Rooting out the cause of crises.
Dr Alexander Moseley

The quirkiness of personality and character of our pundits and politicians notwithstanding, an economic crisis brings out the deepest political and economic philosophies residing in the intellectual population. It is as if all the decks are cleared and the most profound visions of authors and pundits surface with an emotional resilience that comes with apparent understanding, when the daily news responds with a great affirmation to one’s prejudices or theories. Yet it is at such moments, when all is bared as it were, that we should be on guard for pernicious economically and politically destructive theses: we always have much to learn from the historical particulars of course, but we also have to ready our defences against those who would wish to take much away from us and whose economic reasoning is often shallow, reactionary, contradictory, or plainly ignorant and whose policy prescriptions would bring forth more hell.
In the minds of most, the banking system’s failures are either frighteningly spontaneous or caused by a failure of government to supervise or regulate properly – both notions however are painfully inadequate and facile. Behind the crisis is not a failure in economic theory nor a failure of the market system – the theory as to why there exist business cycles has been around for decades, but few care to explore it.
            For the most part, the economics world has bifurcated between those who would resuscitate John Maynard Keynes and the policy of stimulating aggregate demand, and those who maintain that the Monetarist thesis of Milton Friedman and the Chicago School remains intact despite the current credit crisis and who in turn would call for a stimulation of the money supply. Both schools include theorists whose thinking divide the economy Cartesian fashion into “real” and “nominal” economies, and who include sectors such as manufacturing in the first and stock markets in the second. Such thinkers become worried when “the crisis spreads to the real economy,” which leaves us wondering how stocks, investments, and even house prices may be said to be “unreal.” A few dissenting voices point to the similarities between the two schools and who reject the dualism of those who believe that the money supply has no effect on the productive capacities of the markets and who propose more radical solutions such as abandoning the market system altogether or abandoning government intervention.
On the other hand, the political world has seemingly shattered less evenly – there are those who wish to protect the nation’s interests at all costs and to look suspiciously upon international trade and banking as having fostered the problems that we are now or soon will be suffering. On the ostensibly opposing side are those who want greater international ties and the formation of increasingly co-operative or internationally managed banks and corporations, some of whom mutter about the need for a New World Order or proclaim a Wilsonian need to change the world to make it safer for banking. Across the political spectrum, each pundit presents his or her plan of salvation: the banks need more regulation, we need a new Bretton Woods scheme, we should have joined the Euro, we should have got out of the EU, we should leave the banks alone, we should nationalise the banks, we should…we should…Listen to me! Behind every plan uttered, there is an idiosyncratic vision of “how the world should really be run” – i.e. the speaker’s. Nationalists and internationalists, monetarists and Keynesians, all agree however, on using government as a means to secure an economically more stable present and future.
Such voices are not new – they were there in the much referred to Great Depression and they are always there in times of political and economic crisis. At the root, all such philosophies, or voices supporting intervention in some guise or other, assume a statism, a theory that asserts the primacy of the state in all affairs, especially when it comes to a crisis. Looking upon, or “up to” as statists would prefer, government for the panacea has become so embedded in our culture that most media commentators merely bleat the need for government “to do something” – and accordingly, the white knights, the seventh cavalry, the emergency responders, Gordon’s Brownies, or whatever you will, delightedly take up the offer to stick their hands into the mess and form interventionist programmes. One may note in passing that such a disposition is inevitable after a century of state education and welfarism that has formed a convenient dependency culture for those who seek to employ the vast powers now held by governments.
Statism necessarily involves aggregating more power in the hands of the institutions and people. Yet it is precisely Statism that is behind the crises that plague our economies. But to understand in the present context why those voices should be countered both in the name of political freedom and economic sanity, some economic theory is required to grasp the economic mechanism that feeds the roots of statism and its empire of laws and wars.
The modern state relies upon the institution of Central Banking. In its modern guise, this was created with the formation of the Bank of England in 1694 to provide the cash strapped government desirous of fighting wars with the French that no-one was keen to subscribe to (tax revenues had fallen to half what Parliament had offered to find for William III). Financier William Patterson presented a scheme of providing £1.2 million to the government in newly printed bank notes in return for a range of monopolistic privileges and repayment in hard cash. He only managed to raise £72,000, so a credit bubble was created through what C.H. Carroll writing in 1859 called “the organisation of government debt into currency.” By 1696, the Bank was in jeopardy – effectively it was bankrupt, for it did not possess the hard currency that its notes purportedly promised, and as the worthless paper returned to the counter for exchange into gold or silver traders discovered the con. Such scams were not new – they go right back in history to the Egyptians, Greeks, and Romans, as the economist Jesús Huerta de Soto recounts in his Money, Bank Credit, and Economic Cycles (2006). Rather than wrap the scheme up as ill-advised, fraudulent, and economically dangerous (for the rising prices created by the circulation of the fiduciary notes acted as a tax on the people), the Bank’s Act was renewed and further privileges allotted. There ensued the almost decennial rhythmic crises from the South Sea Bubble to the more prosaically titled Credit Crunch. Indeed, the rhythms excited statisticians who sadly thought there was something in the nature of the ten year cycles, such as Jevons and his sun spot theory. Alas, the data did not fit precisely and could not explain the enormous malinvestment that accompanied the boom-bust cycle.
Apologists for Central Banking, such as the previous governor, Charles Goodhart writing in 1988, have argued that they would naturally emerge, But there is no evidence to support this thesis whatsoever as a review of the required supportive interventionist legislation or a quick reflection upon an equivalent scheme elucidates. Consider a Food System: a Central Food Act creates a Central Food Distributor that promises to provide the large Food Suppliers as well as Small Intermediaries with 1.2 million tons of food for the forthcoming year, but farmers only produce 0.072 million tons. The disparity is obvious and famine imminent; it is on all accounts indefensible both morally and economically. Yet today so many voices accept the equivalent Banking System and our elected representatives around the world are acting to increase its promises, i.e. print more notes to “inject liquidity” to secure stability, a proposal as fantastical as Robert Mugabe promising more food while hounding farmers out of business and destroying the economy through hyperinflation.
The modern Banking System is a scam: it is taught to undergraduates as if it were the only method of doing banking and accordingly the fiduciary system is implicatively accepted as a given. Yet banking proper, like food production, is nothing like the fractional reserve system that creates tottering pyramids of empty promises. In investment banking, customers lend bankers £100, who then lend out all or a proportion of that money into more profitable ventures to earn themselves and their clients a return. No economic problem is forthcoming as the money supply is not affected. But in the creation of a Central Bank and its concomitant system of commercial banks operating on a fractional reserve basis, the money supply increases by a multiple of the original liquidity injection and interest rates correspondingly fall as more funds are made available; accordingly, investments are attracted, as Knut Wicksell, Ludwig Mises, and Friedrich Hayek explained many years ago, to interest rate sensitive markets such as the stock and housing markets. A future crisis is thereby created – it cannot be managed nor avoided, it can only be ameliorated by raising the fractional reserve ratios (to a moral 100% would be the ideal!). Pumping more into the system only exacerbates and prolongs the crisis needlessly. Magnify this globally, and one recoils from the contrived disasters from Third World Debt Crises to Credit Crunches.
Concern over politicians taking over the banks, while commendable and rightly noted for the implications of socialism through the back door, is nonetheless a red-herring, for the banking system as it stands is already a government created and managed system. Fractional reserve wholesaling could not exist for five minutes in any other industry for the blatant deception would soon be noted. But the system is highly lucrative to government and the banks: they alone are permitted to create money out of nothing and then charge clients hard cash for the privilege of borrowing worthless currency.
In the surreal context that we find ourselves, which is verifiable to the reader in any study of monetary economics, the economic prescriptions presently abounding appear suitably ludicrous. Monetarists and Keynesians both accept Central Banking and therefore quibble over how best to manage the scam – with market leaning economists preferring the banks to be allowed the freedom to choose between borrowers with the Central Banks acting “more prudentially,” while the socialist leaning economists preferring the politicians to choose; in academia, Marxists proudly refer back to Marx’s views on the inevitability of capitalist crises and gloat over the world’s financial woes as evidence of the forthcoming and oft postponed revolution; and inflationists of all political hues (i.e. those in debt) wish the Central Banks to continue their expansion of the money supply so as they may pay off their debts in a cheapened currency.
Few reject the very system that has created the crisis. The Austrian School of Economists (now spread around the world), has provided a cogent theory on banking crises for a century, yet the mainstream press assiduously ignore their theory that the cause may be within the system itself and so evade any consideration of a brutal reform – of abolishing the Bank of England and the Federal Reserve System and the cohort of Central Banks around the world, the very institutions that sometimes act concertedly and at other times not to foment economic disasters and then shrug in (feigned?) amazement when banks and markets collapse.
And so, the great and not-so great Plans are ushered forth by one and all in a vast array of proposals to tinker, empower, regulate, bash, license, co-operate, thump, nationalise, destroy, dismantle, cajole and so on. All such Plans presume that government is the means of our salvation, which is of course how ministers and administrators would prefer us to think. But when challenged, all fail – theoretically and historically. Liberty, we must remind ourselves, is lost when we hand more power to the state and crises are made into disasters when we allow governments to “manage” or to “plan” the economy. What else does history teach us? Economies are similarly ruined when we entrust politicians to play with economic variables – most precariously the currency.
The explanation as to our present woes is available and its logic impeccable; yet sometimes, reading articles, I wonder whether media commentators prefer having these crises to give them something  to write about rather than to research beyond other people’s headlines to investigate economic theory properly. Surely though, uncovering the greatest scam in modern history is a noble cause?