 Vernon Smith received the 2002 Nobel Memorial Prize in Economic Sciences for his pioneering work in experimental economics. I caught up with the 96-year-old recently in Southern California and conducted a long interview about his life and work that will appear as a reason podcast. Here's part of our conversation about Joe Biden's massive $6.8 trillion budget plan, the role of government spending and Federal Reserve policy in causing inflation, the bailout of Silicon Valley Bank and why Smith believes it's very hard to keep Democrats from wanting to make the world better by spending other people's money. Vernon Smith, thanks for talking to me. Nick, it's great to be here. Over the past four or five years, starting under Donald Trump, but the federal government has just pumped tons of money into circulation. Joe Biden recently proposed a $6.8 trillion budget. We're experiencing inflation. What is the way out of that kind of situation? Well, I think the first way out is for the central bank not to accommodate spend-thrifts in government because it's very hard to keep Democrats wanting to make the world better by spending other people's money. They're really committed to that. And the Republicans to some extent, they could screw up. You're not going to be saved necessarily by them. But the central bank, you see, they are taking, I think, more seriously than they have to. They're so-called fiduciary responsibility to the government. They don't have to accommodate that. You see, when Joe Biden decided to write $600 checks per month for all kinds of people who were sitting at home and not producing any goods because of COVID, well, that's not... You can't stimulate. They call it stimulus. There's nothing to stimulate. It would be like during the Second World War having a stimulus. Well, you didn't need it. You needed the reverse. And so you know that's going to be inflationary. And of course, the Fed fully accommodated that. Whatever of that debt wouldn't be held by private citizens, they bought enough from existing private citizens that they were willing to buy the new debt. You know, the Federal Reserve is not supposed to buy it directly, but it's the same. And moreover, they buy, interestingly, they buy that debt for the account of Treasury. It's called neutralization. They discovered that in October 2008 that, oh, wait a minute, that's the way to do it. You don't buy it and hold it in the bank because that gives the central bank because all of the banks have increased reserve deposits and they will expand credit. So you just transfer it to the Treasury. It's really a Treasury on this hill. It's like it's as though your banker told you, Nick, go and spend whatever you want to. If you don't have enough income about it, we'll float bonds to cover that and we'll hold them in your account in our bank. So that's what the federal government. So there's no budget constraint, none on the government. So recently the Federal Reserve did start raising the interest rate and that had the effect or the standard narrative of the reason why Silicon Valley Bank and Signature Bank had a run on them was because the Fed hiked interest rates and suddenly the long-term bets that these banks have made no sense and people were pulling money out. So is the Fed starting to do its job? Well, in my view, it didn't do its job before and that's why we've got the problem now. It's doing what it always does if there's inflation, you see, it starts to raise, but those inflations are typically coming from excessive government spending that's accommodated by the central bank in the first place. That's where we get inflation. You see, it's not coming from people, it's coming from government. The big stimulus for the inflation came when people were not home, not producing goods because of COVID and then they stimulated the economy. Well, there's no goods. So the prices basically have to go up. It's just arithmetic. And well, what I predicted at the time was that we would have a one-time increase in prices. It would continue only if the government continued to do the deficit finance, in other words. And I don't trust them not to do that, you see. And the problem with inflation, you see, everything that the Democrats are trying to do to help the disadvantaged and the poor is all taken back because those are the groups that are so severely hit by inflation. So you're saying when the governor of California gives you a hundred dollars so that you can afford gas that now costs more money, you're generally not making out too well? That's right. Yeah. Do you think Silicon Valley Bank almost immediately when the run on it happened, the federal government said, don't worry, we're going to cover all deposits? Is that a good idea? Is that a good rule or a bad rule? You've got to think of the consequences. You're taking all risk out of bank deposits. The deposits are the source of investment funds of the banks. So the source of capital they don't have to worry about is just really, they don't have to worry about the default on that. The government will take care of it. To me, that invites banks to not worry very much about doing extremely risky investments. And well, there's a lot of risky, potentially high innovation activities that you'd like to see capital go to, but someone's got to make a judgment because there's lots of those alternatives and most of them are going to go under. So there's a room here for some skill in investing and if you take all of that risk out of it, I think that's extremely dangerous. Do you worry that it's, I mean, right now it's, you know, Silicon Valley Bank gets bailed out. We weren't supposed to do this anymore, right? Because back during the financial crisis, we figured that out and we came up with a new regulation so now Bank would need that. Are you worried that it's, you know, this is just a continuation of bailing out failure? Well, yes, and of course the really big mistake before was to bail out bank equity holders. The presumption was that we were, the thought was, and I think that the government wanted people to believe that we're bailing out depositors, but they did more than that because depositors, you see, are protected by two things, insurance, prepaid insurance of the banks, plus the equity in the bank. That's what is available to cover as a cushion to cover deposit laws and every bank needs to take that risk into account to otherwise it won't get shareholders. They won't buy the common stock, you see, unless there's a reason that risk is not too large and if you take that all that out, I think there's no equilibrium. I don't know how that world would even work.