in parts. There's no reason to say that it is, but nonetheless, you can get an extreme amount of satisfaction out of just grappling with Mises and also enjoying Mises the stylist and Mises the genius. So you spend some time inside his head when you read this book. So all that said, Dr. Joe Salerno, it is great to talk to you from your bunker this morning. Yes, I'm happy to be here. I'm happy to be talking to other adults. It's great. Well, I'm struck first and foremost as we get into chapter 18, which is total action in the passing of time. This whole chapter is about time. It's about the temporal element of economics. It is about time preference. And Joe, the first thing that struck me as I went back and checked, but there's the discussion and treatment here of time preference is really much expanded. You don't find this in the theory of money and credit. No. In fact, I don't think Mises had fully developed his time preference theory in the theory of money and credit. He was a student of Bombavar and Bombavar sort of mixed in psychological considerations when talking about interest rather than just that of purely action. Right. And he actually has this little blurb on page 485 for those of you who are reading this scholars edition where he credits Jevins and Bombavar with the first to completely solve some of the fallacies and the productivity theories, the labor theory of value and that sort of thing for coming up with the idea of marginal utility. But he does mention that he doesn't agree with Bombavar's treatment completely. And if you go back and look, there's actually a footnote to that effect in the theory of money and credit where he says that I accept the terminology and method of attack of Bombavar's theory of interest but he doesn't necessarily accept it because interest is a big part of what we're talking about here. So when he says that time preference is a categorical requisite of human action, does that mean it's an axiom? I mean, give us your quick and dirty definition of time preference. Time preference is the fact that people prefer their satisfactions as soon as possible. That is that a satisfaction available tomorrow is much more valuable, much more amenable to people than one that's available a year from now. And the reason for that is that time is scarce. We are defective human beings, meaning that we lack a lot of things that we would like to have. So given that, you can only get one thing at a time. You can only produce one satisfaction at a time. So if you really thought about it, even if you were in a garden of Eden where everything, outies, laptops, grew on trees, there would still be a scarcity of time. If you had one body, there would still be time preference. You would still have to do things one at a time. So I thought more about this. The only way you get rid of time preference is to try to imagine a world which is really inconceivable of where you can clone yourself an infinite number of times so that you can satisfy yourselves with having a birthday party, with driving an outie, with doing all these things at once that satisfy all of the unfulfilled wants that you have. But today you hear a lot of these themes. There's a lot of crazy people out there saying that we are in an era of post-scarcity that we're going to achieve some sort of singularity. And then there are the transhumanists out there who probably think that we could sort of have enjoy more than one thing at once. And I think some of these crazy ideas are leading us to think that there's, Joe, some new economics out there available to us. Well, again, there's scarcity in the world. If we were beings like God, God-like beings, where we were never dissatisfied with anything, we would not. The very fact that human beings undertake means, use means to achieve ends and continually do that as long as you're conscious and awake implies scarcity. So the very fact, for example, that these people who believe in a post-scarcity world are talking to you and trying to convince you implies that they're dissatisfied with the fact that you hold a different view than that they're trying to assuage their dissatisfaction. Well, maybe I should go get an Audi. I think there's zero interest rates. I should just have one because they're sitting there idle on the Audi dealership's lot. And here I am without one. This seems unfair to me right now. But, you know, he has a lengthy treatment in this chapter about capital. And so rereading parts of it last night, I just jotted down here that capital goods by definition invoke time because you're not immediately consuming them. So the fact that we even have capital in society requires an understanding of time. And he has this wonderful sentence where he says, you know, all of our material wealth is a residuum of past activities. And I thought that's such a great refutation of presentism. People who think that the past is retrograde and dumb and doesn't matter. People who don't want to accept the wonderful material wealth that's around us here in the West is, you know, we're standing on the shoulders of previous generations and we owe them something for that. I thought that sentence was a magnificent. You know, absolutely. In fact, somewhere else he points out that the wealth that we have today, you can trace that back. Now, economically, you don't have to do that because businessmen don't care about where the wealth came from. But just from an historical point of view, you can trace it back to people when they realize that, hey, instead of fishing, I'm going to cut back on the number of fish I eat just by catching them by hand and spend some of that time building a net. So the fact that they built the net and became more productive allowed them then to build an axe and cut down a tree and build a home. And so that this progress in building up capital goes back to the primitive times. And we stand on their shoulders, as you said. And we take it for granted, too, in which we're seeing today. Completely for granted, yes. Now, capital invokes time, but it's also contrary, I think, a caricature on the left in our political world. The capital is transient. You're always either accumulating or consuming it. It's not fixed and finite. It doesn't just rest in certain hands forever and ever. That's true. I'd like to say, and I think this might come from Mises of Rothbard, that capital is a waste station in the production of consumer goods. See, capital isn't independently productive. It's just, for example, the net is a waste station on the way to producing fish for the next year before the net wears out. The net eventually is completely transformed into fish and is in that sense used up. The same thing is true with huge factories that are equipped with robots. Those things aren't fixed. Those things aren't there forever. Those things are used up, they're worn out in producing the automobiles. So, in effect, those are the automobiles in a half-baked cake. So, a full cake is a consumer's good, and the robots and the factory and so on, the other equipment, those are simply half-baked cakes. They're eventually going to be completely transformed into the cars that we use. So, all these capital goods, as opposed to consumer or lower order goods, all these involve time, all these involve some uncertainty and risk. What does all this mean? For our lay audience, what is the length of the structure of production and why should we care about that? Well, there's a couple of ways to answer that, but one, the point that you touched on, it's very important, and once you invest funds and resources, labor and materials in producing a particular type of machine or factory, that becomes what we call inconvertible. You have now sunk all of these things into the production of a particular type of good. You may be able to change the factory slightly. For example, instead of cars, you could produce ventilators. But for the most part, you've committed yourself to the production of a particular type of good. Now, that good is going to be produced over time. That factory last 10 or 20 years or 40 years. And so, the entrepreneur is speculating that the prices that consumers are willing to pay will cover not only the materials, but also the cost that was sunk a long time ago, 10 years prior, in that factory. That's one of the functions, most important functions of entrepreneurs. That is to appraise, to estimate what the future will be like, what people will demand and what type of technology we'll have in the future. Yeah, it strikes me that those of us who are interested in precious metals, I mean, if we look at the gold mining industry, what a horrible industry to be in, because not only do you got to figure out where the gold is, you got to deal with the local government and buy the property and the mining rights, then you got to bring in all this physical equipment and literally rest it out of the ground and then you have to process it and get it to market and all this takes years and years and years and in the meanwhile, the per ounce price of gold is fluctuating like crazy. Why does anybody mine gold, I guess is the question. It's the same reason that people will produce anything for the future. And that is in a modern industrial economy, entrepreneurs are willing to risk their destinies, as Mises says, their fortunes to adjust production to what they think will be more urgent demands of consumers. In other words, they're gap fillers. They see that something's going to be missing in the future or be very, very scarce in the future and therefore command the high price. So they're willing to take the risk of investing today in resources that will take a long time to form into the final consumer's good a year from now, five years from now. Look, an automobile from the time it goes from conception on the drawing board to the dealer's floor is it used to take a U.S. company seven years, a Japanese company to cut that to five or four years. So you're looking at markets and people's desires and wants that are four, five, seven years down the road. Yeah, that's really amazing how complex all of this is. Again, you know, if people get nothing else out of this book, it ought to be a sense of gratitude for the material world we live in, which is not just mere consumerism by any stretch. Now you mentioned this idea of convertibility, presumably an individual or a business initially gets savings or profit in the form of cash and then they convert them into some sort of higher order capital good. And as you mentioned, once it's converted into something, a production line for a Cadillac SUVs, for example, Cadillac Escalades can't be converted into a production line for ventilators because all of a sudden there's a virus. But Mises points out that there is an out for this for entrepreneurs in this sense that they're stock markets. And stock markets give us the opportunity to have some limited convertibility of capital goods and some tradeability of them. Yes, so it allows what we call a mobility of the investor. The investor can get out of that line. Now, he can get out of that line profitably or without making any sort of loss. If there are other people out there that think that these capital goods can still command prices that will return a profit. However, if most people see that this good is not going to be successful on the market, then the only way we can get out is at a loss. But as you said there is that chance of mobility. Now what that does, of course, is allow or make it more appealing for people to invest in these inconvertible capital goods because they know that they can get out maybe with a loss, but they can still get out. Right, because otherwise you've got a factory assembly line that you can't convert into anything and you're not going to barter it for something else. What's interesting is at page 518 Mises has some interesting lines about cash and what we're seeing today is cash holdings by businesses and individuals have been irrational in a sense over the last 10 years because interest rates have been very, very low and holding cash in a money market or a CD or some sort of business checking account relative to inflation has probably been a losing proposition and so in that sense not been rational, cash has been unproductive which is what a lot of people like to argue, but nonetheless now we're finding that companies with large cash balance sheets might be in a position to weather this storm and Mises points this out and this goes to a concept that William Hutt and others elaborated upon the yield for money held, but Mises says here in recent years, economists have paid special attention to the role cash holding plays in the process of saving capital accumulation. Many fallacious conclusions have been advanced about this role and he says, hey look if you're holding cash to purchase factors of production, well that's converted into capital and if you're just holding it because you think it's the most advantageous mode for you at the moment, well that causes a otherwise a fall in commodity prices and it still serves the market so this idea that you're somehow a bad person or you're being dumb and unproductive by holding cash is really being laid bare in this horrible crisis we find ourselves in. Yeah, so Mises I think there is referring to Keynes and before him the monetary cranks that he took his inspiration from like Silvio Gessel and Major Douglas, but in any case what Keynes said was that if people stop spending on consumption and hold that money then that discourages production of consumer goods and since you're discouraging the production of consumer goods you're also discouraging the production of capital goods and so workers are being laid off. So Mises is saying that's completely false in fact what's happening is if people want to hold some of their income in cash instead of spending it on consumer goods well that doesn't change the amount of capital goods back on the amount of consumer goods they're producing they're buying they're purchasing fewer automobiles they're buying fewer fancy restaurant meals and so on. That allows the workers in those industries to become available to produce the capital goods. So even though these people aren't investing in capital goods the prices of those capital goods are going down because they're holding money not spending it and other entrepreneurs are investing in those capital goods and that act of you and me not consuming and just holding the money even that is productive in the sense that it frees up workers and other materials and electricity and other things that can be converted to production of capital goods. It frees that up to produce more capital goods and make us more prosperous in the future. So it's a very important point that Mises is making there. But let's say over the last few years even if someone is losing a couple points a year to inflation in a money market I mean what about the psychic or psychological element that they just they just derives comfort let's say from having a bunch of cash and that might come in handy. No you're absolutely right at very very low interest rates you may want to take that small loss in real purchasing power because there's a little bit of inflation for peace of mind. Because remember the primary reason for holding cash is that the future is uncertain you'll never know when there'll be a medical emergency you'll never know when there'll be a certain sales opportunity that you want to take advantage of. If everyone knew the future perfectly then everyone would and meaning that they know when their income will arrive on exactly what dates and when they'll need to spend money exactly on what on those dates then they would just lend the money until those days and no one want to hold cash everybody would want to lend their money out until they needed to spend it. So it's purely uncertainty at the bottom fundamentally that causes cash holding. So in Chapter 18 he establishes this whole concept of time preference and why we you know axiomatically understand that we prefer our dream house at age 40 rather than age 90 because of time and uncertainty and then in Chapter 19 which is called the rate of interest he applies time preference and gives us this concept of originary interest. So there's a lot of different kinds of interests out there in terminology and economics people use all these ideas but to me as someone who's interested in as a lay person in learning Austrian economics originary interest is really a baseline concept would you agree and give us the definition. Yeah so what means is cause originary interest is where where does interest fundamentally originate from it doesn't originate from people borrowing and lending money it's even more fundamental than that it originates from the fact that people prefer money today to the exact same sum of money let's say a year from now so in other words even though I'm from New Jersey and I have a name that ends in a vowel let's assume you completely trusted me to pay back a loan of $10,000 so I asked you for $10,000 for one year would you loan me the money even knowing I'll pay you back I would have the resources to of course you wouldn't and the reason is that $10,000 today is worth more than $10,000 in the future so I would have to bribe you to lend me that money I would have to offer you let's say $11,000 in the future and the reason is that $1 today is worth let's say on average to you and other people $1 and 10 cents in the future so that ratio of prices that 10% discount on a dollar a year from now so that you have to give $11 back to me $11 back to you to give me 10 today that is originally interest that difference in value between dollars available at different dates now that term is not used by any other economists Rothbard even changed the term to natural that's the natural interest rate that's what naturally arises from so we sloppily refer to interest rates as prices but what he's saying here is that they're a ratio a present to future want satisfaction so they're a signal in a sense but they're not a price am I saying that correctly yes they are not a price now they appear as a price on the loan market but the loan market you know if you go and borrow for a mortgage or if you go take out a business loan interest rate you pay there is determined by supply and demand but not independently it's tied into how what the rate of return is in a business and that rate of return is the originary interest rate so in other words if I expect to make 12% on a business investment and I want to borrow from you then I would pay you up to 12% I'll pay you less than that because I expect 12% and so I would try to pay you as little as possible but let's say then that that becomes most businesses will pay 10% and that's what we think of as the price as the interest rate okay and it is in one it's sort of summed up in one figure 10% but Mises wants us to remember even though it seems like it's a price it really has to do with the ratio of prices yes and I think we should remember here that he's working from Bomberverk's work on interest rates because this was a huge sea change in how we understand what interest is and why it arises I mean it's not income from capital it's not the price you pay to use capital and it's certainly not what the Marxists think which is well the wealthy guys have all the capital and they hoard it and then they charge us poor people to access it but I haven't heard you know when you accept the Marxist definition of interest rates how do you explain negative interest rates how do you explain how is it exploitative to effectively pay people to borrow money I'm not sure that that works but my point here is that this is a fundamentally different way of looking at interest relative to classical economists yeah it absolutely is and here's the difference Mises locates interest rates in people's differences in their values between the present and the future the fact again that you can't have everything at once that you're always dissatisfied meaning that you have time preference you'd rather have things sooner than later so he locates it in this difference that people see in the period after the satisfaction versus the period before the satisfaction so that's very subjective now the classical economists and even the neoclassical economists who came later what they see it as is a return to capital that is the capital is productive that it produces 10% more value if you buy a machine for $100 well it'll produce goods worth $110 a year from now because it's productive but Mises says no that's not the case let's say I invest $10,000 in the machine today and I know that it'll produce let's say hats that I can sell for a total of $11,000 a year from now the point is if you don't have time preference why wouldn't I bid the price of the machine up to $11,000 if the machine can produce goods worth $11,000 then the price should be $11,000 the reason why it's not $11,000 is precisely because people prefer the income in the present they realize that hey I'm laying out $10,000 today and because of time preference in order to do that I have to have the prospect of getting more in the future so the question that Bob Burke asked and that really revolutionized interest theory was simply this if something is going to produce goods worth let's say $11,000 why isn't the price of that thing today $11,000 why is it less and the only reason it's less is because of time preference so what would a world without interest look like in other words some people say that in the Islamic tradition for example you're not allowed to charge interest and that's not entirely true obviously there are plenty of banks charging interest in the Islamic world today but I mean we don't again in a previous episode Pair Bielin was talking about how just cost accounting and applying money prices to things to give us a sense of profit and loss and make that more concrete in our minds was an invention on par with the wheel which was a pretty amazing statement if you think about it but what would a world without interest look like I mean it's actually something that we need to understand in human or civilizational terms let me give you two examples so let's say tomorrow you saw a headline that said needier to strike earth and wipe out most of human life in six months from now let's ask what would happen to the interest rates well no one would stop thinking about the future no one would want to loan money and many people would want to live better now so interest rates would shoot up to thousands of percent on the other hand what if what if that same headline tomorrow in the same newspaper instead of saying that said scientists find fountain of youth that will extend human life to 300 years in that case people would start thinking more about the future people would start saving more and interest rates would drop towards zero they'd never be zero but they drop towards zero so an extension of human life would be a factor if everyone became much more mature and worried about the future instead of knuckling under to this whole idea that we all have to be in debt and enjoy ourselves today you would have a fall on interest rates so interest rates look they can never disappear but they change even over the same person's life so when you're a child when I used to bring my son a designer that had video games in the front he would want to immediately play the video games we're waiting online I tell him no you can't play the video game now but after we allow you to play two two times which is a hundred percent for an hour which is millions of percent per year but he would refuse I mean he'd want to play now so through the life and by the way as you get older without having families and responsibilities your time preference goes down and that would cause a downward pressure on interest rates but as people become older what do we often say when they're 70s 80s we often say they're having a second childhood because they're going out and buying things that they would have never bought before they're going on cruises and so on and so their time preference is going up again they're much more interested in the present because they have fewer years remaining well we've seen obviously this has been speculated in the US but we see in the European sovereign debt market that there are so-called negative interest rates doesn't this chapter by Mises because of time preference imply that negative interest rates would not exist on just a pure market well yes it wouldn't exist on a pure market but you have to realize what's going on there and part of it is that look Mises does point out there's something called plain saving if we got a lot of consumer goods we would pile up some of those consumer goods and wait for the future even though that can of soup and tuna fish and so on even though those things would not multiply would not return us interest so people do say for the future when they're afraid that the future is going to have more scarcity than the present so what's happening I think with these negative interest rates is that because people are fearful of the uncertain let's say about what the future holds they're willing to hold these things that are as good as cash with your basic government securities and since cash does have a cost to holding in vaults and so on and there are vaults of private companies that have rented bunkers that were military bunkers in Switzerland in World War II they've rented them from the government and they have vaults in there and people putting their cash in there but they charge you so people are willing to pay a quarter of a percent or a half a percent to hold the government bond which is as good as cash and it avoids the charge of vaults and the inconveniences and so on so I'm not convinced that that is a pure interest rate a negative interest rate to me that's really a cost of holding cash in a different way right so that's basically a custodial fee exactly right right that's what negative interest rates are you're locking in your losses and of course there's other elements here with respect to government bonds and even corporate bonds which are negative which is that maybe they're looking to sell the underlying bond and maybe they think interest rates are going to drop even more so there's other speculative plays other than just losing money you might be looking to sell obtain a capital gain on the underlying asset itself but so there's all this uncertainty we don't know where interest rates are going and there's this idea of a ratio where let's say from the lender's perspective the entrepreneur's perspective a private equity fund you're saying well I got a figure the ratio the value of the amount of money available to me today versus the expected value of it at a later date and I have to charge interest on that but as Mises points out in the latter part of this chapter here there's an element of entrepreneurial speculation to that right because economic conditions are always changing which may mean the interest rate you agreed on was either too high or too low in hindsight and you can also have a borrower who goes bust so what you actually charge as a market interest rate also has to bake in some money to pay for that speculation absolutely right so Mises points out that the originary interest rate is a pure underlying interest rate and that's the real interest rate the real originary ratio but there are other components and one other component as you point out is the fact that when you lend to a productive enterprise to a business the entrepreneur that runs that business is certainly taking a risk and you realize that this business is risky and you don't know everything about the entrepreneur you don't know you have a feeling that he's going to be good at what he does but there is an element of risk and that's reflected in a percentage point or two or higher at which you lend to that person so for example if you're lending if you're buying a bond from a company that makes bread which is something that's always in demand it's unlikely that people will lose their taste for bread and the demand will fall there's only a very small entrepreneurial component but if you're lending to someone who's going to make a Hollywood movie and we know that about 98% of them don't make money only 2% do then there will be a very high entrepreneurial component on the bond you buy from the movie company or the loan you make to them so that's very important so what Mises is trying to point out is that even as a lender you're an entrepreneur even though you're not directly involved in decision making for the business your money is at risk you are, I think Mises says you're virtually a co-owner of the business right and a lot of people are probably getting re-finance offers in their mailbox right now I know I am on their mortgages and there's an example here where they'll give you a lower rate for a 10-year mortgage than they will for a 30 in fixed rate I should say so there's a little less speculation involved in a decade over three decades you know I worry about this stuff Joe because as you drive around Auburn there are skyscrapers excuse me there's hundreds and thousands of new condominiums fancy new condominiums being built in our bucolic little college town of 75,000 people and the workers are still out there during the shutdown right now and that makes one suspect that at least the next level of lending for the project is still in place and that they're operating and the workers are being paid and the things going up and talk about entrepreneurial speculation what if colleges don't return to normal in the fall and what if there's tons of finished but unsold units and imagine all the risk in that and imagine how the interest rate plays into all of that well of course the fact the interest rates they've driven some basic part of the interest rate down to zero that does stimulate this excess borrowing and this production of these buildings that may never be occupied and that's a tremendous waste to society or they may be occupied 10 years from now but in the meantime those capital goods the labor, the cement and so on could have gone to producing other things that consumers consider more urgent, more valuable so there's tremendous waste in those seeing those cranes and those half finished buildings given that the Fed has beaten down interest rates so much they've definitely distorted entrepreneurial decision making and diverted very valuable resources into lines that are not going to pay off and we as consumers are going to have to pay for that in terms of a lower standard of living well let me just say that these student condominiums which are being built all around Auburn are somewhat nicer than my own college living experience that's all I'm going to say the Coutrements involved the swimming pools, the Starbucks and the lobby, the gyms all that sort of thing but you talk about distortions and that leads us into chapter 20 which is called interest credit expansion in the trade cycle and this is a very succinct 50 odd pages that explains Austrian business cycle theory probably as well as any source does and from this section of the book we get the concept of Mao investment to which you just alluded yes so Mao investment is the way Mises uses the term is an investment in wrong things I mean that's what Mao means bad it's a bad investment it's often been said that the Austrian theory of the business cycle which Mises formulated initially and then Hayek helped develop the theory of over investment that too much has been invested but that's not the case at all there's no extra funds to invest there's no extra saving these funds for investment were created out of thin air and so what they've done is resources only a certain amount of resources that can be invested since people haven't changed the amount they're consuming those resources are the same amount that existed before the injection of the new money those things some of those things are now used to invest in the wrong things they're bad investments so we're throwing literally throwing away some of our wealth and that's where the word Mao investment which I think is a very important word and a very important way of describing the Austrian business cycle theory that's where that comes into play and that's really a central theme in Austrian business cycle theory so what's his goal here at the beginning of the chapter when he talks about money's never neutral we don't have what we call the evenly rotating economy and because it's never neutral there's no neutral interest rate per se why would we concern ourselves with this? that's a very important point because economists as it has developed monetary economics since the end of the 19th century the main theory is that of the quantity theory and there's a German truth that quantity theory but where it goes wrong is that it tells us that look if there's a an increase of money supply an increase of 10% in the money supply well prices are going to adjust pretty quickly and they'll increase by 10% all prices will increase by 10% and they'll increase at the same time at the same rate so Mises was very concerned to point out that this is not the way the prices adjust to a change in the money supply in the real world in the real world first of all not everyone is given an extra amount of money like $1200 that they'll be sending us in fact in the real world the money goes into the credit market that is banks get more reserves and they make loans to specific businesses and those businesses then begin to buy certain things invest in certain things and drive those prices up and the workers that they hire with that extra money then begin to spend money let's say on going to Disney World and driving the price of hotel rooms and so on in Florida and then other people other workers may spend that money on going out to fancy restaurants and so the prices of fancy meals go up but other things haven't gone up so as I tell my students, my MBA students teaching at Pace University in New York money starts to trickle throughout the economy but being a college professor my salary is raised every year or every two years and so it's not until all that money begins to trickle back into New York maybe those people are going to Broadway shows now after a year or two of that new money being in the economy and other people are buying financial services eventually the demand for MBA degrees at my university Pace University goes up so it's only two years later that I get the new money and so during those two years there's been a redistribution of real income and wealth away from me I had to pay a higher price for steak for cars, for beer for two years with the same money income and it's only later on that I catch up so what me the importance of all this to the business cycle is that when businesses first spend money they drive the prices of factories up of raw materials, of equipment and that attracts investment away from producing consumer goods to producing the factories and electricity that's needed to produce these various types of equipment and other factories so there's a complete distortion of the economy because of the way money enters the economy it causes price of some goods to go up before price of other goods and that causes real resources to shift away from what consumers really want that is goods today they want McDonald's hamburgers today to goods in the future after these factories are completed so when the Fed stops inflating stops injecting that new money suddenly interest rates go up they never buy the products of these factories the new equipment and so on and we have the recession and bust Joe it strikes me that even if we attempted some technical means of distributing new money neutrally like literally dropping it out of helicopters and somehow magically no one fought over this and everyone got a hundred dollar bill to me it still wouldn't be neutral because first of all a hundred dollars is a very different thing for someone who's very poor versus someone who's very wealthy and also depending on what you want to buy with it there are varying degrees of elasticity of demand right for certain kinds of products it's not all the same like some products even if everyone got a hundred bucks today you wouldn't be able to raise the price at all and some you know a six pack of beer you might be able to double the price right away yeah yeah that's a very good point I often tell my students look if you won ten million dollars in a lottery would you go out and buy the exact same things you have been buying all along now that you're more wealthy of course not so if you double everybody's cash that they have in their purses, wallets and in their bank accounts they're not going to spend that double the amount of cash on the exact same things that they spent the the their income on prior to getting that new wealth they're going to begin to demand different things and that's going to change the whole economy that's going to move resources around well when he talks about the entrepreneurial component all this he's got this great line about where you know when we have changes in the economy which are artificial in a sense because of credit expansion then the market rate of interest fails to fulfill the function it plays in guiding entrepreneurial decisions so that's a that's I guess malinvestment of a sort and would you say my understanding is that Jerome Powell for example has actually used the term you know colloquially before would you say there are whole classes of economists who dispute malinvestment conceptually yeah yeah I think the monetarists for example would dispute malinvestment in the sense that Austrians use it that is that that there's there's investment that should be going into producing what consumers want consumers goods that because it's now now new monies injected through the credit markets that it's now being invested in more factories that are going to be not going to be fully used they would agree however that if the government suddenly began to spend money on more milk and more lunches and so on for poor people that there will be an increase in the demand for those things at the expense of other things and then when the government stopped you would find that suddenly the farmers that was producing those milk for those programs would find that the demand fell and they would go out of business they would agree with that but for some reason they can't get into their heads they can't conceive of the fact that the economy is not only horizontal meaning many different types of consumer goods but also it's vertical that each consumer good is before it can become a consumer good it's a half baked cake it's raw materials it's capital goods that are going into producing those things and that if you produce too many of those half baked cakes there's not going to be enough resources left to finish the cake and turn them into consumer goods so they would dispute that but they're contradicting themselves because they agree if the government suddenly starts spending money bailing out certain businesses and stimulating the production of certain things well yeah if the government stops stimulating production if it stops buying all this milk or whatever it's buying then yeah there's going to be a bust there but they don't agree with it when it comes to the the whole idea of the business cycle now for our listeners would you say that chapter 20 of human action represents the best single exposition of Austrian business cycle theory or do you think it's found elsewhere in the state or somewhere else I think it's the most informative if you've read man economy and state and you understand the cycle on a basic level I think let's say this is the consummation of your understanding of the business cycle because every time I read it and I read it in a few days again I think it's the definitive statement let's put it that way of Austrian business cycle theory I still think it stands up in that way well that's good news to me because ladies and gentlemen that means if you just read this chapter you'll know more than a lot of economists about what we're talking about towards the end of this chapter he makes a point that I think is so important to what we're thinking about now we're talking about booms and busts and what they represent and he says all present day governments are fanatically committed to an easy money policy and that in order to keep the boom going it's not a one time thing the credit expansion has to happen repeatedly but there's this great idea he's got here this great conceptual notion that economic progress actually means improvement in the quality and quantity of products and we're normally talking about a boom is an increase in the quantity and quality of products that's what we'd like to think it is anyway as consumers or as Americans or whatever we think well that's a good times but he says the problem with artificial booms is that there's not an increase in investment there's actually an increase in consumption so how can we ever have a boom when we're not creating or a true boom when we're not increasing capital yeah so from the point of view of mainstream macroeconomists most of whom are Keynesians a boom consistent in producing more stuff that we can measure by the GDP so when real GDP goes up it's great this same mentality was what made people believe that the Soviet Union was going to catch up in productivity in their economy to the U.S. by the 1970s I think or rather by the turn of the millennium by by 2000 so in the 1970s for example Paul Simas made a famous statement that our economies were converging and that the Soviet Union would be as large in the economy as the U.S. which was a complete falsehood it was a joke what the Austrians look at as you pointed out is the quantity and the quality so if you're just producing if you're digging holes and filling them in again that's activity if you're producing dresses as the Soviet Union did that were only one size large or two size large and extra large and petite women didn't have or and children didn't really have any clothing that would fit to them because it was more stuff even though didn't appeal to consumer demand that's a boom but for the Austrian a boom where I would rather call it sustainable growth is producing the right things the things that best satisfy consumers and you can only know that to an undistorted price system where the interest rate tells the truth about how scarce capital is and how much people prefer the present to the future well the other thing you mentioned is that in the course of a deflationary process there should be a tendency for the market interest rate to rise and our Fed never lets that happen we've had several instances probably who knows since 2008 where interest rates were suppressed and not allowed to rise but in fact in our current environment this current shutdown horrifically deflationary well on both the supply and demand side interest rates ought to be allowed to rise am I getting that right? yes no you're absolutely right that's really a key point that he makes and he makes this more emphatically even than Rothbard and that is this once you've once there's been a bust and a recession people realize how wrong they were entrepreneurs begin to lose faith in themselves they lose faith in monetary calculation so with returns of 5 or 10% they're not going to begin to reinvest they're going to hold cash what's going to spur them or stimulate them to begin to invest again and that's a rise in the interest rate in the following sense that's wages falling prices of raw materials and so on falling in relation to consumer goods because these are the prices that were bid up too high by that artificial injection of new money so it's only going to be when people can get a return of 15% or 25% that they're going to start investing again and then eventually as their confidence returns the interest rate can go back down again and right now I'm talking about the original interest rate the interest return that people get on investing in businesses or in what we call a structural production well of course we live in a political world not the perfect world of necessity and economics and so because of the political world we have to understand voters and politicians and central bankers and so he has this interesting passage at the bottom of page 563 where he talks about voters and he says it's a common phenomenon that the individual in his capacity as a voter virtually contradicts his conduct on the market thus for instance he may vote for measures which will raise the price of all commodities well as a buyer he wants to see these prices low I thought that was really interesting because we you know those of us who are Austrian or libertarian might tend to bitch a lot of voters don't know what the hell they're doing they're economic illiterates and they vote for all this crazy stuff that Bernie Sanders offers and if they just understood they'd vote differently and maybe that's true but nonetheless in the short term in the political sense for politicians and central bankers inflation works kind of works for a while I think we have to understand that it works it's an illusionary effect but it does work it does put workers back to work they're doing the wrong things they're producing the wrong things and they're using scarce resources that could be better used elsewhere but a boom is just that it's a boom in business so the unemployment rate does fall okay wages do rise though later on it turns out that prices rise also and therefore real wages haven't risen or only rose for a little while so yeah it does work in the short run people are misled and entrepreneurs are misled into believing that things are getting better well that wraps it up ladies and gentlemen if you get nothing else from these three chapters it's that we need some long-term thinking in this country both on the political side and on the economic side it's what we're facing here is an absolutely unprecedented crisis of time preference and what I've noted of late which is really interesting to me is that this is an issue the sense that the material prosperity we've enjoyed for the last five or ten years since the crash of 08 is artificial that's that you know we may not agree as to the house and why but that's something that permeates across the ideological spectrum there are people left progressives like Naomi Prins out there writing about this talking about this there are sort of right supply ciders like Dan Yeldi and Martino Booth who are writing and talking about this so this is an opportunity as ugly as things are out there for us to be telling a story about what's happening about why the boom was unsustainable and why the bust was inevitable and we're so grateful to Dr. Joe Salerno for joining us again we'll promote the book you can read it for free online and html format at our site mrs.org just look for human action but also you can go to our bookstore and enter the code HAPOD HAPOD for human action podcasts and get a discount on either the beautiful hard cover scholars edition which we've been using and also a very inexpensive tiny print little paperback which I think is only five dollars with the code so check out the book you know spend some of your free time at home now if you're quarantined or self-quarantined to maybe spend a little time with Mises and you'll come out of it on the other end a lot better informed a lot smarter and I think you'll really have a sense of personal satisfaction from having read and wrestled with this book because it's it's a weighty book so Joe it was great to talk to you and I just hoped that all of our listeners 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