The world is facing the worst financial crisis since at least the 1930s, “if not ever,” the governor of the Bank of England said last week, when he explained to an increasingly sceptical and weary public the bank’s decision to print yet more fiat money and use it to buy yet more government bonds. I doubt that his words or his actions will do much to restore confidence. And they will not mean an end to this crisis.
What type of crisis is this?
This is a financial crisis, for sure. Its root causes are firmly located in money, credit, debt and banking. And I don’t think that the governor was exaggerating when he speculated about its magnitude. This is the Big One.
As we all agree that this is not just another business cycle, the question is what are we dealing with here? How should we define this crisis, and in what context can it best be understood?
This crisis is systemic, not cyclical. It is a crisis of institutions. It is a crisis of policy. It is a crisis of our financial architecture.
When this crisis started in 2007 and intensified throughout 2008, it was often labelled a “crisis of capitalism.” You don’t hear that so often anymore. Granted, there are still the occasional lapses, sadly, even by economists, but the longer the crisis goes on and the longer the spotlight remains on money and banking, the more it dawns on the public just how much the present financial architecture is evidently defined not by the “invisible hand” of the market, but by the controlling hand of the state.
When yet another round of bank “recapitalization” is announced (presumably, at taxpayers’ expense and, thus, driving home the point, once more, that the banks are above the fray of normal and fallible capitalist enterprise)…
…And when the salvation for our debt-laden economy is declared for the umpteenth time to be sought in yet more debt-funded government spending, or in yet another injection of more money created under state monopoly by the central bank and handed to the public as an apparent incentive to take on yet more debt, the public is beginning to wonder if policymakers have not lost the plot, and if we should not fear the “stimulus” more than the unchecked market.
Why are we in this mess?
“Undercapitalized banks” is code for banks that lent too much. How can banks have lent too much – and, obviously, have done so for years, decades even, and have done so the world over in the most enduring and persistent credit binge in history – when they are all under the control of the state central bank, which, in a paper money system, has the monopoly of printing (unlimited) bank reserves and administratively setting short-term interest rates and, thus, controlling lending conditions? Is this not properly called state failure, rather than market failure?
Please remember, the switch from apolitical, inflexible and hard commodity money to limitless paper money under state control was a political decision, not the result of market forces.
And it only came into full bloom with the closing of the gold window by the politician Richard Nixon in 1971. Our financial system is the outcome of political design and popular macroeconomic theory. Both have now revealed to have been self-serving and flawed, not the result of spontaneous human cooperation on markets.
The move to fully elastic fiat money freed both the state and its proteges, the banks, from the golden fetters of inelastic commodity money. Without the straightjacket of a gold standard, the state obtained unrestricted control over the printing press and could engage in “managing” the economy, saving the banks, avoiding or shortening recessions and determining borrowing conditions – and setting them more generously, not least for itself.
After 40 years of government-controlled money, this is the result.
This crisis is the inevitable outcome of the dangerous belief that low interest rates, and investment and lasting prosperity, can be had via the shortcut of money printing – and its twin sisters, artificially low lending rates and never-ending bank credit creation – rather than the time-honoured hard way (and capitalist way) of saving and true capital formation.
This is not a crisis of capitalism. My good friend Brian Micklethwait coined a much better phrase for it: This is the second crisis of socialism. We are witnessing the demise of the paper money standard. 40 years after the global fiat money system was freed of its last link to gold, money everywhere became simply an unchecked territorial monopoly of the state. What we are now finding out is this: The state and the banks need a straightjacket, or they will sooner or later drag us all into a black hole.
Why is this system socialist?There are two ways in which a monetary system can be organized: Either the market chooses what is money, or the state does.
The money of the free market, of capitalism, has always been commodity money that is outside of political control. Wherever the trading public was free to choose, it picked commodities of fairly inelastic supply as monetary assets. Almost all societies, throughout all cultures and civilizations, have come to use precious metals as money.
Commodity money is apolitical money. Nobody can create it at will and use it to fund himself or to manipulate the economy. Crucially, human cooperation via trade does not stop at political borders, and commodity money has always transcended such borders. If gold was money this side of the border, it was usually equally money on the other side, regardless of whose image was printed on it:
By contrast, complete paper money systems that have no link to an underlying commodity are always creations of politics. In such systems, money can be “printed” at essentially no cost and, thus, practically without limit. But not by everybody. Money printing is the privilege of the state and its central bank. Money, in this system, is entirely elastic. But it is political money and closely linked to political authority.
In a paper money world, if you cross a political border you have to swap your money for different money. All the efficiency of today’s 24-hours-a-day, multi-trillion-dollar foreign exchange market, which so easily impresses the untrained observer to whom it may epitomize global capitalism itself, is nothing but the market’s attempt to cope as best as possible with the inefficiency of monetary nationalism and monetary segregation that is the result of every national government wanting its own paper money under its own territorial political control.
To call this system capitalist means depriving the word “capitalism” of its meaning.
In this brave new system of fully elastic fiat money, we put our financial affairs not in the hands of the unfettered market, but in the hands of the state, of politicians and central bankers. This system is properly called a socialist one, not a capitalist one. And this system has failed.
Who are the beneficiaries?
For decades, this system has benefited the state, the banks, the wider financial industry – all of which have grown relative to any other section of society – and those who have assets to be used as collateral for leveraging the balance sheet: real estate, equity portfolios, company stock options. The costs of this system have been spread across the broader public via inflation and the occasional taxpayer bailout. This has been socialism for the rich.
Just like the first crisis of socialism – the collapse of the planned economies under Soviet guidance in 1989 – this crisis, the crisis of government-controlled finance, will also see the overthrow of the present establishment. Although the party leadership is still telling us that they have things under control: Fear not, comrades, with some deficit spending and some astute money printing, tractor production will soon reach targets again.
And just like the collapsing socialist state, the state-paper-money bureaucracy, too, has its true believers. People like Adam Posen, the Bank of England’s quantitative easing enthusiast, who maintains his childlike optimism for and unwavering faith in the power of the printing press. If Â£200 billion of newly printed money, cleverly placed by the apparatchiks into the coffers of the banks and government, have not solved the crisis, surely, the next Â£75 billion will. And why stop here? With another Â£175 billion or Â£275 billion or Â£375 billion, everybody in the U.K. should find a nicely paying job again. To people like Posen, the problem with the planned economy is not that it is planned, but that the plan wasn’t bold enough.
Mervyn King, on the other hand, strikes me as a more Gorbachev-like figure, not a nonbeliever, but too sceptical and too smart to be a fully signed-up party member. There is a fascinating interview with him from September of last year that got little attention in financial market circles, presumably, because it was part of a BBC history program on Chinese paper money, rather than on today’s monetary policy. The question asked was this: Are all paper money systems doomed to fail? King answers: No, he thinks, not all of them (although every single one has indeed failed), but he admits that the recent crisis has made him a bit more cautious in his assessment. Maybe the jury on whether paper money could be made to work at all was still out. Remarkable for a central banker, I thought.Regards,
Detlev S. Schlichter (Hampstead, UK) is a writer and Austrian School Economist. Schlichter has a degree in economics and spent nearly 20 years working in international finance, including stints at Merrill Lynch and JP Morgan. He served as a portfolio manager of fixed income portfolios at J.P. Morgan Investment Management and, in 1996, moved to London to work in the global bond team of the company there. In his career, Schlichter has overseen billions in assets for institutional clients around the globe.