 This is Jeff Deist and you're listening to the Human Action Podcast. Ladies and gentlemen, welcome back once again to the Human Action Podcast. It is great to be with you. And this is the podcast where we're not afraid to get a little bit into the weeds on aspects of economics and economic theory, and in particular Austrian economics. And we have been talking a lot about various books by Haslitt and Mises and Bambereverk and Hayek. And we've been going through some of these books. And as mentioned on an earlier show, we are soon going to embark on a lengthy multi-podcast episode analysis of Human Action. We're going to have a really good time walking through that book. And it's going to be an excellent opportunity for those of you who maybe have read portions of it or are a little frightened or put off by its size to brawl up your sleeves and make the commitment to actually reading it slowly. And I think that you'll find Mises is somebody worth reckoning with and someone who will broaden your mind and expand your horizons because it's a book that I think anyone who wants to be at least semi-serious about their knowledge of economics needs to tackle. That said, we are pleased to join, at least on the new format for the first time, our great friend, Dr. Bob Murphy. So Bob, great to talk to you this morning. Great to talk to you, Jeff. And yeah, let me just echo for those who are really into Austrian economics that, yeah, reading Mises' Human Action is something you got to do. And the language is a little bit tricky at first. But once you understand how he writes, it's actually not that hard. So I would encourage people to definitely listen to Jeff's series on that. Well, what's interesting, Bob, about that book is that a lot of liberal arts majors, like myself, actually enjoy part one of that book the most, whereas most people, I think a lot of professional economists, don't like the first part of that book. That's their least favorite part. Yeah, and I'm embarrassed to admit, I think possibly 15 years ago, I might have told an economics major, oh, just if you need to skip the beginning part where he's just talking about, you know, more like philosophy, just get into the meat of it, and you'll get the quick payoff. And now, yeah, as you say, Jeff, I realize, no, some of the stuff he does in the beginning is really foundational. And that's perhaps the most important thing he does in that book. So yes, I agree with you that I know like philosophy majors tell me their favorite part of human action is the first part. Well, at any rate, you know, what you won't find in that book is a single equation or chart. So when Mises was derided or criticized as a literary economist, that's why. There are a lot of words in that book, Bob. Yeah. So I want to talk about understanding this negative interest rate phenomenon because I think it's really important for our audience to get an idea of where this is coming from, how and why. And hopefully, you will recall, good listener, that a few episodes back, we had Dr. Jeffrey Herbner. We talked about interest rates. We went into Bamberavik and we laid out some various theories of interest rates and tried to understand and grapple with where Austrians came down on all of this as sort of a time preference ratio. So first and foremost, Bob, let's think about that. Take the classical economists, for example. They had this idea of interest rates represent some sort of meeting in the minds of some sort of return on capital. And that's a book that's used in their positive theory of interest. So why would interest rates ever be negative if they represent a return on your capital? I don't get it. Right. And that's a great question. And yeah, and actually just for listeners who go read some of the classical stuff, there was, depending on how far back you go, they would tend to use the word profit sometimes also to mean what we nowadays would mean as an interest return on your invested capital. And so that was the thing that came later, the distinction between profit and what we would call interest. And so just people should keep that in mind that there's that element. And you even see it in modern accounting that what an accountant would refer to as a profit, with net income of the firm, that revenue is above expenses, we would say, oh, yeah, but most of that is just interest. It's not really pure economic profit. So that distinction came later in terms of economic theory. But you're right, it is problematic. And I should say, Jeff, before we observed it with our own eyes, economists, and I would have been included in this, would have said just matter of factly that you can't have negative nominal interest rates, right? So nominal meaning like the actual money amounts being paid, not adjusting for changes in prices or the real interest rate. And the logic was pretty simple. Why would you get $100? Why would you lend it to somebody if he was going to give you $99 next year? Wouldn't you just sit on it? And so that, yeah, that's, and so I think the explanation of what's going on, at least the standard view, is that because growth prospects are so meager right now, and because there's so much uncertainty, the lot of investors would be willing to give up $100,000 now in exchange for $99,999 next year, guarantee, or not guaranteed, there's no literal guarantee, but pledged by a very reputable institution. And so that's why we'll see the actual rates that are negative, they're not very negative, right? It's I think 0.5, negative 0.5% is the most negative in terms of the ECB. So it's not very negative because people could just go to cash, but when you walk through the logistics of it and say, well, yeah, if you were going to have hundreds of thousands in actual currency, you'd have to get insurance on that, you know, you'd have to put it in a vault somewhere. So there are expenses, and I think that's what's driving this. And so you're right, Jeff, that it's in terms of saying, oh, how much am I being paid for the use of my capital? It's not so much, I guess it's just supplying demand that the way things are right now in Europe and Japan, it's the investment prospects are so bleak that if you really want to have something that's fairly safe, actually, you're willing to pay somebody else to guarantee you that purchasing power down the road. But the way things are is because Central Bank and Treasury interventions, correct? In other words, this isn't the market per se. Right, so that would be my, yeah, so everything I've set up till now, I think most mainstream economists and Austrians would endorse. And so yeah, now at this point is where our ways differ. So yes, I personally think, and I think probably most Austrians do as well, that what we're seeing is like the logical absurdity of Keynesian macro policy, right? Well, what do you do when there's a sluggish economy? Well, you push interest rates down. And so you can imagine 10 years ago it's a reductio ad absurdum if Austrians said, okay, well what if you push them down to zero and it still doesn't work and then a Keynesian, would you make them go negative, haha, and probably most people would say, well no, that would never be an issue, and now we are actually seeing that. And so you're right, to me this shows the futility and the absurdity and the bankruptcy intellectually of the Keynesian approach and you're right, Jeff. I mean, certainly I would say, you know, the reason economies are in a bad situation is because of the boom bus cycle that previous rounds of monetary intervention have fostered. So the very, you know, I'm quite confident in saying that, but in other words, if we had had a free market and money in banking for the last 30 years, we wouldn't be in this situation where, you know, the growth prospects are so abysmal that some investors are willing to tolerate nominal negative, slightly negative rates. And also, too, I mean, it's funny, as people are saying, oh no, this is just the market, this is how bad things are, it has nothing to do with central bank interventions. It's like, well then, how come all the central bank balance sheets are so bloated? You know what I mean? In other words, I would take that perspective more seriously, the people who are saying, nope, it's just the natural interest rate, you know, the rate that clears the markets happens to be slightly negative now, get used to it, and central banks are just passively reflecting, you know, reality, because again, Jeff, that's what a lot of mainstream people are saying now. I would take that view more seriously if central bank balance sheets were like they were in 2007, but of course, they're not. They're, you know, they've multiplied greatly, it's not just the Fed, but all the other central banks as well. So it's pretty, to me, it's pretty obvious, yeah, central banks were cutting interest rates and they were injecting unprecedented amounts of base money into the system, and so if you want to say, why are interest rates so low, I would say, well, because they're doing what the textbooks said they were supposed to do. They pumped in a bunch of money and they pushed down interest rates. So that's the classical, or even the Keynesian look at interest rates. What about the Marxists? Bob, they say, well, look, the capitalist has capital, and he loans it to the poor proletarian worker, and the worker has to pay back the capital and interest, and that interest is exploitative. He's taking that excess from the workers, the sweat of the workers' brow. But if interest rates are negative, I don't understand how that gels with the whole Marxist conception of interest rates. Yeah, that's a great observation, and I had so I personally hadn't even thought of that until you just brought it up. Well, you mentioned it, you gave me a little warning to have my wheels going before we started recording, but yeah, I had not thought of that. So you're right, just to recap for the listener, in the standard Marxist view, the explanation of what's the source of interest, and again, if you go look it up, they might have called it profit because in the classical mindset profit just meant the difference between revenues and explicit monetary expenses, so that would include what we nowadays classify as the portion that just goes for interest on the invested capital. Yeah, the idea was the capitalists are the ones with the funds, they can afford to wait and so whereas the workers are on the verge of starvation all the time and so the capitalists have all the bargaining power and so even if the workers collectively at a factory produce a million dollars worth of stuff, then the capitalists can afford to just pay them $900,000 in wages because again, they have all the bargaining power and the workers, they accept it because they have to because they got to feed their families and so then that $100,000 gap is due to just the Marxist exploitation that the capitalists, the surplus they skim off the top from exploiting the workers, from underpaying the workers the true value of their product and so that's the standard view and just incidentally that was one of Bumbaverk's most damning decisive critiques of the Marxist approach was to point out and said, okay if that theory of where interest comes from is correct then empirically we should see industries that are more capital intensive they should have versus ones that are more labor intensive you should see a difference in the rate of return on capital if you have a business that's mostly just hiring workers then that should have a higher rate of exploitation or rate of surplus than one that's just paying for machines because if capitalists are just buying machines from other capitalists there's no source for exploitation, it's the systematic underpaying of wages it's the source of it so again other things equal if there's an industry that's very labor intensive like hair cutting let's say, you know, capitalists who open up a bunch of hair salons in most of your expenses are just paying wages to the hairdressers the rate of return on your invested capital there should be a lot higher than in something like offshore oil drilling where most of the money you spend up front as a capitalist is not hiring the workers but buying all the equipment and everything to go drilling and set up the rig and so forth and yet empirically of course that's not what you see competition ensures that the rate of return on invested capital is roughly equalized at least, you know, taking account risk across industries so that was one of Bumbavarick's, you know, most damning critiques and Marx never really solved that problem so as far as nowadays I confess Jeff, I haven't seen what my guess is Marxist would point to this and say this is the failure of capitalism right, the internal logic of capitalism it always needs to expand, you know, find more markets and grind down profit margins and this is the, you know, so is the seeds of its own destruction and, you know, we see now that returns have actually been driven negative and this is what Marx predicted I'm guessing that's how they would handle it but in terms of, according to their own theory, does this make any sense? No, it really doesn't because it would mean that the capitalists are paying workers more than the value of their product which seems kind of silly, you know couldn't their capital just refrain from doing that Well Bob, but the alternative here is maybe, just maybe, today what's today? It is September 23rd 2019, maybe today is the day that Jeff Deist, non-economist actually added a little tidbit to economic thought could that possibly be the explanation? I certainly would be happy for that for you if that were the case like I said, you thought of that and I hadn't, I don't know if other economists hadn't thought of it but yeah, I've not seen anyone ask what, you know, how does this, you know, how does a Marxist reconcile this? So again, I'm virtually I would be willing to bet a lot of money that Marxists are not going to say you know what, turns out we were wrong that everybody interprets current events and say yep, we just nailed it, everyone says that Keynes in Chicago school Austrians But let's be fair, if in any way that negative interest rates could occur in a naturally occurring market I don't think that's the case but maybe I'm wrong If they could, that's a challenge to Austrian interest theory too because the whole concept of time preference doesn't make sense if interest rates are negative Well here, so I don't want to speak for all Austrians but I don't know if you and Jeff Herbner got into this but Walter Block for example has this article I think it's called negative interest rates colon a taxonomic critique where he's giving a taxonomy and saying these are the different things So for example the pure time preference theory of interest is based on the fundamental premise that present goods are preferred to future goods Other things equal and so you come up with cases where in the beginning of June and someone says do you want fireworks now or do you want them next month on July 4th and so if somebody says I want them on July 4th that's not a violation of time preference because other things aren't equal So likewise here when you get into it and you say even if it were occurring in the marketplace you know like if there were going to be a huge famine predicted next year and it was because of natural causes and you know so you'd still want to have free market capitalism as the best social mechanism for humans to deal with this impending famine you know because again maybe like something just changing the soil or whatever there's an asteroid hits earth and kicks up dust and sunlight can't get through or whatever still you could imagine a situation where because we predict that crop yields are going to be so low next year that people right now are willing to give up 100 bushels of wheat today in exchange for 50 bushels next year so in a sense that's a negative 50% real rate of interest that wouldn't be a violation of time preference because Austrians would just say other things aren't equal so likewise here so I you know as we said I think the reason we're seeing these negative interest rate is because of central bank manipulation but even if it weren't you could come up with some crazy scenario I think the standard Austrian view would just be to say okay it's not that there's negative time preference it's that there's these other circumstances and these really aren't the same goods that are being you know exchanged across time so Bob just to put the brakes on this a little bit give us an Austrian definition of what we would call originary interest rates which I kind of think of as naturally occurring in the marketplace right and so the the way it's often used is the originary interest rate is the rate that you would see so it's the it's the gap between what entrepreneurs pay for the means of production including hiring labor today versus what they expect those factors of production are going to yield and revenue down the road so you spend a hundred thousand dollars on materials and hiring workers and so on to build a house today and then one year later you sell it for a hundred and ten thousand dollars you know the originary rate of interest there was ten percent so you're getting a ten percent return on your money and notice you're not going to the formal loan market not you know the market for loanable funds so that's something that's been in the Austrian tradition at least since Bumbavirk is to say that the interest rate is not determined in the explicit lending and borrowing of cash but rather it's you know it sort of emanates it's from the whole time market as it were and that yes because of arbitrage it's going to be equal if people are literally just you know in the bond market borrowing sums of money but it's just it permeates the whole marketplace so that that gap between what do you pay for the means of production and then what do you expect you're going to get you know from their product is the originary rate of interest and that will be and some people use the phrase natural to mean the rate that is consistent with the fundamentals if I use language like that so the central you know the Austrian view of the business cycle and what Mises said the banks can manipulate the market rate of interest and push it temporarily below the natural rate or what the originary rate would be in a totally free market and that's what sets up the unsustainable boom but with that originary rate in a free market always be positive so here I I think so as you may know Jeff my dissertation I actually criticize some of the Austrian usage I think they use terminology a little bit inconsistently here so I think you could probably find passages where both things happen so in other words it's some some Austrians would say you know in some usages they would say no it can't meaning like because that because they're saying the natural interest rate just reflects the rate of time preference and since time preference has to be positive meaning other things equal people prefer present goods the future goods it would make no sense whereas of what you mean is the actual observed market rate of exchange yeah like I said in theory you could imagine some crazy scenario where there's going to be a flood next year or something and that present goods officially looking at the market rates appear to be trading it at a discount to future goods but that's you know like I said Walter Block or Mises would say okay that's not they're not really the same goods so again it just depends what do you mean if you're adjusting and saying we mean other things held equal then yeah you couldn't have a interest rate because that doesn't make any sense but here's the hang up for a lot of people who think like us or have read Austrian content is that let's say in previous recessions there the central banks had more room to work let's say interest rates were 6% so they cut them 4 points to 2% that's a dramatic decrease and that's you know in an attempt to gin up the economy so we can understand that conceptually we might say the central bank shouldn't do that but we can understand it but when we say central banks take interest rates the same 4 points from 2% to negative 2% because of this this idea I have in my head that interest rates have to be positive or they don't make sense that becomes just a lot more difficult conceptually even though it's the same 4% point rate cut in other words is going from 0 to negative is this really going off a cliff is this really something that is conceptually different that is unprecedented that is historically different that doesn't make sense economically, fiscally, monetarily or is should we be thinking about it less dramatically than I am well I so one big difference that yes it is a qualitative different thing is this issue of the fact that we're talking about nominal rates and so you're right that normally when we're like in the Austrian theory the business cycle yes it just has to do with well what was the market clearing interest rates supposed to be and then if they push it down that's the wrong price and so that you know when entrepreneurs are calculating the present discounted value of future cash flows they're plugging in the wrong number and that screws everything up and that's what gives the unsustainable boom so yes if that's the angle you're looking at in principle the 0 point really shouldn't be that big of a deal it's just a matter of the deviation of the actual rate from what the correct rate ought to be and that's the extent of the distortion but here I think you're right the reason there's something extra weird going on is that again this issue of you can always go to cash and so that's why even mainstream economists before they saw this happen with their own eyes would have said confidently you can't have negative nominal rates right so normally when we're talking when economists are talking about interest rates especially in the context of guiding production and investment decisions they usually mean real rates of interest right so that if you were in a world where prices were rising rapidly the nominal rate of interest would be higher just to adjust for the fact that the dollars you're getting paid the loan back with are weaker than the ones you lent out originally and so economists usually kind of just take that for granted and they're not even talking about that and so that's what's weird about this case it's not merely that the real rate of interest is negative where you know the purchasing power you're getting paid back with is less than what you lent out it's that the actual nominal rate is negative and again that seems weird because why wouldn't you just sit on the cash and so I think that's the thing that's an extra layer of weirdness if you will hear that economists have to grapple with and this goes hand in hand by the way and this might be one of the reasons for it I can't get in the heads of the central bankers but in order to if they wanted to push rates even more negative they have to get rid of cash and so I think that's partly what's going on here is the drive to eliminate cash now in addition to saying well you know criminals use it and there's tax evasion and that's why it would be good to go to an electronic cashless society now they can also say and they have been saying this I'm not putting words on them but I've seen people argue and say oh well really we ought to have negative 1.2% interest rates but we can't because alas people have the option of going to cash whereas if we could just get rid of cash now you can't go to cash and no matter where you're storing your money they can just ding you with the negative interest rate those two things in practice go hand in hand and it does underscore how weird this is that the only way to maintain very negative nominal rates is if people can't hold cash well I'd remember just a couple weeks ago Alan Greenspan said that negative rates are probably coming to the U.S. and it's not a big deal and you know institutional investors and central banks are one thing but individuals when you say hold cash not so simple let's say your vanguard or your TD Ameritrade money market was going to go negative and you said oh my gosh I don't want to participate in this and I've got $210,000 in it good luck going down to you know getting a check from vanguard or TD Ameritrade and good luck going down to your local bank branch and getting physical cash for that if you don't trust banks in other words obviously you could just deposit the money and leave it in your local savings you know your bank savings account or whatever but you know actual physical cash it's very simple to pull let's say $100 bills out of the economy the treasurer could just issue an edict and have banks and cardio ships and other you know Walmart pull hundreds out and submit them and then everyone would just have 20s and so the idea that you can just sit on cash well I guess you can sit out in an account but it's not you know if you don't trust the bank itself or if you're above FDIC limits or whatever it might be there is not the physical cash in the economy to satisfy everyone's desires for this I think if we really got aggressively into negative interest rates either in Europe or the US this is no joke Bob oh yeah so I agree with everything you just said yeah I'm glad you brought that up let me just make sure in case some of the listeners were misunderstanding so colloquially a lot of times we say like oh yeah he got spooked and so you know that investor went to cash you know some portfolio manager got nervous and so he went to cash he put his clients in cash in that context what it means is yeah they sold off stocks and they got into a money market fund or something but what I've been talking about on this episode is the reason economists historically would have said you can't have negative nominal interest rates is that yeah the investor would literally just hold currency like actually physically hold $100 bills or you know euros or whatever and so now when we say well then geez how come it is that institutional investors in Europe are tolerating a negative 0.5% rate of return and the answer is just what you're saying it's cumbersome that in practice what it means so yeah you wouldn't put it in the bank because the commercial bank also is paying negative rates on checking accounts what you would do is you actually take out currency and put it in a safe deposit box just like you know you could put earrings in or necklaces or you could put actual currency there and hold it with a bank but there's storage costs right just like you can't hold jewelry in a safe deposit box for free so likewise here if you wanted to hold a bunch of money that way you could do it and you could say well I'll hold it at my house but then there's a chance there's a fire or you know burglary so that's why you know that's mechanically how is it possible that investors are tolerating these slightly negative rates and I'm saying but notice the rates aren't that negative because yeah if it were like negative 10% more people would do exactly what we're talking about here you know literally pull out currency and so you're right that the authorities to get ahead of that and to pave the way for possibly even more negative rates are instituting measures like you say to try to you know phase out or at least I've seen academic discussions of this to say ultimately right now the thing that's constraining is the reason we can't get back to full employment the reason we're stuck in the secular stagnation is because of this technical limit that the central bank has its hands tied it can't make interest rates go to like negative 3% even though that's what they should be according to our Keynesian model because too many investors will just literally pull out currency and sit on it and so that's why if we could just go to a cashless society or move towards it you know like you say suck out $100 bills and just leave smaller bills there to make change and stuff then investors would have no choice but to tolerate these negative rates and so that so the two go hand in hand and my guess is it's possible partly the drive for negative interest rates is because they realize this will be a justification for taking out cash which I think you know there's other ulterior motives for well you might a cynic might call it a haircut right yeah and the other thing I've seen is that people have likened as well you full reserve Rothbardie and say that banking should be warehousing and so if you're just keeping a bunch of cash they're charging you a warehousing fee because as you said it's safer in the bank potentially than in your house because of fire earth after whatever I'm not sure it's safer in the bank by the way but I don't think this this analogy works because first of all we're not talking about physical cash we're talking about just an account which is electronic blips so that could actually cost the bank very little or Vanguard or your money market to whomever as a matter now they might allow you some online banking services that in fact you know do cost some money and that you know you might reasonably be expected to pay for that but I think when we're not talking about physically warehousing cash you know you go back to Rothbard's idea of a demand deposit versus a time deposit which if I recall he talks about in what has government done to our money and you say if it's a pure demand deposit and they're warehousing it for you it makes sense for them to charge you a few points to hold it and safeguard it but I don't think that's really what's happening here I think this is just a desire to force people into electronic rather than physical and then force them to take a haircut and so you know the question becomes Bob who's buying this stuff Europe there's 13 trillion dollars worth of both sovereign and corporate debt out there that's yielding negative right now and that's about 40% 40% of eurozone bonds if you took a pool of bonds of eurozone bonds and so I think as you reference earlier I think this is basically institutional investors and I think we should point out this isn't a bunch of individuals mom and pops who are saying okay I'm going to go out and buy this negative yielding corporate debt in company X, European company X. There are some people doing this but not very many individuals and even though it's yielding negative 1% I think it's going to pretty soon interest rates are going to be even lower so the bond itself is going to be worth more because there's an inverse relationship between a bond price and it's yield so I'm actually not it's not the interest that concerns me it's I'm making a capital investment for a capital gain and so I think interest rates are going to go even lower and I'm going to sell this bond for more than I paid for that's a very different consideration than interest positive or negative so two different things interest income and capital gains income and of course the flip side of all that Bob is it if interest rates go higher which I think a lot of Austrians think that they will have to over time then that 13 trillion that's currently yielding negative there's going to be huge losses I mean people are going to be wiped out or institutions are going to be wiped out if they're holding enough of this yeah those are all all good points and you're right just quickly on the Rothbard stuff and this is another observation that you that you made Jeff that I heard from you before others so yeah Joe Weisenthal recently had been toying with you know on his Twitter account and then he wrote it up for I can't remember if it was I think it was Bloomberg where he was saying you know why is everyone freaking out about negative interest rates you know why do we assume that the institutions are going to store our wealth for us for free like why wouldn't we have to pay him a charge for that that's what I think he was a little bit confused conceptually but then you pointed out Jeff and I you know and I worked into the Mises wire article I wrote on this stuff saying well yeah actually Rothbardians have been seeing in general you know for the use of a checking account why if you wanted to be 100% reserves and that's what Rothbardians think a genuine checking account demand deposit should be you would pay a slight fee to the bank for the you know the privilege of using your money and them having ATMs all over the country and check clearing services so there's a lot that goes into a bank you know keeping money in your checking account for your use it's not really just them holding it somewhere at a particular branch the way if you had a safe deposit box with your grandma's earrings in them you know you can't go around it at ATM and get earrings shooting out right so it's actually a fundamentally different thing and and I also agree Jeff that yeah what's going on here is is not that I mean certainly these the people who are paying or who are absorbing negative interest charges it's not because they have 100% the banks have 100% reserves and and so that's because my money is so safe now that that's not what's driving this and and yeah it's the situation it's genuinely unprecedented so I think a lot of economists who are talking like oh yeah this is standard and don't worry about this and we know there's no there's no problem from this stuff I think they're bluffing they have to be because yeah we we've never been in a situation like this and you're right if interest rates move up it's going to be devastating to many institution institutional investors in terms of capital losses in central banks as well I mean there was I haven't done the numbers recently but a few years ago I had been following some analysts who were just doing rough back of the envelope calculations just showing things like if US treasuries rise one point then the feds insolvent you know stuff like that so again I don't know what the number is right now but just showing how screwed up the whole situation is with these very low interest rates and people loading up on debt and then yeah if the interest rates rise just the capital losses are going to cause massive insolvencies even among central banks so it's not that the central banks going to shut its doors they can just print money or you know create electronically but in terms of just causing a panic it would be weird if all of a sudden for example the federal reserves assets fell significantly and it technically you know it was insolvent that might that might cause people to try to get out of the dollar well let's not forget that central banks have the most important client of all and that's the states in which they are located so if we look at governments that have national governments that have a lot of debt relative to GDP look at Japan you look at certain countries in western Europe increasingly you look at the US and so if I'm correct last year interest on the national debt was under 400 billion line item in the US in congress's annual budget it was 350 billion something like that and that's with relatively low interest rates although there's a lot of debt out there that's long term and it's and you know there's sort of a blend of interest rates across outstanding treasuries but nonetheless let's say interest rates went from you know 1.75% to just historical averages like 5% all of a sudden congress the single biggest line item in their annual budget would be debt service not Medicare not social security not so-called defense so I don't know that we can ever go back I don't know the governments I'll tell you what Bob a Fed share who raised rates to 5% would would find himself or herself pretty unpopular with congress pretty fast right net that's a great point you made I think what happened partly so I'm going to mention Obama but of course you know Trump is is doing it as well I was in favor of the corporate tax cut I just wish they had cut spending or at least you know kept it constant rather than spending you know letting spending growth occur as well but yeah under the Obama administration there were four years in a row where they had a trillion dollar plus budget deficit right borrowing more than most countries entire GDP is and yet that you know that didn't that wasn't a problem interest rates didn't blow up and so what happened there is that huge surge in debt occurred at the same time that the Fed was doing all this QE stuff and pushing interest rates down at least you know according to our view of what was going on and so I think that masked it so the analogy I was using the time was saying it's like when you're running up credit card debt as a household but you keep getting the offers in the mail for 0% APR balance transfers and so you can be running up the debt and living way above your means and as long as you keep getting those offers in the mail and rolling over onto a new card at 0% it doesn't hurt that much in fact you're like this is great we're getting you know new car we're going out to dinner this is awesome why is everyone worried about you know having a family budget meeting this is fine but of course once you stop getting those offers once your debt gets so big that the credit card companies realize yeah let's not lend this person money we got to start getting paid and it reverts to the normal interest rate then that's when the catastrophe hits and so I think likewise here that the yes the US federal government has been running up huge debt particularly since the financial crisis but the reason it doesn't feel that burdensome is that interest rates to service that that fell during the same exact period so yes we're not talking about a crisis where oh it goes up to double digit rates like it did in the late 70s early 80s just like you say if it just goes back to even approaching normal quote normal levels like in 2005 that's a game over that all of a sudden yeah it just to service the debt would have you know they have to cut all sorts of other programs just to contain the debt from mushrooming quickly out of control and that's and that's partly too like if you look at like the CBO's estimates of long-term spending there's a huge mismatch and it's things like Medicare but also yeah they're building in very modest assumptions about interest rates gently rising over time and so debt service just becomes enormous just from standard you know treasury yields rising slowly over as they keep rolling over the accumulated debt as the existing bonds mature and they got to go in the market and borrow again so if interest rates rise a little bit more quickly than the CBO forecast thinks they will again that's all of a sudden hundreds of billions extra in year a year expense that they weren't counting on well I think we also should forget that the Fed has been out there buying up treasuries it is stood as a backstop against all this so that's you know apart from its machinations of the Fed funds rate there's a reason why treasuries have arisen I would argue that if you look to the United States as a clear-eyed investor and said this is as a corporation this place is never going to get its fiscal house in order look at how much they spend above and beyond what they tax every year and they do this year after year after year they build up $23 trillion in debt and their political situation they've got all these geriatric people and their entitlements are going to expand they're going to be spending way more on social security they're never ever going to get their fiscal house in order ever they go all around the world fighting these wars and borrowing the place is insane so if I'm going to invest in that place I want junk bond rates I mean that's the way I think about it so I don't understand how I understand that the rest of the world to an extent not as much as our own institutional things like Social Security Fund but the rest of the world also owns treasuries so at some point this isn't good for them I think right and what you just said is exactly what I was looking at it and as people who know my career know I famously was wrong in predicting that CPI was going to rise more rapidly than it did because yeah I didn't see any end game to this and I thought investors around the world were going to look at it just as you did and say maybe give them a year or two just to see but once it became clear that their solution is every time there's a downturn they're just going to print more money why would you want to hold dollars in that sort of environment because yes if you hold bonds it might be that the US government slash Federal Reserve acting as a single unified entity just create more dollars to pay you off so they're not formally defaulting on the outstanding bonds but those dollars then you're getting paid back with are clearly less valuable than what you would have thought originally when you bought the bond and so yeah I am amazed that the central banks and governments of the world have maintained this and that they can have such low interest rates especially now that the Fed is loosening again even though unemployment according to official measures is it like a 50 year low like that that's amazing to me that they're showing yeah we got to start cutting rates and they've started buying bonds again if you look at the total Fed assets they had been shrinking for like the last 18 months or something gently like they were letting them roll off a little bit and now they just spiked again the last couple weeks since the Fed just changed course and so you're right Jeff that it's to me I don't see how investors like what do they think is going to happen that and as you say it's certainly not that oh yeah there's Trump administrations and aberration and we're going to get adults in the room who are going to be serious about reforming entitlements after 2020 that's clearly not I mean all the Democratic candidates that are out doing each other saying how much how many trillions they're going to spend on a green new deal in Medicare for all so I I really am surprised and the standard explanation is oh well it's the you know the cleanest shirt in the pack or whatever meaning Europe's house is so messed up also that people go to the dollar but you don't need to go to sovereign treasury you know you can go to gold or bitcoin or whatever and in fairness you do see some of that right that you goal is higher now than it was in 2005 and so on but I am surprised that yes that institutionally so many investors seem to actually believe governments and central banks that they're not going to let price inflation get out of hand down the road well and there's an artificial market for us treasuries I think thanks to our friends in the ECB right at least treasuries yield positive interest yeah however low I mean compared to minus so I'm sure a lot of money flows into treasuries be just because of that yeah so it's certainly on the margin to say you know wouldn't money flow or yes why would investors given that you were going to buy institutional or sovereign debt what the ECB is doing would make you switch over to US treasuries I mean that's certainly true but again just saying well who's to say and part of this too is that there's regulatory requirements right with you know the basil accords and things like that where certain financial institutions have to hold capital requirements reserve you know of a certain category and so maybe there's that sense in which the authorities are kind of forcing people hey if you're going to do business you got to hold a bunch of sovereign debt so that might be partly what's keeping the lid on this but still it does surprise me how much they've pumped in and how much debt governments have run up and yet interest rates you know yields on government debt are still this low that I'm surprised at how long this what to me seems like an unsustainable pyramid scheme I'm surprised how big they've blown this thing up well I want to get back to your mentioning CPI and what happened it didn't happen after the crash you know it wasn't that long before the crash that the U.S. monetary base and base money is the narrowest definition or narrowest example of the money supply so generally as Austrians you say oh my gosh if the money supply grows faster than goods and services in the economy you know inflation is a monetary phenomenon so base money is basically the currency in circulation plus commercial bank reserves at the Fed so not that long ago in the mid-2000s that was only about $500 billion and after all those rounds of QE after Ben Bernanke and then later Janet Yellen went into hyperdrive after the crash of 07 and 08 that amount got up to over $4 trillion so basically 8x so think of think of quad excuse me quadrupling no I'm sorry 8x the monetary base so it went from well under a trillion to over $4 trillion so here's what I don't understand Bob if you can just do that is that meaningless I'm sure our listeners understand that banks don't lend reserves that money is just to meet their reserve requirements it's literally parked at the Fed in the old days they used to borrow from each other overnight to because they weren't as flush with reserves as they are now at least until a week or so ago and the Fed funds rate is the rate at which these banks borrow from one another overnight but since 2008 they've been getting paid interest on excess reserve so they've had an incentive to just leave that money parked so so there's this monetary base which is the narrowest understanding of the money supply it it multiplied many times over so because it's not lent out it's not just general money and credit out there sloshing around in the economy making a Honda Accord double in price so can this really be done forever and ever without any pain I don't get it when does it eventually affect the broader economy and CPI and has it already affected the broader economy has it moved money into let's say fancy housing in certain markets and into equities into the stock markets help us understand the monetary base and why people like Krugman say expanding it doesn't matter sure so with this stuff again I just do want to acknowledge that what I said in 2010 for example looking at this was off and so this is with the benefit of hindsight that I'm now going to offer these remarks just my assessment at the time of what the different factors and how they were going to play out was wrong and so here the stuff I'm going to say is true individually but in terms of how these factors interact with each other it's hard to know Bob it takes a big man to admit he was wrong and it takes an even bigger man to never ever ever be wrong like Trump so there's several things going on so one thing is and you touched on a lot of these things just as you were setting up the question so one thing is but when the feds started doing all that QE you did see prices rise but it was an asset markets right and that's not like a conspiracy theory that was the whole point part of what the fed was doing was saying oh gee we want to cause a wealth effect so you saw the S&P 500 index shoot up even when the fed would make an announcement and if you think about there is a certain logic there that when the feds pumping money in it's investors and the fat cats who are the ones who are going to go and benefit from it immediately another thing as you say is the fed in October of 2008 right so like the month after Lehman and AIG and all that stuff they instituted a new policy of paying interest on reserves and so that's partly what on the margin made commercial banks less willing to use those new reserves as the basis for then advancing more loans to regular people and so there's that element as well and also I've seen people point out like the boom and fracking for example US oil output went up by about 50% from mid-2000s to now and so it's possible in a normal economy or absent the fed pumping and all that money you would have seen the price of oil come way down and so gasoline would have been much cheaper and so the fact that gasoline prices didn't move that much might have been actually yes there was price inflation and energy costs relative to what otherwise would have happened because of all these innovations in the private sector so there's things like that you could say with all the innovations and inventory management and so on it's possible that say hey how come I didn't see prices rise 10% it's possible they did rise relative to things that trends that were already in place that the fed's monetary inflation masked what otherwise would have been price deflation for consumers because of all those innovations so there's a lot of things like that going on now the Keynesian just to be clear they're going to say no you guys are totally wrong your approach is wrong because when nominal interest rates are close to zero treasuries and currency are virtually the same asset so a lot of Keynesians were saying the fed's QE program it's not really doing much to stimulate and that's what they may mean by like a liquidity trap or that's part of what goes along with that they're saying the nominal rates are 0% if you know in other words you have a treasury bond that pays 0% or you have currency just sitting around those are kind of the same thing and so by the fed coming in and buying treasuries in exchange for cash wasn't really doing anything it was almost swapping assets that were nearly identical so I don't endorse that view but I am just saying that's the way some people were interpreting it and so that's why the Keynesians were saying these QE programs they might help a little bit but they're not doing too much because they're kind of swapping assets so normal times that's not true but when interest rates are basically zero they're saying cash and treasuries are kind of the same thing so those are different ways of looking at it but yeah you're right Jeff I so all of this to me it's like we're in an unstable equilibrium like a picture of marble at the top of a very steep hill where if it doesn't move one way or the other it's okay but if it just moves a little bit to me that's where we are that if price inflation did start rising everything would unravel very quickly and so it's like can we just central banks just keep pumping in money indefinitely just to keep pumping up the monetary base I wouldn't think so but again I'm surprised they pushed it up this far already so Bob after all this QE leaving all these American commercial banks flush with reserves at the Fed we still have this crisis a week or so ago where a repo overnight lending between the banks themselves and there's usually a delta between the Fed funds rate and the overnight repo rate between banks all of a sudden some banks had solvency issues I mean what's the point of all this QE if we still have banks with solvency overnight solvency issues yeah so you're I think you're exactly right on that issue that again this is to me showing the reductio and absurd but are you kidding me after all this stuff and even because remember like the way when Bernanke was on 60 minutes and they were saying gee is this going to cause hyperinflation and he was like no these are just temporary measures as soon as the economy recovers we're going to we have an exit strategy we're going to unwind all these programs so to me that's what's so amazing is that yes eventually the Fed you know they did taper for a while they were just treading water and holding their total assets rolling them over and then they even started letting them roll off a little bit but then they reverse course when officially on paper the U.S. economy is fine right again so we as Austrians think there's problems that those official numbers are masking but in terms of the establishment economists it's odd that they have to do all these emergency interventions when unemployment is 4% and the price inflation according to them is fine so yes that is weird that the patient of the economy as it were is still basically needing life support 10 years after they started doing all these extraordinary measures like it's it is interesting to show according to even to their own logic clearly these programs have not done too much have they as far as what was the specific reasons for the flare up I think one big thing going on is that there are capital requirements so the requirements from Basel and things like that that some of these banks are having to satisfy is a separate issue from just their reserve requirements and so that's I think partly what was going on here lies institutions yes they're fine vis-a-vis their reserve requirements but some of them were not fine in terms of their requirements because of capital considerations and that's why some of them were short and rushing into it and then people were saying stuff to oh well they corporations had to pay their tax bills and stuff but I mean I'm sure on the margin those were contributing factors but it's you know that's not something people didn't know about people know when tax bills are due and so I I think there is something going on and that and that the attitude of oh nothing to see here don't worry about it I don't think adds up like to me the fact that yes they had to do these interventions days you know multiple days in a row is showing that the Fed is losing control of some of these key interest rates and that the Fed's not omnipotent and just showing you how tenuous their grip is on this I think a lot of this is like a self-fulfilling prophecy that the reason investors think oh yeah I guess we can keep buying treasuries and so on and we're tolerating these low yields is because they think the Fed ultimately can just come in and is a backstop but at some point it's like the Fed can be a backstop until investors stop thinking it can and then it can't so it's kind of this weird psychology thing where just just like you know the housing bubble if everybody keeps thinking housing prices are going to go up they're going to keep going up and so what makes that change well it's hard to pinpoint but at some point when people start getting nervous and they you know they start selling that all of a sudden there's an avalanche and unravels really fast well to wrap this up I just wonder if this is the new normal in other words this idea of ultra low or even negative interest rates central banks including our own Fed creating lots and lots of liquidity is this just how it's going to be forever because it wasn't that long ago Bob I want to say 2011 Fed officials that like the Dallas Fed for example were saying you know after the crisis we expect the Fed's balance sheet to return to pre-crisis levels and of course we now know that that's never going to happen so is this just how it is now so you're right that the way the Fed was calming investors after that you know right after these QE programs went in is they were assuring them yeah this is just a temporary injection of emergency medicine as it were once the patient recovers will withdraw the medicine and go back to normal and so that you know don't don't worry when you see Glenn back on his show you know having a forklift and showing the monetary base which I don't know if you saw that Jeff but you know Glenn back was doing that at like late 2008 and so yes people were freaking out about all these injections of liquidity and the Fed officials don't worry we're going to suck it all out before prices start rising don't worry and now yes they have officially changed their stance and they are telling people we are going to permanently have a much higher balance sheet indefinitely than we did before the financial crisis so they have officially changed their tune a lot of a kind of like Larry Summers and people like that are pushing this secular stagnation thesis saying yep this is a new normal because of demographics and blah blah blah and the unwillingness of governments to run large budget deficits that yep this is very meager growth going forward as far as the eye can see that's the issue that you know that's the new normal to me I can't see how it's going to continue indefinitely like this they can't just keep printing more money because you would think at some point investors more and more of them will start getting out of these low yields and into something else and again it's like saying we're in an unsustainable bubble and then when someone says well what would make it stop I mean it's hard to pinpoint but you just know if by definition if you're saying it's an unsustainable bubble it means it is going to stop but it's hard to say when well ladies and gentlemen it's a fascinating topic and I'm afraid it's one that's going to hit close to home for all of us and we need to understand it I'm going to put a little pressure on Bob here and say that you know a lot of us have a difficulty conceptualizing and understanding the actual mechanics of how central banks operate how they create money how commercial banks then go and create credit how bank reserves work all these sort of technical and mechanical elements to the interplay between central and commercial banks is difficult for people who are not necessarily well schooled or versed in in those mechanics so Bob is going to write some articles for us a series of articles on fed mechanics that you should all be looking for in the near future because it's something where I think if we're going to be proposing things if we're going to be making assertions if we are going to be saying that these these dead economists from the 1800s were right and the Bernanke's and the Yellen's and the Greenspans and the droggies are wrong we need to be knowledgeable and informed and able to back up those arguments so Bob will look forward to that be sure to check out Bob's great books including Contra Krugman and of course The Choice which is really an excellent I won't say substitute for human action but an excellent way to look at human action which we mentioned earlier on the podcast so stay tuned for more Human Action Podcasts and please thank Bob for being our guest this week thanks for having me Jeff, it was a pleasure like this on Mises.org