John Tamny‘s new book, “Who Needs the Fed?” sparks an interesting discussion with Bill Walton on this episode of Common Ground. Walton and Tamny discuss the role of the Federal Reserve Board and whether it is helping or hurting the recovery.
Bill: [00:01:00] Hi, this is Bill Walton. Welcome to Common Ground where we have interesting and useful conversations with leading thinkers and doers about how the world really works and what sort of things drive personal success, growth, and human flourishing. We’re skeptical about conventional thinking, the status quo, and easy answers. We also hope to provide you, the listener, with useful lines of action that you can take with you and use in your daily life.
Today we have John Tamny joining us who absolutely challenges conventional thinking and the status quo and easy answers. John has had a brilliant career. He’s currently political economy editor at Forbes, editor of RealClearMarkets, senior economic advisor to Toreador Research, and he’s also a senior economic fellow at Reason Foundation, weekly panelist on Forbes on Fox and his writings have appeared in The Wall Street Journal, Investor’s Business Daily, National Review, Financial Times, and London Daily Telegraph. As you can see, John is a prolific and successful author and thinker. We’re here to talk about his most recent book, but I also want to point out that he’s written a terrific book called “Popular Economics What the Rolling Stones, Downtown Abbey, and LeBron James Can Teach You About Economics”. John, welcome.
John: Thanks Bill, thanks for having me.
Bill: We’re here to talk about your book on the Federal Reserve among other things. It’s a book titled “Who Needs the Fed?” I have to say it’s one of the most stimulating and exciting and best books I’ve read in a long time. Congratulations.
John: That’s flattering, especially coming from you. Thank you.
Bill: The book is titled “Who Needs the Fed?” For those of us that need a little primer, what is the Fed, I mean what is the … What are we talking about here?
John: [00:03:00] Well, when we talk about the Fed, what it is, explains why we don’t need it. The Fed began in 1913 as a lender of last resort to solvent banks. If solvent banks had maybe run on their cash, depositors came in and wanted their money back, they had the Fed as a back stop. What we’ve seen over the last 100 years is that it’s unheard of for solvent bank to go to the Fed for a loan simply because they are numerous market sources of near term credit. The Fed exists basically as a back stop for weakened banks, which means the Fed exists to weaken the banking system overall.
The Fed is a bank regulator, but it’s a tragically bad regulator. We’re talking about the individuals who could not get jobs on Wall Street and then banks trying to police those who could. It doesn’t work. The Fed sets the borrowing rate between banks, but an interest rate or price, you don’t need the Fed for that. My argument is that the Fed, their existence shows why we don’t need it.
Bill: A lot of people think that the Federal Reserve Board provides credit. You make a case I think persuasively in your book that the Fed and banks in fact don’t provide credit. Credit comes from somewhere else. Where does credit come from?
John: [00:04:30] It comes from us. We create the credit. The Fed cannot increase or shrink credit. Credit is desks, chairs, computers, trucks, tractors, most of all labor. When you borrow dollars, you’re not borrowing dollars to look at them lovingly. You’re borrowing access to all the things that we create in the real economy. The Fed can only misallocate credit. What banks do, and they don’t do it particularly well as we’ve seen in modern times, they allocate, they help allocate the resources that we create in the real economy. Dollars are what we use to get access to again the trucks and tractors and real economic goods.
Bill: So money is not credit?
John: Money is the opposite of credit. If money were credit, Haiti and Honduras would have every bit as much as we do and counterfeiting would be encouraged. But credit is real economic resources. Where there are productive people, credit’s always in abundance, because those who have resources always want to direct them to their highest use.
Bill: My first job at a business school I was a commercial banker. I’d have borrowers or would be borrowers come and see me all the time, and I guess, let me see if I understand what you’re saying, you’re saying that I don’t create their credit as a banker. They create their own credit by their ability to be productive and do things that are going to be successful.
Bill: [00:05:30] The more likely they are to be successful at their endeavor, the more likely I, the banker, am willing to extend them what people incorrectly call credit. It’s really their credit.
John: [00:06:00] They arrive with the credit. When they walk in the door they have it. In your case you could give away all of our worldly possessions today, but based on your very successful business career you could walk in to most any bank and or investment house and you would have credit. Money would attach itself to you because of what you’ve done in the past. Bernie Madoff with the lowest interest rates in the world would be refused everywhere he goes. You are the credit. That’s something you’ve produced.
Bill: There’s an interesting story in the book about Warren Beatty about his credit and how credit can rise and fall. I mean, I think Bernie Madoff at one point could have gone to any bank and borrowed a lot of money. What about the Warren Beatty story which I think illustrates the rise and fall of people’s credit?
John: Warren Beatty started out a very successful actor, Splendor in the Grasp, Bonnie and Clyde in the 1970s, Shampoo, Heaven Can Wait, and then he had his best director success, Reds. As Beatty himself pointed it out, “I think I can get a movie made at any time.” He was credit persona.
Bill: Yeah, I remember that.
John: [00:07:00] A great looking guy who also made good movies. Then his career started to slow down. Late 80s he had Ishtar. In the early 2000s he had Town and Country. This was a movie that went massively over budget. You know from being in the business yourself the upfront cost of making a movie. Town and Country was released on thousands of screens but at its first weekend I believe it made $6 million. The investors lost their shirts on it. Warren Beatty very interestingly has not made a movie since. He once he had the ultimate credit in Hollywood. He could get any film green lit. Nowadays he’s retired, he’s very rich, but he can’t get a movie made.
Bill: [00:08:00] Credit is really based on our perception and reality that people can make things happen. It starts with people and their ability to create good things. You talk about something I thought was very interesting, is that when people are learning about how to become a good credit, they engage in experimentation process that often results in failure. You talk about the difference between failure in Hollywood and failure let’s say for example in Silicon Valley. Could you talk about that a bit?
John: [00:08:30] Yeah. Hollywood once again makes such a big upfront investment in cost that you may or may not get back years down the line. Silicon Valley is different. The upfront costs are not as great but also the potential for upside is massive. I don’t have to tell you there are very few movies in the history of Hollywood that have earned over $1 billion at present in Silicon Valley right now. Let’s recognize these are private valuations. There are 125 unicorns as in companies valued at over $1 billion. What that tells us is that there’s a lot more credit sources out in Silicon Valley willing to make, to pursue, to attach themselves to an entrepreneur and willing to lose on 99 out of 100 because the one success can pay per overall of the failures. In Silicon Valley it’s kind of a badge of honor to have failed before. You’re not losing as much money in the first place, but also your failure is your path to success. Silicon Valley is defined by 50 years of constant failure that have made it the richest locale in the world.
Bill: [00:09:30]This touches on one of your themes in the book about knowledge and how credit is based on knowledge and knowledge is really what drives the economy, not money. What does that, what do we mean by knowledge driving the economy?
John: [00:10:30] Well because if money drove the economy, then Silicon Valley would be poor, it would look like Detroit because just about every start-up in Silicon Valley fails. Interesting about is that 100 years ago just about every car maker in Detroit failed. 2000 of them in that rough general area were started, 99% of them died. It’s the information that the economy is relying on. It’s that experimentation. Thomas Edison felt he had a great day if most of his experiments failed because he was so much more knowledgeable as a result. Silicon Valley is about constant experimentation that begets the information that powers the economy forward. It’s not easy to open up a McDonald’s, to drill for oil I would add. You know that oil has got a market value once you can bring it out of the ground. With Silicon Valley you don’t know. It’s that path to new information. That is the source of credit growth.
Bill: [00:11:00] You make a contrast between government as a source of wealth or not a source of wealth in the private sector. I think sticking with their failure theme you say that in the private sector failure happens all the time. We expect it. That’s the way we allocate capital. That’s how we learn. By contrast government once you create a program, it never goes away. There’s no definition of failure. Talk about that.
John: [00:11:30] There is no failure. Let’s be very explicit. There is not failure in government. I make the point in the book that Warren Buffett is I think fairly well-realized is a brilliant allocator of capital, but if he were Senator Buffett he would be a disaster as allocator of capital. He could believe everything that you and I believe and he would still be awful at it.
Bill: Well he’d be a young guy as a senator.
John:[00:12:30] That’s right. Another problem. But Buffett with Washington when you are allocating resources there is no such thing as starving your bad ideas. Medicare began as a $3 billion program. In the 2020 it’s expected to be a $1 trillion annual program. It still doesn’t insure all of the elderly. It’s a major failure. If it were in the private sector, it would’ve died 50 years ago and very quickly. But with government there is an unlimited source of funds, productive people like you that will be fleeced in order to constantly pay for government’s failures, their bad ideas. If Warren Buffett were in government, his bad investments would continue to get funding just as much as the good ones would. Added to that, any government program develops a constituency. You cannot downsize. You can’t shut it down. In fact, you’re rewarded the more people you’re hiring because that pleases politicians. In the private sector you’re rewarded for the exact opposite.
Bill: The war on poverty for example, you make a very interesting point in the book, but if you look at the number of people that want to come in the United States that even by the 19th century we demonstrated we’d ended the war on poverty, we’d ended poverty.
John: [00:13:30] Without question. I take great offense when people on our side talk about how we need to fight poverty and we need to have poverty programs. The purest market signal in the world and nothing else comes close is where people want to go, where people want to pursue their own individual dream. The world’s poorest have been fighting to get into the United States for over 200 years now, which is a very clear market signal that we won the war on poverty realistically back in the 19th century. Poverty in the US today is not a function of a lack of opportunity. It’s a function of bad choices.
Bill: We touched early on about the credit and where money goes and you featured Baltimore in your book, which I’d like to learn more about, how Baltimore figures into the Federal Reserve story.
John: [00:14:30] Well Baltimore is probably my favorite chapter in the book because I wanted to make the point that contrary to what seemingly all schools of economics think, the Fed cannot increase money supply or increase resources where they’re not going to be treated well. You think about Baltimore. It’s a very poor city. To believe the monetary school or even the Austrian School to a degree one way to fix Baltimore would be to increase money supply in Baltimore. Yeah, there’d be more money there, it’d be a more prosperous place. Imagine if the Fed were to do that, if it were to buy lots of bonds from Baltimore banks and increase money supply. The money would stay in Baltimore for all about 30 minutes.
You know this well as an investor. Banks cannot long stay in business and investors cannot long stay in business allocating limited resources to where there is a lack of productivity and where people don’t have the means to use those resources well. An increasing money supply in Baltimore would immediately flow well outside the city and probably outside the state.
Bill: I remember, oh, I don’t know, several years ago when Ben Bernanke was chairman of the Fed didn’t we have this idea out there that, his nickname was helicopter Ben and any problems we had he was going to get up into the sky with his helicopter and shower us all with dollars. You’re saying that that won’t work?
John: I’m so glad you brought that up because let’s try the helicopter idea on Baltimore and let’s try it on a country like Greece. Let’s do both.
Bill: They would like that.
John: [00:16:00] Let’s say the Fed and the ECB helicopter billions of dollars into Athens and Baltimore, and let’s imagine something even more ridiculous, that all of that money would spent in Athens and Baltimore. No business is going to expand based on a helicopter drop. That money would be banked in Athens and Baltimore banks. There’s once again very little productivity in both cities. That money would be lent. It would boomerang back to Brussels, back to Germany, it would boomerang to New York City, to productive locales. You cannot force money and credit to places where they are not wanted. This I say defies the thinking of just about every school of economics that says the Fed can stimulate economic growth. It cannot.
Bill: [00:16:30] Well when you push on it, you obviously can’t, there’s no amount of dollars that would cause me to invest in Detroit or Baltimore. You’re right. I’d put it in the mattress. I still have it.
John: [00:17:00] Bet let’s try something. What if you and 100 people like you moved to Detroit tomorrow. I submit to you that money supply and resources would flow in Detroit very quickly. See, what they leave out, and this is the problem with sport stadiums, this is the problem with government spending, if the talent’s not there to rate that kind of resources, the money will come in and flow right back out. But if you Bill Gates, Jeff Bezos, Larry Ellison moved to Detroit tomorrow, it’s going to be a very rich place very quickly with money flowing in, not out.
Bill: [00:18:00] Which gets back to your earlier point about credit. I like being included with Bill Gates, and that would take me out of the equation, but it gets back to the notion of credit. It’s people’s ability to be productive, just taking it for people, for those of us to think about how to become more credit worthy, you’re also talking about at an individual level investing in yourself. The more people are investing in themselves to develop their investment skills, to become an engineer, to become a great teacher or something like that, the more valuable they are at that, the better their credit is. People like Bill Gates have shown the ability, and Steve Jobs have shown the ability to not only do it through themselves but to enlist other people and to cause and create great products and now the world is awash in iPhones and iPads and we’re thrilled.
John: It’s a beautiful thing.
Bill: [00:18:30] Again, coming back to the book, which is just filled. I mentioned at the outset we like the provocative and challenging conventional thinking. I mean you have a view about government spending that the deficit doesn’t really matter but that federal spending is the real issue and the deficit is just financing government spending and the government spending is a negative for the economy. Is that- John: Hugely. That’s … Bill: Explain that. That’s what the helicopter, we’re thinking government’s going to stimulate things, isn’t it?
John: [00:19:00] That’s the theory and it’s proven wrong. If government could stimulate West Virginia would be a rich place because their monuments to Robert Byrd all over the state, but very little economic growth. Let’s be clear upfront. All government spending is deficit spending. Government has no resources. What it spends it extracts from the private sector. The government has nothing of its own. If we’re going to talk about deficit versus what they tax, at least they’re paying for the right to destroy our wealth when they borrow it, when their tax wage is taken.
Bill: [00:19:30] What about this notion that came up? Elizabeth Warren and President Obama say tell us we didn’t build that, that we only had our successful businesses because the government provided roads and free education and all sorts of things like that.
John: [00:20:30] I’m so glad you brought that up, because one of my favorite examples in the book is Russia. In the year 2000 the state of Ohio had more paved roads than all of Russia, 11 time zones combined. That to me is one of the best examples that, “Oh, yes, we did build that. This is all ours.” Because if government could build roads, then Russia would have them. No, for all those years of low economic growth, where they deprived the citizenry of the fruits of their production, the Russian government had very little resources because its people were poor. Government gets its ability to create roads and schools from private sector production. That’s why a state like Ohio which is not even that notable of a state anymore economically has more roads than all of Russia combined. We create the resources. Government has never created a job, or a road, a school in the history of its existence. What it’s able to do is a function of a productive private sector.
Bill: For those that wonder about this, you didn’t build that. The equation is the private sector creates the wealth, the government then taxes some or maybe a lot of the wealth, and then they use that to build the roads. Don’t you need government to build the roads?
John: [00:21:30] Well, let’s think about that. Does anyone think that if government weren’t there to build the roads, that we’d go by horse drawn carriage from Los Angeles to San Francisco. Of course not. There is an incentive among the productive to have ways for us to trade. That’s why we get up and go to work every day, is we want to produce what we’re good at in exchange for all that we don’t have. If government didn’t create roads, private sector sources would’ve done that. They would’ve a much better job at it. What does capitalism do every single day? It turns scarcity into abundance. It turns a cellphone that cost $4,000 in the 80s into something we can get next to nothing for now.
[00:22:00] Isn’t it interesting that one of the biggest frustrations for people in their daily lives is traffic? I think you can tie it into the fact that we don’t have market forces driving the production of roads. Imagine what capitalists could do with the roads in the United States. I’m guessing because it’s in their profit incentive to do so, they would rid us of traffic.
Bill: [00:22:30] I like that thought, although I don’t know quite how we’re going to bring that about. We’ll work on that. What about other aspects of the government though? You make a pretty strong case that almost no government spending is well spent. Even backing up from that, health care, people say, “Well, health care is something different from food or transportation or housing.” Health care is a government item and these other things can be private sector, but health care needs to be a government provided service.
John: [00:23:00] Why would it be, if health care is no different from any other service? Isn’t it interesting that any other business loves lots of customers? That’s their goal, to get lots of customers. Yet somehow health care is a service that is overrun with too many customers, that there are doctor shortages. On a free market all of that would be taken care of very quickly. But it does speak to when government gets involved with something and it doesn’t mean that government people are inherently bad, but when you remove that profit-
Bill: It’s not the people. It’s the system.
John: [00:23:30] It’s the system. It cannot work. In the private sector you’re rewarded for doing more with less. In government you’re rewarded for the exact opposite. It’s no surprise that when government involves itself in certain things that you get very little for a lot.
Bill: One more question in this topic and then I’m going to shift gears back to the Fed. Was there nothing that government does? I mean is it all, is 100% … Let’s say we’ve got a $15 trillion economy and we’ve got 5 billion being spent by federal state. Is none of that trillion to be there? What about police and firemen and things like that?
John: [00:24:30] Well you and I are big fans of George Gilder and experimentation. I want this experimentation to find out what government does well. The point, to go back to just as brand, citizen states should be laboratories for ideas. You want this experimentation that maybe there are things that a local government can come up with. Maybe a local town wants a nice football stadium for its high school. I don’t know. But you want that experimentation locally and then people can say, “Okay, it worked in McKinney, Texas. We’ll try it in Stockton, California.” The problem is when experiments occur nationally everyone suffers their failures. You know in the private sector, we know from Silicon Valley there’s a lot of bad ideas out there. In the free markets we starve them quickly. With government they live forever.
Bill: [00:25:00] I’m president of a local volunteer fire and rescue in our county. It’s astonishing. It works very well with an all volunteer system. I’m not sure we can scale that to New York City. I don’t quite see that working that way, but there could be some other way to deliver those.
Coming back to the Fed, I have been saying and I think you disagree with this, that the reason the stock market has boomed in the last 7 or 8 years is that the Fed have been holding interest rates at zero. My view, I want to hear the other side of this, is that the world is not that all investable right now. Or if you’re an investor and you look around where you want to invest, you’ve got real estate which is okay but not so great, you got commodities which have been in a slump for the past period of time, and when you get interest at zero, you don’t want to put it in the bank. So what do you do? You put in the stock market because that’s the place where you can go to actually get some dividends and maybe some return. Is that …
John: That is the argument made. I reject it in the book. Quantitative easing was the Fed borrowing 4 trillion from banks to- Bill: Explain quantitative easing. That’s … John: It wasn’t money printing. It was just the Fed. Banks hold reserves at the Fed. The Fed pays them 25 basis points. That’s just an interest rate that’s-
Bill: That’s a quarter of a percent.
John: [00:27:00] Yeah, a quarter of a percent on that. Then they’ve used that in modern times or for several years to buy up US treasuries to allegedly keep interest rates down. We know in the real economy it’s hard to do that. Then also to buy up mortgages to stimulate that housing market. The Fed misallocated 4 trillion to stimulate government spending which we know is wasteful, and then to double down on the very rush into housing consumption got the economy in so much trouble to begin with. Let’s get it out there right away that this was bad for the economy. It was anemical to the economy’s health, quantitative easing.
The idea that quantitative easing could’ve tricked the smartest investors in the world in the world’s deepest stock markets to believe that this was good for stock market health I think defies common sense. But people, I still get push back on that. So I’ll just point out that if in fact quantitative easing is a source of stock market health, Japan has got to be explained. It suffered 11 doses of quantitative easing since the early 1990s with no corresponding stock market rally.
We’ll then hear that the low interest rate from the Fed has caused a flight out of low yielding instruments into the higher yield offered by the stock market, but never explained there is why treasury is never corrected, why corporate it’s never corrected to reflect this migration out of bonds and in the stock market. Then the biggest thing that’s got to be remembered is for a QE excited buyer to express bullish optimism in the marketplace. By definition a QE skeptic like you and me gets to express an equal amount of pessimism. For every bullish buyer there’s a bear seller. The passions of the bulls and bears are always, they always equal each other out in any market. After that quantitative easing was telegraphed to end in 2014. Markets knew well before 2014 it was going to end. Markets, they price in the future, never the present. If in fact quantitative easing was stimulating the stock market, this would’ve reflected in a major correction well before 2014.
Bill: [00:29:00] How is the Fed keeping interest rates at zero? Is the Fed doing that, and if rational lenders want to lend, why would they lend at such low interest rate? I know why borrowers would like to borrow, but …
John: [00:29:30] That’s the thing, the Fed is not doing that. Apple is the most valuable company in the world, yet it pays 3%. It’s a very difficult credit market for small businesses right now. I talk about in the book that Brian Grazer, one of the most talented movie producers in the world is rejected for credit 90% of the time. The Fed cannot decree easy access to the economy’s resources and it certainly hasn’t been able to do it right now. Why do banks pay so little for deposits? Well, they’re bailout wards of the state. They can’t take any risks. Banks would be insolvent if they paid a lot for deposits because they don’t have the kind of loans that would make that profitable. I think banks are paying low rates of interest because they’re dying before our eyes as allocators of credit.
Bill: How much of the credit is in the banking system and how much is outside the banking system?
John: [00:30:30] Well, that’s the source of the book’s major major optimism. The Fed tries to stimulate the economy or influence the economy through the US banking system. But as I point out in the book, banks are dying before our eyes as sources of credit. They account for 15% of total lending in the US economy, and that number is in free fall. It is for one because Lending Club, USAA, all sorts of non-bank alternatives are much better at allocating the economy’s resources. That’s the first thing. The second thing, banks are so heavily regulated today. If you want to get into any new line of business it’s a 3 year regulatory process that no one talented is entering the traditional banking system anymore. With the banks dying before our eyes as a source of credit that means the Fed is dying with it.
Bill: [00:31:30] Particularly since Dodd-Frank I think entering the banking business is unattractive. I mean, you’ve got to put up with millions and millions of dollars of filing fees to get going, you’ve got the regulatory burden which there’s some banks, I think there’s a bank in [Louisville 00:31:17] that had poor people in its compliance department 10 years ago. Now they have 40. The number of people they have in the lending department has fallen from 35 to 25 or some numbers like that. What is it? There’s one bank that’s been started in the last 7 years? It’s got a great name. What’s the name?
John: [00:32:00] it’s a Bird in Hand Bank. It’s an Amish country in Pennsylvania. It’s the only new banking institution that’s come out, and for all the reasons you say. It’s too expensive to enter this business anymore. More and more the people banks are hiring are compliance officers helping banks deal with government, as opposed to innovative financiers looking for ways to get credit to those who rate credit. It’s kind of interesting. The Fed is suffocating the very banks that give it any relevance in the first place as is Dodd-Frank.
Bill: Do you know what the big booming market is for consultants now in the financial services area?
John: I assume it’s related to Dodd-Frank.
Bill: [00:32:30] Stress test consultants. They’re spending hundreds of millions of dollars to pass stress test which I think nobody thinks in the real world you can predict the future well enough to know what the stress would be.
John: [00:33:00] Thank you. Furthermore banks in financial institutions conduct stress tests every day. That’s their job, to try to predict the future, the idea that a bunch of people in government are at the Fed. This does not mean knocking government and the Fed, but let’s face it, if you are talented, you don’t work for the Fed, if you know a lot about banking, you don’t work in government because you would be compensated a lot more to actually work in the industry. You’re asking the least talented people to police people exponentially more talented. It’s the equivalent of asking Fairfax high school to beat the Red Skins annually in football. No, the talent mismatch is too great. That’s what we’re asking of regulators today. They cannot do what they’re charged with doing, hence they’re just suffocating banks.
Bill: [00:33:30] Well, let’s sum up here. I think one of my takeaways is you think we don’t need the Fed at all and that in fact we don’t need the government regulating money at all, that that could be a private sector thing. Can you summarize that and I think we’ll …
John: [00:34:00] Well yeah, let’s remember what is money. To quote Adam Smith, “The sole use of money is to circulate consumable goods.” Money is not wealth. Money is what we use to get our … I’ve got bread, I want your wine, but you want the butcher’s meat. With money we’re able to communicate our desires with one another. I can exchange my bread for your wine and you can then use, go to the butcher to get the meat. All you need from money is to be good is for it to be stable. Would you mind earning Amex dollar or Visa dollars or JP Morgan dollars? I certainly wouldn’t. All you want is for money to be stable. Well the private sector creates cars, computers, shoes in all shapes and sizes. Why couldn’t the private sector create money?
Bill: Well, banks printed, had their own money in the 19th century. John: Absolutely. Bill: Before we consolidated it. So it’s been done. Well, this is incredibly interesting. We’ve been talking today with John Tamny who is a brilliant provocative thinker about all things economic. John, I hope we can get you back-
Bill: … because there’s a lot we haven’t explored that we ought to get into. So thank you.
John: I’d love to come back. Thank you very much.
Bill: Great. Thanks John.
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