Sunday, July 08, 2007


Current interest in the nature of money, and its benefits, have lead me to be certainly concerned about the state of the economy. As I said, one advantage of moving away from barter and adopting a medium of exchange is that many of the goods we produce and so would barter with decompose and go mouldy over time. Hence there is an incentive to trade them for a good that allows us to preserve value, so that we can trade it later without making much loss. Gold is such a commodity.

This, however, is undermined by inflation, since increasing the supply of money, the medium of exchange, in relation to the supply of goods it can be bought with steadily floods the market with money, and so reduces its value steadily over time. Due to this, the role of money as a preserve of value is damaged.

Perhaps illustrating this, by looking at inflation in the US, Lew Rockwell wrote,

Since 1990, we've heard about what a low rate of inflation we've experienced. In some ways, it might appear low compared with what we experienced in the late 1970s. The dollar of 1976 was worth only 63 cents by 1981, once the Nixon-Carter inflation had done its work.

The cultural and economic consequences were devastating. A generation was punished for having saved and accumulated capital. Debtors were rewarded, with the government being biggest debtor, of course.

This period of our financial history was called the Age of Inflation. But did it really come to an end? The problem is that we've continued to live through the late 1970s, just stretched out over a greater period of time. The dollar of 1990 is today worth 64 cents. And yet we call this a low rate of inflation, though the same level of devaluation was accomplished.

But what has been happening in the UK? Jan Lester reported:

M4 has accelerated to 14.4% for the year since October 2005[i] (price inflation is always cited instead by the state because that is masked by increased production; but discussing only price inflation is like discussing only the visible part of an iceberg).

So the money supply in the UK has been increasing.

The harm to our ability to save is not the only, and possibly not even the worst aspect of government intervention in the money supply, however. Consider the current apparent consumption/saving ratios:

We Brits have all but given up on saving for the future. That's what emerges from the latest data from the Office of National Statistics (ONS). Indeed the savings ratio (which measures the proportion of our take-home pay that we save) has collapsed to a level not seen in almost fifty years.

For the record, the savings ratio now stands at 2.1%, which is its lowest level since the beginning of 1960. In other words, of every £50 that we receive in take-home pay, we're saving only a quid, which is, quite frankly, a national disgrace!

Add to this the level of debt, and so expansion of credit in the UK.

PERSONAL debt in Britain has reached £1.38trillion because of soaring loan rates, senior Tories warned last night.

That is the equivalent of nearly £55,000 for every household in the country, and twice the level of most European nations.

Up to nine million Britons now confess to having a serious debt problem.

The spiralling level of household debt – which has trebled in real terms over the last 30 years – was revealed by research from the Conservatives’ Social Justice Policy Group, set up to advise leader David Cameron on tackling poverty and social breakdown.

It is plain that as the money supply has been increasing, British people have been borrowing and spending more, and saving less. What will be the consequence of this? Well, I happened to find, in David Conway's Farewell to Marx, a neat summary of the Austrian Business Cycle Theory:

The possibility remains that capitalism need not be subject to the business cycle. This would be so were business cycles due to wholly avoidable, externally produced interferences with the workings of the market. This is the contention of the Monetary or Circulation Credit Theory of the Trade Cycle first propounded by Ludwig von Mises in the twentieth century. According to this theory, cyclical crises and the depressions that follow in their wake are the inevitable result of preceeding booms. These booms, however, are not inevitable. They are produced by wholely avoidable periods of credit expansion. (Banks expand credit as a result of governments and their central banks purchasing assets and thereby increasing bank reserves.) Banks expand credit by lowering the rate of interest below what is called the natural rate of interest. This is the rate of interest that is determined by the time-preferences of members of society. The time-preference of an individual is the degree to which the indivdiual prefers a good in the present to the prospect of that good in the future. It is supposed that all individuals have some degree of time-preference in that they prefer present goods to the prospect of those goods in the future. The degree to which individuals prefer present to future goods determines the rate of interest which is charged for the use of money in society.

The expansion of bank credit artificially reduces the rate of interest below the natural rate. As a result, it sends misleading signals to business men. Business ventures appear to become profitable that would only be so were members of society to have genuinely reduced their degree of time-preferences. As a result of the artificial reduction of interest rates, businessmen behave as if more had genuinely been saved and become available for investment. Production is expanded in the capital-goods industries. The money invested eventually finds its way through to consumers. Because there has been no reduction in time-preferences on their part, they rush to spend this money in accordance with their unchanged consumption/savings ratios. There is an increase in demand for consumer goods. The capital goods industries find themselves without purchasers of their products. These firms are only able to stay in business by means of the supply of further credit. Banks may continue to extend credit and thereby prolong the boom. But eventually credit expansion must stop, as there are limits to the ability of banks to expand credit. When the expansion stops, interest rates go up and the over-extended capital-goods industries become insolvent. Bankruptcies follow and there are firm closures. This marks the period of depression during which the malinvestments are liquidated. After the structure of production has readjusted itself to the time-preferences of members of society, growth may begin again.

According to this theory, it is credit expansion by the banks that is responsible for the business cycle. By their nature, banks favour expansion of credit since they make profits by making loans. However, there are limits to their ability to extend credit since they must be able to to meet all demands for withdrawals. The business cycle would be eliminated, so the theory says, if either fractional reserve banking were prohibited and there was a restoration of the gold standard or free-banking was established. this is a system of banking in which banks are free to make loans beyond their reserves but are not protected by a central bank from inslovency. To date, governments have been in favour of bank credit expansion since this is a politically expedient way of obtaining revenue other than by the unpopular method of taxation.

It seems to me that everything Conway describes is occurring, and we should expect an oncoming recession. And, of course, capitalism will be blamed. Marxists will talk about the inherent instability of capitalism, of the cyclical "crises of capitalism," whilst more moderate statists will talk about how the collapse just proves the need for the state to intervene to prevent the cycles of boom and bust "inherent to capitalism." But we will know that it is the state, always the state, and its control over our money supply, and that the solution is to get the state out.

Further to this, there is a great documentary related to this at the Mises Institute that I recommend checking out.


Anonymous Anonymous said...

"The business cycle would be eliminated, so the theory says, if either fractional reserve banking were prohibited and there was a restoration of the gold standard or free-banking was established"

The majority of Austrians seem to think that free banking alone would not be sufficient unless FRB were also prohibited. De Sotto has a whole chapter on this in his book.

The odd thing is that Austrian anarchists such as Rothbard seem to have held this position, but it strikes me as completely inconsistent with anarchism.

Either the position is false and FRB is perfectly ok in a free banking regime, or it is true in which case anarchism is false. I don't think you can have both.


4:06 PM  
Blogger Richard said...

I'm not sure if prohibition of FRB is imcompatible with anarchism per se. If anarchism is an absence of a monopoly on the legitimate use of force in a given geographic area, then one could still have an absence of a monopoly on the legitimate use of force in a given area even if "legitimate force" includes prohibiting FRB: There could be competition in this "service." I don't think it is likely to occur under anarchism, though, because nobody, under anarchism, is forced to use an FRB or to accept their money. Given this, the only "victims" are those that consented to be "victims," and such people are unlikely to want to spend money on prohibiting others from making them the victims they want to be.

I can't remember David Friedman's case as to why FRB is likely to arise, but I remember being persuaded at the time. And then I remember being persuaded that FRB wouldn't arise because the money would have less value. Whichever, let the market solve it. If Rothbard is right on the latter, then he doesn't really need to prohibit it, because nobody would use the service anyway.

5:49 PM  
Anonymous Anonymous said...

But the Austrian argument (see e.g. De Sotto) is that although FRB could occur consensually as between borrower and lender, it has adverse effects on third parties. Thus it is criminal and should be banned.

To me the whole argument is utterly incoherent, but it is important to emphasise that those such as Rothbard did not take the relaxed view that the market can deal with it. To the contrary, the argument seems to be that the market cannot deal with FRB and thus it must be banned.

So in an austrian-anarcho-libertarian society a consensual transaction between willing adults which will inevitably arise on a free market is to be banned (criminalised even...) because of some indirect non-physical harm to "the economy". Weird.

10:42 AM  

Post a Comment

<< Home