Video Transcript: The Financial Crisis and the Death of Macroeconomics | Joseph T. Salerno
My topic is the financial crisis and the death of macroeconomics. The topic reminds me of an old joke: a Western observer is at a Soviet May Day parade back in the 1980s, and it's the spectacle is overwhelming. The parade begins with crack divisions of Red Army troops, followed by battalions of these very mighty tanks. After which come huge long-range field artillery, rows and rows, followed by the nuclear missiles, okay, that are gleaming in the sun. After that, there's a small group of men, not in step at all, sort of puny, undistinguished looking, in ill-fitting suits. And the Western observer is puzzled, and he turns to his Soviet hosts and he says, "Who or what is that? And they and they respond, well, that's our most terrible and destructive weapon. Those are economists. Well, those are our macroeconomists in the United States. Okay. All right. So I'm here to to to support Gary North what he said yesterday in trumpeting the silver lining amid the gloom the gloom and doom about the financial crisis. After a long and disreputable history of about 300 years, in my four words, macroeconomics is finally dead. As as as Gary pointed out yesterday, its leading leading proponents simply do not know what to do anymore, and they've said so. They've said this in in so many words. In fact, as Murray Rothbard, he actually Murray's always been very was always very insightful. And and back in the 1980s, after the short-lived sort of attraction to monetarism died out because they had had misforecast a recession that never occurred in 1984, 85, macroeconomics was really dead from the neck up. That was Murray's term. Okay, so it's really since the 1980s, macroeconomics has been a zombie discipline, and I'm hoping that this crisis will finally put the zombie in its grave. So let me just give you a very short paragraph on where macroeconomics came from. Where where did it come from? Okay, most people think it started with John Maynard Keynes. People that are a little bit better informed talk about Irving Fisher as a true father of macroeconomics. He first came up with the quantity theory formulated in an equation. But really, macroeconomics is a is a crackpot doctrine that came to life in 1705 in a very slim book entitled "Money and Trade Considered, with a proposal for supplying the nation with money. The author of the book was a Scotsman. His name was John Law. He was a notorious character who was known throughout Europe as a gambler, philanderer, schemer, and escaped convict who had killed a man in a duel in London? He was also the first central banker. True. In 1716, Law became the director of the Royal Bank of France and immediately enacted the principles set out in his book. In four short years, he created a massive inflationary bubble that left the French monetary system in ruins when it when it finally burst, that was the first macroeconomic crisis. There were many more to come. I'm hoping that this one, the current one, will be our last. Okay. So now what I want to do is to set out the dimensions, briefly outline the dimensions of the financial crisis, and argue that it really is worse than we think, because it brought about a great deal of overconsumption, capital destruction, malinvestment, and impoverishment
that still has not been revealed. So let me just talk first about the money supply, because it always starts with the money supply. Macroeconomics is simply the policy conclusion that spending more money can cure anything. Okay, and that's it's been put in different language over the past 300 years, but that's that's the germ of macroeconomics. So so let's start the dot-com bubble. Okay, it burst in early 2000, leading to a recession in early 2001. The Fed reacted very aggressively by lowering the target Fed funds rate. The events of 9/11 led the Fed to ratchet up its expansionary monetary policy. From the beginning of 2001 to the end of 2005, the Fed's one of the Fed's monetary aggregates that I tend to look at, which is MZM, increased by about $1 billion per week. They were creating 1 billion new dollars in the American economy every week from 2001 to 2005 for five years. From the beginning of also, if we look at another one of their aggregates, m2, that increased by about $750 million per week. The monetary base, which is completely controlled by the Fed, increased by about $200 billion over those years, which was a cumulative increase of about 33% The Fed funds rate was driven down below 2% and then held at 1% for almost three years. Yet inflation during this period was very moderate. Okay, the CPI fluctuated between about one and 3% However, since modern macro economists and central bankers tend to narrowly focus on consumer prices to determine whether there's inflation in the economy or not. They believe that the monetary policy had their monetary policy had succeeded in stabilizing the economy after the dot-com bust. In fact, they congratulated themselves in the journals and papers that were produced by the various regional central banks, and they did this by claiming that they had achieved over the past 20 years a great moderation. In fact, what they had really done is to blow up a huge asset bubble that began in the 1990s and didn't come to an end until 2007, 2008. So let me just give you some idea of the dimensions of this. Okay, this is the Fed funds rate, which starting in 2000 was quite high. It was over 6% You can see how it was pushed down and held at 1% there for a long while, then Greenspan allowed it to rise, and that's when we began to get the end of the housing bubble. Okay, and now it's been pushed down again as the recession took place. The gray bar represents the periods of recession. As recession took place, it was pushed down to between zero and 0.25% Here are the measures of the money stock. If you notice that both MZM and m2 were just about $5 trillion in 2001 or so. Okay, today MZM is between nine and between nine and $10 trillion, m2, so representing almost a doubling of the money supply, in in in about nine years. Okay, so massive increase in the money supply. One thing you should notice is that both of of these aggregates began to flatten out in about mid 2009. We haven't had much monetary growth during that period. We've had qualitative easing, but now they're threatening us with quantitative easing again. Qualitative easing simply means socializing the financial system, okay? Trading government assets for for bad assets, taking over financial institutions and so on. Quantitative easing simply means printing
money. Okay, so we're going to be back to printing money again. Those lines are going to start to rise again, very soon. And then this is consumer price inflation, which shows that from 2000, from from 1990 or so, through except for short periods, it fluctuated between 3% one and 3% You can see the, and then then shot up right at as the recession hit. Okay, but for the most part, it was fairly moderate by historical standards. Now let's talk a little bit about the mortgage market. As many Austrians pointed out at the time, the wildly expansionary monetary policy ignited a boom in asset prices, especially in the real estate and stock markets. Rates on 30-year conventional mortgages fell from fell sharply from over 7% in 2002 to a low of 5.25% in 2003, and then fluctuated between 5.5 and 6% until late 2005. But this wasn't really the important story. The important story, and what was more significant, was that one-year adjusted rate mortgages, their rates plummeted from a high of 7.1% in 2000 to a low. There were almost cut in half of 3.75% in 2003, and then they rose to about four 4% and stayed there. But for 2004 and 2005, in addition, and importantly, credit standards were loosened, and unconventional mortgages, including interest owned. Negative equity and no down payments mortgages proliferated. This caused a rapid expansion of mortgage lending, and especially of subprime mortgage lending. The subprime share of the mortgage market rose from 8.262% in 2000 to about 13.5% in 2005. So, yeah, tremendous increase in subprime loans. Also, housing prices accelerated to double-digit annual increases after after a short disinflation that we had during the 2001 recession. That is, housing prices didn't come down in 2001; they stopped increasing as rapidly as they had been in the 1990s. Okay, the housing boom soon turned into a bubble as as people's expectations lost all contact with fundamentals. People who could not afford houses of certain prices were simply buying them because they knew they could sell those houses at much higher prices in the future and then move on to a high, an even higher priced house. By mid 2003, the stock prices began to go up. We began to get a big bull market. Okay, let me just again give you some of the figures here, some of the pictures. This is the 30 year mortgage rate, which was pushed sharply down from over 8% in 2000, and then fluctuated around 6% and then went up to around 7% right before the the the bursting of the bubble. Housing prices, as you can see, rose tremendously from January. If you take that as 100, they rose by 120, 120 percent in the top. I'm sorry, by yeah, 120 percent in in in 10 leading cities, and by about 100 percent in in in 20 leading cities. Okay, and just to give you an idea of the rates of change, housing prices were rising in 2004 and running up to 2004 by 15 to 20 percent every year. They were going up, okay. And again, this is for selected 10 and 20 cities. Okay, and and the housing crisis did not affect the housing bubble. Did not affect the whole country. It affected some some larger cities and metropolitan areas. Now, what's important is what was the effect on household net net worth, because this is sometimes called a balance sheet recession, but it
was also a balance sheet bubble. The sharply rising stock and real estate prices boosted household net worth by over 23 trillion dollars during just three years, from 2003 to 2006. This drove the ratio of household net worth to annual GDP to well over 450 percent. So let me just show you that. Well, this is just the increases in the the Dow Jones. Okay, but okay, here's the household net worth. You can see that in 2002, it's about 40 trillion dollars. That includes all financial assets and real estate assets minus the debts owned by households. So it went from 40 trillion all the way up to 63 trillion in 2005 and 2006. Okay, it's 23 trillion dollars. What did that do? That gave a tremendous impetus to people to begin using their houses as ATM machines, and to engage in all sorts of luxury consumption and consumption that, under more realistic circumstances and under more realistic calculations, they would have never undertaken. So it set off a huge consumption boom. Now historically, the percent of of total household net worth as a percent of GDP was about 350% If you go back all the way back to 1992, it fluctuated about 350 percent between 300 and 350 percent. Suddenly, notice how it sharply rises with the the bubble, the first bubble, the .com bubble, 1995, rise up to 450, falls during our recession of 2001 back to almost normal levels, and then shoots up to over 450 percent to 475 percent of income. Okay, and then again later crashes, which we'll talk about. Okay, so I can point out by comparison for over 40 years, from 1952 until the dot-com crash began in the mid 1990s. The household net worth to annual GDP ratio had held between 300 percent and 350 percent. After nearly falling back to this range, as I pointed out in the recession of 2001, the Fed's monetary expansion drove it up by 100 percentage points in a matter of three years. Okay. Created $23 trillion of net worth, all of which was false, all of which was phony, all of which misled people and misdirected their purchases, and caused what we call an over consumption boom. So the enormous increase in net worth was based almost solely on paper profits and phantom capital gains on households' real estate and financial assets, people were misled by the inflation-bloated balance sheets to cash out some of their home home equity and increase expenditures on consumer goods and services. As we know, in the expression of the day, people began using their houses as ATM machines. Households financed the increased spending on boats, luxury autos, upscale restaurant meals, pricey vacations, and so on through fixed dollar debt. This created a huge consumption boom as monthly real expenditures on retail and food services rose from an average of 160 billion dollars per month between 2000 and 2003 to 180 billion dollars through 2008. Okay, so there's there's a consumption boom, going from 160 billion. Okay, and actually you can see it going through the 90s. It's a huge consumption boom. Okay, and it it was intensified after after after the recession of 2001 by the Fed pouring a billion dollars a week into the economy, and by people thinking that they were wealthier than they really were, this is what has occurred during the boom and the bust. During the boom, you had falsification of
monetary calculation, so it's not just capital misdirected, but people begin to they begin to to misinterpret what prices are telling them. Okay, and and as we'll see, it takes a long time to regain faith in the price system after you've had a crash, after everything you've done, which seemed like the right thing to do given the circumstances, suddenly turns out to be completely wrong. Here's what happens: a personal saving rate. Why save if you're gaining trillions of dollars a year in stocks in your 401k in your houses? So the saving rate in the U.S. fell from around four or 5% even higher if you go back into the '90s. But by by 2000, it was around 4% It declined all the way to less than 1% in 2005. Okay, were consumers just being profligate? Were they not worried about their futures? No, they felt their futures were secured by the fact of this huge increase in net worth that they could depend on for their old age, and fortunately, people came to their senses and began to save much more money out of their current accounts. Okay, rising up to 7% and then 8% by the end of the recession. Okay, and by the way, this troubles the Fed, but we have too much saving. Morons. Okay. Okay. Let me just say a few words. The household debt. Thus, household assets rose by 21 over 21 trillion dollars from 2003 to 2007, liabilities, mainly home mortgages and consumer credit, increased by $4 trillion during the same period. Okay, now the collapse from 21 trillion back by 21 trillion, of course, then made this increase in fixed liabilities. The new $4 trillion that they had in fixed dollar liabilities made it much more burdensome. Okay, one of the results of this was that the year-over-year rate of growth of household debt nearly doubled from 6% during 1997 to 11 percent for three consecutive years, beginning in mid 2003. Okay, so the household debt outstanding is up around 11% Okay, and that's on the right axis. And when the boom came to an end in 2007, housing prices, corporate profits, and markets plunged. The capital gains accumulated since the mid 1990s were revealed to be an illusion. This is interesting. Household net worth, okay, the value of your house and and your financial assets of all Americans declined by $13 trillion, okay, or 20% during one year alone, 2008. That $13 trillion is a figure exceeding the sum of the combined annual GDP of Germany, Japan, and the UK. Okay, that wealth disappeared into thin air. It was actually never there. People thought it was there. Okay, this brought the over consumption frenzy, which had begun in the mid 1990s, to a screeching halt. All right, let me say a few words about the retail slump. One of the most important features. The current recession in the U.S. has been the exceptionally severe retail slump. In the old days during recessions, you didn't have retail stores going out of business. You had construction companies. You had steel companies laying off workers. You had interest-sensitive consumer goods like automobiles cutting back. But you didn't have linens and things, or or some of the other. In fact, let me let me just give you some of the qualitative dimensions of this. The current retail Chrysler filed Chapter 11 on April 11, followed by GM on June 1. This is in 2009. KB Toys, one of the largest U.S. toy
retailers, sought Chapter 11 protection in December 2008, and announced that it was planned to close all of its 460 retail outlets. Circuit City, the second largest electronic retailer in the U.S. declared bankruptcy and closed all 575 of its stores that year. Mid-sized electronics retailer Comp USA closed all 103 of its outlets. Sharper Image, a novelty and electronics retailer, was also has also declared bankruptcy. Linen and Things, the second largest home goods retailer in the U.S. filed Chapter 11 and is liquidating its 371 stores. Fortuneov's, a leading one of my wife's favorites, a leading jewelry and home furnishing chain in the Northeast, filed for bankruptcy, as did mid-sized furniture retailers Levitts and Bombay, both of which are liquidating. Many more retail chains are scrapping expansion plans and proceeding with massive cuts, or have done that, including Disney and Taylor, Footlocker, and many many others. You didn't have these things happening in early recessions because you didn't have the massive bubble that that that created all of this false wealth that people had reacted to, and I had have some statistics here on the quantitative dimensions of the slump. I'll just I'll just read one or two of them for for December 2008, the year-over-year decline in current dollar sales was 11.1% and from January through July 2009, these year-over-year declines fluctuated between 8.5 and 10.5% Now, what's the significance of that? Well, except for two non-consecutive months during the recession of 1990, 1991, in which monthly retail sales dipped slightly below zero in a year-over-year basis, one would have to go back to 1960, 61 to find declines in actual dollars spent on consumption goods. Okay, during a recession. Okay, retail sales also took an exceptionally real retail sales also took an exceptionally sharp plunge during this recession. They declined from 180 billion dollars on a monthly basis, which I talked about in 2006, 2007, to 160 trillion billion. Okay, if you compare this to the current recession, to all recessions, all other recessions beginning with 1960-61, the monthly percent change in real retail sales from a year ago fell by 8% for only three months. Out of all the past recessions going back to 1960-61, you had real retail sales falling for only three months, and that all happened in the mini recession of 1980, and they weren't consecutive. By contrast, during the current recession, real retail sales on a year-over-year basis have contracted by 8% for nine consecutive months, which ended in 2009. Overall, they contracted; they were negative for 23 consecutive months. Okay. All right. Let me just jump ahead here. That shows you the dimension of the something that no one expected, and that was the the retail boom or boom and and slump. Okay, now I want to talk a little bit about capital consumption, which I think is the fallout from all of this. The extent of capital consumption and malinvestment that resulted from the housing boom is revealed by developments in the Wilshire 5000 Total Market Index. This index tracks the total dollar value of all U.S. headquartered equity securities with readily available price data. Okay, so it's basically the total capitalization of all the firms headquartered in the U.S. minus the the capital that was invested by
bondholders. So it's it's it's using the total stock capitalization. It's using total stock value as a as a proxy for the total capital of all our firms. After reaching a high of 15.5,000,000,002,007, okay, the index collapsed and fell to a low of $8 trillion in 1997. So there, there you have almost $16 trillion, and fell all the way to 8 trillion. Okay, it had since. Covered and has been languishing around $11,000,000,000,000.11, and a half trillion dollars. Now, what does that mean? The first time that the Wilshire 5000 reached 11,000, $11 trillion was back in 1997. What does that tell you? That there's been no capital accumulation since 1997. That any capital that was accumulated after that point was destroyed by malinvestment, investing in wrong lines, and over consumption. People consuming their capital, consuming their savings. Okay. And now we can talk a little about the death of macroeconomics. It may happen that even the level of wealth and income that that we think we have now is based on false calculations, because the Fed and the U.S. Treasury, which is a fiscal agent of the U.S. government, have used every tool at their disposal and even forged some new ones in order to prop up housing and financial asset prices. Okay, so we have a bunch of things here. Well, this is percent changes in the Wilshire you don't have to worry about that um the federal deficit see it way down there in the corner you probably can't the federal deficit uh for fiscal year 2009 was 1.4 trillion and is on target for $1.2 trillion for this fiscalyear. um and with trillions of dollarss of deficits each year being for foreclosuredown the road as Gary North pointed out yesterday the gross federal debt has risen from around $4 trillion uh in well I'm sorry around $6 trillion in 2001 all the way up to nearly 14 trillion 10 trillion in addition to federal debt now. The gross federal debt um that's the gross federal debt the amount of the debt held by private investors okay 4 trillion is tell by government agencies and that we don't have to worry about that because if we have a just world or eventually we we bring about a world uh of of a free market economy you can cancel all that debt that's held by government agencies. but private investors hold 8 trillion four trillion of which is held by Foreign investors, So we're on the hook to pay interest on on this debt and eventually the principle the fed's attempt at qualitative easing which is as I said is a euphemism for nationalizing the financial institutions has resulted in its balance rising from 800 billion to 2.2 trillion just in the fall of 2008 very colorful here so this is all of see the the blue is at the bottom the traditional security Holdings government securities they added lending to financial institutions this is qualitative easing liquidity to key markets Federal fed agency debt mortgage backed Securities purchases okay so it jumped from under 1 trillion to um $2.2 trillion okay and the mar now the Market's not buying this I mean this hasn't this hasn't got us got us back on track um despite all of the stimulus programs and the alphabet soup of qualitative easing programs Taff tarp talf ppip fasp amlf so on the US economy is mired in a stalled recovery um caused by what Gary called broken confidence and Bob higs calls regime uncertainty despite the
quantitative EAS easing and the qualitative easing the FED has done that the FED has done and the stimulus programs the deficit spending no one is willing to borrow and invest because they do not know the economic consequences of all these programs andthe other government programs such as cap and trade Dodd Frank Bill and ObamaCare that are scheduled to be implemented no one knows the the effects of this um there's a great graph by Steve hanky here um I'll I'll quickly describe it and give you one more graph and I'll end um as hanky points out the FED has increased the money supply so it's increased its own the very bottom of of this rectang of this triangle the lower triangle is from August of 2008 what you can see there is that the FED has about $800 billion in monetary base and the money supply measured by M2 is $7.8 trillion now that has grown from August 2008 to August 2010 or to June 2010 um the the base is more than doubled and the money supplies increased from 7.8 to 8.6 trillion dollar however what has not grown what has shrunk is borrowing is is is is is is the extent to which people are willing to take on new debt this is what is stalling us um so Shadow banks that is the f Broad Financial system um their the credit extended by that by by this sector has fallen from 16 trillion to 13 trillion um the international positions of of banks those US dollar deposits outside the US has fallen from 13.2 trillion um to 12.2 trillion okay so that's Fallen um and finally the derivatives okay the the um over-the-counter derivatives have fallen from 684 trillion to 615 trillion so the FED is pushing money out but the Market's not taking it the investors well let's put this way the banks don't trust the investors they don't trust the um businesses they don't believe that they don't have confidence that that that there's solvent business or that that businesses out there have good plans for for investment the investors themselves aren't taking the loans because they don't see profit opportunities and they don't see profit opportunities because they believe that we're going to have higher taxes because of the of all the programs that the government has implemented as as well as as as as the pending programs that will be implemented in the future as well as of course the the deficit uh and and the huge debt that we're facing so the US credit triangle is is shrinking and the Market's causing it to shrink okay and that's that's a good thing because entrepreneurs are stepping back and making sure that before they do anything prices and costs are aligned properly that there are pro true prospects for profits what the FED has to do is to step away the government has to step away they have to allow the adjustment to occur and this I think this last um graph shows us um the death of macroeconomics okay as you'll notice I the black line is the federal deficit okay um the the the red line is the Fed funds rate now as they move down the defit gets larger as the black line moves down and the FED fund rates funds rate gets lower as as as a red line moves down that means that we have more spending and more money creation but notice what happens to the Blue Line every time the two the monetary policy line and the uh fiscal policy line
move down is that is as we get every time we get more deficits or greater deficits and lower interest rates what happens to the Blue Line the unemployment line goes up okay so everything they're doing is having the opposite effect to to their intent or to their stated intentions in fact recently uh in May in the a there was an article by University of Chicago Economist Harold huig that pointed out that for every new dollar of government stimulus spending there's a destruction of $3.40 of of of real output in our economy so um I'm happy to report that um it looks like macroeconomics is on its last legs and that you know hopefully it will be put in its grave we just have to say we knew this was coming as Austrians we told you so here are the reasons okay and and here are the data so thank you.