Tape 50 - Stock Market, Is This 1929? Low Point of Current Revision, Subscribers Questions
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- | Hello, this is William Clark of the Chicago Tribune, | 0:02 |
welcoming you once again on behalf of Instructional Dynamics | 0:04 | |
to another visit with the imminent economist, | 0:08 | |
Professor Milton Friedman of the University of Chicago. | 0:10 | |
We're recording this interview on May 16th. | 0:13 | |
It's the end of another rather exciting week, | 0:17 | |
to say the least, in the stock market, Dr. Friedman, | 0:19 | |
and I know even though we've discussed it before, | 0:22 | |
your subscribers would like to hear again | 0:24 | |
whether this portends another episode | 0:26 | |
like we had in 1929. | 0:29 | |
- | Well, it certainly is what everybody is worrying about. | 0:31 |
There is no doubt that nothing gets so much publicity | 0:35 | |
so quickly and widely spread as a drop in the stock market, | 0:37 | |
and there's no doubt that the stock market | 0:41 | |
has dropped very drastically in the last week or two. | 0:43 | |
And not only the stock market, | 0:46 | |
there is no doubt that a feeling of panic, | 0:48 | |
in the sort of literal sense of the term, | 0:50 | |
has been spreading over all the markets. | 0:53 | |
The bond market has been feeling it, | 0:55 | |
so you've had bond prices fall and yields rise. | 0:56 | |
Even the commodity markets, | 1:00 | |
which ought not to be connected with it, | 1:02 | |
have been feeling it. | 1:03 | |
I noticed for example | 1:05 | |
that silver future prices dropped rather sharply. | 1:06 | |
Now there's no particular reason why that should | 1:09 | |
be infected by the panic in the stock market, | 1:12 | |
because the future price of silver at the moment | 1:14 | |
is really contingent on how soon the Treasury | 1:17 | |
is gonna run out of the silver | 1:20 | |
which it's been selling to supplement what's produced. | 1:22 | |
As you know, current production of silver | 1:25 | |
is less than current consumption of silver, | 1:27 | |
and the Treasury has been supplementing it | 1:29 | |
out of their stocks. | 1:30 | |
All estimates are that the Treasury's | 1:32 | |
gonna run out of the extra silver | 1:34 | |
sometime in six, or eight, or nine months. | 1:35 | |
And the silver prices oughta be reacting to that, | 1:37 | |
not to the panicky conditions on the market. | 1:39 | |
But it's often been noted in the past | 1:42 | |
that panic of that kind knows no boundaries, | 1:43 | |
it knows no geographical boundaries, | 1:45 | |
it knows no boundaries by commodities. | 1:47 | |
And it's also often been observed in the past | 1:50 | |
that the people who are involved in the markets, | 1:53 | |
people particularly who are daily involved | 1:56 | |
in the stock market and who are accustomed | 1:59 | |
to looking at tapes from hour to hour | 2:00 | |
are easily given to panic, | 2:02 | |
because this instills in them. | 2:04 | |
They are people who are looking for the very short run, | 2:06 | |
and it instills in 'em a very sharp reaction. | 2:09 | |
So I believe that the sort of scary attitudes | 2:11 | |
of people on Wall Street, | 2:15 | |
and who are in the board rooms all over the country | 2:16 | |
looking at the tape, | 2:19 | |
that those scary attitudes should be discounted enormously, | 2:21 | |
in terms of what they imply for the economy as a whole. | 2:24 | |
I do not believe that there is any way whatsoever | 2:27 | |
in which this panic portends major catastrophe | 2:29 | |
or major problems for the country. | 2:34 | |
On the contrary, I think what's been happening | 2:36 | |
is that the unrest over Cambodia | 2:39 | |
over our foreign affairs in Vietnam, | 2:42 | |
plus the unrest on the campuses | 2:45 | |
has introduced an element of uncertainty | 2:48 | |
of concern about the longer run future | 2:51 | |
of the country and so on, | 2:54 | |
which is manifested in a more panicky reaction | 2:55 | |
in the stock markets and securities markets | 2:58 | |
than you otherwise would've had, | 3:00 | |
that this is a major factor | 3:01 | |
why after what looked as if you had had a big enough decline | 3:03 | |
to discount almost any conceivable economic development, | 3:08 | |
you had a still further decline in the market. | 3:11 | |
Now let me make a number of additional points | 3:13 | |
that are relevant. | 3:17 | |
If you go back to the '29, '33 period, | 3:18 | |
which everybody goes back to and is concerned with, | 3:20 | |
the crucial date is not really October 29th 1929. | 3:23 | |
I think I have that right. | 3:28 | |
I'm not sure of the exact day. | 3:30 | |
But I'm talking about Black Friday, | 3:32 | |
whether it was Friday or Thursday on the stock market, | 3:34 | |
when you had the great big crash in '29. | 3:37 | |
See, that crash started with an enormous decline on one day. | 3:39 | |
That day, if my memory serves me right | 3:43 | |
is October 29th, 1929. | 3:45 | |
But that's not the crucial day, | 3:48 | |
the crucial date in the '29, '33 episode | 3:50 | |
was December 11th, 1930. | 3:52 | |
Now what happened on December 11th, 1930? | 3:55 | |
What happened on that day was | 3:57 | |
that the Bank of the United States in New York failed, | 3:59 | |
the largest bank in the United States ever to have failed. | 4:01 | |
If you look at the record from '29 to '30, | 4:04 | |
in reaction to the stock market crash, | 4:07 | |
you did have a somewhat more severe economic decline | 4:09 | |
than in many of the prior recessions. | 4:13 | |
It was a contractionary period, | 4:17 | |
but it was not a major contraction. | 4:19 | |
It was nothing unprecedented, it was not out of line. | 4:20 | |
If the recession had ended in early 1931, | 4:23 | |
as I believe it might very well have done | 4:26 | |
if it had not been for the further bank failure problems. | 4:29 | |
Why then, we would look back on it | 4:34 | |
and say, gee, that was a pretty tough recession, | 4:35 | |
but nobody would single it out as the great event | 4:37 | |
of the last hundred years, great in the negative sense. | 4:39 | |
But what happened was that this | 4:42 | |
relatively severe contraction from 1929 to '30, | 4:45 | |
I have no doubt that the stock market contributed | 4:49 | |
to that first year of severity, | 4:51 | |
was converted into the major catastrophe | 4:53 | |
that we did experience | 4:56 | |
by the bank failures starting, | 4:58 | |
I say the December 11th one was a crucial one, | 5:01 | |
there were lots of small ones, | 5:03 | |
but that was the one that really changed the atmosphere | 5:04 | |
and started depositors by the millions | 5:07 | |
flocking to their banks and trying to withdraw funds, | 5:10 | |
and caused the sequence of bank failures, | 5:13 | |
which ended up in March 1933 | 5:15 | |
with roughly a third | 5:18 | |
of the banks having gone out of business, | 5:20 | |
and with the quantity of money down by a third. | 5:22 | |
Well, it was this series of bank failures, | 5:25 | |
and the contraction and the quantity of money, | 5:27 | |
which the federal reserve system permitted it to cause, | 5:29 | |
which was the major factor | 5:32 | |
that produced the Great Depression. | 5:33 | |
So the question you wanna ask now, | 5:35 | |
because what people on Wall Street are really worried about | 5:37 | |
when they go back to '29 | 5:40 | |
is not only the crash in the stock market, | 5:41 | |
what the people in New York and Wall Street talk about, | 5:43 | |
it's clear this is what is in the back of their mind, | 5:46 | |
is that there are several large stock market firms | 5:48 | |
that they figure are on the verge of failure, | 5:51 | |
and that there may be some real bankruptcies | 5:53 | |
in stock market firms. | 5:55 | |
That may be perfectly possible | 5:56 | |
and may not happen because the stock exchange | 5:57 | |
will try to bail 'em out and keep 'em from failing. | 6:01 | |
And they say, well now, | 6:04 | |
let's suppose you had those failures, | 6:05 | |
and let's suppose this triggered some failures | 6:08 | |
in other financial or non-financial firms, | 6:10 | |
couldn't this start a wave of distrust | 6:13 | |
and collapse of the kind you had in '29 to '33? | 6:15 | |
And so they bring out the terms | 6:18 | |
like banking panic and crisis, | 6:20 | |
and when they get a little bit farther away from '29, | 6:22 | |
they say, well, maybe it'd be 1907 or 1893, | 6:24 | |
or the other dates of banking crisis. | 6:27 | |
Well, the most important thing to note there | 6:29 | |
is if you go back in history, | 6:31 | |
none of those crises, those panics, | 6:32 | |
have ever produced major effects, | 6:35 | |
unless they have transmitted themselves | 6:37 | |
to the banking and monetary system. | 6:40 | |
If these things could trigger bank failures, | 6:43 | |
runs on banks, a decline in the quantity of money, | 6:46 | |
then they would be potentially of catastrophic importance. | 6:49 | |
But they cannot do that in the present circumstances, | 6:52 | |
and they cannot do it for two reasons. | 6:54 | |
The first is that | 6:56 | |
with federal deposit insurance confirmation | 6:57 | |
insuring deposits up to $20000, | 6:59 | |
the small depositor is not gonna run. | 7:02 | |
He's the one who made the runs in the past, | 7:04 | |
and what happens is even if you had one bank fail, | 7:06 | |
this would not set off a stream of failures in other banks. | 7:09 | |
But the second and even more important reason | 7:12 | |
is that the federal reserve system | 7:15 | |
does have the background of experience now. | 7:16 | |
We know what did happen in the 1929, '33 episode, | 7:18 | |
we have a clearer understanding of the role | 7:21 | |
of providing liquidity in the economy | 7:23 | |
under those circumstances, | 7:25 | |
and there is not one chance in a million | 7:27 | |
that under the same circumstances | 7:28 | |
that occurred in '30 to '33, | 7:30 | |
the Fed would at the moment permit | 7:33 | |
the multiplication of the effect | 7:36 | |
on the monetary system, | 7:39 | |
would permit a sharp decline in the quantity of money. | 7:40 | |
And under those circumstances this cannot spread, | 7:42 | |
in my opinion, to the kind of major catastrophe we had then, | 7:46 | |
or that people are now fearing | 7:50 | |
because of the decline in the stock market. | 7:52 | |
- | Well, that's very encouraging | 7:55 |
and it certainly makes sense. | 7:56 | |
Dr. Friedman, we have a number questions from subscribers, | 7:58 | |
I wonder if we might get into some of those at this time? | 8:01 | |
Here are two which are similar in a way. | 8:03 | |
One says, when will the low point of the economy | 8:06 | |
be reached in 1970? | 8:10 | |
And the other says, Mr. McKracken | 8:12 | |
and other government economists | 8:15 | |
say the low in the economy for 1970 | 8:16 | |
was seen in the first quarter, do you agree? | 8:19 | |
- | Well, those are very related questions. | 8:22 |
No, I do not agree with the estimate | 8:25 | |
attributed to Mr. McKracken. | 8:27 | |
I may say, Mr. McKracken's language | 8:28 | |
has been deliberately somewhat ambiguous. | 8:30 | |
It's not entirely clear that he has stuck his neck out | 8:34 | |
as much as this question indicated, | 8:38 | |
though he certainly has given that impression. | 8:41 | |
But let me go directly to it, | 8:43 | |
because it's also interesting in view of the fact | 8:45 | |
that Paul Samuels, in one of his recent tapes | 8:47 | |
on this or my colleague there, | 8:51 | |
has committed himself much more unambiguously | 8:53 | |
to the forecast that the first quarter was the low point, | 8:58 | |
at the second quarter we'll see the turning point, | 9:03 | |
that we have, as he phrased it, | 9:05 | |
we have started on the upturn, | 9:07 | |
we've reached the bottom. | 9:11 | |
Well, my own opinion is not the same | 9:13 | |
as either that of Paul McKracken or Paul Samuels. | 9:16 | |
And maybe having the name Paul | 9:19 | |
leads to a common opinion. | 9:20 | |
Gospel according to Paul and Paul. | 9:23 | |
There are some signs, which might justify that view, | 9:28 | |
in particular the crucial difference | 9:33 | |
between those who are stressing | 9:35 | |
that we may have reached the turning point, | 9:39 | |
and those like myself, who are inclined to believe | 9:41 | |
that the low point will not come, | 9:43 | |
the turning point will not really come | 9:46 | |
until the third or fourth quarter. | 9:48 | |
The crucial difference is whether you stress | 9:50 | |
the impact of monetary phenomenon on the one hand, | 9:51 | |
or whether you pay a great deal of attention | 9:55 | |
to fiscal factors, | 9:57 | |
because there are a number of fiscal factors | 10:01 | |
which will affect personal income and personal spending. | 10:03 | |
In particular, there's the increase | 10:08 | |
in social security benefits, | 10:13 | |
and there's a retroactive pay increase, | 10:14 | |
which was for government employees. | 10:16 | |
And both of these are going to add funds | 10:18 | |
to the spending stream, or appear to in the first instance. | 10:22 | |
And the stress on a possible turn up in the economy | 10:25 | |
and the low point having already been reached | 10:28 | |
in large part derives from emphasizing these flows. | 10:31 | |
But my own view is, and has been, | 10:34 | |
that this is a very misleading indication, | 10:36 | |
because the question is if the government | 10:38 | |
is going to pay out those funds, | 10:40 | |
where's it gonna get the money from? | 10:41 | |
If it gets the money by printing money, | 10:43 | |
well, then that is expansionary, | 10:45 | |
but it seems unlikely that it will do that, | 10:47 | |
in the sense that while the Federal Reserve | 10:50 | |
is committed now to a steady rate of growth | 10:52 | |
of the quantity of money to a moderate rate of growth | 10:55 | |
of about four percent, three percent per year, | 10:58 | |
it seems unlikely to increase that drastically | 11:00 | |
in order to finance these additional | 11:03 | |
government expenditures. | 11:06 | |
And if it isn't obtained that way, | 11:07 | |
then it will have to be withdrawn | 11:08 | |
from the spending stream someplace else, | 11:10 | |
through government borrowing, | 11:12 | |
which will raise interest rates. | 11:13 | |
And so if you look at the monetary totals, | 11:15 | |
you have to say to yourself, | 11:17 | |
well, the change in monetary policy came | 11:19 | |
about December, maybe January, | 11:21 | |
in a switch from a zero rate of growth, | 11:26 | |
where the money supplied is something | 11:28 | |
like a three, four percent rate of growth. | 11:29 | |
In the ordinary case that takes six to nine months | 11:33 | |
before it's reflected in the change | 11:36 | |
in the rate of growth of the economy. | 11:38 | |
That would bring us to somewhere | 11:40 | |
between July and September or October. | 11:42 | |
And may be that this time it would be a little longer | 11:44 | |
for a variety of reasons, | 11:48 | |
including the liquidity crisis | 11:49 | |
that people have been talking about. | 11:50 | |
That's why I say I think third or fourth quarter | 11:52 | |
is about the best bet. | 11:54 | |
And one point on that, I recently had occasion | 11:55 | |
to go back and look over the figures | 11:59 | |
for the last six or nine months a little more closely, | 12:00 | |
and I am really a little bit concerned | 12:03 | |
about the fact that the relation | 12:05 | |
to the monetary changes has been too close. | 12:07 | |
In our historical experience we have a good deal of leeway. | 12:09 | |
It isn't true that you have a perfect relationship. | 12:13 | |
But now when I went back and looked | 12:18 | |
over the past year really, year and a half, | 12:19 | |
on this episode it's been phenomenally close. | 12:23 | |
In the following sense you will recall | 12:28 | |
that the quantity of money was growing | 12:31 | |
at the rate of seven or eight percent during 1968. | 12:33 | |
That was the reason I at that time | 12:36 | |
and others who had this view, | 12:37 | |
were yelling that we were going to have | 12:39 | |
continued inflation and continued expansion, | 12:41 | |
despite the surtax. | 12:43 | |
In December 1968 you have the first shift in policy. | 12:45 | |
That reduced the rate of growth from then to May | 12:48 | |
to something like four, four and a half percent. | 12:51 | |
Now at the time it looked as if | 12:54 | |
the reduction was more severe than that, | 12:58 | |
because if you remember back, | 13:00 | |
there was a mistake in the figures as a result | 13:01 | |
of the way in which the Euro dollar deposits | 13:04 | |
were being handled and various items, | 13:05 | |
technical items that I needn't go to. | 13:07 | |
And so up until about May or June, | 13:09 | |
the figures were saying | 13:11 | |
that the quantity of money was rising | 13:12 | |
at only about one and a half or two percent. | 13:13 | |
But then it turned out when they recalculated | 13:16 | |
and revised the figures to eliminate the technical errors, | 13:18 | |
it has turned out to be four, four and a half percent. | 13:21 | |
And so that was a much milder switch | 13:23 | |
than at the time, I've thought, | 13:25 | |
and it's led me, at the time, | 13:26 | |
to predict a more serious reaction | 13:28 | |
than we did in fact have to it. | 13:31 | |
Well then however, about May or June | 13:33 | |
the Fed stepped on the brake once more, | 13:36 | |
and from then to the end of the year | 13:38 | |
you have the very, very severe monetary policy | 13:40 | |
of a zero rate of growth. | 13:42 | |
Now let's look at the economy. | 13:44 | |
Take the six to nine month slag, | 13:46 | |
that means that the mild reduction | 13:48 | |
in the rate of growth from in the first half of 1969 | 13:51 | |
should've led to a mild slowdown in the economy | 13:57 | |
in the second half of '69. | 14:00 | |
That's exactly what we have. | 14:02 | |
The more severe, much slower rate of growth | 14:04 | |
from June to December | 14:08 | |
should have started manifesting itself | 14:09 | |
in the first quarter of 1970. | 14:11 | |
Lo and behold, what do we observe? | 14:14 | |
We observe that whatever we look at, | 14:16 | |
there's a sharp acceleration | 14:18 | |
in the rate of decline of the economy | 14:20 | |
in the first quarter of 1970. | 14:22 | |
If you look at the GNP figures in real terms, | 14:24 | |
allowing for the price impact, | 14:28 | |
they fell by a fraction of one percent | 14:30 | |
in the fourth quarter, | 14:32 | |
it was negligible, it was essentially zero. | 14:33 | |
But revised figures have just been issued | 14:35 | |
for the first quarter of '70 | 14:38 | |
and that has raised the rate of decline | 14:39 | |
from an annual rate of one and a half percent | 14:41 | |
to an annual rate of over three percent, | 14:44 | |
so you had it rather severe. | 14:46 | |
If you look at unemployment figures, | 14:47 | |
they are rising very, very gradually | 14:49 | |
from about June or July or August of 1969 | 14:51 | |
to the end of 1969. | 14:55 | |
Then all of a sudden in January they take off | 14:58 | |
and the next three months they went from 3.4% to 4.8%. | 15:00 | |
If you look at the figures | 15:05 | |
that are starting to come out for April, | 15:06 | |
they tell the same story | 15:09 | |
of a continued decline in industrial production. | 15:10 | |
So as I say, on this occasion, | 15:12 | |
you seem to have, if I may summarize it, | 15:14 | |
two step movement in money | 15:17 | |
which is followed in almost precise timing sequence | 15:18 | |
six to nine months later | 15:22 | |
by a two step sequence in the economy. | 15:23 | |
As I say, I stress this to warn the listeners, | 15:25 | |
the subscribers, that this is far closer | 15:29 | |
than on the average you could expect | 15:31 | |
over the past experience. | 15:33 | |
There is just is more noise in the relationship than that. | 15:34 | |
This just happened to have been right on course. | 15:38 | |
Well, given that it's been on course this far, | 15:41 | |
I find it very hard to believe | 15:45 | |
that it's not gonna continue to be on course, | 15:48 | |
and that's why I feel highly confident | 15:50 | |
that the economy will continue to decline | 15:53 | |
for another three to six months. | 15:55 | |
Now I wanna say one word about that. | 15:58 | |
The statistics that come out are going to be | 15:59 | |
highly misleading as Paul Samuels | 16:01 | |
has stressed very instructively in his own comments on this, | 16:03 | |
because in the second quarter of this year, | 16:08 | |
all of the pay increase will be put into the GNP. | 16:10 | |
So the second quarter GNP will show | 16:14 | |
the government pay increase that's already showed up | 16:16 | |
in an extremely high rate of increase | 16:19 | |
of personal income in the month of April | 16:21 | |
because you pile into that a retroactive | 16:23 | |
pay increase in social security. | 16:25 | |
But if you look at the underlying figures, | 16:28 | |
my answer to these two questions is | 16:30 | |
that at the moment, the time would appear to be | 16:32 | |
a low point in the third or fourth quarter. | 16:37 | |
Now this, interestingly enough, | 16:41 | |
goes back to our first comment about the stock market. | 16:42 | |
On the average in past episodes, | 16:45 | |
the stock market has tended to turn up | 16:46 | |
about six months before the economy intended to turn down. | 16:48 | |
Now I hasten to add that it's a very erratic thing. | 16:51 | |
It's often turned down when the economy hasn't. | 16:54 | |
It's often turned up when the economy hasn't. | 16:56 | |
But so far as that average timing pattern is concerned, | 16:59 | |
if I am right about when the timing for the economy | 17:03 | |
oughta be approaching now roughly the bottom of the market. | 17:06 | |
I don't mean to make that as a prediction, | 17:09 | |
because as I say, the one thing I've learned | 17:10 | |
is that it's not safe to make predictions | 17:12 | |
about the stock market. | 17:14 | |
- | Now that's interesting Dr. Friedman. | 17:16 |
Now another subscriber comments on | 17:17 | |
what he calls the apparent paradox of rising unemployment, | 17:19 | |
rising prices, accompanied by other inflationary pressures, | 17:22 | |
while we are seemingly well into a recession. | 17:26 | |
If we are truly well into a recession, he asks, | 17:28 | |
why is there continued pernicious competition for money? | 17:31 | |
- | Well that is a very, very insightful question. | 17:35 |
I believe we are well into the recession | 17:39 | |
and there is no doubt that there is | 17:41 | |
continued pernicious competition for money. | 17:42 | |
However, this is one of those cases where | 17:45 | |
we first have to start by disentangling some words. | 17:48 | |
He says pernicious competition for money. | 17:54 | |
What there's pernicious competition for is credit, | 17:56 | |
not for money, | 17:58 | |
and what he's referring to | 17:59 | |
is the interest rates on money, | 18:00 | |
the interest rates on credit, | 18:02 | |
not the price of money. | 18:05 | |
The price of money is how many shoes or hats or coats | 18:06 | |
you have to give up to get a piece of money. | 18:09 | |
Now it's true that the price of money | 18:11 | |
is continuing to go down. | 18:13 | |
That the price of that in general is going up, | 18:15 | |
but there is some tapering off | 18:17 | |
of the rate of rise of prices. | 18:19 | |
We are seeing some signs of inflation coming under control, | 18:20 | |
and that's consistent with the picture of the recession, | 18:23 | |
at about the right time. | 18:25 | |
However, with respect to the competition for credit, | 18:27 | |
and particularly long term credit, | 18:30 | |
what is occurring now is different | 18:32 | |
from what has occurred at any other post-war two, | 18:36 | |
post World War Two recession. | 18:40 | |
If you look at the experience | 18:43 | |
since the end of World War Two, | 18:45 | |
what you have is that both long term interest rates | 18:47 | |
and short term interest rates | 18:51 | |
have peaked within one or two months | 18:52 | |
of the peaking of the business cycle. | 18:55 | |
Now the latest date anybody would set | 18:58 | |
for the peak of the business cycle, | 19:00 | |
in this occasion is December | 19:02 | |
and it's not clear whether the historians, | 19:04 | |
when they go back, will really pick December. | 19:05 | |
They may pick October or November or December, | 19:07 | |
they may pick even an earlier month, | 19:09 | |
but nobody will pick a later month I think than December. | 19:11 | |
Suppose you take December, | 19:15 | |
and the by the post-war path, | 19:16 | |
both long and short rates | 19:18 | |
should have peaked long before this, | 19:20 | |
that is they should have peaked around December, | 19:22 | |
and as I say, to the best of my recollection, | 19:25 | |
in no case was a peak in rates more than | 19:27 | |
two months later than the cycle peak. | 19:30 | |
Short rates did peak. | 19:34 | |
Short rates have been behaving, | 19:35 | |
more or less, as anticipated. | 19:37 | |
Of course in the last couple of weeks | 19:39 | |
with the panic in the stock market | 19:41 | |
there has been an upsurge in short rates, | 19:42 | |
though they're down again a little now, | 19:44 | |
but the level of short rates today | 19:46 | |
is still decidedly below the level | 19:49 | |
that was prevailing, let's say, | 19:51 | |
in November or December last year. | 19:52 | |
On the other hand, long rates, | 19:53 | |
far from coming down, are higher now | 19:56 | |
than they were then. | 19:58 | |
And that is where there is a real paradox | 20:00 | |
in terms of the post World War Two experience. | 20:02 | |
Now it's interesting to go back and discover | 20:05 | |
that what's happening there, however, | 20:07 | |
is a reproduction of what the pattern | 20:09 | |
used to be before World War One. | 20:11 | |
One of the ways I find it's useful | 20:14 | |
to try to get some understanding on one of these situations | 20:15 | |
is to try to see how it fits into our historical path | 20:18 | |
and where you can find an episode | 20:21 | |
that has some parallel with it. | 20:23 | |
And if you go back before World War One | 20:25 | |
you will find that the typical pattern | 20:27 | |
of long term interest rates, | 20:29 | |
was that they kept on rising on the average | 20:30 | |
past the peak in the cycle | 20:33 | |
to about halfway through the recession | 20:34 | |
and then peaked out. | 20:36 | |
And the explanation which was given for that at that time | 20:37 | |
was that you had an extremely strong | 20:39 | |
role played in the capital markets by the railroads. | 20:42 | |
Railroads were a major user of capital. | 20:47 | |
Now if a railroad starts right away, | 20:49 | |
starts to build an extra line, | 20:51 | |
it's of no use whatsoever until it's finished. | 20:53 | |
No use having it built halfway between A and B, | 20:56 | |
can't go anywhere. | 20:58 | |
And consequently, once a railroad started building a line, | 20:59 | |
there was enormous pressure on it | 21:02 | |
to continue it, even though business had turned down. | 21:03 | |
This meant that after business turned down, | 21:07 | |
railway expenditures on right away continued very high | 21:09 | |
and the demand for capital from railroads | 21:13 | |
continued very high and this held on the demand side, | 21:15 | |
represented a high demand for capital. | 21:19 | |
On the other side, the supply side, | 21:21 | |
the banks at that time would get | 21:22 | |
very squeezed for liquidity around the peak | 21:24 | |
and they would be very hard put to it | 21:26 | |
to maintain their liquidity | 21:30 | |
under the circumstances with the large demand | 21:32 | |
for loans in the market as whole from railroads, | 21:33 | |
and from distressed firms in the short term market, | 21:36 | |
and so you had a rather stringent supply, | 21:38 | |
high demand, interest rates kept on rising, | 21:41 | |
and they turned down about | 21:43 | |
the middle of the recession for two reasons, | 21:45 | |
because the railroads started completing their projects | 21:47 | |
on the one hand and on the other, | 21:49 | |
you started to have a gold inflow from Europe | 21:51 | |
to relieve the liquidity position of banks | 21:53 | |
because the downturn in the U.S. | 21:55 | |
would reduce U.S. imports, increase U.S. exports, | 21:58 | |
produce a favorable balance of trade, | 22:01 | |
balance of payments, | 22:03 | |
and this would be reflected in a gold inflow from abroad | 22:05 | |
which would relieve the banking system. | 22:07 | |
Now you have a remarkable parallel to that | 22:10 | |
in this particular episode. | 22:12 | |
The parallel to the railroads | 22:14 | |
has been the stubbornness of capital expenditures | 22:15 | |
on the part of enterprises. | 22:17 | |
You've had businesses who are convinced | 22:18 | |
that construction costs were going to be higher | 22:21 | |
after a while than they are now, | 22:23 | |
and therefore they were determined | 22:25 | |
to build their capital expenditures regardless | 22:27 | |
almost to the price they had to pay for credit. | 22:31 | |
And that, really, is a counterpart to the railroad, | 22:34 | |
it's been high demand. | 22:36 | |
On the other side, | 22:37 | |
you have had the banking system far more squeezed | 22:38 | |
for liquidity on this occasion | 22:40 | |
because of the extremely tight monetary policy | 22:42 | |
of the Fed in the last half of last year | 22:44 | |
than they had been in most other post-war periods. | 22:46 | |
Now the third factor is a very interesting factor, | 22:50 | |
is that the change in monetary policy | 22:53 | |
about the early part of this year | 22:55 | |
is a counterpart of the gold inflow. | 22:57 | |
It is beginning to ease the liquidity position of bank. | 22:59 | |
So you have all the ingredients of that earlier episode. | 23:01 | |
Now how far will it reproduce? | 23:04 | |
Does this mean that the long term rates will continue | 23:07 | |
to rise or that they will come down? | 23:11 | |
Well I think that depends on whether | 23:13 | |
this pressure for capital project stays up, | 23:15 | |
and here I believe there are considerable signs | 23:19 | |
that it's tapering off or going to taper off. | 23:22 | |
I may say, from this point of view, | 23:24 | |
the stock market decline is a wonderful thing. | 23:27 | |
If I didn't look at it from the short range point of view, | 23:29 | |
if I stand away and look at it | 23:31 | |
in perspective of national policy, | 23:33 | |
the stock market panic is fine. | 23:36 | |
I cannot think of any better way | 23:38 | |
to break people's inflationary expectations, | 23:40 | |
to make people recognize | 23:43 | |
that we aren't going to have inflation forever. | 23:44 | |
And it's an essential feature | 23:46 | |
that people revise their expectations of inflation | 23:48 | |
in order that you have a reduction | 23:51 | |
of the capital spending boom, | 23:53 | |
in order that you have interest rates come down. | 23:55 | |
It will contribute to a tapering off of inflation. | 23:58 | |
So I may say, from a national point of view, | 24:01 | |
there is no reason to bemoan the stock market crash, | 24:03 | |
though of course from the point of view | 24:06 | |
of any one of us who own stock, | 24:08 | |
it's not so pleasant, but we are, | 24:09 | |
as it were, benefiting the economy. | 24:11 | |
When I said this to some stock market people in New York, | 24:14 | |
where I happened to be yesterday, | 24:16 | |
they said yes we are great benefactors for the economy, | 24:18 | |
we're burying the economy on our back, | 24:21 | |
we're sacrificing ourselves and so on. | 24:22 | |
Well let's go back, well if indeed | 24:24 | |
you do have some tapering off | 24:28 | |
in this capital expenditure pressure | 24:29 | |
and you do have the easing liquidity | 24:32 | |
in the banking structure, | 24:35 | |
well then I would suppose that you might continue | 24:36 | |
in the pre-World War One pattern, | 24:39 | |
and that pattern was that the interest rates | 24:42 | |
started down about halfway through the recession. | 24:44 | |
On my calculations, we're roughly about halfway through | 24:47 | |
the recession now, which means that | 24:50 | |
whether you look at the post-World War Two experience | 24:52 | |
or pre-World War One experience, | 24:54 | |
in either case you ought to anticipate | 24:56 | |
a substantial decline in long term interest rate. | 24:58 | |
I say substantial decline in long term interest rates. | 25:01 | |
Whether it's substantial or not | 25:04 | |
depends on how successful we are in curbing inflation. | 25:05 | |
- | Are utilities particularly like the railroads used to be | 25:09 |
in being caught with projects that they have to complete | 25:12 | |
regardless of the-- | 25:14 | |
- | Yes, utilities are. | |
They are, but utilities do not amount | 25:17 | |
to as large a fraction of total capital expenditures now | 25:18 | |
as the railroads did earlier, but you are quite right, | 25:22 | |
that they are more directly like them. | 25:24 | |
- | We recently had some new figures | 25:27 |
on the deficit in the first quarter | 25:29 | |
international balance of payments, | 25:31 | |
that is the United States deficit, | 25:33 | |
and we have a subscriber who asks | 25:34 | |
is there a possibility of an international money crisis | 25:37 | |
and a rise in the price of gold, | 25:40 | |
which might be relevant | 25:42 | |
in view of these balance of payments. | 25:43 | |
- | Yes, at the time, as I say, | 25:44 |
panic tends to spread without boundary | 25:47 | |
and it could perfectly well spread to the gold market, | 25:49 | |
but I think that it's necessary to separate | 25:53 | |
two parts of his question. | 25:58 | |
Before the two tiered accord of 1968, | 26:03 | |
to say that there was a rise in the price of gold | 26:07 | |
was equivalent to saying that there was | 26:10 | |
an international money crisis. | 26:12 | |
But those two statements no longer go together. | 26:14 | |
It is now perfectly possible for the price of gold | 26:16 | |
to move independently of whether | 26:18 | |
there's an international money crisis. | 26:19 | |
I think a rise in the price of gold | 26:21 | |
is very, very likely. | 26:23 | |
If it doesn't come now it'll come a year or two from now, | 26:25 | |
because it's another case like the silver case, | 26:27 | |
where current consumption, or hoarding and other purposes, | 26:30 | |
is either equal to or in excess of current production, | 26:34 | |
and the difference is being provided out of stocks, | 26:37 | |
and that cannot continue indefinitely | 26:39 | |
without a rise in the price of gold, | 26:41 | |
so I think that on commodity grounds, | 26:43 | |
there is a very very good reason to expect | 26:45 | |
that over the next five or ten years | 26:47 | |
gold will rise more or less regularly in price. | 26:48 | |
But on the other hand, I do not think | 26:52 | |
that there is any possibility in the near term | 26:54 | |
of an international money crisis | 26:56 | |
or particularly a dollar crisis. | 26:58 | |
We do have very gloomy figures in the balance of payments, | 27:02 | |
a large deficit in the liquidity balance | 27:08 | |
and a large deficit also on the official settlements balance | 27:10 | |
but this only offsets what were large surpluses | 27:14 | |
on the official settlements balance last year. | 27:16 | |
The actual situation in terms of the holding of dollars | 27:19 | |
by foreign central banks is not in any way | 27:21 | |
discouraging or troublesome. | 27:23 | |
And moreover, as I've emphasized in these tapes before, | 27:26 | |
the world is, at the moment, on the dollar standard, | 27:29 | |
and there is no way in which you can have a dollar crisis. | 27:31 | |
There's nothing for the foreign central bankers | 27:33 | |
to do with those dollars. | 27:36 | |
What could happen and what may happen, | 27:37 | |
is that you have changes in the policies of other countries | 27:45 | |
in order to reduce the accumulation of dollars. | 27:49 | |
This is not, as I've emphasized before, | 27:51 | |
a good thing. | 27:53 | |
But the fact is that we have nothing to say | 27:54 | |
about our balance of payments at the moment. | 27:56 | |
Our balance of payments has to be the sum | 27:58 | |
of whatever all other countries desire, | 28:00 | |
because of the fact that the dollar | 28:02 | |
is the international standard | 28:04 | |
and consequently, we have to be passive | 28:06 | |
under present circumstances. | 28:10 | |
- | Here's a subscriber who would like you | 28:12 |
to get back to the stock market for a moment. | 28:14 | |
He asks, why does volume follow price on the stock market? | 28:16 | |
- | Well that's a very perceptive question. | 28:21 |
The thing is, if price and volume | 28:24 | |
indicate two different things in the stock market | 28:26 | |
or in any market. | 28:28 | |
The volume of trades in a market, in the stock market, | 28:30 | |
is an indicator of how much difference of opinion there is. | 28:34 | |
Let us suppose some event happens overnight, | 28:37 | |
like for example a Cambodian episode, Cambodian foray, | 28:39 | |
and that everybody agrees that that's a reason | 28:47 | |
for stocks to be marked down in price, | 28:49 | |
then prices will fall but nobody will buy or sell. | 28:52 | |
In order to have somebody buy and sell, | 28:55 | |
you gotta have one person who thinks the price is too low | 28:56 | |
and another who thinks it's too high. | 28:58 | |
So large volume always indicates | 29:01 | |
widespread differences of opinion. | 29:03 | |
Now the reason why the bottoms of past bare markets | 29:06 | |
tend to have been marked by a period of crisis | 29:10 | |
with the sometimes sharp falls in prices, | 29:13 | |
but almost always increasing volume, | 29:17 | |
is because the bottom of a market must be a period | 29:19 | |
of when differences of opinion are emerging. | 29:22 | |
The market's been falling because | 29:23 | |
people thought on the whole it's gonna go down, | 29:25 | |
now people, sooner or later, it's gonna rise. | 29:26 | |
That must be because there develops a new sentiment | 29:29 | |
that it's gonna go up. | 29:31 | |
At such a turning point, you almost inevitably | 29:33 | |
have a widespread difference of opinion, | 29:34 | |
and therefore you have a large volume. | 29:37 | |
Similarly, when the market goes up a great deal | 29:39 | |
and you're at the top of bull markets, | 29:41 | |
well again, volume will tend to go up | 29:43 | |
because there will be a widespread difference of opinion, | 29:45 | |
and that presages a turn in the market. | 29:48 | |
So you should look at volume for a sign | 29:50 | |
of how agreed people are | 29:52 | |
and for price as sign for what value they set on the market. | 29:54 | |
- | Here's a subscriber who says, | 29:59 |
reading your comments, that the small saver | 30:00 | |
is heard under regulation Q, I agree, | 30:02 | |
but I sincerely question if the mutuals | 30:04 | |
and the savings and loans | 30:07 | |
are really worth protecting. | 30:08 | |
Perhaps these institutions in their present form | 30:09 | |
have outlived their competitive usefulness, please comment. | 30:11 | |
- | Well that's a very good question. | 30:16 |
I don't believe that eliminating regulation Q | 30:19 | |
would in fact threaten the existence | 30:24 | |
of mutuals and savings and loans. | 30:28 | |
The subscriber takes it for granted | 30:30 | |
that if you eliminated regulation Q | 30:31 | |
and forced the mutuals and savings and loans | 30:34 | |
to compete openly, that they would be destroyed. | 30:36 | |
As a matter of fact they might not be. | 30:41 | |
But then I go on and I'm fully in agreement | 30:43 | |
with him beyond that. | 30:45 | |
If indeed they would be destroyed, | 30:46 | |
if indeed in an open and free market, | 30:47 | |
these institutions cannot compete | 30:50 | |
and provide small savers with as a high a return | 30:52 | |
as other institutions can provide them, | 30:55 | |
then these institutions would have demonstrated | 30:58 | |
they had outlived their competitive usefulness. | 31:00 | |
I don't know any other test | 31:02 | |
that is as satisfactory for the proper functioning | 31:04 | |
of an institution as the free market test. | 31:08 | |
I have only one qualification to this | 31:10 | |
and that is unfortunately, we do not have free competition | 31:12 | |
in the commercial banking business either. | 31:15 | |
In order to get a charter to set up a commercial bank, | 31:17 | |
a franchise, you must demonstrate, | 31:19 | |
either to a state banking authority | 31:21 | |
or to the controller of the currency, | 31:24 | |
that there is a need, a social need, | 31:26 | |
certificate of convenience and necessity, | 31:28 | |
a social need for a new bank. | 31:32 | |
Now that's absurd. | 31:33 | |
It's not inappropriate that there'd be | 31:35 | |
objective criteria for setting up a new bank. | 31:36 | |
You might require that nobody could set up a bank | 31:38 | |
unless it had a minimum amount of capital, | 31:40 | |
unless maybe it was a member of the FDIC. | 31:42 | |
Such objective criteria, | 31:45 | |
while I might be in favor of or not, | 31:46 | |
raises a different kind of a question, | 31:49 | |
than requiring some set of human beings | 31:51 | |
to decide whether the market needs another bank, | 31:53 | |
and so I would say that | 31:56 | |
I would extend this individual's comment. | 31:58 | |
He happens, as I see from the card, | 32:01 | |
to be an official of a bank, | 32:03 | |
I would assume a commercial bank, | 32:06 | |
to say that he is entirely right, | 32:08 | |
but he should extend it to his own banks, | 32:09 | |
and come out in favor of an easier and more objective | 32:11 | |
availability of franchises for commercial banks. | 32:14 | |
And then let's have free competition with commercial banks | 32:18 | |
and savings and loan, mutual savings banks, | 32:20 | |
all competing freely with one another. | 32:24 | |
Indeed, I have often commented that | 32:25 | |
a real sign of problems in our commercial banking system | 32:28 | |
is that there are so few failures. | 32:33 | |
It must be that they're over protected. | 32:35 | |
- | Thank you very much, Dr. Friedman. | 32:37 |
We've been visiting with Professor Milton Friedman | 32:38 | |
of the University of Chicago. | 32:40 | |
If you have questions or suggestions | 32:42 | |
for subjects on which Dr. Friedman | 32:44 | |
might comment on future tapes, | 32:46 | |
please sent them to Instructional Dynamics Incorporated, | 32:47 | |
166 East Superior Street, Chicago, 60611. | 32:51 | |
This is William Clark of the Chicago Tribune. | 32:56 | |
We'll be visiting with Dr. Friedman again | 32:58 | |
in a couple of weeks. | 33:00 |
Item Info
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