I chanced this morning on the superb collection of essays from Ludwig von Mises, The Causes of the Economic Crisis and Other Essays Before and After the Great Depression (PDF).
In his Stabilization of the Monetary Unit—From the Viewpoint of Theory written in 1923, he showed considerable foresight:
Only the hopelessly confirmed statist can cherish the hope that a money, continually declining in value, may be maintained in use as money over the long run. That the German mark is still used as money today [January 1923] is due simply to the fact that the belief generally prevails that its progressive depreciation will soon stop, or perhaps even that its value per unit will once more improve. The moment that this opinion is recognized as untenable, the process of ousting paper notes from their position as money will begin. If the process can still be delayed somewhat, it can only denote another sudden shift of opinion as to the state of the mark’s future value. The phenomena described as frenzied purchases have given us some advance warning as to how the process will begin. It may be that we shall see it run its full course.
Obviously the notes cannot be forced out of their position as the legal media of exchange, except by an act of law. Even if they become completely worthless, even if nothing at all could be purchased for a billion marks, obligations payable in marks could still be legally satisfied by the delivery of mark notes. This means simply that creditors, to whom marks are owed, are precisely those who will be hurt most by the collapse of the paper standard. As a result, it will become impossible to save the purchasing power of the mark from destruction.
And in 1946, he commented on using easy money and deficit spending to stimulate the economy after a long period of cheap credit (The Trade Cycle and Credit Expansion):
In discussing the situation as it developed under the expansionist pressure on trade created by years of cheap interest rates policy, one must be fully aware of the fact that the termination of this policy will make visible the havoc it has spread. The incorrigible inflationists will cry out against alleged deflation and will advertise again their patent medicine, inflation, rebaptizing it re-deflation. What generates the evils is the expansionist policy. Its termination only makes the evils visible. This termination must at any rate come sooner or later, and the later it comes, the more severe are the damages which the artificial boom has caused. As things are now, after a long period of artificially low interest rates, the question is not how to avoid the hardships of the process of recovery altogether, but how to reduce them to a minimum. If one does not terminate the expansionist policy in time by a return to balanced budgets, by abstaining from government borrowing from the commercial banks and by letting the market determine the height of interest rates, one chooses the German way of 1923.
The Bank of England hopes to avoid all this by manipulating people’s expectations about inflation and GDP growth. I don’t think it can be done – too many commentators can see through it.
Nevertheless, they are going to give it a try. The best that can be said for it in the context of the German experience which Mises predicted and lived through is that at least if coming events are well understood, contemporary errors may at last produce the paradigm shift in economic thought necessary to put us on a more just and moral economic path.
Steve Baker is Conservative MP for Wycombe and a co-founder of The Cobden Centre. He was previously an aerospace and software engineer. Among other things, he worked with major banks and regulators internationally. His personal and political website is at stevebaker.info. | Contact us
22 August 13 | Tags: Books, Inflation, Mises, Money | Category: Economics, Politics | 7 comments
EQUITY markets jumped yesterday after the Bank of England shocked investors by indicating that rates would stay at historic lows in the near future, despite recent signs that the British economy is starting to strengthen.
That investors are shocked by the news that Mark Carney plans a further extended period of easy money is more surprising than the news itself. But it turns out markets are good at responding to superficial data over the clearly stated intent of big players in the market, like central bank officials.
Consider the evidence of Lord George, former Bank of England Governor, to the Treasury Select Committee in 2007, in which he confesses his role in seeding economic disruption in an attempt to avoid recession:
Tuesday 20 March 2007 – Treasury – Minutes of Evidence
Q117 Ms Keeble: What makes it worse is that the one tool that the MPC has is interest rates and that filters through to our constituents in the form of higher mortgages. That makes them complain even more; it becomes cyclical.
Lord George: Yes, if house prices are going up. But one has to step back and recognise—I referred to it earlier—that when we were in an environment of global economic weakness at the beginning of the decade it meant that external demand was declining. Related to that, business investment was declining. One had only two alternatives in sustaining demand and keeping the economy moving forward: one was public spending and the other was consumption. It is true that taxation and public spending can influence the demand climate and consumer spending, but confronted with what we saw we knew that we had to stimulate consumer spending. We knew that we had pushed it up to levels that could not possibly be sustained in the medium and longer term, but for the time being if we had not done that the UK economy would have gone into recession, just like the economies of the United States, Germany and other major industrial countries. That pushed up house prices and increased household debt. That problem has been a legacy to my successors; they have to sort it out, but we really did not have much of a choice about what we did unless we accepted that we would yank it back or give up stability altogether. That is the point I am trying to make in answer to Mr Newmark. There are some people—maybe lots—who say that house prices is the biggest problem, that the mortgage rate is going up, housing is not affordable and so on.
And a few weeks ago, the Bank’s Andy Haldane confessed that they “have intentionally blown the biggest government bond bubble in history” (I abridge a little):
Wednesday 12 June 2013 – TRANSCRIPT OF ORAL EVIDENCE
Q41 Mark Garnier: … If you thought that QE was creating financial instability, would you try to warn the MPC and, if so, how would you do it?
Andrew Haldane: I absolutely see it as my one of jobs as an FPC member to alert not just the MPC but this Committee and the wider world if I thought that QE, or monetary policy actions more broadly, was posing significant risks to UK financial system stability. …
To the substance, this is a risk that I feel very acutely right now. If I were to single out what for me would be the biggest risk to global financial stability right now it would be a disorderly reversion in the yields of government bonds globally, for any one of a variety of reasons. We have seen shades of that over the last two or three weeks. Let’s be clear, we have intentionally blown the biggest government bond bubble in history. That is where we are, so we need to be vigilant to the consequences of that bubble deflating more quickly than we might otherwise have wanted. That is a risk. It is one we as FPC need to be very vigilant to.
So, by officials’ own admission, the Bank under Eddie George created levels of debt-fuelled consumption which they knew could not last in the hope of avoiding recession and, following that bubble bursting, they have now deliberately inflated the biggest bond market bubble in history. When I see markets herding in response to the pronouncements of these big players, I think “What could possibly go wrong?”
It is certainly true that the central banks can alter economic expectations but the idea that they can do so helpfully is fanciful. It is founded on the same errors as socialism and like socialism, it cannot work because the information necessary is not available and because it relies on aggregating away much that makes us human.
We’ve had two confessions from central bank officials. I feel I can predict confidently that Mark Carney will one day confess, more or less, “We thought we could manage the economy by steering the expectations of tens of millions of people using monetary policy to blow various bubbles while making pronouncements about policy. We were wrong.”
One of the great tragedies of our circumstances is that so many people will label this central planning “capitalism”. Eventually, the state will have to get out of money and banking. Mark Carney’s coming failure should accelerate the day.
What the Bank of England is trying to do is restart the money creation process which dropped us into this mess while keeping expectations of inflation low. It’s an extremely dangerous game, one which Hayek explored in his Nobel lecture: it is a policy which cannot create sustainable prosperity but which may create massive inflation, with all its destructive effects.
Having mostly failed to see this crisis coming before failing to predict even the general pattern of events, senior economists now want more of the medicine which already nearly killed the patient. This may look like madness or stupidity to those of us without a high level of formal education in economics. It is neither. Contemporary economists are trapped in an intellectual prison founded on now-old errors of method and epistemology: the knowledge and simplifications necessary to make their mathematical models work are unavailable and invalid respectively.
As a result, economists and central bankers in particular think it is their task to intervene when the choices and actions of tens of millions of people produce aggregate statistics they, and politicians, don’t like. Massive economic disruption and misallocation of resources — ultimately, human suffering — is the result. Unfortunately, it looks like those few who hold the terrible power of monetary policy are determined to test their ideas to destruction.
Following the UK credit rating downgrade, I gave Newsnight an interview. They chose a couple of sentences in which I pointed out the reality that welfare, health, education and debt interest are about 3/4 of spending on 2012 figures and that they will have to be cut eventually if we are serious about the state living within its means. You can find it at 17:00. If I had been given longer, I would have said those things you can find in this interview with RT:
We have been on a merry-go-round of deficit spending, excruciating taxes, heavy borrowing and easy money for most of 40 years. That merry-go-round is now running down and will stop. Attempts to spin it up through monetary policy are extremely dangerous: they will store up worse trouble for later.
If the Government does not act to end expansionist policy in time by a return to balanced budgets, by ending government borrowing from the commercial banks, by stopping quantitative easing and by letting the market determine the height of interest rates, then it will have chosen the German way of 1923.
In this podcast we discuss how debts are undermining Western civilisation, the significance of unequal taxation and how iDemocracy most definitely does not mean voting by computer. And, oh yeah, what is the difference between a metaphor and a simile?
Blue-chip mystique still clings to it but you can feel the reputational parabola slowly gathering momentum on the downside. Its projects are too large and diffuse, the resources to achieve them too crude and there are mounting signs of unhappiness and confusion at the top.
Given their long-standing rock star status, pity the central banker; the fall from grace may be vertiginous.
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The Governor of the Old Lady seems more attuned to this unfolding trend than most. On my reading, he metaphorically ran up the white flag in a recent speech. It was the oddest mixture of explanations, implicit apologies and rationalisations imaginable from such an august perch. Do have a look; it’s not long.
King finished with an amusing touch: “As for the MPC [Monetary Policy Committee], you can be sure we shall be looking for as much guidance as we can find, divine or otherwise. What better inspiration than the memory of those children on Rhossili beach singing Cwm Rhondda.”
Perhaps the South Wales Chamber of Commerce seemed a forgiving place to lay out some of central banking’s many puzzles.
Put simply, his message was: I know what we’re doing seems a bit crazy, and I know all the fundamental problems are still out there waiting to be solved, but what else can we do?
What’s even scarier is that I understand what he means. After all, most of the really important stuff, like correcting the monstrous accumulated imbalances of recent decades and setting a more sensible course for the future, isn’t within the Bank of England’s remit. And yet, because the magic wand is in their hands, everyone looks to them to do something. Anything.
Which, as we know, they did. Cumulative QE (so far) of £375 billion, or 25% of GDP, enough for top spot amongst its Western institutional colleagues. As King suggested, the market is well and truly sated:
During the crisis central banks have provided liquidity to banks on a truly extraordinary scale, so much so that there were no takers for additional liquidity in our latest auction. It is still useful to keep their auction facility as an insurance policy. But banks are now overflowing with liquid assets.
Insurance policy indeed. Any more QE would seem in danger of plunging the whole business into farce.
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King, as he often does, got to the nub of the matter early on in his speech:
In the long run, we will need to rebalance our economy away from domestic spending and towards exports, to reduce the trade deficit, to repay our debts, and to raise the rate of national saving and investment. So you are probably puzzled by the fact that we seem to be doing exactly the opposite of that today. Almost 4 years ago now, I called this the “paradox of policy” – policy measures that are desirable in the short term appear diametrically opposite to those needed in the long term. Although we cannot avoid long-term adjustment to our economy, we can try to slow the pace of the adjustment in order to limit the immediate damage to output and employment.
He’d be only too aware, I’m sure, that our current intolerable mess is the result of giving in to a long succession of apparently desirable short-term policy measures. In each of the would-be and actual recessions of recent decades, politicians and central bankers strove to “limit the immediate damage to output and employment.” And, for the most part, succeeded. Trouble is, of course, in doing so earlier excesses were never allowed to sort themselves out; instead, they were carried forward with compound interest and then added to afresh.
How does one ever decide that now, finally, is the moment to pay the piper?
Thing is, even if King thought the time was now (or, quite possibly, a few years ago), it’s out of his hands. He can advise, plead, cajole, threaten to resign, but he can’t decide. So too with his compatriots elsewhere, many of whom have also been delicately (and sometimes not so delicately) pointing out the limits of of monetary policy and pleading for deeper structural reform.
As King said immediately after his comment about banks now overflowing with liquid assets:
Their problem remains insufficient capital. Just as in 2008, there is a deep reluctance to admit the extent of the undercapitalisation of the banking system in many parts of the industrialised world. The verdict of the market is clear – without central banks support banks still find it expensive to borrow.
What’s true of the banking system is no less true for the economy more generally. There’s way too much debt and not enough equity. Until that imbalance is dealt with (together with all the real world distortions it fostered) there’s no chance of organic growth, just the hyped up, artificial variant produced by great bouts of fiscal and monetary stimulus.
Central bankers are burdened with a kind of original sin. After all, without their unfailing support and encouragement (together with the very nature of the fiat fractional reserve banking systems over which they preside), the credit excesses of recent decades would have been quite impossible. Can any of them coolly and dispassionately disentangle and measure the system in which they’re so deeply embedded?
I don’t know, but it’s not hard to imagine King lying awake in the early hours of the morning.
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So what’s the endgame?
With overall debt levels rising (still), rates pinned to the floor and vast amounts of excess liquidity sloshing about (thank you Mervyn, Ben, Mario et al), a private sector busily trying to repair its collective balance sheet and economies everywhere in the doldrums because of massive imbalances, anyone who says they know the answer is dreaming.
What we can say is that policy is distinctly, perhaps even irretrievably, assymmetrical. Central bankers are conditioned to leap into action at the merest hint of renewed weakness, much less deflation. As with both fiscal and monetary stimulus in recent decades, the political incentives all run one way. In the absence of sustained, reassuring economic growth, it’s hard to see what might change this bias.
Right now, all the resulting excess liquidity is mostly languishing in reserves at various central banks, collecting a paltry return and seemingly doing no harm. There’s a bit of fresh lending going on here and there, but demand is low and the banks, generally, remain relatively cautious. Fact is, central bankers are tearing their hair out because of the financial system’s lack of responsiveness.
Careful what you wish for, perhaps? According to Ashwin Parameswaran, the market’s current willingness to hold unusually large quantities of money because of the crisis induced desire for safety and liquidity may not hold if “real rates turn significantly negative”:
Once real rates become sufficiently negative, credit growth explodes and the positive feedback loop of ever higher inflation fuelled not just by currency repudiation but by active exploitation of the banking and central bank discount window to access essentially free loans is set in motion. In other words, hyperinflation in modern capitalist economies is characterised not just by a collapse in the demand for deposits but an explosion in demand for loans at the free lunch level of nominal interest rates enforced by the central bank.
Whether these huge reserves might one day wreak unexpected havoc is something I’ve long wondered about too. What I hadn’t realised until I read Ashwin’s links was how critically important explosive private credit growth has often been in earlier hyperinflations.
It makes perfect sense, of course. Once the incentives are strong enough (and what could be stronger than seriously negative real rates?) the whole machinery of credit and money creation is unleashed. One shudders to think how silly things could get.
Could it really happen today, in the US, the UK, or Japan? Could central bankers miscalculate or lose control so badly as to set this particular doomsday machine in motion?
Cassandra though I often am in these matters, I struggle to see it. After all, there’s no shortage of historical horror stories at hand. Still, like armies, central bankers are inclined to fight the last war, and after the 1930s they’re understandably paranoid about letting debt deflation get the upper hand. As Bernanke said at a conference honouring Milton Friedman on his 90th birthday: “Regarding the great depression. You’re right, we [the Fed] did it. We’re very sorry. But thanks to you, we won’t do it again.”
So it’s not inconceivable. It just needs inflation to get away enough to generate juicy negative real rates. With so much dry tinder already around and central banks all leaning one way, that’s not inconceivable either. Remember too that while individual banks can get rid of reserves through making loans or purchasing investments, overall, banks can’t. What one loses, another gains. One can therefore imagine an accelerating rush by individual banks to deploy reserves, all of it, at a systemic level, entirely fruitless and on the other side newly hungry demand intent on exploiting negative real rates. While the notion of hyperinflation still seems . . . well, a bit hyper, it doesn’t strike me as an easy beast to rein in if it bolts.
To bring it under control, central banks would either have to vaporise sufficient reserves through sales from their portfolio to give banks pause, or, raise the rate they pay on reserves high enough to discourage the process. Neither seems attractive. Brave indeed would be the central banker who embarked on the former in these bone china delicate times. As for the latter, with reserves so high (and still growing) it sure wouldn’t be cheap.
Although everyone agrees that freedom is important, political freedoms are often prioritized over economic freedoms. Many believe that the best way to maximize personal freedom is to furnish each individual with an equal voice in the democratic decision-making process. After all, the logic goes, how can you be unhappy with a choice that you had a hand in making?
Professor Jason Brennan explains that an equal vote is not tantamount to personal freedom. In fact, he posits that many democratic outcomes are injurious to individual freedom. Unless it is limited by a constitution that protects certain rights, majority rule can make individual liberty all but illusionary. If we truly care about freedom, Professor Brennan argues, then individuals should be given the largest possible sphere of personal and economic autonomy. Only then will individuals be allowed to take full control by making choices about all facets of their lives – not simply which lever to pull on election day.
As Professor Brennan concludes, economic liberty is about much more than dollars and cents; it’s about allowing individuals to “lead the lives that they regard as authentically theirs.”
Those of us who believe liberty under the law is the best route to peace and prosperity owe a tremendous debt to everyone involved in the Learn Liberty project. If ever we are tempted to despair at the state of contemporary public debate, we need only remember that our generation is blessed with this fabulous communication mechanism, the Internet, and all the wonderful resources provided by fellow travellers who share our view that civilisation is best advanced by the voluntary cooperation of free people.
Steve Baker is Conservative MP for Wycombe and a co-founder of The Cobden Centre. He was previously an aerospace and software engineer. Among other things, he worked with major banks and regulators internationally. His personal and political website is at stevebaker.info. | Contact us
24 August 12 | Tags: Democracy, Economic Freedom, Video | Category: Politics | 2 comments
The gold standard has returned to mainstream US politics for the first time in 30 years, with a “gold commission” set to become part of official Republican party policy.
Drafts of the party platform, which it will adopt at a convention in Tampa Bay, Florida, next week, call for an audit of Federal Reserve monetary policy and a commission to look at restoring the link between the dollar and gold.
I wonder if Alan Greenspan will restate his commitment to the essay he never repudiated, Gold and Economic Freedom. As Greenspan pointed out, gold is inseparable from economic liberty and property rights. The question could quickly become whether the people of the United States and the world are ready for a a society with a just and moral base.
This is a question that was posted to me by a journalist who has read my book and is following this website. He suggested I make it into a blog.
This essay is not directly about the fiat money crisis so it might at first look a bit “off message”, but I guess for everyone who has read Paper Money Collapse and has been reading this website, the connections are obvious enough. This is a big, big topic, and probably too ambitious for any single essay. Although the following is fairly long even by the standards of my website, it still cannot be an exhaustive treatment. Many questions will be left unanswered and many objections – including many I already anticipate – will not be addressed. I hope the reader still finds it worth the effort.
For a long time I considered myself a classical liberal – as did Ludwig von Mises who inspired much of my work. I no longer think that this position is logically consistent. The classical liberal position, although advocating a much smaller state than today’s political consensus, still assigns too many powers to the state. Nevertheless, it offers a good starting point for the discussion. So let us start here.
Utilitarian arguments for the strictly limited state
The classical liberal position on the role of the state can approximately be described as follows: the state should stay completely out of the economy. There is no role for the state in industry, banking or money. Money is gold, or any other commodity chosen by the trading public. The supply of money is thus outside of political control, and banking and finance are entirely free market businesses with no state support, no guarantee nor any explicit or implicit backstops. (For an explanation of why such a system is not only possible but indeed more stable than our present system, and why it is even the only system that is compatible with the free market economy, please see my book Paper Money Collapse.)
Additionally, all means of production are privately owned and their use is directed by market prices, and by the opportunity for profit and the risk of loss. Profit and loss are essential tools for the consumers to direct the activities of private enterprise so that they conform as much as possible to the wishes of the buying public. The state is not involved in education, healthcare or old age provision or any other so-called social services. All these activities are organized privately for the simple reason that all these activities require the use of scarce resource, including labor, and any rational allocation of scarce resources requires market prices. Only on the basis of market prices is rational economic planning possible. Only market prices convey the urgency that the public assigns to the various competing ends to which resources can be put at each point in time. But market prices can only be determined if the resources are privately owned and traded on free markets. Private property is thus the essential tool for extensive social co-operation. Private property allows trade and the formation of market prices. This then allows the rational and efficient employment of these resources by entrepreneurs. The whole process is the only one logically possible to facilitate an extensive division of labor and the constant accumulation of capital employed in private enterprise, and it is the system of extensive division of labor and the constant accumulation of capital that makes our high living standards and any further advances in living standards possible.
Britain’s National Health Service will never deliver a satisfactory service. This is not because the people who work in it are incompetent or lazy. They could be the most motivated, devoted and well-meaning people on the planet and they could still only deliver suboptimal results and do so at considerable cost. Why? Because the NHS has to deliver health services for an entire nation without the help of true market prices and profit and loss accounting. These are the tools of capitalism that – day in and day out – allow the private sector to make informed decisions about best resource use – ‘informed’ because they reflect the preferences and wishes of the customers, the consumers.
Despite the widespread sentimental attachment to the NHS and its superficially appealing motto of delivering health care “free of charge” (obviously not true for the majority of citizens), the fundamental shortcomings of any service organized along socialist lines should be glaringly obvious to anyone. While the still fairly unrestricted private mobile phone industry in Britain delivers the latest advances in telecommunications technology to people across the entire social spectrum with remarkable speed and at constantly falling prices, the nationalized health service bureaucracy has people wait in line even for many routine and long-established procedures and provides such service at ever more staggering cost to the taxpayer.
That health service and education are too important to be left to the private market is a common prejudice that puts economic logic on its head. Because they are important they should be allowed to employ the tools of the private market.
But what does that mean for those who are too poor or for whatever reason unable to obtain the market income to afford themselves even a minimum of these services? – I am not going to evade that question. It is, of course, a standard response. I will come back to it a bit later.
What does the argument so far mean for the size and role of the state? – The state would, of course, be rather small by today’s standard. It would only have one function: to protect private property, which necessarily includes property in ourselves. The state’s role would be to protect every citizen and his or her property from aggression, whether that aggression comes from inside the country or outside the country. The state would be reduced to what the German social democrats of the late 19th century derogatorily but still accurately called the ‘night-watchman state’. The state would provide security services, including police, army, courts and related services. Its only function would be to provide security and protection. Those citizens who do not transgress against other peoples’ person or property or those who are not being transgressed against, would hardly ever come into contact with the state and its representatives. This would indeed be a minimal state.
Thus far, we have argued on the basis of utilitarian considerations. A prosperous society requires high degrees of division of labor and efficient resource use, which in turn require market prices, which in turn require private property. Under utilitarianism, private property is first and foremost a social convention, a means to an end. And the function of the state is to secure this means: private property, the existence of every individual’s inviolable private domain, as the basis for voluntary contractual cooperation and the spontaneous growth of society.
Ethical arguments for the strictly limited state
But such a minimal state can also be constructed on ethical grounds and considerations of justice. Every state is an institution that is based on compulsion and coercion. It can be seen as a depository of legalized, institutionalized and regulated force or threat of force. But what type of force is ethically defendable and could therefore provide an acceptable conceptual basis for institutionalized force? Only defensive or protective force fulfils that requirement.
To answer questions of ethics we need to start with the acting individual. In an otherwise peaceful, cooperative society, at what point am I justified to apply force or the threat of force when dealing with other people? Only if and when these people threaten my life, health or my property. This does not mean that any type of violent response is deemed justified in such situations, but it is clear that if force and violence can be justified at all, it must be in situations of self-defense, which include defense of property. If I am justified to defend myself from attack, I must also be allowed to defend those material goods that I have obtained through my work by applying my own body and mind. If this were not the case and if others were allowed to avail themselves of the fruits of my labor by simply taking them from me, it would mean they could live off my work and thus practically enslave me, which would be equivalent to an attack on my person.
By transferring the individual’s right to self-protection and self-defense of life and property to a specialized organization that fulfils the task of looking after these rights for all members of the community, no new special rights have come into existence. It is not claimed that the state has any rights or powers that the individual citizen does not have already. In fact, the state’s legalized force would have its origin in a concept of natural rights that originate with the individual citizen and that that citizen would have even in a stateless society (although in such a society he would have to enforce these rights himself or in voluntary cooperation with others). The state could perhaps be thought of as a pooling of these individual rights to allow for their more organized, standardized and thus more predictable safeguarding.
The utilitarian case against the welfare state
We can now turn to the question of provision for poor citizens or for those who for any reason are unable to adequately support themselves. While good arguments can be made that those in society who are better off have moral obligations to give support to weaker members of society, it is clear from the reasoning above that the state should not enforce such support. Again, the state is an organization that operates through compulsion and coercion. By assuming ‘social’ responsibilities the state must redistribute income and property on an ongoing basis by application of force or the threat of force, and must thus be permanently in violation of its original mission, which was to protect rightfully gained private property from violent interference, and thus support the institution of private property that we identified as absolutely essential for any functioning society. The state cannot simply add a redistribution function to its property protection function – the former must always violate the latter. Both functions stand in logical conflict. Either the state is a property-protector or a property-re-distributor and property–re-allocator. The state cannot be both at the same time.
In the original concept of the state as organized force for the purpose of security provision, a person who rightfully obtained property through production or voluntary exchange with other members of the community should be able to rely on the state to protect his ownership from any violation by a third party. But the moment the state assumes any responsibilities for ‘social justice’ or ‘distributive justice’, the state has to become a private property invader itself, and every person has to fear that parts of their income and property – although lawfully obtained – will be taken by the state by force and reallocated to other members of the community.
It is clear that under a state that assumes ‘social’ responsibilities, any right to private property is ultimately conditional. Rights to property are only protected by the state as long as the state does not consider third parties more in need and morally more worthy of ownership of the property. Every piece of property in such a society is therefore under a cloud of uncertainty, and this stands in direct conflict to the original mission of the state. The element of uncertainty is magnified by the fact that while it is possible to lay down clear and universal rules for how property can be rightfully and legally obtained, and to therefore give every member of society clear rules that are known before the act of what constitutes rightful and what constitutes unlawful attainment of property, any notion of what constitutes ‘distributive justice’ after the acts of production and trade must necessarily be arbitrary and subject to considerable change over time. It should not be surprising that all states have greatly expanded their range of redistributive policies and social legislation and regulation in recent decades. Once the state has taken it upon itself to pursue the logically non-definable goal of social equality or justice, it can ask for ever more wide-reaching powers. The idea of a minimal state has now become utterly unrealistic.
By contrast, any redistribution of property or income through acts of charity stands in no conflict to the institution of private property. The giver and the recipient of charity both know who the rightful owner of the property is. The recipient is aware that he is being supported by the generosity of others. The giver also retains control over who he wants to support and to what extent he wants to support that person. All of this changes when the state as monopolist of legal coercion becomes the middleman. The recipient no longer considers himself dependent on the economic success and charity of others but now has a legal claim on support from the state – receiving support becomes the person’s legally enforceable right. With at least a minimum of income now secured, the incentives to change one’s behaviour to regain economic independence are weakened. The original owner of property, meanwhile, no longer has control over where his money goes and will probably lose any interest in the plight of those who require support. By having been taxed by the state, he considers all duties to society’s weaker members fully discharged of.
The defenders of the welfare state will argue that it is more just to introduce an element of uncertainty into the lives of the economically independent than to keep society’s weakest members subject to the complete uncertainty that poverty and dependency on charity inevitably entail. While this is an appealing argument and probably a widely shared sentiment, it cannot dispel concerns over the fundamental conflict between securing private property on the one hand and persistently redistributing private property on the other. A welfare state is, fundamentally and conceptually, a persistent threat to the notion of private property, and private property is undeniably the economic foundation of any society. Additionally, any concept of ‘social justice’ is by definition arbitrary and will be the source of tremendous strife whenever it is supposed to guide practical politics. Furthermore, a state that concerns itself with the distribution of income and property among its citizens will never be a small state, or even a limited state.
The ethical case against the welfare state
The argument has so far been based on utilitarian considerations. But we can base it also on theories of ethics and justice. We have argued that a state that confines itself to the protection of person and property of its citizens against any unprovoked acts of aggression bases its right to legal force on the rights to such force by its individual members. The state assumes no privileged position but simply exercises the rights that the individual citizen already has but that the citizen may consider to be secured and enforced better through a state organization. This view, however, is no longer tenable when the state enforces redistribution of income and property.
While it is certainly within generally accepted principles of justice if I use proportional force to stop my neighbor from stealing or damaging my property or from inflicting injury on me or anybody in my family, it is certainly outside the established norms of justice if I decided to force my neighbor to support third parties, chosen by me, who I think are deserving of my neighbor’s support. By making ‘social justice’ its goal, the state claims a right to legal force that none of its citizens has. The state has now become a law upon itself, a ‘higher’ entity whose standards of right and wrong no longer correspond to those of its individual citizens. Any idea that the state could simply represent a convenient and efficient pooling of individual rights for the purpose of their better protection is now untenable. The state can do and does what nobody outside the state can do. The state qua state defines its own notions of morality and forces them upon its citizens.
We have now explained why any state that assumes larger responsibilities than the minimal state which confines itself to articulating, clarifying and enforcing the rights of its individual citizens to their own life and property must be in violation of its citizens’ rights to their own life and property and can no longer justify its existence on the basis of any ‘social contract’, for such a contract can only ever encompass the rights that individuals already have and which they may then voluntarily transfer to the state entity as part of entering such a contract. We have also seen that a state that gets involved in the distribution of income and property among its citizens must undermine the institution of private property, which is essential for human cooperation in a market economy and the basis of any prosperous society.
From classical liberalism to anarcho-libertarianism
While such a minimal state – a pure protector of life and property of its citizens, an enforcer of laws and a provider of courts to facilitate the resolution of conflicts and the further development of the laws – would be a much better guarantor of individual liberty and of peaceful cooperation than today’s heavily interventionist, constantly meddling and increasingly authoritarian state, and while most libertarians today would be happy to see a return to this classical liberal vision of the minimal state, even this concept is still flawed for as long as the organization that calls itself a state claims to have a territorial monopoly on providing protection and security services and a monopoly of ultimate decision making in its territory (this is in fact a very good definition of the state by Hans-Hermann Hoppe). If the state not only uses legal force to protect life and property of its citizens but if the state, as all states presently do, uses force to stop citizens from voluntarily exiting the state’s framework and establishing or joining different and competing arrangements on its territory, then we will have to also reject this minimal state on the basis of the analysis above.
First, again, are utilitarian considerations. Providing security services also necessitates the use of scarce resources. How many resources are to be allocated to providing security, which resources should be used and to what extent, are essential questions. Without private property, market prices and free entry into the market of security provision, the results will again be far from optimal. Even in the area of security provision, market-based solutions are undoubtedly superior. This important argument was first developed by the 19th century Belgian economist, Gustave de Molinari.
Second, we have considerations of ethics and justice. If the state claims to derive its legitimacy to use force from the individual citizen’s right to use force to defend his own life and property, this must mean that the individual’s rights are the origin of the state’s rights, and that the latter can never supercede the former. To put this differently, a state that claims a territorial monopoly on security provision and conflict resolution must argue that the individual who had the right to use force for defence of life and property in the first place has, by pooling these rights into a state-like organization, now forfeited these rights forever and is not to be permitted to reclaim these rights and enforce them by alternative means. This is logically an untenable position.
It seems fair to assume that law and security provision have a lot in common with money in that they, too, are subject to network effects. Just as the co-existence of many parallel monies is suboptimal, the co-existence of many different legal frameworks and security arrangements is inefficient. But none of this means that individuals have not the right to make alternative arrangements if they deem present arrangements to be insufficient or even a threat to their own life and property. We conclude that at a very minimum the minimal state must concede a universal and inviolable right of every individual or group of individuals to secede at any time.
A lot of what I argued above may appear to many like idle libertarian theorizing with little relevance to present political reality. But a crisis of the present state fiat money system is now inevitable. This crisis is part of a broader crisis of the welfare state and, in fact, of democracy. As these crises unfold, people will again revisit some fundamental questions about the size and role of the state and its relationship to the individual. Against this backdrop, discussions like this one could become very relevant indeed. As states everywhere go broke, as the promises of the cradle-to-grave welfare state are defaulted on, and as politicians lose control over their overstretched fiat money empires, citizens will again consider looking for and establishing more suitable and functioning alternatives to present state apparatuses.
I will finish this easy with a short extract from Lysander Spooner’s outstanding pamphlet No Treason, NO IIfrom 1867, in which he delivers a fascinating interpretation of the American constitution that is an excellent presentation of the points I was trying to make toward the end of the above essay. Here is Spooner:
The Constitution says:
‘We, the people of the United States, in order to form a more perfect union, establish justice, insure domestic tranquility, provide for the common defence, promote the general welfare, and secure the blessings of liberty to ourselves and our posterity, do ordain and establish this Constitution for the United States of America.’
The meaning of this is simply: We, the people of the United States, acting freely and voluntarily as individuals, consent and agree that we will cooperate with each other in sustaining such a government as is provided for in this Constitution.
The necessity for the consent of “the people” is implied in this declaration. The whole authority of the Constitution rests upon it. If they did not consent, it was of no validity. Of course it had no validity, except as between those who actually consented. No one’s consent could be presumed against him, without his actual consent being given, any more than in the case of any other contract to pay money, or render service. And to make it binding upon any one, his signature, or other positive evidence of consent, was as necessary as in the case of any other contract. If the instrument meant to say that any of “the people of the United States” would be bound by it, who did not consent, it was a usurpation and a lie. The most that can be inferred from the form, “We, the people,” is, that the instrument offered membership to all “the people of the United States;” leaving it for them to accept or refuse it, at their pleasure.
The agreement is a simple one, like any other agreement. It is the same as one that should say: We, the people of the town of A━━, agree to sustain a church, a school, a hospital, or a theatre, for ourselves and our children.
Such an agreement clearly could have no validity, except as between those who actually consented to it. If a portion only of “the people of the town of A━━,” should assent to this contract, and should then proceed to compel contributions of money or service from those who had not consented, they would be mere robbers; and would deserve to be treated as such.
Neither the conduct nor the rights of these signers would be improved at all by their saying to the dissenters: We offer you equal rights with ourselves, in the benefits of the church, school, hospital, or theatre, which we propose to establish, and equal voice in the control of it. It would be a sufficient answer for the others to say: We want no share in the benefits, and no voice in the control of your institution; and will do nothing to support it.
I was glad to see Cobden Partners’ Gordon Kerr on Bloomberg yesterday, explaining why the Greek bailout will fail:
As I wrote elsewhere, the western world may be in a second crisis of state socialism, a crisis of the welfare state. It appears that politicians’ excess spending pledges over what they could raise in taxation have been covered indirectly by chronic credit expansion since the end of Bretton Woods. As Hayek, Mises, Huerta de Soto and others have explained, that was bound to lead to a banking crisis.
If this thesis is essentially correct, it may be that Greece is simply in the vanguard of a pattern which we should expect elsewhere. That implies a need for everyone who cares about peace and prosperity to think fundamentally and without fear or favour about our plight. That’s why I am proud to be associated with both the Cobden Centre and Cobden Partners.
He said the FPC would also look out for dangerous linkages in the financial system and identify exotic new instruments that might undermine stability. It would be charged with containing credit booms as well as limiting the damage of “credit busts”.
There can, of course, be little doubt that, at the present time, a deflationary process is going on and that an indefinite continuation of that deflation would do inestimable harm. But this does not, by any means, necessarily mean that the deflation is the original cause of our difficulties or that we could overcome these difficulties by compensating for the deflationary tendencies, at present operative in our economic system, by forcing more money into circulation. There is no reason to assume that the crisis was started by a deliberate deflationary action on the part of the monetary authorities, or that the deflation itself is anything but a secondary phenomenon, a process induced by the maladjustments of industry left over from the boom. If, however, the deflation is not a cause but an effect of the unprofitableness of industry, then it is surely vain to hope that by reversing the deflationary process, we can regain lasting prosperity. Far from following a deflationary policy, central banks, particularly in the efforts than have ever been undertaken before to combat the depression by a policy of credit expansion—with the result that the depression has lasted longer and has become more severe than any preceding one.
After a number of interventions about the futile search for stability and the breach of the rule of law inherent in the proposals, I said,
I very much welcome the Bill, which I hope and believe will prove to be the zenith of contemporary thought on bank reform. With due deference to my right hon. Friend the Member for Hitchin and Harpenden (Mr Lilley), I wish to talk about three potential elephants in the room. First, I wish to make some remarks about accounting, then I wish to discuss the conduct of individuals and liability, and finally I wish to talk about financial stability.
I know that the Minister has heard my views on the international financial reporting standard, but I draw his attention to a letter in yesterday’s Financial Times by Lord Lawson, under the headline “Forget Fred and focus on the real banking scandal”. He stated:
“The auditing of banks’ accounts, however, is fundamentally flawed in itself. The IFRS accounting system itself has proved to be damagingly pro-cyclical, and the ability to pay genuine (and genuinely large) bonuses out of purely paper profits, which are never subsequently realised, is at the heart of both the bonuses that cause such public and political outrage, and the reason why bank management consistently does so well when bank shareholders do so badly.”
Andy Haldane, the executive director for financial stability at the Bank of England, gave a speech in December. I shall not read out all the remarks that I meant to cover, but he concluded by saying that
“if we are to restore investor faith in banking sector balance sheets, nothing less than a radical rethink may be required.”
He was referring, entirely, to accounting standards. I therefore refer the Government to my private Member’s Bill introduced on 13 May 2011, which seeks to introduce parallel prudent accounting for banks. It is a couple of pages long and I hope that it can be added to this Bill.
I also refer the Government to “The Law of Opposites”, a paper produced by the Adam Smith Institute and written by my colleague Gordon Kerr, who has spent 25 years “gaming accounting rules”, as he would perhaps say, in order to make a profit. The banking system is in a far worse state than is generally believed. I do not see how either the Financial Policy Committee or the prudential regulation authority can operate without a true and fair view of the state of financial institutions, and I do not believe for a moment that the international financial reporting standards give that to us.
On the conduct of individuals, we fail too often to think about the pattern of regulation in which we have engaged. It seems that the first thing that legislation does is to damage the incentives and disciplines of the market. Having thereby created moral hazard, regulators come along to try to mitigate the consequences of that moral hazard. A banking licence today is a licence to lend money into existence, at interest, with the risk socialised. When we look at central banking, deposit insurance and limited liability, we find that moral hazard is absolutely rife in the banking industry, even before we consider investment banking. I suggest to the Government that it is time to increase the liability of banks’ directors. There should be strict liability for them, and bonuses should be held in a pool and treated as capital for at least five years. I will introduce a private Member’s Bill to that effect on 29 February.
We have talked about financial stability and the difficulty of defining it. There has been a sense that there is some kind of equilibrium economy—an evenly rotating one—in which there could be a sustainable and stable quantity of credit. Indeed, on pages 14 to 16 of the Joint Committee’s report there is an interesting discussion about the need to regulate credit.
To leave time for my hon. Friend the Member for North East Somerset (Jacob Rees-Mogg), I will just say that if we were talking about any other commodity and were discussing adding to a failed regime of price control a regime of quantity control, we would certainly reject the idea out of hand. In Lord George’s testimony to the Treasury Committee before the crisis, he made it absolutely clear that the Bank of England had created a credit bubble to avoid falling into recession, yet we are going to give the Bank even more powers, more tools, [resulting in] more risk of ruin and more big-player effects and distortions of economic expectations.
I congratulate the Government on introducing the Bill, and I sincerely hope that it represents the absolute zenith of contemporary thinking on interventionist bank reform.
In the following video, my remarks begin at 21:31:
I should think society will learn, in the next few years, some important lessons about the use of arbitrary power by monetary and financial authorities. Hold tight.