Best of the Week
Most Popular
1.SNP Offers Labour Deadly Death Embrace Alliance, Holding England to Ransom, Destroy UK From Within - Nadeem_Walayat
2.Gold And Silver – Most Widely Used Currency In Western World? Stupidity - Michael_Noonan
3.Election Forecast 2015 - Coalition Economic Recovery vs Labour Collapse - Nadeem_Walayat
4.Election Forecast 2015 - Debates Boost Labour Into Opinion Polls Seats Lead - Nadeem_Walayat
5.Why are Interest Rates So Low? Ben Bernanke, Confused as Ever, Starts His Own Blog to Prove It - Mike_Shedlock
6.Leaders Debate Election 2015 - Natalie Bennett Green Party Convincing Anti-Austerity More Debt Argument - Nadeem_Walayat
7.Labour Economic Collapse vs Coalition Recovery - UK Election Forecast 2015 - Video - Nadeem_Walayat
8.China’s Stock Market Mania; How High can Red-chips Fly? - Gary_Dorsch
9.Gold and Misery, Strange Bedfellows - 31st Mar 15 - Dan_Norcini
10.Ed Miliband Debate Election 2015 Analysis - Labour Spending, Debt and Economic Collapse - Nadeem_Walayat
Last 5 days
One Stock Market Where You Haven't Missed the Bull Market Boom Yet - 26th Apr 15
Migrant Crisis - Europe Has Completely Lost It - 26th Apr 15
What Obama's First-Ever Energy Review Missed - 26th Apr 15
Sheffield Hallam Election Battle 2015, School Places Crisis, Can Nick Clegg Win? - 26th Apr 15
Stocks Bull Market Looks to Resume - 25th Apr 15
Gold And Silver - The U.S. Is A Corporation. Precious Metals Stand In The Way - 25th Apr 15
When the Nuclear Money Option Fails - 25th Apr 15
The War on Cash Special Report - 25th Apr 15
China Economic Slowdown Story - Why “Didi Dache” Is a Phrase You Need to Know - 25th Apr 15
The Trans-Pacific Partnership and the Death of the Republic - 25th Apr 15
Stock Splitting Caused the Stock Market Crash - 25th Apr 15
China Stock Market Parabolic Mania’s Global Risk - 24th Apr 15
What Will Happen to You When the U.S. Dollar Collapses? - 24th Apr 15
Why 2 of U.S. Dollar's Recent Bottoms Have 1 Thing In Common - 24th Apr 15
UK Economy Debt Timebomb Will Explode After Election - 24th Apr 15
Are Gold Stocks the Cheapest Ever? - 24th Apr 15
God, the Stock Market and Pascal's Wager - 24th Apr 15
Greedy Insurers Are in for a Nasty Surprise – Positioning You for Big Profits - 24th Apr 15
Four Things Missing From Obama’s First-Ever Energy Review - 24th Apr 15
How to Grow a Regenerative Medicine Industry - 23rd Apr 15
Stocks and Bonds Seven Year of Negative Returns; Fraudulent Promises - 23rd Apr 15
The Existential Danger To The Euro Is Elections - 23rd Apr 15
Stock Market No Clear Direction As Investors React To Quarterly Earnings Releases - 23rd Apr 15
Is China The Next United States? - 23rd Apr 15
U.S. Oil Glut: How High Can It Go? - 23rd Apr 15
Distorted Financial System Expect Deflation, Inflation And Hyperinflation - 23rd Apr 15
What McDonald’s Corporate Earnings Report Is Really Telling You - 23rd Apr 15
Gold Price Forecast to Become Priceless - 23rd Apr 15
FDIC Plots a Bank Heist Involving YOUR Accounts - 23rd Apr 15
$GOLD Price Year 2007 Again - 23rd Apr 15
Stocks Bubble - The Spread between Stock Prices and GDP is Blowing Out - 23rd Apr 15
Ukraine War - When Did We All Become Murderers? - 23rd Apr 15
Libya Crisis - EU Leaders Are Indicted for Nazi-Style Crimes against Humanity - 22nd Apr 15
Why Alternative Energy Isn’t Taking It on the Chin Despite Low Oil Prices - 22nd Apr 15
Bill Gross - German 10-Year Bunds Short of a Life Time - 22nd Apr 15
How to Profit from the Drop in the Oil Price - 22nd Apr 15
The U.S. Dollar's Move Is More Dangerous than You Think - 22nd Apr 15
Apple Watch Means Apple Will Become Worlds First $1 Trillion Stock - 22nd Apr 15
Half a Stocks Bubble Off Dead Center - 22nd Apr 15
They Said Go to College - Learning to become Debt Slaves - 22nd Apr 15
Best Cash ISA 2015/16, Instant and Fixed Savings Interest Rates, New Flexible Withdrawal / Deposit Rule - 22nd Apr 15
Unsound Banking: Why Most of the World's Banks Are Headed for Collapse - 21st Apr 15
Bitcoin Recent Low Price Volatility Might Be Deceptive - 21st Apr 15
Currency Wars Back As Russia Buys Gold - One Million Ounces in March Alone - 21st Apr 15
The Greece 'Grexit' Issue and the Problem of Free Trade - 21st Apr 15
Why Europe Lets People Drown - 21st Apr 15
Wealth Destruction for the 99.9 Percent - 21st Apr 15
SNP Publish England's Suicide Note as Pollsters Still Forecast Labour-SNP Election Disaster - 21st Apr 15
Characteristics of Extremely Over-Indebted Economies - 21st Apr 15
Trader Education Week -- a Free Event to Help You Learn to Spot Trading Opportunities - 21st Apr 15
Gold & Silver Alert: Silver Stocks’ Signal - 20th Apr 15
Now is the Time to Buy Resource Stocks, Especially Gold Equities - 20th Apr 15
DJ Transportation & Utility Averages Suggest Stocks Bull Market Is Over - 20th Apr 15
Crude Oil Price Bull Market Hope - 20th Apr 15
Stock Market Bears Get Slaughtered Despite Greece Counting Down to Grexit Financial Armageddon - 20th Apr 15
The Rise of the Paper Machines - 20th Apr 15
Gold and Silver Inflection Point - 20th Apr 15
SP500: A Butcher's Stock Market (Chop Chop Chop) - 20th Apr 15
Are Stock Market Bears Slowly Gaining Control? - 20th Apr 15
Sugar Commodity Price Bear Rally - 19th Apr 15
Avoid the Spread of the Stock Market "China Syndrome" - 19th Apr 15
Stock Market Going Nowhere Fast - 19th Apr 15
An Easy Way to Profit From the Two Biggest Trends in the Stock Market - 19th Apr 15
No Scripture Is Divine, Authentic and Beyond the Creation of the Human Brain - 19th Apr 15

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

The War on Cash!

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.


© 2005-2015 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

Free Report - Financial Markets 2014