Steve Hanke on Hyperinflation, Monetary Policy, and Debt
Oct 29 2012

Steve Hanke of Johns Hopkins and the Cato Institute talks with EconTalk host Russ Roberts about hyperinflation and the U.S. fiscal situation. Hanke argues that despite the seemingly aggressive policies of the Federal Reserve over the last four years, there is currently little or no risk of serious inflation in the United States. His argument is that broad measures of the money supply lag well below their trend level. While high-powered reserves have indeed expanded dramatically, they have not increased sufficiently to offset reductions in bank money, in part because of requirements imposed by Basel III. So, the overall money supply, broadly defined, has fallen. Hanke does argue that the current fiscal path of the United States poses a serious threat to economic stability. The conversation closes with a discussion of hyperinflation in Iran--its causes and what might eventually happen as a result.

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Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


Oct 29 2012 at 10:26am

This was a very good podcast. Econtalk at its best.

Strangely, the part that interested me the most was the short discussion of Northern Rock. Not the central point of the podcast to be sure, but I’ve always been fascinated by explanations/narratives of the business cycle that follow specific institutions. The Northern Rock story makes me intensely curious exactly which two French money market funds Northern Rock had been dependant on, and why they went down.

Oct 29 2012 at 12:34pm

[Comment removed for supplying false email address. Email the to request restoring this comment. A valid email address is required to post comments on EconLog and EconTalk.–Econlib Ed.]

Oct 29 2012 at 1:38pm

I agree with MichaelM that this podcast was an example of Econtalk at its best. I found the most interesting parts to be the insights about profit-maximizing banks:

  • book/value stock ratios constraining banks’ access to equity markets,
  • the resulting post-Basel III asset management strategies,
  • disguised subsidies from the Fed via interest on reserves (arguably also driven by a post-Basel environment).

That said, I thought Hanke was less than compelling when trying to refute Meltzer’s future inflation scenario. I’m not sure pending high inflation would force the Fed to “face the music” and tighten significantly. If history is any guide — for example inflation in the late 70’s — our institutions need a current crisis to force them to trade short-term pain for long-term gain. Of course, once an inflationary crisis has erupted, it’s difficult and painful to play catchup.

Mirza D
Oct 29 2012 at 3:04pm

Very interesting podcast but the recording quality wasn’t the best. Russ, are you using a different mic? Sounds like there is a lot of breathing noise picked up while prof. Hanke is talking. Your voice also sounded very hissy.

John Voorheis
Oct 29 2012 at 3:30pm

Overall a decent podcast, but I’m disappointed that both Russ and the guest repeated a misleading talking point about the Fed’s treasury purchases. The 75% number comes from, IIRC, the first quarter of 2011, when the Fed indeed was the dominant purchaser of T-bills. Since then, though, the Fed hasn’t bought anywhere near that fraction, and in fact has even on net decreased some T-bill holdings. This wasn’t a huge part of the podcast, but it would have been nice to hear something other than a parroting of talking points.

Russ Roberts
Oct 29 2012 at 3:48pm

Mirza D,

I’ve been using the same technology for a while, but sometimes, if the guest has trouble hearing me, I put the mic too close and it picks up my breathing when I’m listening. I’m working on it. Sorry for the distraction.

Russ Roberts
Oct 29 2012 at 4:56pm

John Vooheis,

Some talking points are true. Some are somewhat true (only true for a particular time, for example, as you suggest.) It would be helpful if you could provide some data to know how true it is or how not true rather than relying on your own ability to recall correctly, which may just be a different talking point. But to be honest, didn’t realize it was a talking point at all.

Peter Palms
Oct 29 2012 at 5:01pm

If there has been no serious inflation, why is the ounce of gold that cost $34 in 1957 now costing $1,700 while a nice suit at Barneys still costs the same ounce of gold it did in 1700 in a haberdashery in London.

Why was my school tuition at Rutgers $12 a credit in 1957 when I graduated without any debt for financing my education, when now $30,000 debt is common

Why was my rent $100 a month and it is now $2300.

What has happened to this country

[broken url removed. Please check your urls before submitting your comments.–Econlib Ed.]

Jacob Steelman
Oct 29 2012 at 5:09pm

Great podcast. I was particularly interested in Hanke’s discussion about state money and bank money. Bank money as I understand it is the creation of credit (money) by the banks as a result of the fractional reserve banking system.

David Sage
Oct 29 2012 at 6:18pm

Could it be that mortgages are hard to get because the banks don’t want to lend money for a long time at the current low interest rates, when they anticipate that interest rates will go up?

Especially if they are profitable now without making mortgages.

Of course the banks will blame the problem on regulation.

John Voorheis
Oct 29 2012 at 7:17pm


Perhaps “talking point” is even a bit strong – although it has shown up in stump speeches and interviews by Romney, for whatever that’s worth. In terms of data, the Treasury reports all the results of new T-bill and T-bond auctions here:

In each report, there’s a line for SOMA, which is the amount of bonds purchased as part of OMO. The Fed hasn’t bought *any* newly issued 7, 10 or 30 year bonds since the June auctions of this year. Looking specifically at the June auctions, the Fed bought $296,081,700 out of $29,000,049,100 newly issued 7 year notes (1.02%), $1,482,702,800 out of $22,482,717,900 newly issued 10 year notes (6.59%) and $917,863,600.00 out of $13,917,865,200.00 of 30 year notes (coincidentally also 6.59%). That’s one month, but I think you’ll see similar results for other auctions in 2012.

Now, even 6.59% might be problematic, but the 75% number is off by at least an order of magnitude for recent auctions.

Oct 30 2012 at 9:36am

I agree with the guest that there will not be hyper-inflation with the US Dollar for two reasons not really mentioned:
1. The reserves of the USA banking cartel would drop to nothing. The Fed being partially owned by these banks will simply not let that happen to its buddy banks.

With Big Ben at the helm, the rate of price increases could get rather high in the 20% to 30% per year range above the 5% to 9% that it is currently, not 2% to 3% as mentioned in the discussion.

2. Foreign central banks similarly will not want their holdings of US Dollar based assets to go to zero either. I just do not see the governments of China and Japan wanting to explain to their populace that their 2 trillion dollars in US Government Debt would barely buy a home in the Washington DC area. I would expect these folks to massively increase the amount of their own currencies causing high price increases on their own turf to fight a rapidly dropping valued dollar.

Peter Swinson
Oct 30 2012 at 6:46pm

Enjoyed the podcast. Mostly over my head but still interesting. I’m not in finance or banking but I assumed it was a given that spending half again what is generated in tax revenue results in inflation. Is the point that we won’t have hyper-inflation (50% or greater per month)? The 20% annually of the late 70’s was pretty bad.

Timothy Wright
Oct 30 2012 at 9:59pm

Enjoyed the podcast. It seems that the guest is proposing that the basel regulations are too strict, because the broad money supply is lower that it was before the crisis. But there has been other EconTalk guests who argued that the banks are allowed to leverage too much making the overall system too fragile. If this is true, then we don’t want the broad money supply to go back to the good old days. Should the banks have capital requirements?

I would like to hear the guests opinion on that. How much should the banks be allowed to leverage? What should be the target for broad money supply and is the past a good approximation?

Oct 30 2012 at 10:24pm

Bank Lending Constraints

There are (at least) two primary constraints to bank lending:

1- solvency requirements, and
2- liquidity requirements.

There is wide public confusion that conflates those two.
However, they are two different things.

The liquidity requirement is also known as “reserve requirements”.
How much liquid “cash” banks are required to have to meet daily
operational payouts, etc… just like you as an individual have
liquid cash (ie assets not tied-up in investments) to cover
near-term, expected (an some unexpected) expenses/payouts.

AFAIK, the reserve requirement has not changed for decades in
the US banking system. It is set at 10% of liabilites.
Anything over that is “excess reserves.”

[ Actually, in a monetary regime that targets interest rates,
the banking system is not reserve constrained at all… but thats
another story. ]

The solvency requirement is also known as “capital requirements”,
aka equity aka assets – liabilities.

While “reserves” are an asset, they are not “capital.”

Oct 30 2012 at 11:35pm


Regarding the mystery of interest on excess reserves (IOER):

Recently, even Paul Volcker says he doesn’t understand the continuing IOER.
See here:

Volcker says:
“I don’t quite understand why they’re putting all this money into the economy and then paying interest on excess reserves of the banks…”

In the same article, (and elsewhere), the Fed’s reason (currently)
of not cutting IOER is that it would destablize the money-market mutual
fund industry.

Destablize how ? Here’s their theory: there’s too much demand/not enough supply
for very low risk assets.. And, the $2T excess reserves behaves like
$2T of no-risk assets which yield 25 bps.

Their theory is that if the IOER where cut to zero, those excess reserves would
likely go chasing/bidding on the same very low risk assets that MMMFs hold, driving
those yields to zero or negative. Who would want a money market fund that paid
zero or negative ? Probably nobody.

(Really, that reason doesn’t make sense either, but I can’t articulate why
in a short comment.)

I agree with Russ: probably the main function of IOER
is a slow backdoor bank recapitalization at public expense.

David B. Collum
Oct 31 2012 at 8:22am

Hi Steve. Enjoyed the podcast.

It seems to me that the discussion needed some discussion of loss of confidence. Once that is gone, attempts to stem the inflation become exceedingly challenging (feedback loop). Think Beanie Babies: Once that silly bubble burst even constrained supply did not protect their price, which is now zero. I also worry about a rapid surge in velocity–release of the monetary capacitor with a loud “crack!”–will occur unexpectedly. Again, confidence loss seems like a proximate trigger.

One could argue that the market is attempting to tell us that the debtors are saturated, and it is time for a hiatus (an albeit deflationary one.) Attempts in the 20’s to stem the post-war deflation put off, but ultimately failed to preclude, the post-war deflation. This is described in lurid detail in “Banking and the Business Cycle” (1937) by Phillips, McManus, and Nelson. This notion of trying to force consumption by a spent consumer seems stunningly irresponsible to me.

I personally am able to muster up some latitude to Bernanke for stemming the hemorrhage (stemming bank runs), but now he seems to be doing elective surgery. Seems to suffer Hayek’s “Fatal Conceit”, something Greenspan had a a terminal case of. What makes a dozen guys think they are smart enough to control something so complex that it requires evolutionary forces to shape and adjust baffles me. If they were biologists, they would be redesigning elephants because “they are too fat, too slow, and don’t need that long trunk.”

Ferguson (“When Money Dies”) argues that the German inflation stemmed from the state accepting private liabilities onto its balance sheet and is not as strongly tied to reparations as many would claim. Seems like we are doing precisely that. Does that put us at risk of hyperinflation? Not a clue, but it seems likely.

In case y’all missed it, check out Einhorn’s denunciation of the Federal Reserve in his Buttonwood speech excerpted over at Zero Hedge. This may be one of those savvy, rich guys Russ refers to.

Got gold? (That’s actually a real question for Steve!)

NB-Larry White’s “Clash of Economic Ideas”, which I picked up on the podcast, was great. I also picked up on that low-carb diet and have dropped almost 30 lbs since July. Your podcasts are really useful.

Trevor C
Oct 31 2012 at 9:43am

Really good podcast. It changed my perspective on what is happening in the US and the rest of the world.

I would really like to see David Walker interviewed. I think he would be able to shed a lot of light on the fiscal situation in the US.

Becky Y
Oct 31 2012 at 3:41pm

Very interesting podcast, much of it over my head, but still interesting. . . not one where you cd listen and multi-task other things. . .

I wanted to let you know Russ, that I have a concrete example of “What I’ve learned listening to Econtalk”. . . on the ballot in Long Beach CA is a measure to mandate that the larger hotels offer a living wage of $13/hr to their hotel worker staff. My pre-Econtalk self would have automatically voted for that automatically. . . I still might vote for it, but after 2 yrs of Econtalk under my belt, at least I realize that the world is more complicated than I previously thought, and I am struggling with my decision.

on that note, I am also still undecided on the presidential election. Do you know of any non-partisan websites that might be of assistance? I dread doing research b/c everything I find is so partisan and unhelpful. . .

Thanks! keep up the fabulous podcasts!

Dr. Duru
Oct 31 2012 at 9:12pm

First, thanks Steve for the link to the Chicago Tribune with Volcker questioning interest on reserves. I keep hearing it brought up in podcasts, but the discussion about it, until now have come up short in explaining what’s going on. I finally understand it now as a way to recapitalize banks.

There were two things I would have liked to hear more about:

1. Dollarization seems like an easy fix to hyperinflation, but what happens after that? Presumably, the agent causing the inflation thought this inflation would solve a problem. For example, I can only assume dollarization does not suddenly fix budget problems and over-spending. The fiscal authority must agree to the discipline. And in doing so, someone, some group must suffer for a time. Who were those people in cases like Yugoslavia? Zimbabwe?

2. I was sitting on the edge of my seat waiting for the guest’s prescription for monetary policy. It seems the easy answer is that the Fed should have opposed Basel 3 (or was it 2?). Yet, right after that, we learn that this agreement benefited American banks over European banks? so doesn’t that advantage assist U.S. banks in recapitalization as business flows from overseas? Can you clarify this? And isn’t there more the Fed should have done or should be doing than this?

Dana Gardiner
Nov 1 2012 at 3:48pm

Russ: in both the solutions to the hyperinflation examples in this talk the currencies that were having problems were solved by linking to another currency: Zimbabwe to the US Dollar, Bulgaria to the Deutschmark; but what happens when the currency hyperinflating is the US Dollar? What happens when the worlds reserve currency is the one that is hyperinflating? Then what?

John Berg
Nov 1 2012 at 11:41pm

Best podcast to date and a personal reward for scrupulous attendance to This podcast provided direct answers to some personal questions which I won’t discuss here because I have exposed my identity. But I will email Russ directly with the details.

John Berg

Nov 2 2012 at 1:08am

Econtalk does some of its best work discussing the Fed and monetary policy. This was a great discussion.

I hope that one day Russ slays the interest on reserves beast because he seems to been battling it for a while with no satisfaction.

This post: and the links to it lead me to think that IOR is a somewhat complicated subject and just saying it’s a smoke and mirrors subsidy to bail out banks seems too simple an explanation.

John Berg
Nov 2 2012 at 3:47am

More to Dana Gardiner’s comment:

I remember the hockey stick curve of 1990s when interests rates go up and push compound interest into the stratosphere! If my ROI must include planning on 12% interest, what must my price for my widgets be to ensure a profit a year from now?

John Berg

Nov 3 2012 at 11:25am

Thanks Russ for another great podcast. I have no economics background whatsoever, so this show has been a big help in getting my head around current events. John V. kind of anticipated my question, but I was going to ask why on one hand you guys said the Fed was buying 75% of US treasuries, but on the other you said that right now it is “no problem” for the US to find buyers. If it were no problem then the Fed wouldn’t be playing such a large role, right? But I guess if the 75% number is incorrect then that might explain it.

Rob Parrish
Nov 3 2012 at 1:54pm

As a long time listener of Econtalk, I can say this is one of the best shows that has been aired. It was very informative and very much focuses one’s thinking on the pros and cons of Basel 3 and Dodd/Frank.

Romney has said that he will strive to make adjustments to both those Basel 3 and Dodd/Frank. It is now more clear to me where the opportunities for improvement are. I, for one, am hoping that he will be elected and will take prompt action to make those changes.

The most interesting nugget of information in this podcast (for me) was the fact that Basel 3 considers Treasury bonds “risk free”. Is that one reason for the explosion of government debt under Obama?

(This is my first comment on this site. I started an international shipping business about the same time that the podcast started airing. What I have learned here has very much helped me develop my business. Russ, thanks for that. My twenty some odd employees thank you, too. Our senior staff, all in their early thirties, now listen to your podcast each week and, as a result, are better at their jobs. We all thank you.)

David F
Nov 3 2012 at 5:23pm

This was as stated before econtalk at its best. Very enlightening.

Nov 4 2012 at 10:01am

Interesting but difficult episode. What I did not understand for example is the issue of non-priced rationing. Banks have a shortage of capital (Basel III requirement), so they can lend less, but still they use a low interest rate and ration on other factors. Why would they do that? Why not use the most efficient mechanism: pricing?

I also understood virtually nothing about the reasoning why monetary policy would be too tight. First, I thought I understood that the money broad money supply was shrinking, but later in the podcast I heard it just was just under the original growth trend line. M4 was ‘only’ growing at 4,5% annually. Why would that be insufficient? Why would monetary policy be too tight, if inflation is still quite high?

Graham Hay
Nov 5 2012 at 4:30am

Very interesting guest. One can deduce from his analysis of the symptoms and causes of hyperinflation, that the US is living through the aftermath of a period of excess inflation, but one that manifest itself in asset prices rather than the general level of goods and services in the economy. Central Banks too narrow definition of inflation has led them down a three decade path of setting interest rates at rates which fostered excess speculation and financial leverage, at a time when lax regulation made it very easy for certain entities to take advantage of this. The opening of global labour markets and entry of low cost manufacturing, and weakened state of labour unions played at least as significant a role as did central banks in bringing down headline inflation over he past 3 decades. Some serious introspection, and ultimately a market based mechanism of setting Fed discount rates must be introduced to prevent repeated bubbles and their aftermath.

David Beckworth
Nov 5 2012 at 12:21pm


Really like this podcast too. Like John Vooheis, I too would note that the Fed has not been the biggest purchaser of Treasuries over the past few years of the crisis. Households, their financial intermediaries, and foreigners have bought far more and are a much bigger factor behind the low interest rates on treasuries. Here are some posts where I provide data and discuss this issue more:

Nov 7 2012 at 4:22pm

If Northern Rock was profitable and solvent but illiquid, then why wouldn’t other banks (private profit-seeking banks, not the Bank of England) loan them at profit all the liquid funds that they needed?

Nov 7 2012 at 4:38pm

What is a “difficiency” of money supply? Is it merely a low total amount of money relative to historical levels? What is the right level? What is the right availability of loanable funds, the levels that existed between 2000 and 2007?

I understand how decreased bank lending might result in opportunity costs from lost profitable ventures, but then the complaint shouldn’t be the low money supply per se, but damaging restrictions on bank lending. No?

Nov 7 2012 at 11:31pm

John Voorheis,

If I’m not mistaken, the percent of total issued Treasuries that are purchased by the Federal Reserve is usually taken from the Fed’s quarterly flow-of-funds report. I believe the relevant table is here:

Comparing rows 1 and 15, the table shows, as far as I can tell, that just under 61% of Treasuries issued in 2011 were purchased by the Fed (61% is the number I’ve seen reported, not 75%, e.g. This was unusual compared to prior years, but if you look at the annualized quarterly numbers for 2011, I think you’ll agree that one must wait for a whole year average for 2012 before concluding that 2011 will not be repeated in 2012. So we won’t know if it is a fluke until next spring. Wait to see what 2012 Q3 and Q4 show, given the dramatic quarterly variability and lags associated with Fed Treasury purchases.

And one issue with the 2011 result is that it does appear the Fed is propping up Treasury rates. The increase in Fed borrowing almost perfectly offset the drop from 2010 in rest of the world Treasury buying (row 12). And rest of the world buying has not yet picked up in 2012. Will the Fed again bailout Treasuries, if indeed that is what was happening?

Nov 8 2012 at 10:06am

CORRECTION: holding down Treasury rates, not propping up.

Nov 9 2012 at 12:32am

The purpose of the sanctions and other pressures being applied to Iran is to provoke Iran into doing just what the guest fears they might do – close the Straits of Hormuz. That is exactly what the U.S. and Israel want them to do because it would provide the casus belli they need. Same thing the U.S. did to Japan to provoke the attack on Pearl Harbor. When propaganda fails to drum up popular support for war, then you push your victim to an act of desperation or execute a false flag attack. These tactics have been practiced for centuries.

Fortunately, I think the Iranians understand what the U.S. is trying to do and will not play into our hands. They are working with their neighbors to maintain mutually beneficial trade. The risk to the U.S. is not that the Straits would be closed, rather that a strong economic and military coalition will emerge in east Asia that will challenge the hegemony of the U.S., and more importantly, the U.S. dollar.

War is big business in the U.S. – lots of money to be made by lots of companies.

Nov 13 2012 at 10:20pm


Great episode, but it left me with one important, simple question. Around the 39th minute the guest says

And they will have to face the music under the Meltzer kind of scenario. And what do they do?

The topic was quickly changed. I’m interested in what the Fed can do to kill inflation besides raising rates. Thoughts?

Joseph Ripple
Nov 16 2012 at 3:35pm

The banks don’t have to shrink assets, they can simply stop paying dividends (and they can probably stop paying huge bonuses and salaries too). Nobody is suggesting that the banks issue more shares in this market. See the Admati podcast that Russ did. The banks continued to pay dividends throughout the crisis which was equivalent to throwing capital out the window when the system needed it most. Bernanke should have halted all bank dividends for a period of time, but he didn’t have the political capital to do that even in the crisis. The banks are too strong politically.

Hanke suggests that Dodd/Frank and Basel III are having a huge effect, but both will likely have a no or limited impact. The banks still own the politics, so the laws are always in their favor. Unless the banks somehow lose political control, which didn’t happen during the crisis, then we will have no real bank reform and it’s just a matter of time until the next crisis.

Mr. Econotarian
Nov 20 2012 at 5:11pm

Is M3 really “down”?

That does not seem consistant with this M3 estimation graph

It was flat from 2008-2010, but appears to be up 6% since then.

Comments are closed.


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Podcast Episode Highlights
0:33Intro. [Recording date: October 19, 2012.] Russ: Topic is hyperinflation. What is hyperinflation? Guest: Traditionally it's been defined as any rate of price increase that exceeds 50% in one month. The person who did the work and eventually defined it was Professor Phillip Cagan, who was at Columbia. That was the origin of the 50%, and since then it's been traditionally used by everyone who is studying hyperinflation. Russ: And, historically some famous hyperinflations would include the Weimar Republic in Germany, right, in the 1920s? Guest: Yes. That one actually peaked out in October of 1923. But it was only the 5th highest one in the world, and it was much below the big high ones above it. Russ: What are some of those? Guest: Well, it peaked out in October of 1923--this is the Weimer--at 29,500% in one month. Now, that's an awfully big number. Russ: It seems like it. Guest: But if then we jump up to number 3--and by the way, there are 57 countries that have had hyperinflation--that was Yugoslavia in January of 1994. And that one was 13.3 million percent. So, we are going Germany, 29,500 up to 13.3 million. In Zimbabwe in mid-November of 2008, it peaked out at 79 billion percent, in a month. And then Hungary has got the number 1 spot, July 1946; I'm not going to give you all the zeros but that one peaked out at a daily equivalent rate of 207% in a day. Russ: Now, it's hard to relate to those numbers. Guest: Yeah. It's very hard to relate. This piece I did with one of my assistants, Nick Kruz--we listed all 57. We've documented now all known. Some weren't known until we did this piece, that will eventually be appearing as a chapter in a book. Right now it's a Cato Working Paper. But to get your head around the numbers, the monthly rate gets so high that the best way to do it is to translate them into daily equivalent rates and then another thing that we've done is have a metric for the time required for prices to double. So, in Hungary, that huge inflation that's number 1, the prices were doubling in 15 hours. Zimbabwe, 27.4 hours. Yugoslavia, 1.4 days. And so forth. The thing that kind of intrigues me about it, and the reason I kept pushing ahead with this research, which was kind of onerous basically to get all the metrics organized and find all the cases and actually come across some cases that have never been reported before--out of the 57 cases I've been involved either directly or closely with the stopping of 10 of the 57. So, as they say, I've had some experience with stopping these. Russ: Before we get to that, though, let's talk about--well, I actually just want to talk first about the logistics. When prices are doubling every 15 hours--is that really a meaningful phenomenon in terms of trying to measure it? If you are actually making transactions at those prices, you are getting up early. Every second you are losing money. You can't scratch your ankle on the way to the store. Guest: Yeah. It actually is meaningful in the sense that the unit of account you are using isn't the hyperinflating currency. The unit of account you are using is solid currency. It was gold in Greece, for example. Now, it's typically the U.S. dollar. So, anything that a merchant wants to sell you, they will first think in terms of how much in dollars, and then they'll translate. Usually they'll get on their cell phone and ask a dealer what the rate is for whatever the local currency is vis a vis the dollar. And if you've got local money, they'll charge you that. Or maybe they'll charge you that plus a premium, because they are going to have to run down a moneychanger and change it. Russ: Right. Guest: Depending on how fast they are will be the premium that hey charge you. Russ: But if there is no available obvious alternative to the local currency that's having that problem, pretty quickly the economic system breaks down and you are in a barter economy, right? Guest: Well, you do have a lot of barter. Let me give you the Yugoslav case because I was there. I was the adviser to the Markovic government. Now this was before the hyperinflation, but right before--it was in 1990 until the middle of 1991. And barter was occurring. And what you would do--let's say you had relatives; let's say you were in Belgrade. All your relatives out in the country would be supplying you with foodstuffs. And other transactions in Yugoslavia were always taking place in Deutschmarks anyway. Any significant purchase required Deutschmarks, and the reason why was that they had endemic and very high inflation in Yugoslavia: from 1971 until 1991 the average annual rate of inflation 76%. It was the second highest annual rate over that 20-year period that was recorded. Zaire was number 1. So, the economy, in a hyperinflation, or even in a very high inflation, what happens--yes, there is a lot of barter that starts seeping into the system. And basically the hyperinflation throws a monkey wrench into the economic system because you can't calculate costs properly. So it becomes very cumbersome. But the other thing that happens is that foreign currencies start being substituted for the local currency. Russ: Because people don't want barter. Guest: You get currency substitution taking place. And in a place like Zimbabwe, for example, what happened with that hyperinflation is that eventually people just stop using the Zimbabwe dollar. In November of 2008. It came to an end, and there was spontaneous dollarization that took place, where the U.S. dollar and to some extent the South African rand and a few other currencies from borderline countries crept in, and the Zimbabwe dollar just wasn't used. For anything. Russ: Right. Guest: And the next step was that the government was forced then to officially dollarize the country and change the budget and require taxes and so forth to be paid in dollars. So, the Zimbabwe dollar is gone now, and Zimbabwe is officially dollarized. Russ: So the trillion dollar Zimbabwe note that one of my students sent me--you are saying that's worthless now. I'm very disappointed. Guest: Well, on e-bay it has a lot more value than it ever did when it was circulating.
9:39Russ: So, this is a softball question: What causes hyperinflation? There's a harder question behind that. Obviously what causes it is a rapid increase in the money supply. Guest: A very rapid increase in the money supply. And you get this--ultimately what causes the money supply to explode. Russ: Right. Why would a nation do that? Guest: That's the fiscal situation. And Yugoslavia for example, at the end, about 90% of all the government expenditures were being financed by the printing press. By the central bank. In other words, tax receiving were only about 10% of expenditure, so the budget deficit, in short, was running about 90%. Russ: And so, rather than cut expenditures or raise taxes, neither of which was politically appealing, they just printed the money and punished their citizens. They taxed people through this process we are talking about. They devalued any currency that people were holding and made their lives less pleasant. Guest: Right. Russ: So, we're going to talk about Iran in a few minutes, but before we do that, let's talk about the United States. Which--we are not having hyperinflation; but we do have a fiscal problem. We do have--we are spending a relatively large amount, relative to what we take in. We are spending a trillion more than we take in, a little over a trillion. We've done it for four years in a row. We did it before that in a significant amount as well. And people keep buying our bonds. And so it seems okay. But one of the institutions that's buying those bonds is the Federal Reserve. I've read that a very large portion of U.S. Treasuries are being purchased by the Federal Reserve. Can you explain that? Guest: Since they started the so-called Quantitative Easing. I think roughly since the Lehman collapse in September of 2008; I think it's about 75% of the total is being purchased by the Fed. Russ: So, can you explain to me what that means and what it portends for the future. Guest: Well, let's just start with Lehman's collapse in September 2008. That's a convenient date. Since that point in time, the Federal Reserve's balance sheet has increased roughly by three and a half times. So that means they are buying a lot of these bonds. And that's where they go, on the asset side of the balance sheet. Now that means that high-powered money, or what I call state money--the amount of money produced by the state--has more or less tripled. It's exploded. And this has many people concerned; and they get excited and say we are going to have hyperinflation tomorrow. That's a hyperinflation nexus. The Fed's buying all these bonds; their balance sheet is exploding; high powered money is increased very rapidly. And people conclude that it's going to be like Yugoslavia, or the Weimar Republic, or something like that. Now, it has meant that state money has increased from about 6.5% of the total money supply, when you measure the money supply properly with a broad measure, like M3--so we went from state money being at about 6.5% at the time Lehman collapsed, until now it's about 15%. So, you've more than doubled the size of state money. But the problem is: I said 15%; now state money is 15% of the total amount of the money supply--meaning that state money is peanuts. What really is important is bank money--and bank money is created by the commercial banking system and shadow banking system, and that's what really counts. So, in a way we have had the following scenario develop after Lehman: We've had ultra-loose monetary policy with regard to state money and the Federal Reserve. But with the financial regulation, that it was legislated with Dodd-Frank, and also with what is called the Basel capital requirements, and specifically Basel III, which is being imposed on banks--to increase the capital-asset ratios of the banks. These two things--financial regulation and Basel--have in effect imposed ultra-tight monetary policy on the banking system and bank money. So, as a result of the two, we've had the total amount of the money supply actually being very anemic, not growing very much at all. And in fact, if you look at a trend line since 2009 and look at the endpoint today of the trend line as you are going left to right, that point is about 7.5% higher than the actual level of the money supply that we have. So, you could argue that relative to trend we've got a deficiency of about 7.5% in broad money. And the reason why is that the dominating feature has been the reregulation of banks and the tight monetary policy imposed on bank money. Which accounts for 85% of the total amount of money in the economy. Russ: So, that's consistent with Scott Sumner's view, who argues that monetary policy has been very tight, rather than loose. Everyone looks at the so-called aggressive policy of the Fed. But my question then is: You are saying that banks have been highly regulated and you can also argue that the economic system is not very optimistic right now; it's kind of uncertain. But banks have huge excess reserves. So, you are saying they are constrained. But it appears they are very unconstrained. Guest: Oh, no: they are profit-maximizing. Banks are profit maximizing. So what happens is if you are imposing capital requirements on banks vis-a-vis Basel III, and you are requiring the capital-to-asset ratio of a bank to go up, how do you change that ratio? Well, one way to do it is to raise capital and increase the numerator in the capital-asset ratio. The problem with that is that the price of shares for banks now is much below the book value of the shares; and if you actually issue more shares and try to raise capital, you are diluting the existing share holders, when you have those conditions existing. And so the existing share holders don't want to raise more capital. So what you try to do is reduce the assets that you have and specifically what you want to do is reduce the risk-assets. Those that come under the umbrella of Basel III, that require a certain amount of capital-- Russ: High ratio-- Guest: to be set aside against them. So, here's what we've had since Lehman. Loans to commercial enterprises have gone down in the United States. Mortgages have gone down in the United States. Interbank lending has essentially disappeared--which is almost the lifeblood of the banking system, the interbank.
18:27Guest: So, what's gone up? Because the total amount of the assets that banks have, the consolidated system, has gone up. So, what's gone up? One thing that's gone up: government bonds. Because government bonds are deemed to be risk-free by Basel. You don't need to set aside any capital to buy government bonds. So, government bonds have exploded--the holding of government bonds. The other thing that's exploded are, you mentioned excess reserves. Well, you've got cash. Cash has gone way up. So, banks find it profitable to avoid the Basel regulations in effect by accumulating government bonds and cash. And they make money at it, because there's a yield spread between the amount they are getting on the cash and the amount that they are having to pay for the amount they borrowed to go into cash, or go into excess reserves. Now, excess reserves--reserves at the Fed--are actually receiving interest. Russ: So, I've always been puzzled by this, so maybe you can help me. The story you've just told is that banks have rationally responded to the incentives of regulation and the Fed offering reserves to accumulate large excess reserves rather than issue more stock, rather than raise more money. As a result--or maybe I'm getting the narrative wrong--but at the same time, at least, the money supply is limping along, not exploding, despite the high increased balance sheet of the Fed. So, Ben Bernanke knows all this. He knows all these facts. They are not secret. You and I aren't the only people, and the listeners of EconTalk, that know that M3 is actually down, not up. What are they doing? What is your guess as to what they are thinking? Guest: Well, the big problem is, in economic lingo: we've been talking about, and I've been talking as a monetarist. An old-fashioned monetarist. And in particular, a broad money monetarist. Broad money counts, and it's the thing that dominates the economic picture. Russ: Broad meaning including bank money, not just state money. Not just reserves. Guest: Right. State money as well as bank money, ending up with something--the best measure we really have is what Professor William Barnett has been producing, and that's the Divisia M4; and that's the broadest measure and is measured correctly and so forth. And that's been lagging behind. Now, it's picking up just a little bit. But that measure is only growing at about a 4.5% per annum rate. I should say, year over year. The year over year rate of growth is still very slow in this broad measure. It's now relatively high compared to where it was a year or two ago. Russ: But, just to put it in perspective--hang on; let me re-enter you into the issue of Bernanke in a different way. He famously said, before he was Chairman of the Fed, I think in a conference with Milton Friedman: We've learned our lesson from the Depression when we let the money supply drop. Because bank money shrank during the Great Depression, dramatically, when we had all these closures and contraction of lending. And by bank money you mean all the liquidity that banks produce, their lending based on those reserves that they hold at the Fed. And so he said: We'll never let that happen again. And what you are saying is he let it happen again. Guest: Oh, he absolutely doesn't have a--he's probably one of the worst chairmen we've ever had at the Fed. He's strictly not a monetarist. There's no question about it. He's an inflation targeter. He's made his reputation as an inflation targeter, and as long as they are hitting that target, and now let us say it's in the 0-2% range, although one of the Fed governors, a president of a regional Fed, Evans, has indicated that maybe 3% would be an appropriate top level. We can get into that if we want to get out in those weeds and little bit later. Russ: No. I don't. Keep going. Guest: The bottom line is that Bernanke is not a monetarist and he's certainly not a supply sider. He doesn't have a supply side orientation on monetary policy. And the supply siders, they like to look at prices, not quantities. So, unlike a monetarist, who would be looking at the quantity of money, they would be keeping their eye on prices. Now, what do I mean by that? That means foreign exchange rates; the yield curve; gold; maybe a basket of primary commodities, 20 or 25 commodities. They'd be looking at things like that. And asset prices--the stock market as well as commodity prices as well as foreign exchange as well as interest rates and the yield curve. That would be kind of a supply side type of approach. The monetarists would be looking at the quantity of money, mainly. I'm actually looking at both, to tell you the truth. Whereas Bernanke--he doesn't even have those prices on his dashboard. If you look at what he's looking at, it doesn't include the dollar exchange rate. The critical thing--the dollar exchange rate, the price of gold. He claims he's not looking at those.
25:00Russ: So, with the benefit of hindsight, what should he have done? Given that he's let M3 or M4, these broad measures of liquidity in the economy shrink? That's had a real impact on the economy; it's slowed the recovery; it's made it anemic. What could he or should he have done? A lot of people have faulted him for being way too aggressive. You are saying he wasn't aggressive enough. How could he have implemented a policy to make up for the shrinkage in bank money? Guest: Well, he could have come out against the Dodd-Frank financial legislation. That would have been maybe a politically dangerous thing to do, going head to head with Congress. But the other thing he could have done-- Russ: And you mention-- Guest: He could have put a freeze on Basel. Basel has a direct input into the capital requirements of the banks. But you see that, the reason the Americans love Basel III is that the European banks that the American banks are competing with in the international market, they are relatively undercapitalized compared to the American banks. So, basically, by imposing Basel III, you are mandating--you have a government banks that says that the European banks have to shrink faster than the American ones. Russ: Lovely. How did the European banks fail to get that fixed? They knew that, too, right? Guest: Well-- Russ: Or is this an unintended consequence? Guest: The origin of this is interesting. My diagnosis of the thing is that there was a--the crisis really started in August of 2007, and it happened in Europe and the United Kingdom in particular. There was a bank called Northern Rock. Northern Rock was a mortgage institution. It was solvent at the time and it was very profitable. And their funding source for the mortgage--they would lend long, long-term mortgage--is they were using money market funds issued in France. And in August, two of these French money market funds froze up. And so the Northern Rock people went to the Bank of England and they said: We need the lender of last resort; we are solvent; we are willing to pay whatever the penalty rate is and borrow from the Bank of England. Sir Mervyn King, head of the Bank of England, still is, said everything was fine; and they arranged to do this. But there was one little catch, and that is there was a reporter from the BBC that was friendly with somebody working at the Bank of England, and the trap at the Bank of England leaked the information that Northern Rock was going to get a substantial lender-of-last-resort loan from the Bank of England. And that was reported by the BBC. Well, what happened then--the depositors of course panicked because they said: it's obvious that Northern Rock is bust and they've had to go the Bank of England; and we want our money back. So you had the first bank run in a hundred years in the United Kingdom. And that really burnt the politicians. At the time, Gordon Brown was the Prime Minister, and Darling was the Chancellor of the Exchequer. And of course they ended up having to foot the bill for Northern Rock, ultimately going under. Which was a big bill. Because of this bank run business. Russ: I thought they were solvent? Guest: They were solvent; but what if every depositor comes in and they want their money today? Russ: Well, if they are solvent they have the assets to cover it. Guest: You've got a liquidity problem; you have to liquidate everything that you have to pay everybody off; and even though on paper it looks like you are solvent and you have good paper and you've got a profitable operation, you are forced to cough up the money. Russ: Yeah; I don't understand that; but we can come back to that or maybe skip it. Because, in theory-- Guest: At any rate, it was a liquidity thing. They needed to come up with the money. Basically they needed to liquefy their asset side of their balance sheet in a matter of a few days, and the only way they could do that is to have the government come in and bail them out. Russ: Well, okay. Guest: To pay the depositors off. And as a result of this of course there was a political price, and, as I say, Gordon Brown got burnt. He was holding the bill; the taxpayers were upset because they had to pay the depositors off that had wanted their money back from Northern Rock. And he led, then, this campaign to recapitalize banks. Everyplace. And it became an international mantra. And the herd followed. And that's where the Basel thing accelerated and got going. And then in the United States it came, and Secretary Geithner is a big advocate of recapitalizing banks. Russ: Yep. Guest: Part of it is a little bit disingenuous because it's advantageous to the United States relative to areas of Europe where they are undercapitalized and have a big gap to make up to get back to Basel III. Russ: By capitalized, you mean: Have a lower rate of leverage, meaning having a larger asset base rather than borrowed money to finance your operations, correct? Guest: Well, not asset base. Capital base. Equity. The equity is, remember, on the right-hand side of the balance sheet, so you've got to have a bigger equity and less borrowing on that right-hand side; and then on the left-hand side, that's where the assets are. And of course, you can increase your capital-asset ratio very quickly by just dumping assets and not raising any more capital. That's more or less what's been going on, because it's so unattractive to raise capital now, due to the fact that share prices are below book value for most banks. Russ: But the argument for this recapitalization is that if banks have more equity and less borrowing, they have a bigger cushion if their asset values fall. Guest: Right. Russ: That's the argument of Basel. Guest: That's the idea. It comes back--what you said about leverage is exactly right. It forces you to have less leverage than would be the case if you had a lower capital-asset ratio.
32:32Russ: So, let's come back to this issue of the risk of inflation of a sizeable amount in the United States. I'm going to review how we got to where we are in the conversation. You argued--convincingly to me, but then, I'm a monetarist--that although high powered money, state money, you call it, reserves at the Fed: that's grown dramatically. It's more than doubled since 2008. Guest: More than tripled. Russ: But there was a shrinkage of lending and liquidity in the private sector--what you call bank money--so that the total money supply, the total amount of liquidity sloshing around in the economy has fallen. And as a result, our economy is hesitating. And hyperinflation is the last thing we have to worry about, despite the massive activity of the Fed. What Allan Meltzer would argue, and has argued on this program--and I don't know if he'd still argue it; it was a few years ago--his argument was: But eventually, when banks get more optimistic about the future and the economy starts to recover, then all those excess reserves, instead of sitting on the balance sheet of the Fed, they are going to go out into the real economy, and there will be inflation. So that bank money that had shrunk during the bad times will start to expand, and then the pressure will be on the Fed to shrink back its state money, its printing press money; and that's going to be politically unpalatable and we are going to get significant inflation. What do you think of that argument? Guest: Well, Professor Meltzer and I have corresponded on this, and as we've agreed--we generally agree on almost everything except this point. Russ: Okay, good; that's lively. I like that. Guest: And it does put one in a very awkward position, to actually be in disagreement with, shall we say, I think, the acknowledged dean of the Federal Reserve now, with his three-volume work on the Fed. So, let's get down to why I don't agree. You made Professor Meltzer's argument. That's still his argument. My argument is: If things start unfolding and banks get more optimistic and reduce the amount of cash they have and the amount of government bonds that they have and put it into commercial and industrial loans and mortgages and interbank lending and all these things, we will, in short, increase the level of the money multiplier in the system. So that high powered money, right now, the money multiplier that is associated with high powered money is let's say about 5 or 6, depending on what monetary aggregate you are looking at, relative to high powered money. But let's just say it's 5 or 6 relative to M3. What it was before the Crisis, it was about 12. So, the money multiplier is about half of what it used to be. And another way of looking at what Professor Meltzer is saying is that he's worried about once the money multiplier goes back to, shall we say, normal levels of 10 or something, that state money will kind of goose the system. It will end up bleeding through the banking system, the fractional reserve system. And even if there was no change in the volume of state money circulating, that you would have a huge increase in bank money because with the optimism, the money multiplier would go back up to normal levels and bank money would increase. And therefore the broad measure of money would ultimately increase; and yes, you would definitely have aggregate demand increasing and getting up to some level--let's say, in boom periods in the United States aggregate demand, the final sales by purchasers, gets up to 7.5 or 8%, something like that. And if growth is about 3%, long term trend rate of growth about 3, 3.1, or 3.2%, just subtract the 3.1 from the 7.5 and you've got inflation. So that is a concern. But the Fed should be able to realize the problem that they've gotten us into with this inflation targeting scenario; and the very lower interest rates, big expansion of their balance sheet. I'm not saying that that's been a good policy. But the reality is that's what they've done. And they will have to face the music under the Meltzer kind of scenario. And what do they do? Russ: He says they won't want to. Politically it will be too unpleasant for the Chair of the Fed to be called in front of Congress to ask why he's taking away the punchbowl before the party is even getting started. Guest: But that's always something that a Fed Chairman faces. I would say that in this case, they should put Bernanke in the hot seat, for a number of things. Russ: Yeah, well, I'm with you there. Let me take an implication of what you said that I've asked many times on this program, which is: Why the Fed is paying interest on reserves? Are you suggesting the possibility then that the Fed is paying interest on reserves to compensate the banks for the unpleasant compliance with Basel III? This is a way to soften the blow? Guest: It allows them to make good money on risk-free assets, basically. And with these profits, to recapitalize themselves and increase the capital-asset ratio. And it gets back, yeah, to the Basel thing. It's a mechanism that allows the banks to do this. They are making very good money on so-called risk-free assets. At least as defined by Basel, they are risk-free.
39:40Russ: So, the other day I was meeting with some people who were much savvier and much wealthier and wiser than I am. And they asked me about this issue. And they think the dollar--they are not the only people I've met who believe this--they think the dollar is going to disappear. They think there is hyperinflation coming; you ought to be buying gold. We don't give financial advice on this program, so we are not talking about that. But I'm talking about their perspective. They think the dollar is cooked: that the long run, to go beyond the immediate today and tomorrow--but the fiscal situation in the United States, we're going to end up like Zimbabwe. We are going to have too many promises that we've made to public pensions and to Medicare and Social Security; the Fed is already buying up all of those government bonds; they are going to keep doing that. And ultimately we are talking hyperinflation; the dollar is disappearing. So, you are not as pessimistic as they are. Guest: No. As far as gold goes, I like gold; I'm not making any recommendation, but I've done some. Various Bloomberg shows and so forth. But the problem is not going to be a Zimbabwe hyperinflation. If anything, the problem right now, today, is the fact that we have a deficiency in broad money, for the reasons that I gave--mainly because we have imposed ultra-tight monetary policy on bank money. That's what all these people--just missing the picture, basically. They are going on and on about state money, and the fact that state money is a portion of the total amount of the money supply has more than doubled since Lehman. But it's only 15% of the total. Russ: Yeah. I like your point. Guest: The big thing is bank money; and bank money is being crushed. And that's why, overall, my assessment is we have a little deficiency in the money supply. Not great[?] like they do in the European monetary system where you have places like Greece--where the deficiency is something like 45%. The gap between where I think they should be if they'd been following a trend rate of growth in the money supply and where the money supply actually is. You've got about a 45% gap. And all these countries in Europe that are really in trouble, the southern countries, they have huge monetary deficiencies. The only country in Europe that is on trend is Germany. All the other ones are running big deficiencies. Russ: So, let me ask a different concern that these folks have, which I also hear, which is: We are going to end up like Greece. We can borrow money right now for some reason--one argument is we're the tallest pygmy and everyone else has lousy, they are even worse. So, people will still buy our bonds. But as our debt-to-GDP ratio continues to rise, because of these fiscal issues, eventually people are going to stop buying our bonds; we are going to go bust; and we are going to print up money. Guest: Don't get me wrong: I am with them; now you are talking about something else. Russ: Yeah, I know. Guest: We are going to shift from this hyperinflation thing to the fiscal. Russ: Yeah. I'm shifted. Guest: And the fiscal situation is a very simple problem. We have a huge fiscal problem in the United States, and it bears some of the earmarks that you've just repeated. But the main thing here is that government expenditures relative to GDP, they are outside the range that we've observed in the United States since the end of WWII. They are very high. So the problem isn't not enough taxes. The problem is cutting government expenditures and getting government expenditures down in the zone again. Getting that number down from 25% of GDP at the Federal level to something like 22%, for example.
44:09Russ: Well, I agree with you philosophically, but what's holy or sanctified about 19%, or 22%? What's the big deal? I agree with you that philosophically, 25% government--I don't like what they spend it on. I don't see that that's a good allocation of resources. But that's my philosophical position. I could try to make a case for it empirically. But why is it a crisis? So, what's 25? Big deal. Guest: Well, here's the crisis. Once you get out of the zone that we've been in since WWII, no matter what political party--it's not really a partisan thing. In fact, fiscally the most prudent President we've had has been Clinton. Russ: Correct. Guest: President Clinton actually reduced government expenditures as a percent of GDP over his two terms by 3.9%. Now, there's no other president that even comes close to that. In the last two years that Clinton was President, he actually was running a fiscal surplus. I remember the big deal then. The big panic. The folks you were talking with about what's going to happen with hyperinflation and the bonds, their big panic was there wouldn't be any government bonds. There wouldn't be any 30-year paper left in the United States. Russ: I didn't understand that. Guest: How would the economy run if you couldn't be trading 30-years? And the yield curve would disappear. And so on. So, here's the problem. There isn't anything magic, as you point out, about being in the zone. Russ: Let's say 20%. It's an historical level. Guest: Something like that. The problem is that we are in a new regime now. We are up above that level that we've been at. We're outside the range; and transitions and regime changes are a problem. It's a little bit like--they interviewed one of these guys that went down Niagara Falls in a barrel. And he survived and came out at the other end. And they said: Well, sir, how was that ride? And he said: Well, it was pretty calm above the falls and below the falls, but the transition was a bitch. And that's the problem we have. We are in a transition now. And if we stay above, it's going to be this kind of Niagara Falls kind of problem. There's no question about it. Russ: Why? Why? Guest: So, we have to figure out whether to go down the falls and undergo the transition, or whether we will dial back government expenditures and get it down in the range that we've been at historically. No matter what party, by the way. It has nothing to do with parties. Russ: But why is it like going over Niagara Falls? We just borrow more money. What's the big deal? Guest: Well, you raise the specter. If you are having to borrow a trillion dollars a year, that's a lot of bread, as they say. Russ: The world capital market is pretty big. Guest: The capital market is pretty big; we'll have absolutely no trouble doing this today. You can see it reflected in the interest rates and the shape of the yield curve and the rest of it in the United States. There has been no problem. But the markets run on expectations. And if you expect this kind of borrowing as far as the eye can see and no dialing back on government expenditures or dramatic increases in taxes, eventually you will have a problem with the markets. Russ: You'd think so. Guest: The markets will eventually see through it. They might not do it tomorrow, but eventually they will. And then what would happen? Guest: In that case interest rates will simply go up. Right? And, you get a lot of squeezing out of private activity. Right now, you see, the problem in the United States--they are complaining, your friends, about the specter of hyperinflation and all the rest of it, and loose money. But the reality is, we are in a credit crunch in the United States for the reasons that I've given. Money is very hard to get. Russ: What's the evidence for that? I've heard that, that it's hard to get. Guest: Well, you look at the Federal Reserve System; they survey businesses and private individuals, the sort of non-bank public. And you look at the surveys that they do, and you don't have to be a rocket scientist to figure out that people want to borrow money and find it difficult to get it. Russ: Despite the fact that it's everywhere, supposedly. There's all this money in the system, but you can't get it. It's a paradox. Guest: See, this is--let's look at mortgages, just to get it down to ground level. Mortgage rates are at record low levels. But the problem is getting one. Because you have to meet standards. There is non-price rationing going on, to use economic jargon. And the standards required to obtain a mortgage or a loan are simply higher or more onerous than they have been in the past. And that's how the supply of mortgages is being rationed. A lot of non-price rationing is going on. Russ: I've heard that. I think it's true. I've talked to mortgage brokers and real estate folks, and they do say it's very hard to get a mortgage despite the fact that the rates are really low. You'd think at that rate--the question then is: Why are the rates so low? Guest: Well, the rates are low because the Fed has stepped in with this Operation Twist. They are buying on the long end. Russ: But their argument, you are saying, at this low price there are a lot of people that want the money. They are just, for non-price reasons, they are not being allowed to get it. Guest: One of my friends in Baltimore, he'd applied for a mortgage; and he was in a position to move from the suburbs down to the end of the inner city, an apartment. And he applied. And the problem is the apartment was in an old apartment building and there weren't any comparable sales. Russ: For the assessment. Guest: And as a result of there not being comparable sales in the area, he could not get a mortgage. And this went right up to the day that the closing was supposed to occur. He wanted to move; his wife wanted to move; all the rest of it. And so, to tell you how risky this guy was: He had enough money in the bank, he just paid cash. He closed; he didn't want to miss the closing. He wanted the apartment. But the bank led him on until literally two days before the closing they finally flipped the red flag up on him. And the reason they did is because of the requirements of Fannie Mae and Freddie Mac. They required comparable sales for evaluation. And the bank itself wanted to unload those mortgages on either Freddie or Fannie--I can't remember which one right now. So, that was the thing that queered it. Now this was a non-price rationing kind of thing getting thrown into the picture. Russ: I've heard that, too.
52:47Russ: I invited you to be a guest on EconTalk to talk about Iran, because you'd written something very provocative on that. And I started off with our discussion of hyperinflation to get to that. And we have now made a very long, 40-minute detour in the U.S. situation. Which I'm very grateful for. But I'd like to talk in our closing minutes about Iran. Because it's an example of hyperinflation, and it will maybe bring us full circle. You argue that Iran is experiencing a hyperinflation of about 70% a month--the 50% being the benchmark. How do you know that? You are I think the only person who has noticed. People have noticed that there is inflation. But you claim to measure it. How do you measure that, and why is it happening? Guest: The way you do this is the way I did it for Zimbabwe. You see, Zimbabwe, they stopped in June of 2008 reporting any kind of hyperinflation, any inflation numbers. But the one thing that was going on, there was a black market in the currency. And if you know the change in the value of a local currency vis-a-vis the U.S. dollar, then you can impose what's called purchasing power parity, and make a calculation and easily determine what the rate of hyperinflation is. Russ: A rough guess. Guest: So that's the mechanism. So, there's one free market price in Iran, and that's the black market rate. I've got good information on what the black market rate is. Russ: How do you get that? Guest: So, I can look at the changes in that free market price, which is an objective measure of value, and from that I can make a calculation about the implied inflation rate that's facing the Iranians. Russ: How do you get that? Guest: Those are the steps. It's just a two-step process. Russ: How do you get the black market rates, though? Where do those come from? Guest: Well, there are various sources. One that I've been using, the Association of Exchange Rates in Iran, has been reporting these. Now, once I detected hyperinflation and published that, they shut down all the websites and I couldn't get this information for a few days. Now I have a way of obtaining it, and I have a good time series on what the black market rate is. Actually, they have a multiple exchange rate, so the official rate is 12,260 Iranian rial to the dollar. That's for a couple of categories of items--actually two: medicines and high-priority items, you get a very good rate if you qualify on that; and you get that at the central bank. And then, there's another rate of about 25,400 that you get through licensed dealers; that's kind of a controlled rate, too. And then there's a black market rate that's free. And so you basically have three prices for the same thing in Iran. And of course all the distortions that come with that kind of multiple exchange rate system they have. Russ: So, why are they experiencing hyperinflation? Guest: Well, one reason--hyperinflation, you mention early in the show, is always a monetary phenomenon. So, there have been very rapid increases in the money supply since 2010 in Iran. But in addition to that, you've had what's kind of akin to bank runs in currency markets, and that is you have panic sellings of rials every once in a while. Or to think about it in a different way, the demand for rials just collapses. Everyone wants to get out of the rial and get into gold or U.S. dollars because they anticipate bad times down the road. Maybe they anticipate that the black market will be totally shut down and it will be very hard to exchange any currency, so maybe they want to get out for that reason. It's an expectations thing. The people on the street expect the rial to decline in terms of its purchasing power and they want to get something that's going to retain purchasing power. And from time to time you get these big plunges in the exchange rate. And when you get the big plunges they've experienced in September and October, of course that leads to the implied inflation rate being very high. And then I can go back and just look at the press and the price of a key commodity--chicken. And it matches up almost perfectly with the calculations I'm making from going from the black market exchange rate to the implied inflation rate. And I've done this with a number of countries. As I say, I've studied all these 57 episodes of hyperinflations. So, the analysis works very well. And we had, by the way: the Weimar Republic, the place where this approach of going from the exchange rate to the implied inflation rates using purchasing power parity--actually it was Jacob Frenkel, distinguished economist who did one of the classic studies on this. And Frenkel published in the Scandinavian Journal of Economics back in 1976 something called "A Monetary Approach to the Exchange Rate: Doctrinal Aspects and Empirical Evidence". And that was all about the German case, where he just clarified the whole picture and validated this approach that I've summarized to you. Russ: So, just for our nontechnical audience: Purchasing power parity is exploiting the fact that goods of similar quality have to sell for similar prices across the world, if they are tradable. Guest: Yes. Russ: That's what you are exploiting when you try to-- Guest: Yeah, exactly.
59:47Russ: So, do the sanctions that the United States and Europe have put on Iranian financial transactions--is that part of their hyperinflation? Guest: Well, that's part of the panic selling kind of thing and the collapse in the demand for the rial. The sanctions come in through that door, and changing people's expectations in Iran and motivating them to try to unload what they think will be a depreciating rial and getting something that they think will be more solid. But, that's on the one hand. On the other hand the history of sanctions has usually been counterproductive. Russ: Correct. Guest: Usually sanctions, when they are imposed, tend to keep your enemy in power and force a regime change. Russ: I think they are mainly for the home country. Guest: And the thing that is concerning to me about sanctions in Iran is that not only can they be counterproductive, but they can be outright dangerous because the Iranians control the Strait of Hormuz. And if the sanctions get tighter and tighter and tighter, and oil can't be sold--any oil can't be sold by the Iranians--they have virtually nothing to lose by shutting down the Strait. If they did that, 35% of the world's crude oil comes through the Strait; and 20% of the liquefied natural gas [LNG] in the world comes through the Strait. So, the mullahs, in short, have an ace up their sleeve. And we don't want them to ever play it. We don't want the Strait of Hormuz to ever be shut. Because we really would have an economic mess on our hands if we had all of a sudden 35% of the world's crude being cut off and 20% of the LNG. Russ: Well, I think we know how that ends up. Guest: Yes. Russ: They don't end up controlling the Straits, but that's war. Guest: Well, I think what you end up with then is unless we can figure out some kind of diplomatic solution to the Iranian problem, we simply have something shaping up that will have either a horrible end or a horror without end. One of the two.
1:02:29Russ: Well, let's move to a cheerier conclusion. You said you'd been involved personally in a lot of the hyperinflations [hyperinflation cleanups--Econlib Ed.], 20% of all of the hyperinflations in history. How do you end them? What's the endgame? And I'm sure there are different ones. Have you been called in to find some attractive endgames for countries that have lost control of their currencies like that? Guest: Well, one is Zimbabwe, 2008. Now that was not a government pro-active policy move. Mugabe was the President and he still is President. And what happened was there was spontaneous dollarization where people just stopped--refused--to use the Zimbabwe dollar and started to use the U.S. dollar and a few other currencies. And that forced the government in Zimbabwe to abandon eventually the Zimbabwe dollar, even for fiscal purposes. And as a result, they officially dollarized Zimbabwe in 2009. So, one way is spontaneous dollarization, which leads to official dollarization. Or, if the government is proactive, they would just officially dollarize and use some foreign currency. Now, that's one approach. The second approach, the one that I've been involved most with is the Currency Board System. And the Currency Board System, in Bulgaria, for example--I was President Stoyanov's adviser in 1997. And in February of 1997, the monthly inflation rate was 242% in Bulgaria. So they were hyperinflating well over the 50% benchmark. In July, on July 1st [1997? 1999?--Econlib Ed.], we installed a Currency Board and the Currency Board issued Bulgarian lev. The lev were backed 100% with Deutschmark reserves. And they were allowed to trade in absolutely fixed exchange rate with the Deutschmark, with full convertibility and free trade. So in that case the lev just became a clone of the Deutschmark. And the hyperinflation, it stopped within a day. And within 30 days the interest rates in Bulgaria were down to single digits. Russ: So, the Currency Board is a way for the government to regain credibility. By gathering those reserves, right? Guest: Well, by promising to only issue a currency if there's 100% reserve backing for that currency, with an anchor currency. And the other rule is that locally-issued money will trade in an absolutely fixed exchange rate with the anchor currency. And if it's a credible program that they put in, then, bang, you've solved the problem. Because the local currency becomes the anchor currency. Russ: I know you've written a lot on that. It's an interesting idea.

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