Since the industrial revolution economic slumps have created periodic mass unemployment. Austrian School economists explain that the business cycle stems from fraudulent state sanctioned banking practices. Keynes’s followers are again leading us into another major slump.
Since the industrial revolution economic slumps have created periodic mass unemployment. Austrian School economists explain that the business cycle stems from fraudulent state sanctioned banking practices. Keynes’s followers are again leading us into another major slump.
From the beginnings of industrial society in Britain a couple of centuries back there have been cycles of boom and bust. The bust results in slumps in activity, and therefore unemployment. Cyclical unemployment did much to discredit liberty, or laissez-faire, and promote socialism.
What has the Austrian School, the economics wing of the libertarian tendency, got to say about the sufferings of so many at the hands of apparently free market credit or business cycles?
Before answering this question, let me distinguish the business cycle from the harvest driven economic fluctuations. These have plagued agrarian societies throughout history. Bad or good harvests, especially in a row, caused big fluctuations in food prices. People could go from spending a third of their income on bread to spending all of it. Those below the subsistence level faced starvation, again.
When you spend all your money on bread you can spend none on other goods. Tradesmen and artisans making such goods therefore were crushed. This was going on for example in 1789 when the French Revolution began. It accounts for a lot of the militancy of the struggling Paris artisans at the time. In the early stages of industrialisation, societies could unfortunately suffer from a combination of both harvest and credit cycle slumps at the same time. Later better agricultural technology ironed out feast and famine.
Back to the classical business cycle, also known as ‘boom’ and ‘bust’, which came into being during the 19th century. The Austrian School explains that it is always caused by the creation of new money out of thin air by what amount to fraudulent - though entirely legal - banking practices. These used to be characterised as ‘fractional reserve banking’. Banks did not just lend out funds (i.e. gold) deposited with them for safekeeping, which is in itself a fraud. They also lent many times the amount of currency they actually held. Before 1914 in Britain the currency would either be gold or bank notes convertible into gold.
The idea was to maximise banks’ interest income by lending the same money several times over, which is another fraud. Every time a loan is made by a bank the new money lent is in effect created out of thin air as the same moment as the loan. But, if too many bad loans are made, depositors may grow anxious and ask for their cash back. But more claims on cash have been lent than there is cash to meet them. There can’t be enough actual cash to go round and pay back every depositor’s money.. Once confidence was lost, there would be a bank run, perhaps a collapse similar to Northern Rock just a decade ago.. That would be the end for the bank and its directors and shareholders in a free society.
And rightly so. But in our fairly un-free societies, irresponsible banks are bailed out by state chartered Central Banks using their own state conferred money creation powers. Such banking systems are privileged by state-made laws and are wrong. Without the state these dodgy practices would cease. The key point? There would be no boom and bust cycle, in other words no bank credit cycle, in a free society because there would be no money creation in an honest banking system.
In return for permitting fraudulent lending and money creation, governments borrowed lots of newly created money to fight wars. Bankers have paid themselves generous commissions and bonuses. More recently, Democratic Socialist vote buying and overseas aggression have both been underwritten by constant money creation.
When Marx and Jeremy Corbyn finger banking ‘capitalists’ as contrary to our wellbeing, they have a point. Well as Dumbledore in Harry Potter says of the Daily Prophet newspaper, they are bound to report the truth occasionally, if only by accident.
How does money creation out of thin air cause the business cycle? Far more loanable funds are created by banks than there are real saved resources available to undertake investment projects. The excess of bank lending is likely to show itself in a tendency for interest rates to fall. The interest rate is a vital price in business. It enables businessmen to calculate the merits of implementing various alternative projects.
In a free society there can be no fraudulent money creation. Therefore, lower interest rates would truthfully indicate that relatively more real savings, i.e. accumulations of unconsumed goods, are available. In other words, society’s ‘pool of investible capital’ , in Austrian School parlance, is actually bigger. But in an impaired society where bankers create money from nothing, lower interest rates are fake news.
In both cases businessmen, whose job it is to calculate the most effective way of producing marketable supplies of goods and services, factor the apparent abundance of capital into their calculations and decisions.. They ‘do the numbers’ and decide accordingly.
Things would turn out well in a free society. But not so much with us. In a free society there would simply be more, properly conceived investment reflecting the real increase in available savings. There will be stable employment and rising living standards. That is because capital markets correctly signaled abundant real saved resources for all projects undertaken at the correct interest rate signal.
For us, even in periods of otherwise sound money before 1914, the result has been a great deal of avoidable distress. Unsound future production decisions (economic calculations) are made because of misleadingly information about the true level of investible savings. Businessmen, and indeed political entrepreneurs, embark on over-expansive undertakings. The problem is that the pool of investible savings in society is not big enough to complete them all. Nor do the projects represent the right product or production decisions given the reality of capital shortage.
At first there is a surge in activity as projects get going. There is great competition as everyone tries to complete their projects. This is the ‘boom’. Prices are bid up because there are not enough saved resources to go round. Additional loans are conjured up out of thin air to finish the job. But money creation can never bring real savings into being, though it can steal from savers and transfer value to banks’ favourite customers. After a bit, problems with these projects become obvious. Banks suddenly worry about the safety of their loans. They call them in at the same time. They did this sooner under the old gold standard because loans had to be repaid in real money.
But in the end the same thing happens under either monetary regime – gold or paper. When the loans are called in, work on projects, and in mis-conceived activities, ceases. Interest rates peak as loans dry up and money vanishes back into thin air. New savings are urgently sought to rationalise bankrupt undertakings. This is the ‘bust’. It hurts a lot. But it is the healing needed after a boom. The boom itself was the disease.
In Austrian School terms fake money driven booms create ‘malinvestments’. These have to be liquidated during busts to clear the way for economic progress. You can’t know how many malinvestments existed until they are cleared away, which they inevitably will be. At the moment one would suggest that global supply chains, financial sectors and modern governments are all stuffed with doomed misconceived activities. Real estate and high-end services, especially in big cities hosting fissile concentrations of politicians, officials, banks and crony corporate HQs, are also likely to feel the winds of change. The more so where the state’s underclass dependents are gathered.
Time now to consider the Keynesian explanation for the boom and bust or credit cycle. Strange to relate the state is the redemptive hero of his saga. Keynes picks on businessmen. Whereas in reality they succeed on the basis of careful and unsentimental calculation, Keynes asserts that they are prey to ‘animal spirits’ and engage in crazy projects. Only far-sighted, public spirited politicians can make things right. It is quite laughable. And worse, what is the solution according to the sage of Bloomsbury? More creation of money out of thin air, of course. He is busy inflating his economically illiterate ‘level of demand’. He even suggests forcibly diverting society’s diminished pool of investible savings to digging holes and filling them in. Perhaps that is the idea behind the otherwise inexplicable HS2 scheme.
Keynes suggested more money creation would cure slumps, end the business cycle and cure mass unemployment. But wait, hadn’t the Austrian School already explained that boom and bust were actually caused by the banks’ money creation in the first place? Brilliant.
However, Keynes’s ideas did highlight interesting possibilities for vote hungry politicians. State-sponsored money printing can delay and alter the course of downturns.
Malinvestments about to bite the dust are important to politicians. There are donations and dependent voters at stake. And a lot of people really want to avoid that bracing contact with reality as long as possible.
As Mises had already explained (again), there is no avoiding the collapse of the bubble in asset prices caused by money creation and artificially low interest rates. But you can resort to money printing, as Keynes suggested, to ‘kick the can down the road’. Maybe another politico can take the blame instead.
Why not kick the can down the road indefinitely? Because errors accumulate and zombie enterprises proliferate. They use resources so badly. They cannot even pay interest on their debts, let alone repay them. It’s like one of these huge forest fires you see on the news. Malinvestment dead wood has been spared in previous conflagrations. We now have a lot more dead wood that the fire will be correspondingly huger.
The biggest zombie is the state. It borrows to pay its interest. To keep the show on the road, money printing has been stepped up and interest rates lowered steadily. Interest rates are around zero. Neither the state nor the distended capital markets could bear proper interest rates. True to the incompetence of monopolistic, centralised state decision making, governments have now (May 2020) provided the pin for their own everything bubble in the form of medically pointless, but economically disastrous, lockdowns. I hope I am wrong but you too may see the approaching end of the road.
Mises’s analysis is worth understanding to see what might happen next. Governments have two options. One is to stop money creation and take deflation on the chin. They should have done this in 2001 and 2008. In this case consumer prices, tax payments and wages would fall. Property and financial assets would fall a lot more. Non-productive activities would fail and be closed or adapted. That means a lot of the government and finance sectors would vanish. Many debts would be defaulted on, including government debt. However after a year or two genuine progress would start up again. This V shaped recession would be the best possible outcome. It resembles what happened with a working link to gold. Unfortunately, a prosperous future has no votes. Politicians believe that they cannot afford a slump on their watch. They also do not realise that it probably cannot be deferred. So they are doubling down on money creation to avoid ‘deflation’. That means that they are choosing a much longer inflationary depression. The problem is that such depressions continue as long as it takes until governments stop interfering and rein in money creation. This is effectively the story from 2008. We have been in a Main Street depression since then.
In the inflationary scenario which most governments increasingly embrace, money creation and the resulting depression will only end when most state currencies are no more. It may not take so long. When people see that all dollar-based currencies could soon be completely worthless they could abandon them rapidly. The search will be on for any values that politicians cannot abuse. This time the entire dollar complex would be junked. Pounds, euros, yen and a 100 or more monies are just brightly coloured dollar franchising opportunities.
And here’s the thing. Hyperinflation will run its course. The old state currencies will be worthless and abandoned. At that point, a deflationary reset - the thing the politicians are so desperate to avoid - will still happen anyway. The months or years of monetary chaos in between will just be more time wasted by the governments’ irresponsible folly.
What will Democratic Socialist societies do? Tax revenues will fall. Either way, deflation or hyperinflation, states will not be able to borrow or to print their own money. They won’t be able to honour their promises. Something will have to give. Let’s hope that enough people realise by then that politics is a non-essential occupation. Writing off the state as an ideal is the only way out for humanity.