Ask economists how much money there is and you will get many answers. You know money is what you can exchange for real goods and services, but economists often include things like time deposits, which cannot be spent because they have fixed terms. Money is one half of every transaction, so its supply really matters. According to my colleague Dr Anthony J Evans of Kaleidic Economics, the Bank of England’s preferred measures, “Narrow Money” and “Broad Money”, are either too narrow or too broad. From the perspective of the Austrian School of Economics, Anthony, together with entrepreneur Toby Baxendale, chairman of The Cobden Centre, has established and now publishes a different measure which they call “MA”. A chart (see above) of the growth of MA shows a pattern that is not visible in the Bank of England’s measures.
Given a good measure of the money supply, we shouldn’t be surprised that our economic and financial troubles continue.
I had the great pleasure last night of speaking to the Economic Research Council on the subject of Political Economy and the Crisis. I argued that:
Economics should become political economy, embracing the problem of knowledge in the social sciences, morality (think Adam Smith’s Theory of Moral Sentiments) and public choice theory, in particular.
Classical liberalism is the most robust political economy.
The Austrian School offers important insights, particularly into business cycles and capital theory.
The Austrian School predicted and intellectually survived the crisis.
That reality is, or should be, a challenge to the contemporary paradigm.
The implications for financial reform are profound.
We had a lively Q&A covering subjects from the Chinese socio-economic model to the residual role of the state. We agreed that we must not seek a rational reconstruction of society and we left outstanding the key challenge: to determine how to reform the financial system to deliver a free-market monetary regime.
My slides are available as a PDF here. For related reading, please see our primer and this article on the need for a paradigm shift in economics.
Let us establish some principles first. Central banks do indeed pose a risk to economic stability but not because their monetary policy is constantly too tight but because is it systematically too loose. Inflexible commodity money – such as gold and silver – has everywhere been replaced with state-issued fully flexible paper money under the control of central banks for one reason and one reason only: so that the supply of money can be constantly expanded in accordance with politically defined goals (such as a certain growth rate, a certain inflation rate, a certain unemployment rate….and constantly expanding bank balance sheets). Today’s consensus believes the following: When inflation is low and thus not an imminent threat, the central bank should ‘support’ economic growth via low interest rates and a moderate expansion of the money supply.
This is precisely the dangerous fallacy that made the dramatic events of the past four years ultimately inevitable. Yet, nobody seems willing to learn the lesson.
Constant expansion of the money supply and the persistent lowering of interest rates below the levels that would be justified by available savings – the raison d’etre of paper money and central banking – lead to misallocations of capital. Always. This – and not higher consumer price inflation – is the most immediate negative effect of monetary expansion. Today’s consensus is, sadly, still obsessed with CPI inflation (CPI= consumer price index). As long as monetary expansion doesn’t lead instantly to a higher grocery bill, the mainstream considers it a welcome boost to growth and practically a free lunch. This is a gross misconception, and this misconception is in essence still behind most of the commentary on monetary policy today. And it was again on display in the debate about the ECB’s recent move.
You can read Detlev’s superb article in full here but beware: he believes “that a collapse of the paper money system is practically inevitable”…
In the article, we argue that the collapse of the present banking orthodoxy is inevitable. So-called “quantitative easing”, plus the inflationary combination of central banking with fractional reserve deposit taking is unjust and we should insist that banks operate according to the same commercial principles as any other business.
TCC has had a great year and, last Thursday, we held our first Cobden Centre Christmas reception in celebration at the National Liberal Club.
In 2010, we have raised our profile and we are now well on our way to being the scholarly, effective and powerful educational charity that our founder and Chairman Toby Baxendale always intended. Today, we are increasingly respected by scholars, students and opinion formers alike.
Already, TCC teachings are starting to change the parameters of debate concerning money and banking.
Organisationally, it is a slick, professional and cutting edge organisation.
At the beginning of the year, the Chief Executive, Dr. Tim Evans, started to pull together a unique Network of Voices (Senior Fellows), a high quality Academic Advisory Council, and a small number of core staff.
With a web site initially developed by yours truly and, more recently, by Mark Goodhand, the organisation’s web content and visitor numbers have grown spectacularly over the course of the year, as you can see below :
In the Spring, the organisation held a colloquium, its first annual lecture and it launched its Education Network – the latter being made possible with the appointment of its Executive Director of the Education Network, Sam Bowman.
In the summer, the Chief Executive, Dr Tim Evans, launched TCC’s bi-monthly speaker dinners.
With my election to Parliament, the autumn saw the launch of an All Party Parliamentary Group on Economics, Money and Banking, not to mention a Private Members Bill concerned with bank reform, championed by my friend Douglas Carswell MP.
Throughout 2010, TCC Directors, Fellows and Supporters have spoken at many scholarly and educational meetings including Warwick University, Cambridge University, Oxford University, London University, a Conservative Party Conference Fringe Meeting and countless others.
Today, the organisation has a database with many, many hundreds of people on it.
It uses Facebook, Twitter and other social media platforms to multiply its impact.
And through use of videos and the recent launch of Cobden Centre Radio – ably overseen by Andy Duncan and Brian Micklethwait – the TCC is also becoming a past master at on-line outreach and communications.
Finally, in recent times all of this has started to bear fruit in terms of the organisation’s broader media successes.
Having been recently promoted in newspapers such as the Daily Telegraph, the Wall Street Journal and across a host of blogs and other web sites, we end this year not only established with a good reputation and visibility, but with a firm foundation upon which to prioritise a step change in our fundraising during 2011.
The Cobden Centre is now an active presence in the world of ideas and practical action and we look forward to the years ahead.
On Saturday, I spoke again to set out the scale and scope of our financial and monetary mess and again, the audience welcomed the presentation. I find this encouraging: while people are typically horrified by the true levels of debt and debasement that have been entered into by states on our behalf, generally, people are prepared to believe that reform is possible.
I was put very much in mind of two attitudes.
As Sean Corrigan has indicated, Bagehot’s classic treatise is not so much a defence of British monetary orthodoxy as a despairing attempt to show how to survive the banking crises which are inevitable under such a system. As Bagehot wrote:
I can only reply that I propose to retain this system because I am quite sure that it is of no manner of use proposing to alter it. [...]
We must therefore, I think, have recourse to feeble and humble palliatives such as I have suggested. [...]
Many will object that it is impossible to bring about such a return [to a universal respect for property rights], now that we have progressed so far on the way toward a global paper money. This is a thoroughly defeatist point of view because it takes the coming disaster (hyperinflation or global tyranny) for granted. Most importantly, however, it is morally wrong. As we have argued, we face a problem of the human will; but this is after all only a problem of the will.
Now, I suppose a thoughtful person might question whether Hülsmann is engaging in hyperbole with his reference to “the coming disaster”. It seems a very reasonable question and, though I don’t propose to begin answering it here, I reflect on the trouble faced, not just by the UK, but by the Eurozone and the USA and also on the actions of their Central Banks, treasuries and legislatures: a broader range of predictions than we are accustomed to has become credible.
Denying the facts of our predicament will not do, but nor will a hopeless despair. The central, optimistic path is serious bank reform working towards honest money. As I reflect on responses to my speeches, from students, Conservatives, businessmen and others, and as I consider the increasing success of grassroots campaigns like Positive Money, I am increasingly persuaded both that Hülsmann is right to reject defeatism and that there are good reasons to believe that the will to deliver worthwhile reform may yet emerge.
You can find Andy Duncan’s review of Hülsmann here.
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.
“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.
Today, Cobden Centre comrades and I are off to inject some Austrianism into the Positive Money conference. As you can tell from the Cobden Centre’s literature page, we are not afraid to work with other schools of thought — there are significant areas of overlap.
Does the fundamental design of the banking system automatically lead to an unstable, unproductive, unfair and unsustainable economy and society? If the answer is yes, then should we take the opportunity to truly fix the problem now, or simply make superficial changes and start saving up for the next bailout?
This is, of course, very much where I am coming from. However, there is a hint of anti-capitalism about the conference page, something which I hope to contribute to overturning.
The fundamental problem is, after all, the state: state monopoly, state planning, legal privilege, the socialisation of risk and the privatisation of profit. What is wrong is that we have the appearance of capitalism without the correct institutional architecture.