Banking is undoubtedly corporatist. To put it another way, if one were to read Ayn Rand’s “Atlas Shrugged” and to replace the words “railroad” and “rail company” with the words “credit” and “bank”, one would get a pretty good description of what has been going on in recent years. We have had a failure of the free market in the allocation of credit in this country. It is extraordinary that we compound that failure by talking ourselves into seriously suggesting that politicians and technocrats should ration credit. The absence of a pricing mechanism at the heart of the banking system is ultimately what caused the credit boom and the banking failure. In a normal market, when demand for a product increases, the price for that product goes up. That, in turn, stimulates supply.
In banking, unfortunately, things are a little different. When demand for credit increases, the price-the interest rate-is kept low or constant. Pricing does not therefore stimulate increased supply. On the contrary, a supply of additional credit is not met through higher savings. It is met by the creation of candyfloss credit-by banks being able to conjure up credit out of thin air. Banks do not meet the additional supply of credit by encouraging more people to save; on the contrary, they continue to lend IOUs on the basis of IOUs on the basis of IOUs. At the height of the credit crunch, for every pound deposited in a bank, IOUs had been written out some 44 times through the miracle of fractional reserve banking.
Banks have a legal privilege to conjure up credit out of nothing that ultimately stems from their ability-this is an extraordinary fact-to call a depositor’s deposit their own, to treat it legally as if it were their own, and to lend against it many times. It is that practice that has resulted in a credit pyramid and runaway credit booms, unrestrained by the pricing mechanism that would normally apply and would normally restrain demand and supply. The demand is unrestrained, the supply is unrestrained, and the price is low. The result is Ponzi credit bubbles. An incredibly distortive and disruptive effect is created every 20 or 30 years in supposedly free-market economies that have corporatist banking at their heart, and it leads to sugar-rush booms.
To challenge the terrain of this debate, I should like to take the House back to a landmark in the development of British monetary and banking orthodoxy-the Bank Charter Act 1844, also known as Peel’s Act. It represented the victory of the currency school over the banking school. The former had realised that systemic crises and banking collapses were largely attributable to the excess creation of fiduciary media-that is, claims on money not backed by a fund of actual money. The Act, introduced by Peel, therefore eliminated the practice of banks issuing their own notes. Unfortunately, the currency school had not realised the economic equivalence of notes and demand deposits, so the Act left the banks virtually unmolested in their ability to issue fiduciary media.
My hon. Friend the Member for Bromsgrove (Sajid Javid) mentioned the wall of money that hit the markets, and we might reasonably ask where that wall of money came from. It has become common practice to say that interest rates were too low for so long, and therein lies the insight. When that happens, people are encouraged to borrow and the banks are encouraged to extend fiduciary media well in excess of real savings. Low interest rates ought to indicate prior production and real savings, but when central banks deliberately suppress interest rates and issuing banks pour fuel on the fire by issuing fiduciary media, what we find is that wall of money hitting the market. In our case, that money principally headed off into the housing market.
At the heart of our difficulties is the fact that there was an omission in the 1844 Act. The deposit-taking banking system is built upon that Act and a body of case law, which have left the banks with the legal privilege of treating demand deposits as their own property. That allows the system as a whole to create a wall of fiduciary media. That is the heart of our crisis, but it is not part of the mainstream contemporary debate, and I believe that it should be.
We both said much more: please follow the links above for the full text of our speeches.
Many of the authors and Cobden Centre advisory board members (including some distinguished academics) would like to see money eventually re-rooted back into some kind of commodity backing. Why? Simply put: the record of government control of the peoples’ money has been catastrophic!
One ounce of gold today is worth $1,093.40 and 1/20 oz therefore $54.67 but the dollar pre World War I was just a name in the USA for 1/20 of an ounce of gold: what would have cost $1 before World War I would cost $54.67 today. The dollar has lost its purchasing power. In fact it has lost 98.17% of its purchasing power in 100 years. One dollar today should buy something like a single person’s weekly food shop, not a single daily newspaper.
The fate of the pound sterling has been even worse than that of the dollar. One ounce of gold today is £692.26. So if a pound sterling pre World War I was just a name in the UK for 1/4 of an ounce of gold, it would imply that the pre World War I purchasing price was 1/4 of £692.26 or £173.06. In fact the pound sterling has lost 99.42% of its purchasing power in 100 years. One pound should buy something like a good week’s food shop for a family of four and not just one daily newspaper like it would today.
This was written at the start of this year, so the figures are actually even worse now!
Governments do not like the gold standard as it forces them to be honest with our money. Thus, if they have created the conditions for a credit induced boom, they hope a bust can be worked out of the system, for example, by the currency depreciating against other currencies. Under a gold standard, gold (money) would exit the country and cause a deflationary correction by forcing prices down to their real market clearing levels. Politicians do not get re-elected telling voters the unfortunate truth that they have been living beyond their means and that there is no magic fix to the prior problems created by excessive credit expansion.
The basic needs of human society are often mediated via the price mechanism. By this, I mean virtually all our essential goods and services that sustain our needs are transacted via the medium of money. This allows entrepreneurs to allocate resources where they are most urgently needed. Artificial bubbles in the price mechanism prevent this smooth allocation from happening. The Greenspan bubble in the USA and the Brown bubble here are testament to the power of governments to be popular while sowing the seeds for the actual destruction of our wealth. With the retail price index at nearly 5%, we are having a sizeable potion of our wealth confiscated each year, silently and by stealth, as the biggest single indebted entity being the State itself, engineers, lower real repayments of capital and interest.
Never in our lifetime have we seen such distortion and such uncertainty.
Why did we leave honest money behind? How often are you told you are swivel-eyed, mad-eyed or a loony tune when you ask “what about linking money back to gold?” Indeed, Robert Zoellick dared to ask that when he suggested that gold may well form a small part of a new world-wide money system, and was roundly and rudely sounded down.
The pundits remind us that during the 1930s the recession was deepened massively by the gold standard, and some even argue it caused the recession! Revisionist history is fashionable, as we know, but I would encourage a look at the facts.
Churchill, posturing and the overvaluing of GBP when returning to the gold standard
Churchill as Chancellor of the Exchequer had his moment when sadly for us, he contributed massively to the Great Depression. During World War I, the expenditure on the military was facilitated when the payment of promissory notes (redeemed in gold) was suspended, leaving bank-created credit unconstrained. If you borrowed at a rate that was $4.87 and could pay your government debt back at a rate of $4.87 even though the real worth had now fallen to $3.40, you are paying back much less. Under some odd posturing suggesting there was a need to establish pre war parity with our great trading partner and lender, seeming to hang onto the notion that we might still be their equal, Churchill, in his worst economic act, sought to mis-price money at an overvalued rate.
None was more open to the thought of these past glories than the then Chancellor of the Exchequer, Winston Churchill, for whom the past was part of life itself and also a rich source of family prestige and personal income. His address to Parliament on 28 April 1925 announcing the return to gold was a Churchillian occasion. The self-governing dominions, he observed, had moved or were moving to re-establish the gold standard, so over the whole of the British Empire there would be ‘complete unity of action’. The success of the step was being ensured by American support – $200 million from the Federal Reserve Bank of New York, $100 million from J. P. Morgan. The consequence would be a great revival in international and intra-imperial trade. Hence-forth nations united by the gold standard would ‘vary together, like ships in harbour whose gangways are joined and who rise and fall together with the tide’. As a minor defect, gold could be had only for export. There would be no more gold coins. The New York Times reported next day that, according to opinion expressed in the lobby’, the Chancellor’s speech was one of the ‘finest in a long line’ and ‘fully up to his own high reputation as a parliamentary orator’. Its headline said that Churchill’s proposals had carried ‘PARLIAMENT AND NATION TO HEIGHTS OF ENTHUSIASM’.( New York Times, 29 April 1925) Sixteen years later Churchill would be well cast; no man was so well equipped to make the lion roar. In 1925, both he and oratory were, without doubt, a misfortune……
The error they defended was in restoring the pound to its pre-war gold content of 123.27 grains of fine gold, its old exchange rate of $4.87. In 1920, the pound had fallen to as low as $3.40 in gold-based dollars. Though it had since gained and was still gaining, the pre-war gold content and dollar exchange rates were far too high. That was because, for these rates, British prices were far too high. Because of this high British prices anyone possessed of gold or dollars could do better by exchanging them for the money of one of Britain’s competitors and buying there. And Englishmen likewise could do better by exchanging pounds for dollars, gold or other currencies at the favourable Churchillian rate and buying abroad. In 1925, the price advantage in doing so was about 10 per cent. Exports, as always, were essential for Britain. So, other things equal, British coal, textiles and other manufactured tools could only become competitive at the new exchange rates if their prices were to come down by approximately 10 per cent. A very uncomfortable process”
(Background and consequences of Winston Churchill’s House of Commons “Gold Standard budget Speech”, from “Money: Whence it came, where it went” by John Kenneth Galbraith (First Published 1975), Page 174 to 178)
when Britannia ruled the waves and the pound was regarded with respect and awe in all the world’s money markets. They assumed that the restoration of the pound’s parity with the American dollar would re-establish Britain’s pre-war prosperity. None seemed to realize that England had squandered its wealth between Sarajevo and Versailles, or that the country’s shrunken export trade could no longer provide the surplus needed to re-establish London’s fiscal ascendancy over the rest of the world
(The Last Lion: Winston Spencer Churchill Visions of Glory 1874-1932″ by William Manchester, Copyright William Manchester 1983, Sphere Books Ltd, 1984. pp 568-570. , Pages 645 to 649)
What we can learn from this is that just like the despotic Nero or Henry VIII who debased their currency to enrich their Treasury, Churchill through vainglory and a puffed-up belief in the importance of the role of our nation in the world, sought to overvalue money, leading to a massive outflow of money as people would move their gold to where it was sold for more purchasing power, as Gresham’s law dictates. Also, with all our exports being greatly overvalued, large sections of industry became uncompetitive. Much as I acknowledge Churchill’s greatness in his leadership during the War, his conduct during the Great Depression made it deeper and longer than it should have been via his misuse of the people’s money. Governments have a truly appalling record at pricing money, this is but one example.
Glory the gold bugs and we will celebrate the day when hapless politicians have nothing to do with our money. The one thing for sure is that government itself if not responsible enough to have this unique control of our money.
And so the pain goes on. European bank shares fell sharply last week as news of an €80bn-€90bn (£68bn-£76bn) bail-out for Ireland sparked fears that senior creditors of Irish banks could soon be forced to accept losses.
Such concerns were particularly acute among investors in the UK and Germany – exposed to €110bn and €102bn of Irish bank debt respectively. The third-most exposed country, incidentally, is the United States.
The centre of the turbulence on Europe’s financial markets shifted last week, though, to Spain and Portugal, causing their governments’ borrowing costs to soar. The reason is that the rescue package being finalised between Dublin, the European Union and the International Monetary Fund may impose “haircuts” on all those who leant money to banks in the Republic – not just the “junior creditors”.
Michael Meacher’s motion comes first, followed by Government and Opposition amendments. No doubt we shall be whipped to vote through the motion as amended by the Government.
1 BACKBENCH BUSINESS (10th allotted day) [Until 10.00 pm]
BANKING REFORM
Mr Michael Meacher
That this House, concerned that no action has so far been taken which would prevent a recurrence of the financial crash, calls upon the Government to establish a clearing house for approval of all financial derivatives and to set in place alternative mechanisms to remove the implicit taxpayer guarantee, other than to purely deposit-taking banks, in the event of any future banking collapse.
As Amendments to Mr Michael Meacher’s proposed Motion (Banking Reform):
Mr Chancellor of the Exchequer
Vince Cable
Danny Alexander
Mr Patrick McLoughlin
Mark Hoban
David Gauke
Justine Greening (b)
Line 1, leave out from ‘House’ to end and add ‘alarmed by the failure of the tripartite system during the financial crisis, welcomes the Government’s policy of reforming the regulatory architecture and applauds the swift action it has taken, alongside the Financial Services Authority and international partners, to strengthen both domestic and international prudential regulation.’.
Alan Johnson
Chris Leslie
Mr David Hanson
Kerry McCarthy
(a)
Line 2, leave out from ‘to’ to ‘and’ in line 3 and insert ‘show stronger leadership in efforts to reform the supervision of derivatives in order to deliver improved transparency and risk disclosure’.
I shall try to speak, but since a debate of no more than three hours has been recommended by the Backbench Business Committee and since both Government and Opposition are all over it, who knows whether I shall get in?
In the meantime, I have prepared some remarks which are thoroughly Cobdenite.
The European Council agreed at its meeting in Madrid in June to launch the first Stage of economic and monetary union (EMU) on 1 July 1990. The Council also confirmed the objective of the progressive realisation of EMU but did not specify how that objective was to be realised. By common consent the next steps in economic and monetary integration of the twelve Member States will be crucial to the future economic development of the European Community. That development must be based on firm and durable foundations which reflect both the diversity and the unity of the economic and monetary situation in the Community. This paper suggests how such sound foundations should be laid in a way which avoids the pitfalls of other approaches now under consideration.
Follow the link above for details of how Britain thought competing European currencies would have been a better alternative to Delors’ Euro: competition would have made money honest.
It’s a fascinating read which lays aside the notion that competing currencies are far beyond the mainstream. What a pity this plan wasn’t enacted.
And a grateful hat-tip to Michael Fallon MP, who brought the existence of this paper to my attention.
With Ireland and Greece et al, falling under the demeaning tutelage of the world government’s IMF and World Bank, the appropriately-named Max Keiser has made the eerily compelling argument that Germany will soon leave the Eurozone and will then become a world superpower rivalling China and dominating Europe, even though most of the point of the EU was to prevent this very thing from happening:
It would seem that the more coercion you place upon a system — such as the squeezing of a bar of soap — the more likely you are to accelerate the creation of that which you are trying to restrain.
I wonder what Professor Hoppe thinks about Herr Keiser’s prediction?
I also wonder if the pervasiveness of the work of Ludwig von Mises throughout the German-speaking world, particularly via the channel of the post-WWII “Wirtschaftswunder”, has anything to do with this? This German “Economic Miracle” was inspired by Ludwig Erhard, Wilhelm Röpke, and Konrad Adenauer, who managed to throw off the Keynesian economic shackles of the US occupation power, one glorious Sunday afternoon, when they instigated a successful economic coup on the 20th of June 1948, when the US imperial prefects missed the ball by being at the country club; on this remarkable afternoon these three men threw off the draconian post-war hegemonic regulations of the occupiers and created a new currency, the Deutsche Mark, to help this move away from the US-controlled Reichsmark.
Wilhelm Röpke, in particular, is sometimes seen as being well within the ambit of what you might call the outer orbital sphere of the Austrian School.
Perhaps Herr Röpke still has supporters in Germany who can continue his economic legacy? If these people are sufficiently strong, I wonder what they will call their new German currency if Herr Keiser is right in his prediction? My personal hope is that the new German money will either be named “Die Golde Mark” or named “Die Silbere Mark”.
Thus, it would be interesting if we managed to solve the EU problem in the UK and our dishonest paper money problem, by following an independent Germany out of the EU and by adopting a specie-backed honest money while we’re about it. Because with Germany out of the Euro, our EU strangulation really will be over, because the strangler will be dead — machine-gunned through the heart by the escaping Germans, though I had better finish there before I am tempted to build an appalling analogy based upon either Das Boot or Colditz.
There is just one more thing that needs to be said:
“Germany cannot keep paying for bail-outs without going bankrupt itself,” said Professor Wilhelm Hankel, of Frankfurt University. “This is frightening people. You cannot find a bank safe deposit box in Germany because every single one has already been taken and stuffed with gold and silver. It is like an underground Switzerland within our borders. People have terrible memories of 1948 and 1923 when they lost their savings.”
The refrain was picked up this week by German finance minister Wolfgang Schäuble. “We’re not swimming in money, we’re drowning in debts,” he told the Bundestag.
Now, we certainly don’t always agree with Ambrose but there is a certain weary inevitability about the worsening of financial news. Where will all this deficit financing, QE and so on end? See also Is inflation now beyond the Bank’s control? by Jeremy Warner.
Pace those who have made such a big deal out of Chairman Bernanke’s November 19th speech, but it is hard to find anything therein other than the usual rehearsal of super-aggregative error and unabashed American blame-shifting.
To our mind, it was hardly news that Blackhawk Ben felt that the world monetary system contained a ‘structural flaw’ – nor, indeed, that he completely misidentified its essence. It may be too uncomfortable a truth for him to face, but this is a problem which does not consist solely of the malign outcomes of surplus countries trying to peg their exchange rates, per se, so much as of the fact that there is no effective constraint on the OTHER side of the transaction – at least, not for large economies in general and for the provider of the world’s reserve medium, the United States, in particular.
The existence of such a wilfully ‘loosened joint’ between the supply of and demand for goods and services should be contrasted with the system which prevailed before the Great War (one is tempted to say, for the greater part of human history) under which an equilibrating pressure was at least theoretically delivered by the need to settle net trade imbalances between two regions with a genuinely scarce, OUTSIDE money such as gold or silver (whether in the form of specie or bullion) and not by means of the near-costlessly replicated IOUs of its biggest spendthrift.
As the redoubtable Jacques Rueff was always at pains to point out, the present regime, whereby the world’s largest excess consumer can painlessly force an increased issue of its liabilities onto its hapless counterparties, is a ‘childish game of marbles’ (i.e., one in which the ‘winners’ must always surrender their gains to the ‘loser’ at the end of each round); one in which the most persistent and largest DEFICIT offender faces few immediate consequences of an habitual irresponsibility which can, on occasion, degenerate into outright rogue behaviour (‘It’s our currency, but your problem!’).
Indeed, the unbridled enjoyment of just this facility – of this self-assumed prodigal’s charter – is something which has indisputably tended to discourage non-inflationary investment in the very industrial capacity needed to provide that extra quantum of valuable goods and services which would either have competed more efficiently with that same nation’s imports or paid for more of its exports – a point all too conveniently overlooked by the Fed and its serried ranks of apologists.
While we should be careful lest we impose our preferences on those of others, trade – whether within or across borders – tends to deliver greater and more lasting mutual gains when each party freely exchanges elements of its produced wealth. When one of those involved is habitually persuaded – or coerced – into conducting such dealings on tick with a truculent profligate who is bound ultimately to renege on what he owes – who, indeed, feels he is doing his supplier a favour by relieving him of his goods in the first instance – it is more than a little hypocritical to berate the seller-creditor, not the buyer-debtor, when things do eventually go wrong.
For Bernanke to criticize the surplus nations is thus nothing new at all – it is, au contraire, perfectly consistent with the long-held US policy of whining at its trading partners whenever they fail to mimic, in sufficient degree, its own chronic inflationism. It is an act of special pleading on a par with the Chairman’s ludicrous notion of a ‘global saving glut’ and, moreover, it represents a full and sycophantic toeing of the Administration’s line that those who are most successful at meeting global customer demand (not infrequently under the ownership of American shareholders and subject to the guidance of American management expertise, it should further be noted) should, on that account, be penalised for those same customers’ inability or unwillingness to offer anything other than irredeemable promises of future compensation in exchange for the wares they so eagerly snap up..
Notable, too, in the arguments of a man who shares the implicit, Keynesian/Monetarist delusion that consumption is a source of wealth – rather than comprising the act of its final extermination – is the notion that adjustments must always incorporate increased spending on such an eradication of worth, even if this comes at the added cost of providing governmental subsidies to encourage it (in the form of ensuring greater availability of just that same ‘retail credit’ whose lavish extension helped trigger the global crisis, in combination with the strangling coils of a strengthened ‘social safety net’ – i.e., with the imposition of the same kind of Ponzi scheme welfare state whose spiralling costs and perverse incentives are presently throttling the West’s recovery and the threat of whose most minuscule reduction has already provoked open violence on its streets).
Mr. Bernanke should also ask himself what would happen to American standards of living were the Chinese, the Arabs, the Germans and the rest to take him at his word. If this meant they were henceforth to use their surplus dollars directly for consumption, rather than channelling them toward the kind of unthinking vendor finance which has helped suppress world prices for so long, with money already so easy, his country would face an inflationary wave which its hollowed out industries could not easily expand to counter. If America is being ‘impoverished’ under present policies it is because their settings encourage it to consume too much of its precious capital. Given this premise, we cannot expect that same capital to materialize instantly and to begin pouring out a plethora of cheap goods the moment the external tap is turned off. Nor is it certain – as the argument implicitly assumes – that (outside the farm belt, at least) the extra spending would find its way into US cash registers instead of being shared out between the great producing nations themselves in a kind of BMW-for-oil-for-plasma-TV triangular trade.
Conversely – though far less conceivable in practice – each of these great world suppliers could start to eat a much greater share of their own cooking. To see what this implies, let us push it to an extreme and envisage it taking the form of a total export ban. Given the recent brouhaha over a handful of Rare Earths, and the more significant dislocations caused when certain governments impose their rice or sugar embargos, can you imagine the howls of pain which would emerge if this denial of custom extended to some goodly part of the $1.8 trillion the US buys abroad each year?
A further implication is that, given the near universal prejudice the mainstream holds against ‘deflation’ – i.e., falling prices – even when this reflects genuine market signals regarding the beneficial attainment of increased prosperity through higher material productivity – the idea of ‘burden sharing’ is rendered even more suspect since it beggars belief to suppose that deficit countries would ever allow reserve-driven credit contraction to take place. Indeed, with the exception of his rehearsal of the empty formula that US fiscal (but never its monetary) policy may need to be trimmed back (though not just yet, of course), Bernanke devotes most of his time arguing that, as has been the case at least since WWII, surplus countries can do nothing other than to swallow whatever reserve-driven degree of credit inflation the US forces down their gullets, regardless of the havoc this unleashes upon the general populace (of whom only some fuzzy minority will be counted among the evil exporters being targeted, in any case).
Quite how this asymmetrical transmission of a faulty macro-policy of free-riding is supposed to speed the proportionate adjustment of relative prices – and hence the optimal allocation of capital – around the world is not at all clear.
Even more tellingly, the introduction of a truly improved system would imply the acceptance of a semi-automatic mechanism wherein the central bank (to the extent one is actually still needed) would exist simply to facilitate cross-border settlements and – in the case that the local currency is not fully convertible (and coinable!) on demand by its users into some scarce, external monetary asset – to help regulate the value of the former so as to maintain its relevant, contractual parity. This clearly requires that all ideas of ‘dual mandates’ regarding the level of employment – as well as all the other hubristic, Gosplan-style programmes and corporatist feather-bedding presently countenanced – would have to be abandoned. Such a drastic diminution of function and importance is not something the self-perpetuating bureaucracy of the Fed – not to mention the equally otiose apparatchiks at the US Treasury, the IMF, the WTO, and all the other supranational, alphabet soup of busybodies – would at all relish, one presumes.
It must also be emphasised that the necessary corollary to this overthrow of the present pernicious monetary apparatus is that if we are then to avoid the triggering of a self-aggravating collapse whenever any resulting restriction does begin to bite, the maximum degree of domestic price flexibility must be induced in the system – i.e., wages and prices must all adjust without interference from either central banks or governments as rapidly and as uninterruptedly as possible.
Without such a resolve – though its adoption may well run counter to the sophistry of the predominant Progressive creed espoused by our rulers – we are only half way to our goal. Just as in bridge construction, half-solutions in these matters are not only no solutions at all, but entail even greater hazards to those undertaking them. Were we to attempt the one without the other, the inevitable failure would surely risk a further eighty years of the counter-productive denial of the workings of economic law by two further generations of Nobel laureate, idiot savants!
Though he later recanted his belief in its message, Lionel Robbins’ near-contemporaneous treatment of events in his ‘Great Depression’, remains one of the most cogent and lucid expositions of what went wrong in that dark decade and also of what kept it in a state of ‘wrongness’ for such an unconscionable length of time after the initial crisis.
Among its many, telling comments, the following stands out by way of its relevance to the turmoil taking place in Europe today and so is worthy of an extended reproduction here:-
“……The boom was remarkable, not only for the proliferation of fashionable fraud; it was remarkable, too, for a change in the methods of straightforward financing… by a conspicuous increase in the proportion of public investment which takes the form of fixed debt rather than participating ownership. This tendency was bound to accentuate the difficulties of any period of depression. In part, the change was due to… increased participation by banks in the financing of all kinds of enterprise created a market for bonds where equities would have been unacceptable…The big insurance companies, moreover, through whose agency so large a proportion of the savings of the poorer and middle classes are invested, had a preference for this kind of investment…”
“But in part it was due to the increased economic activity of States and governmental bodies. The most intractable and disastrous masses of fixed debt which have obstructed recovery in the slump have been debts of this sort… Of the total amount invested in Germany in the years 1924-1928, it has been estimated that at least 40 per cent was on account of governmental bodies. Much of this was spent on the carrying out of works such as the construction of swimming-baths, the financing of housing schemes and so on, which had little prospect of being financially remunerative… Much of this money is irretrievably lost. But, because it was borrowed by government bodies, recognition of this fact is slow to come and liquidation has thus been delayed. Paradoxically enough, economists who have urged that this sort of thing has not proved its worth in practice, are often called by their opponents, ‘deflationists’…”
Is it so hard to see that, when the crisis broke, the Irish authorities should have restricted themselves to guaranteeing banking deposits up to some fairly modest ceiling amount and then left bank shareholders, bondholders, and wholesale depositors to negotiate over the division of whatever small residuum their ill-advised investments had left them?
By extension, if and when those creditors themselves were sufficiently embarrassed as a result of their folly, the authorities in their own jurisdictions – whether German, Dutch, French, British, or whatever – should have applied exactly the same salutary treatment to them in their turn. Losses would undoubtedly have been substantial, but the foredoomed attempt to disguise them has not only not made these any lesser, but has prevented anyone from embarking upon the process of working to put right the shocking loss of wealth they have entailed in the interim.
Yes, there would have been considerable disruption and a highly regrettable hardship would have been imposed not just on the few, highly-visible ‘Rich’ but also on the many, nameless, less well-off – but can anyone say that today’s consequently pressing need to throw the engine of government debt accumulation violently into reverse will not occasion at least equal amounts of suffering in a far more protracted manner and without even the merit of fairness and equity in making the malefactors’ willing business partners bear the first (and probably the largest) portion of the losses?
As it is, the Irish ‘rescue’ looks like it has only served to underline how perilously entwined the fortunes of sovereigns and their banks have become. As we have noted before, under the rules of this multi-trillion shell game, the sovereigns guarantee the ECB which funds the banks which buy the government debt which provides for everyone else’s guarantees. No wonder scrutiny is switching back to Spain and Eurobank stocks are sagging, once more.
And to think that the former UK Prime Minister used to boast that he had ‘saved the world’ when he set the standard by being the first to rush to conclude a similar pact of mutually-assured destruction into which the hosts of cherubim and seraphim, surely, would have feared to tread.
As if this were not enough for markets to try to rationalise, there is just the risk that it travels back to the US – whether via the ‘putback’ of dodgy mortgage loans to FNM/FRE and/or the banks, or via a possible Muni implosion when the Build America Bond programme expires at year end.
Bigger yet is the threat posed by China’s inflationary outbreak. Although we derided its crude attempts to suppress prices and boost welfare payments – and while the market was briefly relieved that the PBoC did no more than hike reserve ratios for the umpteenth time – it does appear as if something a little more draconian may be coming down the track, possibly after the Central Economic Work Conference has discussed any such measures in three weeks’ time.
Certainly, if we are to take the China Daily at its word, we should be reducing risk exposures where we can: -
“…The latest move to contain excess liquidity and the forceful measures that the central government has taken to stabilize prices show the determination of Chinese policymakers to fight inflation. Though these moves may not be enough to tame inflation once and for all, they are a good start before more aggressive actions become necessary to battle inflation that is unlikely to end anytime soon, as debt-laden rich countries keep flooding the world economy with their newly printed money.”
Well, if Ben can blame it all on Zhou, he is surely entitled to give a little of it back, but the main point is that the former’s indulgence in QE might just be about to run into the latter’s switch to QT. We know which we think will carry more weight in setting commodity prices.
As the bailout of Ireland begins in earnest, many in the media are asking “What went wrong?”, and coming to some dubious answers. The circumstances are well known. Ireland saw a long boom before the financial crisis. That boom was accompanied by a large rise in house prices and a boom in building construction. After the financial crisis and ensuing world-wide recession, many Irish banks were bailed out by the government or nationalised. The Irish government practised austerity policies, increasing taxes and reducing expenditure. But, as the cost of the bailouts increased, so did the budget deficit.
Many commentators are now claiming that Ireland’s membership of the Euro was the underlying problem (for example, Peter Oborne. In this argument many sound economic ideas have been mixed with careless ones.
One argument is that if Ireland had not been part of the Eurozone it would have been able to devalue it’s currency. It’s true, that if Ireland still had the Punt then this would be possible but not as significant as many people believe. In today’s world with floating fiat currencies controlled by central banks there is no clear concept of “devaluation” any more. The economic prospects of the region encompassed by each currency and the policies of the central banks are taken into account by the exchange rate market, and the exchange rate fluctuates minute by minute. This means there are two different arguments. The first, which focuses on the private sector, is that when a country enters recession the value of it’s currency falls allowing a growth in exports. This is a dubious argument, but whatever its merits it could not have seriously improved the financial situation of the Irish banks or the Irish government. The second argument is that in a crisis the state’s central bank may create money and use it to pay debts and finance bailouts.
A modern state can easily create new money without having additional assets. If Ireland had kept the Punt, it’s own fiat currency, then the government could have bailed out the banks using newly created money. But, that would simply be a hidden tax. Inflation would ensue then holders of money and money-substitutes would see the real value of those assets fall. Holders of assets denominated in money such as loans and bonds would see those fall in value in real terms too. The tax would be paid by the people through this loss of purchasing power. Any permanent increase in the stock of money must lead to inflation, though there may be a time lag until it becomes noticeable. A temporary increase could only be achieved by withdrawing money from circulation afterwards, and that could only be done with taxation. That governments can create money to get themselves out of sticky situations is beneficial to governments, but not to the people they’re supposed to serve.
Critics of the Euro also claim that the Eurozone currency area could not have worked. According to this view the ECB must run monetary policy to suit the core Eurozone countries. But interest rates that are a good fit for Germany and France will cause problems in other Eurozone countries. There is some truth in this. In the years before the crisis, the ECB ran low interest rates to stimulate the northern European economies, particularly Germany and France which were struggling with rigid labour markets. A side-effect of that policy was the building booms in Southern Europe and Ireland which weren’t sustainable. Though there is some truth in this view, it’s still confused. The idea that labour market problems can be successfully compensated for by reducing interest rates is from Keynesian economics. The idea that central banks reducing interest rates to excessively low levels causes unsustainable booms is from Austrian economics. These views can’t be mixed because they come from conflicting theoretical starting points. It isn’t possible that Keynesian economists are right in France and Germany but Austrian economists are right in Ireland and Portugal. In my view the ECB’s low interest rates may have been an attempt to stimulate the Northern European economies, but that policy wouldn’t have worked under any circumstances. The ECB’s policy came at a cost to Ireland and the Southern European countries when the property bubbles burst, but that cost doesn’t reflect any benefit to the Northern European countries.
It’s true that a Central Bank faces greater problems if the currency area that it regulates spans many countries with different conditions. But, as we have seen, Central Banks can’t avoid recessions and crises even if they only regulate the currency of a single sovereign nation.
Many countries have found themselves facing the consequences of the bad decisions made by Central Banks. Ireland isn’t unique in that respect. What makes Ireland unique is the extraordinary lengths that the government have taken to support banks and property developers. In September of 2008 the Irish government guaranteed for two years all bank accounts with Irish banks and almost all loans to those banks. This September, when that guarantee was due to expire, it was extended for another three months. The government decided that rather than risk paying out on that guarantee they would bail out banks as and when they needed it. They nationalised the worst-affected bank – Anglo Irish Bank in 2008. So far, through several bailouts Anglo-Irish Bank has cost the Irish government €22.9 and the other banks have cost ~€10.1, though the extent of losses hasn’t been fully recognized and will probably be much greater. It is these debts that have caused Ireland’s budget deficit to rise much more than those of other countries.
There have been many rumours about corruption in the Fianna Fail and in Anglo-Irish bank. The actions of the former board of Anglo-Irish bank are under investigation by financial regulators and the police, the former CEO has been declared bankrupt. There are close links between the ruling Fianna Fail party and many property developers, that was the subject of jokes long before the crisis. The previous Taoiseach Bertie Ahern was investigated for receiving bribes from property developers. I think there’s probably some truth in these allegations of corruption. But the politicians that form the government had many ways they could abuse their power for personal gain. A politician has many ways he can make a little on the side without bankrupting his country.
It’s ideas rather than corruption that have created such a great crisis for Ireland. The government thought that the resources the state could lay claim to were inexhaustible. They believed that if the state guaranteed bank accounts that this guarantee alone would satisfy the markets. The Finance Minister Brian Lenihan once called the guarantee the “cheapest bailout in the world so far”. The government forgot that the power of the state isn’t magical. A government can transfer the liabilities of banks onto the taxpayers, but they can’t abolish them. Back in 2008, the government were worried that the failure of a bank would harm Ireland’s reputation, but in the long run their cure was worse than the illness.
As Phillip Booth wrote, the first step the Irish government, the IMF and the EU should take is to end the guarantees.
Europe is trapped in a cycle where debt is being passed round and round in circles – the banks are bust so the Irish government bails them out; the Irish government’s debt is owned by other banks and if the government defaults, they go bust; the EU as a whole then tries to rescue both in opaque arrangements which are only sustainable because Ireland is so small; now Britain is getting involved.
Responding to debt crises in this way is entirely unsustainable, we potentially have crises in Italy and Spain around the corner and nobody can shoulder their indebtedness.
The EU has been sitting around doing very little for the last two years (except for dreaming up new regulations for the banks, hedge funds and private equity). What it and the nation states involved should have been doing is ensuring that banks can be wound up in an orderly fashion so that all providers of capital and credit potentially lose money except for depositors who were insured at the beginning of the crisis. The EU governments are simply underwriting mistakes made by private businesses and then blaming it all on “casino capitalists”.
The Irish government’s debt position would not, in fact, be that bad if it were not for the bank guarantees. Ireland is not another Greece (or Italy) – its underlying position is sound. The key issue has not changed since the beginning of the crisis – it is the need to recognise failed financial institutions for what they are and not load the cost of their bad loans onto taxpayers in general. At the beginning of the crisis, the bail-outs were understandable; we have now had two years to sort out proper legal mechanisms for winding up banks.
