Batten the hatches and blame the banksAs the world economy heads into stormy seas, questions should be asked about the wisdom and morality of monetary policy managed by central banks.The recent collapse of a major US investment bank, Bear Stearns, is evidence that the world economy may be sailing into a gale. Earlier this week the head of the International Monetary Fund, Dominique Strauss-Kahn, told a conference that "The financial crisis which started in the United States is more serious and more global than it was a few weeks ago. The risks and dangers are very high. The economic environment is still worsening." If a storm lies ahead, it will certainly test the seaworthiness of competing theories of economic thought. Here we feature an analysis by Finnish economist Oskari Juurikkala, who presents a radical perspective. (The views are those of the author, not MercatorNet, which is open to a range of interpretations.)
I am not sure if this is a viable remedy, given the magnitude of the problem. If the dollar is dumped, its declining exchange rate will exacerbate price inflation in the US and cause a downward spiral of crisis and deep depression. But more importantly: Is the Fed’s strategy even basically just? It may seem as if it is the exclusive business of politicians and central bank wizards to determine the right monetary policy. Monetary policy is, after all, a complex science that is far beyond the comprehension of us ordinary people. Nothing could be further from the truth. For one thing, it is not their money -- it is ours. It is ordinary people who suffer when governments and central banks bail out failing banks (which, by the way, made big bucks taking all those risks). Secondly, monetary policy is really not all that complicated. Printing-presses and counterfeit money When a central bank lowers interest rates, it engages in an activity that is not morally neutral. News reports often fail to convey what is going on. Lower interest rates are achieved, effectively, by increasing the money supply. In other words, it is achieved by printing money "out of thin air" and selling it inexpensively to banks. If it still doesn’t sound morally dubious, consider doing it yourself. Go on, be a tiger: buy a printing press, and print a couple of US dollars, a handful of Euros, a pile of Swiss Francs, and finally a bag of Yen. That’s called fraud. What does counterfeit money do? Clearly, it enriches the counterfeiter, who can purchase real goods and services with the newly acquired dosh. Does it increase the amount of real goods and services? The answer is simple: No. By creating new money, no economic resources are generated in the process. But someone has to pay for the profit of the fraudster, and this is the rest of the people. The purchasing power of their money balances is eroded, often without them ever realizing why it happened. Thus monetary inflation redistributes wealth. By how much, depends on how much inflation. In Mugabe’s Zimbabwe, annual price inflation hit 1000% a while ago -– I doubt they are counting any longer. Public goods, private goods If monetary policy is so simple, why is there so much fuss about it? For one thing, it is complicated, too. Moreover, there are usually some who benefit from the arrangement. Often, as in the case of Zimbabwe, it seems to be the government that benefits. This was also the case in ancient Rome, which tried to cover its deepening financial difficulties by clipping coins and debasing the metal. Over time, this led to hyperinflation, which according to some commentators was the main factor that destroyed the empire. By year 270 AD, a silver denarius only contained 0.02% silver. Soldiers rebelled and no longer accepted payment in Caesar’s money. Other times, the government is more of a minority partner in the deal. It is news to many an economics student that, historically, most central banks were private entities serving the private interests of the financial sector. Historically, most central banks were once private corporations. The Bank of England was founded as such in 1694, and was only nationalized in 1946. The US Federal Reserve System was founded in 1913 as a legal hybrid, which however is considered by many as a private corporation. It is formally owned by its member banks, about whose owners little is known. As a special privilege, the Fed has never undergone a complete independent audit, and it is claimed that it keeps some of its records secret. Causing bubbles Monetary policy claimed to serve worthy goals, such as high employment, price stability, and economic growth. That may be so. But it is doubtful. It is now widely accepted that price inflation is predominantly caused by the expansion of the money supply, which is caused by the central bank. As more money enters the market through private hands, the value of each unit is diluted. As to economic growth, it is true that inflationary monetary policy can stimulate economic activity -– but only for the short term. This is the argument of supporters of the Austrian school of economics such as Ludwig von Mises and the Nobel Prize-winning F. A. Hayek. By intervening in financial markets, monetary policy artificially lowers interest rates below their market rates. This encourages investment and consumption bubbles, such as the dot.com bubble of late 1990s and the real estate and overconsumption bubble in recent years. We know that all bubbles must come to an end. What is more, the effects are destructive both economically and socially. Workers must be laid off, investments liquidated at low prices, and houses sold. Yet there are some who benefit: those who know what is going on and are able to ride the wave in both directions -– up and down. Lessons from banking history Debasement of money has been a temptation throughout the history of money. On top of that, there is so-called fractional-reserve banking, which refers to the use of demand deposit money in the bank’s lending business. Banks borrow funds from their depositors and lend those funds to the banks’ borrowers. They make their money by charging borrowers a higher interest rate than they pay depositors for use of their money. Many economists, including Milton Friedman and others at the University of Chicago in the 1950s have identified it as the source of banking instability throughout modern times. Fractional-reserve banking was censured already by Roman jurists, who thought it dishonest and legally unsound. Yet modern scholarship shows that it was precisely this instability that provided the justification for inflationary central banking. Interestingly, the struggle for sound monetary practices is anything but new. The Romans knew all about it. It was constant in Medieval Europe. The French especially experienced the bitterness of unsound banking in the 19th century. It was also present in the United States from the very beginning, as the letters of Jefferson reveal. For example, Jefferson noted the consequences of paper money in a letter to Josephus B. Stuart: "That paper money has some advantages is admitted. But that its abuses also are inevitable and, by breaking up the measure of value, makes a lottery of all private property, cannot be denied" (1817). In another letter, to John Taylor, he identified the problem with unsound banking: "I sincerely believe... that banking establishments are more dangerous than standing armies, and that the principle of spending money to be paid by posterity under the name of funding is but swindling futurity on a large scale" (1816). They were courageous words then, and they are so today, as we watch the dramatic consequences of unsound financial practices reveal themselves in slow motion. Trained in economics and law, Oskari Juurikkala works in mining and finance. He is also consultant with Ansgar Economics and founding editor of Kultainfo.com, the leading precious metals website in Finland. |
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The global financial crisis is rapidly moving ahead. Be not surprised, this was foreseen by many a long time ago. What is also going to happen is quite certain, as the Ben Bernanke-led US Federal Reserve has been open about its strategy: use all means possible to save the banks, regardless of what happens to the dollar.
Comments (14)
M. Bagshaw said...GOT GOLD ?
Canada | Friday, 21 March 2008 at 1:54 am
Frank Daley said...For those interested in a simple graphical analysis of two key sets of parameters for the major US banks (Bank Portfolios - 90+ days late and Total Charged Off Mortgages) see:
http://and-still-i-persist.com/2008/03/12/
charting-the-banking-crisis-a-boomerang-demo/
Australia | Friday, 21 March 2008 at 10:25 am
Jim said...Thank You Oskari for your quite interesting take on the banking nightmare. I found myself in agreement with most of what you’ve written. My interest is piqued by ... “The US Federal Reserve System was founded in 1913 as a legal hybrid, which however is considered by many as a private corporation.”
The Federal Reserve is incorporated in the State of California, as such it is a private corporation. Can you shed any additional light on its status as a “legal hybrid”?
However you view the current situation it would appear that we are in a world of hurt.
United States | Friday, 21 March 2008 at 1:10 pm
Antonio Regidor said...Help me guess if this was one of the old chinese proverb that went like this.
Money is like manure: Spread it well it might grow but if you let it stay in one pile it will stink.
Just how much gold did US of A ever return to China after T.V. Soong?
United States | Friday, 21 March 2008 at 1:24 pm
ck :-) said...hmmm…
The U.S. used to be the world’s most skillful entrepreneurs and managers. Is this a sign of the times, ... or just an incompetence? What happened? A great learning guide, ...to begin with, Oskari. Thank you for your insight.
ck :-)
Philippines | Friday, 21 March 2008 at 7:01 pm
Mark Dionne said...What does Mr. Juurikkala propose? If the central bank does not “print” more money at some point, eventually money gets too scarce and you get deflation. If it prints too much, you get inflation. Either you switch to something like gold, which has its own problems, or you need to have a body that you trust to keep the money supply at the right level.
Who benefits from inflation? Debtors, since they get to pay back their debt in money that is easier to come by. Who is the biggest debtor around? The US Government. Do you want the US government controlling inflation (printing of money)? Better the Fed (i.e. the bankers, who loan out money, and want to keep it from losing value) than the US government.
Some smart people think the problem is that the investment banks, such as Bear Sterns, are NOT fractional reserve banks. They can create credit without the same restrictions on reserves that are in place for the US commercial banks. This makes for a much less stable system. Barney Frank, Chairman of the House Financial Services Committee, is already talking about changing the regulations on this.
-- | Saturday, 22 March 2008 at 7:14 am
Mark Dionne said...Ha, Andrew Leonard at Salon just stole my post. :-) Here:
http://www.salon.com/tech/htww/2008/03/21/barney_frank_new_federal_reserve/index.html
He also points out:
“...the Federal Reserve Board of Governors is now almost entirely staffed by Bush appointees, a cross section of the general public not known for its pro-regulatory sympathies.”
-- | Saturday, 22 March 2008 at 7:33 am
Jose Maria J. Palabrica said...Thank you for your very informative article. You certainly raised troubling issues however, I have not seen any recommendations on what positive action ordinary citizens from so-called third world economies (where I came from) can do to remedy the situation.
Philippines | Saturday, 22 March 2008 at 8:26 am
ck :-) said...hmmm…
...to start, buy Made in the Philippines!
ck :-)))
Philippines | Saturday, 22 March 2008 at 4:57 pm
Oskari said...Dear readers,
Thanks for all the comments. Some brief replies:
1. Jose Maria: The path to sound money will not be easy. This however is true of most social issues.
There are two ways of approaching this: (1) What would the ideal system be? (2) What can I personally do to contribute to a more just society? Regarding the first, remember that any improvement is an improvement. As to the latter, try to apply your mind to it, and you may discover many things you can do.
This may be idealistic, but I think education and awareness are key.
2. Mark: the question of inflation vs. deflation is certainly among the biggest questions theoretically in current monetary economics. It is a complex issue, but bottom line seems simple to me: stable money is the best money. Without monetary inflation, you get modest price deflation as a result of economic growth, but that is not bad (in fact it’s good).
This article may answer some of your questions (however, it’s quite long and extreme at times):
Deflation: The Biggest Myths
http://www.mises.org/story/1254
This is a shorter article:
The Imaginary Evils of Deflation
http://www.gold-eagle.com/gold_digest_02/mayer091202pv.html
3. The ideal arrangement? I would like to keep it simple: take both government and private interests away from manipulating money, and apply normal legal rules of contract and property to banking.
I recommend Jesús Huerta de Soto’s book, “Money, Bank Credit and Economic Cycles.” It presents both the economics and law and money and banking since the earliest days. You can download it free of charge at http://www.mises.org/books/desoto.pdf
4. Jim: I agree with you. I tried to soften this point but the choice of words may have been misleading. As far as I know, the Fed really is a fully private corporation. But some may argue it is a “hybrid” in the sense that there is some political control over its appointments and activities. Whether this control is good is a matter for debate.
Finland | Saturday, 22 March 2008 at 8:12 pm
Juergen Siemer said...In my opinion it is very important for families to understand that the current central bank and government policies both in the US and in Europe are unfair against families. Altough those policies are reasoned as “saving the financial system”, “saving the economy”, or even “saving the world”, the only ones who are going to get saved are financial investors and top management of investment banks or hedge funds.
Oskari is right: Those who pay for the rescue are the families and the working people. Deficit spending in general and printing money in particular is against the interest of families. And by the way, it is also against the principles of a free market economy.
We are trying to explain this (in German) in familientrends.de
Germany | Sunday, 23 March 2008 at 12:05 am
ck :-) said...Hi Oskari,
Many thanks for your brief replies, above. Can you help us with this?
To restate our government’s press release, “The Philippines is making a comeback. Second-quarter growth of 7.5% was the highest in two decades; unemployment was 8%, the lowest since 1997. After a slip on subprime financial worries in August the stock market has made a full recovery and recently posted record highs. It is up 28% for the year.”
Sounds all too good, doesn’t it? But how come many an ordinary citizen does not feel anything different from the above? Are all these, an example of financial hype? For whom? As always, Thanks!
ck :-)
Philippines | Tuesday, 25 March 2008 at 9:28 am
independent said...In 1907 the federal government provided $25 million to JP Morgan to buy out a rival bank and end a panic. Today, JP Morgan gets $30 billion for the same purpose. The only thing that’s changed is inflation, the bypassing of legislation, and JP Morgan/Chase is running out of rivals to acquire. At least in 1907, you had to convince Congress it was worth spending all that money “to save the economy.”
Regardless of what system or scheme has been regulated or unregulated by the government, financial markets and banks are prone to booms, busts, and panics. In many ways, history suggests that the stronger the central bank, the stronger the crash (remember, the Fed has never been so active as now or in the 1929-1931 period leading up to the great bank failures).
American history from even before the revolution goes back to issues of currency - and a few periods worked out quite well with competing currencies. They didn’t even have digital markets to standardize the trades and they still made it work, until the bankers got together and decided to regulate competition out of the market…
So now the same few banks sit at the top, as they have for the last ~100 years, and they can get their fix of public funds without bothering about public opinion or Congressional approval. Who dare calls it a conspiracy?
http://www.undergroundpolitics.com/index.php/history/federal_reserve_conspiracy_theory.html
United States | Tuesday, 25 March 2008 at 2:46 pm
PJ said...Low interest rates are not achieved by pumping new money into the system, which is (anyway) precisely not counterfeiting because it is not counter. Our inflation comes from deficit spending and the trade imbalance. The Government is pouring money we don’t have into the economy and not creating any new goods, but they are doing it by selling bonds and promising to pay in the future. And we send billions of dollars to China in exchange for plastic garbage, which means they have lots of dollars and we have nothing of real value.
The internet bubble had little to do with government monetary policy, and everything to do with excessive investment and a misunderstanding of the explosive earning power of the internet, mixed with some good old fashioned wasteful spending. I am with you on the bad state of the dollar, but you flow pretty freely in between attacking the Fed and private banks, which are totally different propositions.
I completely agree that there is a serious moral element to monetary policy et al. that is being igonred, particularly when you talk about bailing out banks that made money with predatory lending policies to poor “sub-prime” people that couldn’t afford it. But to suggest that the Federal Reserve is counterfeiting money to benefit investment banks at the expense of the private sector is misguided, and to do so rhetorically is, I believe, irresponsible in light of the actual situation.
The US economy needs responsible politicians to curb the deficit and responsible citizens to encourage stable lending and borrowing practices. One might suggest that a precious metals expert would add that the US should return to the gold standard, but I digress…
United States | Thursday, 27 March 2008 at 7:22 am
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