 This is Mises Weekends with your host, Jeff Deist. Ladies and gentlemen, welcome back once again to Mises Weekends. I'm your host, Jeff Deist. As you can see, our guest is Mark Thornton, our own senior fellow here at the Mises Institute and someone who was very prescient during the mid-2000s in calling the housing and stock market bubbles that ended up ravaging so many buyers just 10 years ago now. And because he was so prescient, I think we ought to be listening to him about the current situation, which feels very dangerous, which feels very bubbly. He's got a new book coming out on this very subject called The Skyscraper Curse, which the Mises Institute plans to release this spring, perhaps around May. So we'll talk about that a bit as well. But Mark, let's start with this. Our new Fed Chair, Jerome Powell, took over on Monday after a very volatile Friday. Again, this week, just yesterday on Thursday, the Dow lost another 1,000 points. He's had a rough week. Do you think he is going to be as committed as Yellen and Bernanke before him to sort of propping things up, or do you think he is going to be more hawkish than his predecessors and sort of hold the line when it comes to tapering and not engaging in more QE? Well, I have to admit that I wouldn't want his job right now. I certainly don't blame him for the volatility in the stock market. Some people have mentioned the fact that he came on board along with the 1,000-point crash in the Dow. He is considered pretty much in the same line of thinking as Janet Yellen, maybe slightly more hawkish. And he's, of course, he's not academic. He doesn't come from an academic background. He comes more from a business-type background, a legal-type background. So you can expect him to support the status quo. You can expect him to support the establishment cause. But otherwise, I wouldn't think there would be much difference between him and his predecessors at the Fed. But that's interesting to me that he's a lawyer. And apparently when he first came to the Fed, obviously not as chair, but as an economist there, apparently he was very adept at devouring a lot of knowledge about monetary policy and history. But doesn't that strike you as strange in this sort of technocratic age that we have a non-economist, or at least by his original training at the helm of the Fed? Well, you know, I don't really like the idea of academics, mainstream academic economists being in charge and controlling the board and all that. I think that's a mistake. I think you need a mainstream economist on there. You should also have an Austrian economist who specializes in macroeconomics on there as well. That's clearly what's been missing at the Fed. But otherwise, yeah, I'd like to see lawyers, I'd like to see bankers, especially people who are interested in making sure the banks don't go down the tubes, who don't, you know, policy doesn't set the banks up for failure. And that's essentially what the academic economists who have been at the Fed have been doing. Well, if we go back to the period before the last crash, so call it the mid-2000s. First, on Greenspan later, Ben Bernanke, we're talking about the fundamentals and the economy, we're sound. When other people were like yourself, we're writing about the housing bubble. Jim Cramer, you recall, he had that mad money show and he was hyping all these different stocks and we had cab drivers and waitresses buying multiple condominiums and day trading, this sort of thing. Does it feel like that period again to you? I know that's not a well-defined term, but does it feel like we're up against something as dangerous? Oh yes, very much so. Every cycle is gonna be different. Every cycle is gonna have a different name to it, but the types of behavior that you identified with the housing bubble, the day traders and the cab drivers giving tips and all that stuff, that has come back, it doesn't seem exactly the same, but I think people are a little more reserved than they were the last time around because they got burned. I'm talking about the same people. The rotation of people between cycles is significant enough, but with this bull market, this bubble in the stock market, many of the people are the same people who were around during the housing bubble. Now on Wall Street, it's probably a little different. The turnover on Wall Street with the traders and the bankers and that sort of thing, they don't last that long on Wall Street. 10, 12 years is a career, and so there's probably been more turnover on Wall Street than there has been on Main Street. Yeah, it's interesting when Janet Yellen had a retirement party the other day. They had a lot of photos of some of the Fed economists, and they were very young, definitely millennial heavy, and many of them haven't seen a lot of down times in the markets. That's going to be interesting to see if Powell presumably has to rely on these people. I want to touch on something you identified in one of the papers you wrote in 2004. We'll link to both of these papers on Mises Org and with the show. You talked about CPI and how one way it has a blind spot in really properly measuring inflation is that when it comes to the housing price component, it measures it in terms of an average rental price rather than what it requires to actually purchase a house. And when there's this huge dichotomy between what a house costs to rent versus buy, that's a warning sign for you. And you indicated that this is one of the tricks that allows FedGov to conceal inflation. Yeah, concealing consumer price inflation. Of course, there's inflation all around us in bond markets and stock markets, but if we look at consumer prices, of course, housing is the single biggest item in the consumer's budget. So consumer price index has to measure housing somehow. And it's very, very difficult to measure housing prices because every house is different and every house is different over time. So they use rental equivalents with respect to housing to measure housing prices. The problem there is when you get into a housing bubble and the demand for housing goes up as renters become buyers, the demand for condos and apartments goes down. And consequently, the CPI is measuring falling housing prices while housing prices for sale are actually going up. So they're moving in the exact opposite direction. This is very unusual. And it's a sure sign that something at the Fed is a miss and something that in the residential area is gone horribly wrong because those two things should go hand in hand in a normal natural free market economy. Do you think CPI is manipulated for political reasons? In other words, is that overstating it or there's obviously a tendency by any current administration to want to downplay inflation. Do you think CPI is useless or do you think it has benefit? Well, we certainly have to have something to grasp onto the CPI consumer price index has many faults to it. Whether it's politically motivated or not, there's certainly an interest at the Fed to keep it down as low as possible. But on the policy side, they say they're suffering from a CPI that's too low. So they want the policy mechanism to increase CPI but their natural tendency is to want to reduce it. So CPI is sort of a way for the Fed to take credit for increases in productivity in the economy. And there's some natural reasons why the CPI is biased downwards. For example, if something is going up in price over time, it tends to be either eliminated from the basket or its weight is reduced. If something is coming down in price electronics, for example, and people are buying more and more of it, so as the price falls and the demand increases, there's a natural tendency that when there is a revision that the weight either enters the basket as a new product or its weight is increased. So talking about the stock market crash that happened earlier this week, there's a lot of crashes, multiple, apparently the dows regained much of what it lost. But what are some of the things that you, Mark Thornton, look at as indicators that we might be near the top of a very unpleasant bubble in whatever market? Well, as we came into this year, 2018, the thing that I was looking at most was the bullishness in the markets and the bearishness in the markets. And right now, basically, until these many crashes that we've seen in the last week or so, bullishness was at an all-time high. And bearishness was at an all-time low. So if you look at things like the amount of cash mutual funds hold really near an all-time record low, that means that mutual fund managers are very bullish. And all of those indicators were as we moved into January, January, the bullish indicators were at all-time highs or near it and bearish indicators were at all-time lows. So that's a contrary indicator, but I think you really have to keep your eye on that one. Well, it's interesting, if you say fund managers are deploying their cash capital rather than sitting on it, they want it active in the market, why aren't banks lending the way they used to be prior to the crash of 0809? And we have all these bank reserves that the Fed's created through successive rounds of QE and a lot of it's just sitting there in the monetary base rather than being actually lent out. Well, the amount of margin loans actually, I think is at or near an all-time high. So yeah, that's another indicator. When the amount of margin loans increases, that's a very bullish indicator. It means you're probably in a bubble and headed for a crash. And then, of course, once you start crashing, then of course people pay back that margin loans as much as possible. And typically at the bottom of the stock market cycle, you see very low levels of margin debt. So it's the typical scenario where people are buying high and selling low, which is very unfortunate, of course. So when we look at crashes in the past, generally the public is looking at things like there's a stock market crash itself. There's a big spike in unemployment. There's a big drop in housing prices. These are the kind of things we normally look at. But what's interesting is that they don't always occur at the same time and they can happen in sort of fits and starts. So this time around, what should we be looking at? Is it the Dow? Is it the overheated equity markets or is it something else? Yes, that's absolutely right. It never comes in one whoosh. It's a day-to-day thing. It takes time to develop. It takes time for people to change their psychology. So for example, we've seen people the last week or so during this turmoil, they've been sticking with some of these very hot stocks like Amazon and Facebook and all that stuff because they've been so good. And the losses in the more general stock market, the S&P 500 and the Dow have actually stayed apace with those hot sellers. So those hot stocks. And so yeah, you really do wanna look underneath the hood, so to speak. And the two that I look at at this timeframe, when things have started to happen, but we don't know where they're going, which is kind of what everybody admits to, is the small cap stocks, the small cap index, the Russell 2000 index. These are smaller corporations. They don't have the muscle that the S&P 500 has. And so it's a quicker monitor of risk in the economy. So if there is real risk coming into the economy, people tend to bail out on the small cap stocks first because they're more vulnerable. And the other thing I look at is oil prices. Oil prices is a great indicator of where the economy is and where it's going. It's the master resource in the world economy. And so it's an accurate, fairly accurate gauge of the fundamentals in the economy and demand and things like that. And what's happened to small cap stocks and oil prices is they've fallen almost 10% each since last week. And so those two leading edges of markets, tell me that there's something real here. What's surprising maybe about the crash of 2008 was that most commodities dropped, but some gold and other precious metals didn't. So even in a certain sector like commodities, you can have different outcomes. Oh yeah, the commodity market, for example, is consistent many, many markets. And of course, gold and oil held up very well in the wake of that. As all the central bank money came in, there was plenty of money around to keep the demand for those two commodities high for a considerable period of time. They both crashed. And now what we've seen is a more sounder foundation for commodity markets. And so precious metal prices have recovered somewhat and I expect that to continue. Energy prices have recovered somewhat that will probably continue. And then this is all gonna bleed over into other commodities such as grains and metals and that sort of thing to the extent that they're not related to probably industrial production. So looking at commodity prices and looking at the different types of commodity areas I think is very useful. And it gives, there's a sort of a long-term element in commodity price relations. For example, oil prices are related to fertilizer prices and fertilizer prices are related to grain prices and grain prices are related to cattle prices and that takes place over a period of time. So as one market is jiggled a little bit, it filters through to the fertilizer, to the grains, to the meats and so forth. And so, Austrians don't like overall price indexes because they mask some of the real features and functions of what's going on in the economy. But if you break down commodity price indexes, for example, you can see the flow of the economy, the flow of these materials over time, the workings of everything before it becomes consumer goods. So we love that kind of thing. Well, in addition to commodities, there's a whole nother market we need to consider the crypto market. Do you think the recent crash in Bitcoin and some other coins has anything to do with the broader macroeconomy or is it sort of a separate market that's still emerging and finding its own way? For the long time in its infancy, I think cryptocurrencies were a completely separate matter. And I think that the more recent bubble in cryptocurrencies and the subsequent crash means that cryptocurrencies are being integrated into the wider macroeconomy. And institutionally, of course, Bitcoin has become part of actual markets now. You can buy futures, you can buy these things independently of Bitcoin itself. And so that's a tangible sign that it's become part of the overall macroeconomy. And symptomatically, of course, its bubble and subsequent bust is another symptom of what has been happening in central banks around the world. You know, there are indices out there that attempt to gauge volatility, like the VIX, do you put any stock in those? Can they help us sense when it's time to get out of a market? Well, I do look at the VIX, I think it's an important tool to understanding what's going on in a market today or the last week or the last month. And what we've seen is since the financial crisis is that the VIX, as a measure of volatility, has been in a downward path, it's been at record lows. And you'd like to be able to say, okay, it's at a record low. That means that we're gonna get more volatility in the future. And eventually that will happen, but as an investment vehicle, you can be completely out of the money by the time anything does happen. So it's probably something we should keep our eye on, but in terms of investing, it's an incredibly tricky vehicle to try to make money off of. But this comes up all the time, the question of timing, right? That's what people really want from economists. They want forecasts and predictions. And it's also, I would say, a criticism level at the Austrian business cycle theory. In other words, if you can't tell me when all this newly created money is going to cause a bubble to burst, then what good is it? So devil's advocate, talk a little bit about Austrian business cycle theory. And do you think business cycle theory is correct but incomplete, for example? The Austrian business cycle theory doesn't really give us any actual tools to measure the magnitude, the timing and severity of what's going on during the bubble or what's going on during the crash. And so we're basically left at that point and Austrian economic theory, then you have to add additional tools, technical analysis, fundamental analysis, psychological factors. And I think the psychological factors, if you're paying attention to people becoming day traders or bartenders giving away tips and people leaving their jobs because they've made so much money, somebody who has no talents really for making money but ends up becoming super wealthy because they were just invested in the right thing at the right time and so they're quitting their job, all those things you have to pay attention to as well. So Austrian business cycle theory is a general guide but to get specific and make timely forecast is incredibly difficult and you have to rely on other tools other than Austrian economics. Although Austrian economics will tell you a little bit about psychology matters and that timing matters and that all sorts of other factors that are described just describing a business cycle. So it points you in the right direction but doesn't actually provide you with the tools. But the criticisms of Austrian view of money more generally but more specifically the Austrian business cycle theory, I'm not sure our critics really believe that inflation, price inflation in anything, stocks, houses, whatever it might be is a monetary phenomenon. I think they just reject that. In other words, a Krugman would say as long as interest rates are kept low that no amount of QE will be harmful. This seems like magic to an average person. So describe how our critics would see this. Well, it's a puzzle to me as well. I mean, I have a difficult time understanding why so many people can't even understand a very simple theory like the Austrian business cycle theory but Keynesians believe that everything is based on psychology. Other mainstream economists believe that everything is the result of some random technological shock. Austrians incorporate both of those things except we provide an economic cause. That's one of the things that nobody else does is we provide an economic cause of the business cycle which is artificially manipulated interest rates. For mainstream economists, other than the Keynesians, it's just random shocks that you can't do anything about that you can't anticipate. So you won't hear Chicago economists really saying anything about the business cycle until after the fact. Keynesian economists will typically start out with their explanation for a boom bus cycle or a crash in the marketplaces. For whatever reason, this happened and then there's a result. The psychology went down and then people stopped investing and then people stopped buying and so they give you a description but for the cause, their cause is for whatever reason. That's a quote from Krugman from the previous cycle going back and you can hear and read a lot of economists from the Keynesian school who will say that just for whatever reason, this happened, mystery and that set off a series of changes in the economy which put us into a recession. But if it's true, at least in the minds of someone like Paul Krugman that you can create all these new bank reserves and give all these commercial banks hundreds of millions of dollars, trillions of dollars actually in new reserves at the Fed and as long as they're not sort of actively out there leveraging on that to create a bunch of new loans in the economy that no harm will come of it, well then what was the point? In other words, has QE just been a sort of cronious recapitalization of commercial banks who found themselves in trouble in 08? Yes, basically the answer to that is yes, is that the Fed took all of these risky assets off of the hands of the banks and gave them reserves which are not risk, there is no risk associated with it so they reflated the balance sheets of the banks and they gave banks a dependable source of income by paying them interest on the excess reserves and through that in other means basically they stabilized the balance sheets of the banks as they existed back then, of course they've created a very bad balance sheet for the Fed at the same time, if interest rates go up and they have gone up a little bit and the yield curve is flattening which is another bad sign, the Fed's balance sheet is gonna look awful if the interest rate on government bonds increases from where they are now to maybe four, five percent that's gonna make their balance sheet look bad and if when the real estate market tanks, all of their mortgage-backed securities are gonna start looking really bad as well. So you can delay things, you can transfer problems around but the Fed has no magic wand for turning bad investments into good investments and to turning government debt making it disappear. And even if they could, is that really a good thing for the economy or is that just another bad thing for the economy adding problems to the existing problems? Well, ladies and gentlemen, Mark Thornton, Dr. Mark Thornton was one of the few economists who called both the housing stock market crashes of the late 2000s. So really we ought to be listening to him rather than the talking heads at Bloomberg or CNBC. His new book is going to be called The Sky Shaper Curse, it's gonna be out in a few months. It might turn out to be a very timely bookmark for 2018. Let's hope it's not too timely because I don't wish a crash on the American people but it sure seems like what the Fed has been doing is setting us up for just that. So with that, thank you so much, Mark, for your time, ladies and gentlemen, have a great weekend. Subscribe to Mises Weekends via iTunes U, Stitcher and SoundCloud or listen on Mises.org and YouTube.