 Welcome back to Mises Weekends. I'm your host Jeff Deist and this weekend we are talking about last Monday's Mini crash in the equity markets Bloomberg is reporting that the world's 400 richest people a.k.a. The Forbes 400 lost about 124 billion dollars in wealth at least on paper Monday alone So here to talk about what we should make of all this and whether deflationary crashes are actually the cure Rather than the problem is our own dr. Joe Salerno. So if you're interested in markets, stay tuned for a great interview Dr. Joe Salerno, welcome back to Mises Weekends. How are you? Thank you? I'm fine. I'm happy to be here to begin Joe, I'd like your thoughts on last Monday's stock market crash I see Bloomberg is reporting that the Forbes 400 wealthiest families lost about 124 billion dollars At least an equity value on Monday alone. Should we view this as a loss in real wealth? There was this all just a paper loss. It was it was paper wealth It's false wealth that has resulted from the zero interest rate policies of the Fed When you push interest rates down that low what happens is that you know future Incomes are capitalized at a much higher value So households look at their balance sheets and they see their 401ks going up and they see the value their homes going up and so on and that gives them the full sense of security and the prices savings rates as we saw in the Early part of the 2000s same thing is happening today Of course, the losses feel very real to the average investor They endure a lot of psychic pain and at least on paper They now have less money than they had before last Monday Absolutely, not only do they think they had more than they do but they also Active on on that premise and they didn't save enough or they reduced their saving rates Which means that they're making themselves poor in the future again thinking that that they had all of this wealth already stored up It's interesting Joe that the financial press correctly identifies Monday's mini crashes a deflationary event of sorts But they never want to talk about the inflationary monetary policy that led up to the crash itself that led Equity prices to be overheated in other words for a bubble to burst there has to be something that inflated it in the first place Yeah, well the problem is twofold one mainstream economists have convinced journalists and so on that when that inflation is Simultaneous increase in all prices in some sense that it all happens at once But as Austrians we know that's not true that it happens step by step that it affects first one sector Then the next sector first housing and then maybe equities and so on and eventually affects prices of everyday goods that we purchase and and number two There's a problem because Milton Milton treatment for example has sort of banished He has a lot of influence and he's banished the whole idea of asset inflation from a vocabulary That's starting to come back now But when people talk about inflation or deflation They are only referring to the prices of consumer goods or or or wholesale of producer goods They never look at at asset markets anymore And that's because of these theories that were developed by Keynes and then later by Friedman Joe deflation is routinely characterized as a monster to be slayed something that Monitoring fiscal policy has to fight against but if deflation is defined as falling prices as a result of greater productivity Isn't it benevolent? I mean why is it so hard for people to understand deflation as a benevolent phenomenon? because they've been convinced that prosperity means rising prices and that The way the Fed operates during periods of growing real Output we've also had increasing prices with the Fed increases the money supply at the same time So people have had a look on that phenomenon as sort of all part of the same thing That is prosperity means increases in my nominal income my my the price of what I sell going up And so they don't understand that prosperity can also be distributed throughout the economy by falling prices And your income your nominal income your salary and so on staying the same But being able to purchase more real goods and services That's the natural way that an economy grows where you have a gold standard of some other market commodity is money So Joe since the great crash of 2008 the monetary base Basically the Fed's balance sheet has more than quadrupled in the same period the Dow Has roughly tripled so doesn't this suggest that there's potentially a much greater than 10% downside out there for equity markets Yeah one one reason why they should be aware it is because eventually There's going to be banks as Let's assume that they they buy a speculative story in a sense that they believe the economy really is improving and you you begin To get more lending and so on what's going to happen is that the money supply not not the base money But the money supply the money deposits and currency in the hands of everyday people is going to increase And we're going to have a burst of inflation in consumer goods prices and so the Fed may react to that by Beginning to sell off part of its balance sheet That is to get rid of the mortgage-backed securities and so on and at that point You know who knows what's going to happen to the housing sector Joe Do you think Monday's crash puts to rest any possibility that the Fed will raise interest rates in the fall? You know I saw something very interesting Well, you know William Dudley the president of New York said yesterday said that It does put it in doubt that they'll raise interest rates or makes the case less strong for raising interest rates, but the guy named Dalio Who is the head of a hedge fund a billionaire mentioned that he sees maybe them raising Interest rates very very, you know 25 or 50 basis points but then going ahead after that and using that as a cover to Continue QE that is to bring in another round of quantitative easing in which they go crazy and and and buy Begin buying up assets and expanding the balance sheet again So he sees them you're carrying through on what they said But in a way that really is neutralized by what they do after that that is Implementing another round of quantitative easing. I find that very plausible Joe people watch what the Fed does and what it says because they want to get some predictive value out of it, right? What they want to do is time markets But there's so many billions of inputs involved in any particular stock market and so many billions of individual actors across the world You know, how should we view this idea of market timing and the tremendous knowledge problem that goes into any attempt to succeed at market timing? Okay, the Austrian stress that that the unit of analysis in economics is the human being and human human decision and we know that human decisions and Actions depend on expectations about the future and those Expectations are very volatile or they can be very volatile Especially in a period of monetary disequilibrium that we have today So what what what happens is that yes, there's going to be certain movements or certain trends But we don't and as Austrians we know that a bubble can't last forever But there are a lot of stories out there that drive the bubble what a Brendan Brown call speculative stories And one of those stories came to an end today came to an end this week, of course That the Chinese economy was so strong and and recently we know the story about commodities continually going up and the US having a miracle and in the Shale oil and gas that came to an end to as commodity prices have tested new lows Bottom line is that you cannot time because you cannot predict The changes in expectations that that people go through during a period of monetary disequilibrium Well, you bring up China Can we put to bed once and for all this myth that when a country devalues its currency it can somehow create? generalized economic prosperity by doing so yes What's happened there though is you know people are blaming China in some sense for Taking a shot in the currency war, but really what happened was that its currency was losing value They were actually holding the currency up They were buying up their own currency, which is the opposite of what they were doing You know in the past when they bought up US dollars to keep the value of the dollar higher So all they did was they on they unhinged it from from the peg I mean a peg is a price control and they allowed it to drop 2% I Whereas for example, if you look at The euro the euro for a while dropped by about 10 to 20 percent against the US dollar and other currencies have dropped against the US dollar and no one has Has really complained about about that as being a part of the currency war So so so China was was just that's not the problem with China The real problem with China is that from 19 on up from 2009 Until this year it's been increasing the money supply on a yearly basis by 15 to 30 percent And that has caused a tremendous bubble in the stock exchange in real estate sector and so on and just in the last year They've decreased the rate of growth in the money supply to 10 percent So as Hayek's pointed out when an economy becomes Adjusted to to a very high rate of inflation Even if you cut back that rate of inflation or rate of monetary growth to something that's lower like 10 percent, which is very high you begin to get the the first the beginnings of What we might call a recession Okay, and and and financial disarray and that's what you see in China But shouldn't we cheer the fact that China is no longer engaged in price fixing by pegging its currency to the dollar Yeah, I mean in fact we we wanted them to stop Keeping the value of the dollar up. We told them to stop price fixing a number of years ago We put pressure on them the IMF put pressure on them And now that that the tendency of their currency is to drop suddenly everybody's up in arms about what China has done Well, I applaud what they've done You know Given that we have national fiat currencies Which are each controlled by their own nation's central banks. They're different commodities and they should Fluctuate in value against one another. It tells the truth about their their actual values So when a country or a central bank purposely sets out to devalue its currency Isn't it just in effect shifting wealth from savers to exporters? Yes, and that's only in the short run by the way As you devalue your currency, obviously you what what you're doing is you're printing up more of your currency um And putting into circulation to drive down the value of your currency now If exchange rates change first and they usually do so the value of your currency goes down You do give a boost to your exporters at the expense of your consumers at home We'll have to now pay higher prices because your currency is cheaper But eventually that's offset by the fact that prices rise in your country as a result of the greater amount of Currency in circulation so in order to keep boosting exports You have to inject new money into the economy again and again to keep the to keep the the currency depreciating and and so you get into a circle of inflation Joe one last question for you at our event earlier this year in stanford connecticut both david stockman and jim grant We're talking about the importance of the federal funds rate And stockman calls it the single most important price in the entire economy And for those unfamiliar, we're talking about the overnight rate at which commercial banks Borrow from each other for liquidity purposes. Can you talk about the systemic effects that flow throughout the entire economy? When the fed engineers or suppresses the overnight federal funds rate? Yeah, yes, because the interest rate is part of every price Okay, our economy is a structure of prices that incorporates Time that there are time at all prices if you have any sort of a capital good or a piece of land The value of that land depends on how you value money over time So when you distort the interest rate, you change the whole into what we might call inter temporal Structure of prices. So the interest rate really is a proxy for this the structure of prices Which is then distorted and that's What james grant's point was and and he was quite correct What has to happen is that the fed has to step back and allow Interest rates to adjust to what we austrians call their natural level which will reflect the actual profits Or long-term profit being earned in various production processes Right now the economy is over financialized in the sense that It's it's finance and interest rates that are driving the economy rather than the other way around The real economy Entrepreneurial investments and so on should be what drives the values of stocks bonds the height of interest rates and so on Dr. Joe Salerno, I really appreciate your time today and thanks for coming on the show ladies and gentlemen You have a great weekend