From page 154-155, “Alchemists of Loss: How Modern Finance and Government Intervention Crashed the Financial System” by Kevin Dowd and Martin Hutchinson. Referring to the causes of the 2008 financial crisis:
“It is here that one can most ferociously blame Fed Chairmen Alan Greenspan and Ben Bernanke, and their decade and more of irresponsibly cheap money. By distorting price signals throughout the economy and producing burst bubble after burst bubble without any significant improvement in living standards except at the very top, they have not only gravely damaged the economy, but enabled the Left to claim that free markets “don’t work” so we must bring in government and the unfortunate taxpayer to solve our economic problems. Of course, this crisis is not a failure of free markets and not even a failure of capitalism – unless you accuse modern mangerialist crony capitalism, in which case you would be right.”
This quote jumped off the page at me. It surmises the cause the cause of the boom that lead to the bust – low interest rates and loose monetary policy (as the authors point out on page 154, from 1995 the Fed expanded the money supply 5% faster than output for 13 years). It hints at the damage this has caused to the reputation of both free markets and capitalism, even though it had very little to do with either. It also correctly acknowledges that much of the growth and rise in living standards enjoyed during the boom was illusory.
It is a fascinating world we live in. There are few people who suggest that the government should control the price of milk or manipulate the supply of shoes. Luckily, most people recognise that government is hilariously incompetent at the functions it already performs and would resent it encroaching into areas where the free market already provides a valuable service.
Yet when it comes to money, the masses are blissfully ignorant. Money is a commodity like most other goods, albeit a special one with value added as a widely accepted medium of exchange. So why are we happy that governments (through their central banks) are allowed to manipulate the price (interest rates) of money?
We accept that the government would do a lousy job of supplying milk but simultaneously believe that it’s all knowing bureaucrats can somehow get the supply of money just right. We would rightly shudder at the thought of the government setting the price for a pair of shoes but are perfectly happy to allow it’s all knowing functionaries the discretion of setting interest rates.
Money is not the creation of the state. Just as the state did not invent money, nor is the state required to manage money. Money came from people, emerging through “spontaneous order”. People, interacting with each other through voluntary exchange gradually realised that certain commodities are uniquely desirable to use as money (due to properties such as divisibility and function as a store of value etc).
So what materials did individuals (free from government coercion) decide to use as their preferred money? The historical record is clear – they chose gold and they chose silver. I know of no example when people, free to choose, have settled upon paper. This is because paper money is intrinsically worthless. It can only function as money via government “fiat”, coercively imposed upon society via legal tender laws.
It shouldn’t take a great deal of imagination to understand why the state likes it this way. The printing press gives the state an unrivalled power – the ability to create money out of thin air. Except it is nothing like as harmless as that. The price is paid for by those who save, those with pensions and those on lower incomes. Inflation is a stealth tax on the poor and the thrifty, simultaneously eroding the value of saved capital and redistributing wealth from the poorest to the richest in society.
The financial sector is largely complicit in this redistribution, benefiting as the first recipients of the freshly printed money. They enjoy the benefits of the new money before inflation has eroded its purchasing power. By the time the new money reaches the poorest in society, any benefit to be derived from it has been wiped out by the increase in prices. Thus are the poor forced to pay more for everyday items and sacrifice a portion of their savings through loss in purchasing power.
Further damage is caused by the “misallocation” of capital as a result of low interest rates. In English, this means that when money is cheap people invest it in products, processes and ventures which are not sustainable. Sub-prime housing bubble anyone?
Interest rates should convey information about the time preferences of society. When people value present consumption more they will save less, driving interest rates up. When people defer consumption they save more, which drives interest rates down. However, in our current, centrally planned monetary system the interest rate is just an arbitrary number decided upon by a central bank committee (sound soviet enough for you?). The entrepreneur looking to invest capital receives a false signal – artificially low interest rates will falsely signal that society is prepared to defer consumption and has saved more capital to be in invested in longer, more marginal production processes. Except that society has done no such thing. Businesses inevitably make foolish investments and begin production of products which later turn out to be unprofitable. The end result? Boom followed by bust.
The neatest trick of all is that somehow all of this is blamed on free market capitalism. It should be clear that there is nothing free market about fiat money and centrally planned interest rates. The blame lies squarely with the state.
aforkinaworldofsoup 