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The failure of interventionism

By Justin Jefferson - posted Thursday, 30 April 2009


Government policy response to the current economic crisis involves two false assumptions which cannot withstand critical scrutiny. It assumes that the problem originates in "unregulated markets", rather than in monetary policy. And it assumes that government can make the situation better.

The argument in favour of individual planning of economic activity through markets, rather than central planning through governments, is that central planning cannot avoid gross unintended surpluses and shortages in all the wrong places. Since the boom and the bust are evidence of exactly such gross surpluses and shortages, let us try a thought experiment.

Let us for a moment suspend any assumption that the crisis could not have originated with government policy, and instead ask: “How could manipulating the money supply, and in particular lowering interest rates, cause the symptoms we are witnessing?”.

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Governments cause inflation

If we gave John Jones a licence to print and spend money, he would endlessly print and spend, wouldn’t he?

Well governments are intrinsically inflationary for exactly the same reason. All the instruments and institutions of monetary policy have in common that they give governments power to inflate the money supply.

Printing paper money or lowering interest rates is the same economically as counterfeiting. It works by skimming a fraction from everyone who uses money.

But the worst effect is not mere rising prices, nor even the direct fraud involved. Inflation causes the cycle of economic booms and recessions, and consequential injustice.

To understand how the process begins, we need to understand the difference between money and money substitutes. Banknotes were originally not money, but money substitutes: paper claims to real money - gold - in the bank.

If there is always 100 per cent gold on deposit to redeem all the banknotes, no issue arises. The problem is when banks issue money substitutes - banknotes or loans, say - in excess of the real money they hold in reserve. Then if everyone claims their real money at the same time, someone must miss out. This is where “bubble” problems originate.

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In a market unhampered by government interventionism, banks that issued money substitutes in excess of real money on deposit, without the knowledge or consent of the relevant depositor, would be breaking the laws of contract and fraud. The market would eliminate them through loss, bankruptcy, and depositors withdrawing their deposits.

But to promote inflation, governments use their monopoly powers to permit, encourage, and even require banks to lend out in money substitutes more than the real money they actually hold in reserve.

But it gets worse. Governments have long since (forcibly) replaced society’s preferred real money with fiat paper money - based, not on gold, but on politicians’ promises. Which do you trust more?

Thus government’s “economic management” of the money supply forcibly imposes on society not one but two vast Ponzi schemes of fake money piled one on top of the other - and all in the name of economic “stabilisation”.

You wouldn’t let someone take as much money from your bank account as they want without your knowledge or consent, would you? Well there is no more reason to trust government with control of the money supply in general.

It may be thought that this power to re-distribute wealth by printing money is a useful instrument of social justice. But in practice it is used to exploit the poor, the workers, the financially unsophisticated, the fixed-income middle class, and savers. It most favours the financially sophisticated, banks, politicians, real estate speculators, and many other vested interests in political favouritism. It is ironical that those most professing concern for social justice are the first to assume the innocence and usefulness of this anti-social and unjust arrangement.

Austrian theory of the trade cycle

Money is not the same as wealth. If we doubled the amount of money in the economy overnight, we would not be twice as rich. The underlying real wealth would be the same.

Increasing the money supply starts the boom in the sector where the new money enters the economy. Those receiving the new money bid up prices.

Inflation falsifies the means of economic calculation - prices. It sends signals to entrepreneurs that there is a demand for real goods, when in fact the demand is fake - just a bubble of extra paper money. Inflation sends signals that there is much more real capital available than in fact there is.

As a result, entrepreneurs begin projects that cannot be completed having regard to the amount of real capital available. Now the whole point of being economical is to use resources to satisfy the needs and wants that the consumers consider most urgent. But inflation misrepresents people’s preferences. Capital and labour flow into the activities demanded with the new money, creating a “bubble”. As a result, an enormous amount of the people’s real capital is mal-invested.

Eventually, something has to give. The real capital is not enough to satisfy both the real underlying demand, and the fake demand set off by the excess money substitutes. The boom must collapse. Either the lenders realise that the loans can’t be re-paid and stop lending. Or the inflation accelerates and threatens the total breakdown of the function of money as a medium of exchange: like Weimar Germany, or Zimbabwe, or the way Obama is heading.

As Warren Buffett said, “When the tide goes out, you can see who’s swimming naked”. The recession is the process by which the market reveals which businesses are servicing the real demand, and which are servicing the fake demand originating in government’s manipulation of the money supply. The recession is the process by which the mass of ordinary people reject government’s over-valued paper money and re-assert their own valuations as against the central bankers.

Actions speak louder than words. Every act of buying, or abstaining from buying, is a vote in the market democracy. The sovereignty of the mass of people as consumers thus re-directs the allocation of capital. Entrepreneurs must liquidate capital that has been mal-invested and re-allocate it to productive purposes in real demand. If they don’t, they go broke, and their property passes into the hands of entrepreneurs who will supply what the consumers consider most urgent.

Some capital - such as petrol - can easily be re-allocated to different uses. But much mal-invested capital is in a particular form - such as a BMW - which can only be turned into a more productive form - say, cattle - at great loss.

It is this underlying destruction of capital, on a vast scale, that is the real cause of the recession.

Governmental intervention cannot improve the situation

Current policy responses to the recession are nothing but an attempt to preserve economic activity at levels and in places they were in the artificial bubble. They are doomed to failure - like trying to repeal the law of gravity by throwing things in the air. At best they prolong the day of reckoning until the current crop of politicians are retired on a pension - paid for by all the people they defrauded.

Unfortunately, the only cure for a recession is a recession. There is nothing government interventions can do to fix or improve the problem caused by its own re-distributionist interventions. This is because, if they could, we would have discovered a way to make real wealth out of thin air by passing laws or printing paper. It doesn’t exist. This is a matter of economic science, not “ideology”. We cannot make bread out of stones no matter what ideas we have.

It is important to understand that government’s power to inflate the money supply confers no net social benefit whatsoever. It is an engine of exploitation, privilege, and abuse, that is all. The original social injustice behind the greed of the boom that leads to the bust, is the greed of trying to get something for nothing by urging the government to take or sneak it from someone else - monetary policy.

Trying to re-distribute other people’s income and savings is not a solution: - it is what causes the problem in the first place.

In decrying the recession and its unemployment we should be condemning the ideology of economic interventionism that causes it. Governments are no more capable of managing the money supply than they are of managing the economy as a whole.

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About the Author

Justin Jefferson is an Australian who wishes to show that social co-operation is best and fairest when based in respect for individual freedom.

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