Best of the Week
Most Popular
1.Crude Oil Price Trend Forecast 2016 Implications for Stock Market - Nadeem_Walayat
2.Odds of Winning Walkers Crisps Spell & Go olidays K, C and D Letters - Sami_Walayat
3.Massive Silver Price Rally During The Coming US Dollar Collapse - Hubert_Moolman
4.Pope Francis Calls For Worldwide Communist Government - Jeff_Berwick
5.EU Referendum Opinion Polls Neck and Neck Despite Operation Fear, Support BrExit Campaign - Nadeem_Walayat
6.David Morgan: There Will Soon Be a Run to Gold Like You've Never Seen Before - Mike Gleason
7.British Pound Soars on BrExit Hopes Despite Remain Establishment Fear Mongering - Nadeem_Walayat
8.Gold Price Possible $200 Rally - Bob_Loukas
9.The Federal Reserve is Not Going To Raise Interest Rates and Destroy Gold - Michael_Swanson
10.Silver Miners’ Q1’ 2016 Fundamentals - Zeal_LLC
Free Silver
Last 7 days
David Cameron Questioned on Out of Control Immigration at TEN TIMES Conservative Election Pledges - 30th May 16
Bitcoin Price Skyrockets And Is Now Up More Than 100% This Jubilee Year - 30th May 16
This Is Not The America My Parents Immigrated To In 1957 - 30th May 16
“Debt, Not The Economy, Reaches Escape Velocity” With Graham Mehl - 29th May 16
EU Referendum, Black Vote LEAVE or REMAIN? Which is Worse for Racism for Britain's Ethnic Minorities? - 29th May 16
Billionaire Gross: Jubilee Debt Relief as Prelude to New Global Economic Order - 29th May 16
Wargaming North Korea - Assessing the Threat - 29th May 16
EU REMAIN Population Forecasts - England 4.1 million Explosion, London Migration Crisis - 28th May 16
A Guide to the Trump-Sanders Debate - 28th May 16
Gold And Silver – At Significant Support. New “Story” Developing - 28th May 16
The Next Systemic Lehman Event - New Scheiss Dollar & Gold Trade Standard - 27th May 16
Energy and Debt Crisis Point to Much Higher Silver, Metals Prices - 27th May 16
Gold Junior Stocks Q1 2016 Fundamentals - 27th May 16
These Crisis Markets Are Primed to Deliver Big Gains, Platinum Never Cheaper! - 27th May 16
Operation Black Vote BrExit Warning for the Wrong EU Referendum - 27th May 16
UK Immigration Crisis Hits New Extreme, Catastrophic ONS Migration Stats Ahead of EU Referendum - 27th May 16
Many of the World’s Best Investors Made Their Fortunes This Way…And You Can Too - 27th May 16
The Ugly Truth About Stock Market Manipulation and Gold Prices - 27th May 16
Gold Price Looking Vulnerable While Gold Stocks Correct - 27th May 16
The 5 Fatal Flaws of Trading - 27th May 16
The Next Big Crash Of The U.S. Economy Is Coming, Here’s Why - 27th May 16
A New Golden Bull or Has the Market Gone Too Far Too Fast? - 27th May 16
It Feels Like Inflation - 26th May 16
Negative Interest Rates Set to Propel the Dow Jones to the Stratosphere? - 26th May 16
S&P Significant Low has Occurred – Not Likely! - 26th May 16
Statistics for Funeral Planning in UK Grave - 26th May 16
Think Beyond Oil And Gold: Interview With Mike 'Mish' Shedlock - 26th May 16
Hard Times and False Mainstream Media Narratives - 26th May 16
Will The Swiss Guarantee 75,000 CHF For Every Family? - 26th May 16
Is There A Stocks Bear Market in Progress? - 26th May 16
Billionaires Are Wrong on Gold - 26th May 16
How NOT to Invest in the Gold Market - 26th May 16
The Black Swan Spotter...Which Saw the Oil-Crash coming; now says the “Invisible Hand” will push Brent to $85 by Christmas - 26th May 16
U.S. Household Debt Still Below 2008 Peak - 25th May 16
Brexit: Wrong Discussion, Wrong People, Wrong Arguments - 25th May 16
SPX is at Strong Resistance - 25th May 16
US Dollar, Back From the Grave? - 25th May 16
Gold : Just the Facts Ma’am - 25th May 16
The Worst Urban Crisis in History Could be Upon Us - 24th May 16
Death Crosses Across The Board Are IRREFUTABLE Stock Market Sell Signals - 24th May 16
Bitcoin Trading Alert: Bitcoin Price Stays below $450 - 24th May 16
Stock Market Crash Death Cross Doom Prevails - 23rd May 16
Did AMAT Chirp? Implications for the Economy and Gold - 23rd May 16
Stocks Extended Their Rebound On Friday - Will They Continue Higher? - 23rd May 16
UK Treasury Propaganda Warns of 3.6% Brexit Recession, the £64 Billion Question? - 23rd May 16
Stock Market Support Breached, But Not Broken! - 23rd May 16
George Osborne Warns of 18% Cheaper House Prices - BrExit for First Time Buyers - 22nd May 16
Gold Bull-Phase I Continues to Confound (The Trek to “Known Values”) - 22nd May 16 r
Avoiding a War in Space - 22nd May 16

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

Why 95% of Traders Fail

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.


© 2005-2016 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

Catching a Falling Financial Knife