Best of the Week
Most Popular
1. Will Gold Price Breakout? 3 Things to Watch… - Jordan_Roy_Byrne
2.China Invades Saudi Oil Realm: PetroDollar Kill - Jim_Willie_CB
3.Bitcoin Price Trend Forecast, Paypal FUD Fake Cryptocurrency Warning - Nadeem_Walayat
4.The Stock Market Trend is Your Friend ’til the Very End - Rambus_Chartology
5.This Isn’t Your Grandfather’s (1960s) Inflation Scare - F_F_Wiley
6.GDX Gold Mining Stocks Fundamentals - Zeal_LLC
7.US Housing Real Estate Market and Banking Pressures Are Building - Chris_Vermeulen
8.Return of Stock Market Volatility Amidst Political Chaos and Uncertain Economy - Buildadv
9.Can Bitcoin Price Rally Continue After Paypal Fake FUD Attack? - Nadeem_Walayat
10.Warning Economic Implosion on the Horizon - Chris_Vermeulen
Last 7 days
Is War "Hell" for the Stock Market? - 19th Apr 18
Palladium Bullion Surges 17% In 9 Days On Russian Supply Concerns - 19th Apr 18
Breadth Study Suggests that Stock Market Bottom is Already In - 19th Apr 18
Allegory Regarding Investment Decisions Made On Basis Of Government’s Income Statement, Balance Sheet - 19th Apr 18
Gold – A Unique Repeat of the 2007 and How to Profit - 19th Apr 18
Abbeydale Park Rise Cherry Tree's in Blossom - Sheffield Street Tree Protests - 19th Apr 18
The Stock Market “Turn of the Month Effect” Exists in 11 of 11 Countries - 18th Apr 18
Winter is Coming - Coming Storms Will Bring Out the Best and Worst in Humanity - 18th Apr 18
What Does it Take to Create Living Wage Jobs? - 18th Apr 18
Gold and Silver Buy Signals - 18th Apr 18
WINTER IS COMING - The Ongoing Fourth Turning Crisis Part2 - 18th Apr 18
A Stock Market Rally on Low Volume is NOT Bearish - 17th Apr 18
Three Gold Charts, One Big Gold Stocks Opportunity - 17th Apr 18
Crude Oil Price As Bullish as it Seems? - 17th Apr 18
A Good Time to Buy Facebook? - 17th Apr 18
THE Financial Crisis Acronym of 2008 is Sounding Another Alarm - 16th Apr 18
Bombs, Missiles and War – What to Expect Next from the Stock Market - 16th Apr 18
Global Debt Bubble Hits New All Time High – One Quadrillion Reasons To Buy Gold - 16th Apr 18
Will Bitcoin Ever Recover? - 16th Apr 18
Stock Market Futures Bounce, But Stopped at Trendline - 16th Apr 18
How To Profit As Oil Prices Explode - 16th Apr 18
Junior Mining Stocks are Close to Breaking Downtrend - 16th Apr 18
Look Inside a Caravan at UK Holiday Park for Summer 2018 - Hoseasons Cayton Bay Sea Side - 16th Apr 18
Stock Market More Weakness? How Much? - 15th Apr 18
Time for the Gold Bulls to Show their Mettle - 15th Apr 18
Trading Markets Amid Sound of Wars - 15th Apr 18
Sugar Commodity Buying Levels Analysis - 14th Apr 18
The Oil Trade May Be Coming Alive - 14th Apr 18
Big Cap US Stocks Fundamentals - 13th Apr 18
Jaguar Land Rover Cuts 1000 Jobs on Diesel Sales Slump, Long-term Discovery Sport Review - 13th Apr 18
Stock Market SPX May Tangle with the 50-day MA - 13th Apr 18
Longtanding Chinese War: Intrigue & Betrayal - 13th Apr 18
How I Own My Gold - 13th Apr 18
ISupply Energy Consumer Warning - Never Put Your Account Into Credit! - 13th Apr 18
SPX Resistance May Prompt A Massive Short Squeeze - 12th Apr 18
Stock Market High Volatility is Not Consistently Bearish for Stocks - 12th Apr 18

Market Oracle FREE Newsletter

Trading Lessons

Towards a New Monetary Order

Politics / Central Banks Jun 25, 2010 - 12:17 PM GMT

By: Thorsten_Polleit

Politics

Best Financial Markets Analysis ArticleHenry 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.

Thorsten Polleit is Honorary Professor at the Frankfurt School of Finance & Management. Send him mail. See Thorsten Polleit's article archives. Comment on the blog.

© 2010 Copyright Ludwig von Mises - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2018 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules