Where do we go from here? A journalist’s questions…

January 21st, 2009

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We were asked for comments by a journalist. Here are the questions and our answers…

Is this the intellectual failure of mainstream economics, as some have argued?

We believe that at the root of this Global Financial Crisis (GFC) lies the moral failure of humanity. Through this moral failure, the world is allowed to get carried away and believe in what it wants to believe. Mainstream economics provide the intellectual framework for this belief. Strip away this faulty intellectual framework and one will be able to see clearly how humanity is magnificently capable of self-deception. As we wrote in Is this the beginning of the loss of confidence in fiat money?,

Is this crisis a surprise? If you listen to the mainstream economic schools of thought, central bankers, mainstream financial media, captains of the financial industry and so on, it looked as if this looming financial disaster is something that no one can see coming. The common underlying excuse (that was un-said, un-written but implied) goes something like this: ?No one could ever foresee this! It?s impossible! Only hindsight can tell!?

Now, we would like to make it clear that this is completely false. Please note that we are not accusing individuals of lying. Instead, our point is that this excuse is a sign of collective mass delusion. If you look at the 6000 years worth of the history of human civilisation, you will find that humanity is repeatedly capable of mass delusions.

Has the global financial crisis brought to a head a growing dissatisfaction with the corruption of money, as is also being argued in some quarters?

Let recall a story as mentioned in Understanding the big picture in the inflation-deflation debate,

In one of the movies about Marco Polo, it showed a scene whereby Marco Polo was astonished to see his Chinese slave exchanging goods for pieces of paper:

He ask, ?What are you doing??!!!??

His slave replied, ?I am buying something.?

?But money is gold and silver! How can a piece of paper be money?!?!?

If you lived back then, it was obvious why money should not be pieces of paper backed by nothing. Firstly, such money is vulnerable to forgery. Secondly, it can be re-produced at almost no cost. Thirdly, as we said before in Recipe for hyperinflation, the integrity of such money depends on the integrity of the authority that issues it.

Today, the world runs on a fiat monetary system in which money enjoys legal tender status through the authority of the government instead of through the choice of the free market. In today’s credit system, money has become intangible, imaginary and hard to define, to the point that its supply (‘quantity’) can be inflated and deflated from thin air by central banks and the financial system. Currently, the global financial system (private sector), through debt defaults, de-leveraging and so on, is contracting the quantity of ‘money’ (deflation) while governments and central bankers are trying to do the opposite (inflation). The result of such government intervention is extreme volatility in prices. Once this happen, money can no longer function as a yardstick for unit of accounting and store of value. For example, take a look at oil prices from July 2008 till today. Such extreme volatility cannot be simply explained with traditional economic model of supply and demand, which assumes that the integrity of ‘money’ trusted. Once this integrity is broken, prices can no longer convey vital information to the free market. Without this information, the free market breaks down and no long-term planning can be performed (see Real economy suffers while financial markets stuff around with prices).

As long as governments keep on intervening, the situation will get worse and the dissatisfaction will grow.

Will things ultimately stay in the same after some adjusting, or will  the global economy (and the Australian economy) look dramatically different in 12 (24) months time?

We doubt the status quo can be maintained. The genie is already out of the bottle. In due time, we believe the global economy will be very different. The only thing we are not sure is the time-frame. Today’s GFC is the accumulation of decades of unsound monetary system, starting from the severing of the final link between the US dollar and gold in 1971. That breakdown was accelerated after 2001, with Alan Greenspan’s unsound monetary policy.

If it?s true that laissez faire capitalism was given its head to a dangerous degree, what needs to be done now – and can we trust governments and central banking systems to get it right?

Firstly, the laissez faire capitalism was not really laissez fair in the first place. As we explained in What cause booms and busts? Introduction to the Austrian Business Cycle Theory,

If we generally let market forces set the price of things (e.g. stocks, consumer goods, bonds, real estates, etc), then why is it that the price of money (interest rates) should not be chosen by the market? Does the central bank know better than the market to set the ?right? price of money?

We have a centralised command economy (for the price of money) in the midst of a laissez faire free market. True laissez faire will not give so much power to one man (Alan Greenspan) to mismanage. The worst thing we can do is to give more power to the government. Alan Greenspan set the price of money to be too cheap for too long. Credit became too cheap and too easy to get. Obviously, supply more cheap credit is the wrong medicine. The GFC is a correction to what had been distorted for too long. Government interventions to prevent this distortion will prolong the agony and cause other unintended side-effects.

How do you regulate better?

Today, there is one country totally unaffected by the GFC. That country has the most stringent regulation in the world. That country is North Korea.

How does bailing out banks and businesses make sense?

In a free market, the incompetent businesses will go bankcrupt and cede control to the competent. By bailing out businesses and banks, the government is giving an unfair advantage to the incompetent. This introduces moral hazard by rewarding incompetency. As we all know the rest of the story, communism became a failed experiment.

What happens when the bailout money runs out?

Remember, the world is running on a fiat monetary system. ‘Money’ will not run out as long as governments are willing to do whatever it takes to destroy its integrity. Already, Bernanke and company have already thought of what it means by “whatever it takes” (see Bernankeism and hyper-inflation). He once said this,

The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning.

What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

And what happens to those in the finance world who have done nothing but take risks and do the deals that make the money…how will they cope?

As we questioned before in The myth of financial asset ?investments? as savings,

Can the printing of money, which spawns the growth of an industry to shuffle it, cause a nation to be richer in the long run?

Real prosperity lies in real capital formation and the accumulation of capital goods. Shuffling of ‘money’ is not the path to long-term sustainable wealth. The GFC clearly shows it. It’s time the world gets back to the honest basics.

Who?s MAKING money now (apart from those running insolvency practices)?

There will be bound to be some smart (or lucky) short-term traders who profit from all these volatility. But look at the big picture, no one benefits in a depression- everyone’s standard of living will decline. In such a day, ‘money’ becomes meaningless.

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