By both mainstream economists and the general public the cycle of “boom and bust” is believed to be a tendency inherent in any capitalist economy. The fact that the latest of such cycles, beginning in 2008 (and arguably not having ended), originated in the banking sector and that large banks and bankers ratcheted up huge earnings and bonuses only to cause disaster has implicated banking as representative of the very worst aspects of capitalism – the epitome of uncontrollable greed that ends in catastrophe.
Unfortunately this popular view of the mainstream could not be further from the truth. In fact, with its intimate ties to the state and its special, legal privileges it is hard to imagine a less capitalistic industry than banking. Part of the deception – wilfully inflamed by politicians and their lackeys – is one that engulfs other industries subject to state meddling such as utilities markets. This is the belief that, simply because the participants in the industry in question are private individuals or entities that are not officially part of the state, the enterprise must be classified as part of the free market and saddled with all of the supposed flaws of that system. Very often, however, private companies and brands are simply the public facade of what is essentially a state owned operation or state controlled cartel.
Britain’s railways, for example, are owned by Network Rail, a non-departmental public body with no shareholders. The train operations are parcelled out into geographic monopoly franchises that are awarded to private companies by the state on terms that are dictated by the state – which, apparently, even includes such menial questions as whether a particular train can have a refreshment trolley. The network and all of its operations is, therefore, under the de facto control of the state. And yet when you are stranded for two or more hours on a crowded platform because of delays whose logo is it you see everywhere at the station? Whose name is embossed proudly along the side of the train that you’ve been waiting an age for? Consequently who – and, by extension, which economic system – gets all of the blame for the problems? Why, it is of course those evil private train operators who are part of the free market! This is just as true in the banking sector as it is in the railways. Banking is nothing more than a state run cartel operated in front of the public by private bodies.
The supporting pillar of the banking state cartel is the central bank. Although this body is not always state owned it possesses a key legal privilege which is to be the sole producer of the nation’s money supply. Since 1971 (but in practice much earlier) all of this money in the world has been paper money, irredeemable in and un-backed by any precious metal or market-chosen commodity. This is a very hefty privilege indeed – for who wouldn’t want to have the legal ability to just print money that can be exchanged for valuable goods and services?
The central bank can manipulate interest rates (the most important prices in the economy) and control the volume of money either by changing the reserve requirements of the commercial banks or by making open market purchases (usually of government bonds but since 2008 pretty much any asset) with freshly printed cash. At the very bedrock of the banking system, therefore, is an institution that is blessed not by the voluntary exchanges of individuals but rather by the aegis of the state. This institution would not exist in a genuine, capitalist economy as its powers rely not upon free exchange but upon state enforcement. Money would not be a centralised, state issued ticket on worthless pieces of paper nor would anyone have monopoly control over its production. Rather, money would be a commodity such as gold or silver. No one would be able to simply wave a wand and make gold appear in the way that central banks can make paper money appear, nor could anyone simply do the equivalent of no productive work in order to purchase valuable assets. Rather the bankers, like anyone else, would have to earn their money through productivity that serves consumers. The volume of money in the economy would be regulated not by the central bank’s fiat but by the demand for freshly mined gold from the ground. Interest rates would be set by the demand for and supply of loanable funds (which itself would be determined by societal time preference rates) and not by the arbitrary decrees of monetary policy.
The reason why private banks appear to be the epitome of greed is that they are the channel through which the central bank’s deeds flow. They are the recipients of new money from open-market operations and of new loan-issuing powers when reserve requirements are altered. Credit expansion under the business cycle therefore affects the banking industry first and it is this industry that demonstrates the largest paper gains – all of those huge profits and hefty bonuses – and, consequently, the most catastrophic losses when the inflation stops. And yet the only method of making the fraudulent and destabilising fractional reserve system work, at least for a time, is the monopoly issuance of paper money by a central authority, robbing people of the ability to redeem notes that are over-issued and allowing the banks to inflate continually in concert.
Furthermore, under this system banks are endowed with a special, legal privilege in that they do not have to time their assets in line with their liabilities. When the disaster of “borrowing short” to “invest long” finally unravels who is that steps in to save the day? Why, the cartel-managing central bank of course, in its role as a lender of “last resort”, permitting the private banks to privatise their gains and socialise their losses with a fresh influx of newly printed cash.
Once this fact – recognised in the US as the infamous Greenspan put – is understood by the private banks it will serve only to inflame risky and reckless business ventures. After all, why bother to lend with prudence when you know that someone else will mop up the mess? None of this would be possible in a genuine, capitalist economy where each bank would have to suffer its losses and take full responsibility for the risk in its loan portfolio.
This short description indicates that banking as it is practised today is woefully far from being a capitalist industry. Rather it is an industry that is well and truly in bed with the state, relying on the state for its profits, for the sustainability of its operations and for the absorption of its losses. “Private” banks they may be but a part of the free market? Absolutely not!
Next week’s myth: Price Stability