Two defences of the penalization of prudence, as a response to the current economic circumstances, have been published in the last couple of days. First, Martin Wolf lampooned the “austerian” argument that “you can’t cut debt by borrowing”. No surprise there. Then Charles Bean, Deputy Governor of the Bank of England, told savers to “stop moaning and start spending“, as the Daily Telegraph paraphrased his comments. Low rates, he argued, were part of the essential strategy to “return the economy to a reasonable level of activity as quickly as possible”.
“Austerians” can deal with these arguments easily within their own circles by reference to Austrian theories of the business cycle, capital, interest, etc. But The Cobden Centre does not exist merely to preach to the converted. We ought to recognise the attraction to many (probably the indebted majority) of the apparently easy escape offered by people like Wolf and Bean, and the comparative repugnance to those people of an argument that the “good times” were an illusion, and the “bad times” are a necessary correction.
I have been struggling to find an explanation that might be comprehensible to people of the opposite view, why exceptionally-low interest rates created by manipulation of monetary policy by governments and central banks are neither natural nor beneficial. I don’t suppose the following will convince many, as so many people’s attitudes are conditioned by their perception of the interests of those they care about (particularly themselves) and less by a rational assessment. But perhaps it might swing one or two.
Forget money. Money isn’t the key to wealth or welfare. Harnessing our resources as efficiently as possible to maximise our quality of life is the key to wealth and welfare. (Let’s put aside the welfare arguments about interpersonal comparisons and aggregation of utility for one second, and accept that the previous sentence is intuitively reasonable as a broad rule for most people, and defensible to a limited extent on the basis of Pareto optimality in the way that Rothbard suggested)
Increases in wealth and welfare are not independent of our human choices, but fundamentally dependent on them. We can easily destroy wealth and reduce our welfare through our choices. If I burn down your house and you burn down mine in response, there has been an absolute net loss of wealth and welfare. War is a wealth- and welfare-destroyer on a grand scale, and no amount of economic activity from the production of the tools used to kill and destroy can ever tip the welfare scales against the weight of death and destruction. It may be defensible as a necessary evil, but never as an economic benefit.
Wealth can also be destroyed and welfare reduced by more subtle means than overt destruction. If we consume goods that are important to our quality of life, without making provision for their continued availability in the future (or the availability of some equivalent), we have destroyed wealth and reduced our welfare in the long-term; for instance, if we consume our seed corn in anything other than the most desperate circumstances. Or, as Mises put it in Human Action,
It may sometimes be expedient for a man to heat the stove with his furniture. But if he does, he should know what the remoter effects will be. He should not delude himself by believing that he has discovered a wonderful new method of heating his premises.
Conversely, human choices can create wealth and increase welfare. If I am a painter and my neighbour is a plumber, and instead of burning down each other’s houses, we decide to employ each other for our specialisms rather than doing the work badly ourselves, we achieve a better outcome more efficiently than through self-sufficiency, and thereby have more time and resources for things we enjoy. We have chosen to increase rather than reduce wealth and welfare.
But it is unlikely that all my plumbing needs will coincide (in timing and value) with my neighbour’s painting needs. We need a store and measure of value that enables us to purchase each other’s services when needed, and in more granular and comparable units than bartered goods or services. Hence money.
And although I know that sooner or later I will need some plumbing services, and my neighbour knows he will need some painting services, neither of us knows when, so we have to make sure we are putting enough away to be able to purchase necessities when required, preferably with reference to the ageing of our pipes and decor and the increasing likelihood that purchases will be required, plus some allowance for risk. Hence capital.
Everyone benefits from having a little money and capital, and from having a fundamental understanding of the concepts (sadly rare nowadays). But it is no more necessary or likely that everyone has an equal understanding and skill at handling money and managing capital than that they have equal understanding and skill at painting or plumbing. Allocation and growth of capital is as much a specialist skill as any other, and society benefits as much, under the division of labour, from specialists focusing on that skill as on any other.
But how do we know who the best-equipped specialists are, and ensure that they take the lead in their field? Good painters and plumbers get more jobs at higher rates, and are thereby encouraged to stay in the business and expand their activities. Bad painters and plumbers eventually run out of work that pays enough to bother, and have to switch to something they are better at.
It is the same for capital-allocators, or entrepreneurs. Profit (built up into investment capital) is the evidence that they are good at it, the reward/incentive to focus on capital-allocation, and the means to do so. Losses (and accumulated debt) are the evidence that someone is not good at marshalling resources to make more than the sum of their parts.
We do not say that we should redistribute the means to paint and the available painting work from those who are good at painting to those who are bad at it. In fact, we don’t say that for any skill, except the skill that is most important to the increase of our welfare: the allocation of capital to achieve the most efficient improvement in our quality of life.
It is no disparagement or deprivation to recognise that some people are not good at allocating capital. If they have other skills, they can charge for those, and probably earn more by focusing on what they are good at than if they were distracted half the time, trying to cope with something they are not good at. They can take payment from an entrepreneur who knows how to maximise their value and minimise their costs better than they do themselves. That is a symbiotic arrangement to be proud of, not ashamed. It is a voluntary and equal arrangement of mutual interest. The entrepreneur is probably a lousy painter, but it isn’t considered demeaning to him that his colleagues will try to keep the paintbrush out of his hand as much as possible and keep him focused on the thing he is good at. But for some reason, the reverse is considered a power imbalance and a social injustice.
That is why it is so important that investment be based on real profits and savings. It ensures that the people making the investments are the people best-equipped to judge which investments are the most effective deployment of capital.
And that is why using monetary policy to discourage saving and encourage consumption is so harmful. It ensures that choices on spending are being made too much by those whose judgement has proved poor, and too little by those whose judgement has proved good. And it distorts the relative values of the different things on which they could spend their money. Consequently, we get more ill-judged spending and less well-judged spending than we would without the policy distortion. More ill-judged spending and less well-judged spending results in destruction of capital and a reduction in the wealth and welfare of society as a whole, to everyone’s detriment in the long-run.
Besides giving debtors an unhealthy ongoing responsibility for spending decisions, soft monetary policy relies on two other groups to substitute for savers and entrepreneurs on spending decisions: politicians and bankers. That, of course, suits politicians and bankers very well. But it is less good for society at large.
Politicians have rarely, in their path to power, demonstrated much skill in the allocation of capital. Indeed, for many of them, politics is a way of getting to play with other people’s money on a scale that they could never have earned by their own efforts, by demonstrating very different (almost diametrically opposite) skills to those required for the allocation of capital. Not surprisingly, managed by people like that, government almost always runs at a loss. The more government runs, the more significant are those losses to the welfare of society as a whole. The projects that politicians choose to encourage are usually those that are operating least successfully – almost by definition, as most cries for political help come from failing businesses, and politicians get more political reward for helping organisations that “need” help than those that don’t.
Modern bankers have demonstrated repeatedly how few of them are heirs to the traditional banker, whose role was precisely the judicious allocation of the capital of his savers, through a deep understanding of the claims of entrepreneurs, who would vie to invest those savings and grow the capital for everyone’s benefit. That sort of banker has been eliminated from the institutional structure of most modern banks. He has been replaced by (a) a large majority of modestly-paid employees who are hidebound by rules, unauthorised to apply judgement, and free to lend only against those sorts of unproductive assets (e.g. property) whose assessment requires little understanding and experience, and (b) a small minority of excessively-remunerated gamblers. If only by their attitude to remuneration, these gamblers show themselves unfit to allocate capital, as they are so keen to consume rather than invest such a large part of their bank’s resources. They expect returns so quick and persistently accelerating that they could rarely be the product of genuine investment that creates genuine wealth. Their rewards stem mostly from their privileged positions as partners and agents of governments’ soft-money policies. And, despite their privilege, they prove remarkably adept (with their political friends) at destroying capital by blowing bubbles and failing to predict the inevitable bust. Hardly the best evidence of good judgement in the allocation of capital.
These are the only two options. Either, through soft-money policy, you penalize the prudent and reward the profligate, and put the responsibility for the growth of our wealth and welfare in the hands of debtors, gamblers, politicians and their clients in failing organisations. Or, through hard-money policy, you ensure that the people who get to make the decisions on capital allocation are the people who have proved themselves best at allocating that capital in the past. Despite the harsh consequences for over-extended debtors, the choice should not be difficult. Yet, probably because of a misunderstanding of the nature of wealth and capital that fosters an irrational jealousy, too many people continue to cling to the wealth-consuming option.