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[This talk was
first given at the SIX Swiss Exchange Bond Event, 2010.]
Henry Ford is
alleged to have said that "it is well enough that people of the nation do
not understand our banking and monetary system, for if they did, I believe
there would be a revolution before tomorrow morning."
The spirit of his
words encourages us to put forward questions about the banking and monetary
system — especially in view of the international credit-market crisis.
Is it a good thing that central banks have cut interest rates essentially to
zero and have increased the base-money supply dramatically to support the
financial sector? Will depression be prevented if governments underwrite
banks' balance sheets and run up huge deficits in an attempt to strengthen
production and employment?
To answer these
questions, a diagnosis of the root cause of the debacle is indispensible, and
once the root cause has been identified, a proper remedy can be formulated.
The diagnosis
provided by the Austrian School of economics can be distilled into one
sentence: governments have caused the monetary and economic debacle by taking
control of money production.
Money and Credit
To explain this
one-sentence conclusion — which may of course be surprising or even
irritating to many — it must be noted that the defining characteristic
of today's monetary systems is that state-controlled central banks hold the
monopoly over the money supply. The US dollar, euro, Japanese yen, British
pound, and the Swiss franc share the essential feature of being currencies
produced by governments.
What is more,
these monies are produced through circulation-credit expansion — credit
that is not backed by real savings. One can even say that today's monies are
produced out of thin air. These monies are often called fiat money:
they are established by government decree, not legally convertible to any
other thing, and created by political expediency.
Fiat money
regimes create economic disequilibria, and do so inevitably. This is because
the rise in circulation credit lowers market interest rates below their
natural levels — that is, the levels that would have otherwise
prevailed, had the credit supply not been artificially increased.
The
downward-manipulated interest rate induces additional investment and, at the
same time, provokes a rise in consumption out of current income, at the
expense of savings. Monetary demand outstrips the economy's resource
capacity. A rising money supply pushes up prices sooner or later, be it the
prices for consumer goods or for assets.
What is more, the
artificially suppressed interest rate shifts scarce resources increasingly
into more time-consuming production processes for capital goods — at
the expense of production processes for consumer goods, causing intertemporal distortions of the economy's production
structure.
"Under privatized money production, the government and its
central bank would be closed down and lose control over money
production."
A
circulation-credit-driven boom is economically unsustainable and must be
followed by bust. If the injection of additional credit and money out of thin
air was a one-off affair, it presumably wouldn't take long for the artificial
boom to unwind. A recession would restore the economy back to equilibrium.
Unfortunately,
however, the increase in credit and money out of thin air is not a
one-off affair under today's monetary systems. As soon as recession
approaches public opinion calls for countermeasures, and central bankers
increase the credit-and-money supply even further, thereby bringing interest
rates to even-lower levels. In other words, monetary policy fights the
correction of the debacle by taking recourse to the very action that has caused
the debacle in the first place.
Such a strategy
may work occasionally. But as soon as credit expansion comes to a halt
— that is, when commercial banks refrain from lending altogether
— the inevitable adjustment will unfold. Borrowers will default, and
firms will liquidate unsound investments and cut down jobs.
The longer an
artificial boom is kept going, the greater the malinvestments
are that have to be corrected, and the higher will be output and employment
losses.
Mises knew that pushing
down interest rates to ever-lower levels would not solve the problem but
would lead to an even-bigger disaster. He wrote,
There is no means
of avoiding the final collapse of a boom brought about by credit expansion.
The alternative is only whether the crisis should come sooner as the result
of a voluntary abandonment of further credit expansion, or later as a final
and total catastrophe of the currency system involved.[1]
Intervention and
Reform
If one subscribes to the diagnosis provided by
Austrian School of economics, two important observations must be made. First,
more circulation credit and fiat money at lower interest rates will not, and
cannot, prevent a disaster that has been caused by too much credit and money.
Second — and this aspect may not attract peoples' attention right away
— governments' ongoing attempts to fight the economic correction will
destroy what little is left of the free market order.
In his book Interventionism, Mises explained that
market interventions would not create a lasting system of economic
organization. He wrote,
If governments do not give them up and return to the
unhampered market economy, if they stubbornly persist in the attempt to
compensate by further interventions for the shortcomings of earlier
interventions, they will find eventually that they have adopted socialism.[2]
Interventionism in the field of monetary affairs
— most notably by governments controlling money production — has
caused damage on the grandest scale.
There are a number of economists who have identified
the serious economic and ethical problems caused by fiat money. Among them
are, most notably, Ludwig von Mises, F.A. Hayek,
and Murray Rothbard. They basically recommend
privatizing money production, which would pave the way to sound money —
money that is compatible with the principles of a free-market society, money
that does not cause boom-and-bust cycles.
Under privatized money production, people would
freely decide on the kind of money they wanted to use. Such a money would presumably be anchored by gold, but it could
possibly be anchored by other media (for example, silver or platinum). The
government and its central bank would be closed down and lose control over
money production. From then on, the interest rate would be determined by
free-market forces rather than government action.
Conclusion
The global monetary fiasco is a reminder that it is
high time to seek monetary reform along the lines of that which is
recommended by the Austrian School of economics. It is the only way to
protect and maintain peoples' freedom and economic well-being.
Murray Rothbard wrote that
"Mises, almost single-handedly, has offered us
the correct paradigm for economic theory, for social science, and for the
economy itself, and it is high time that this paradigm be embraced, in all of
its parts."[3] This holds true especially for Mises's
monetary theory.
So if one wishes
to hold a positive view on the progress of civilization, it necessarily
implies that the future monetary system will be a free-market-money system,
as envisioned by the Austrian School of economics — and that the era of
fiat money must come to an end.
Notes
[1] Ludwig von Mises, Human
Action (Auburn: Ludwig
von Mises Institute, 1998), p. 570.
[2] Ludwig von Mises, Interventionism (New York: Foundation for Economic Education, 1998),
p. 91.
[3] Murray Rothbard, "Ludwig von Mises and the Paradigm for
Our Age," Mises Daily, August 18, 2009.
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