The failure of interventionism

Government policy response to the current economic crisis involves two false assumptions which cannot withstand critical scrutiny. It assumes that the problem originates in "unregulated markets", rather than in monetary policy. And it assumes that government can make the situation better.

The argument in favour of individual planning of economic activity through markets, rather than central planning through governments, is that central planning cannot avoid gross unintended surpluses and shortages in all the wrong places. Since the boom and the bust are evidence of exactly such gross surpluses and shortages, let us try a thought experiment.

Let us for a moment suspend any assumption that the crisis could not have originated with government policy, and instead ask: “How could manipulating the money supply, and in particular lowering interest rates, cause the symptoms we are witnessing?”.

Governments cause inflation

If we gave John Jones a licence to print and spend money, he would endlessly print and spend, wouldn’t he?

Well governments are intrinsically inflationary for exactly the same reason. All the instruments and institutions of monetary policy have in common that they give governments power to inflate the money supply.

Printing paper money or lowering interest rates is the same economically as counterfeiting. It works by skimming a fraction from everyone who uses money.

But the worst effect is not mere rising prices, nor even the direct fraud involved. Inflation causes the cycle of economic booms and recessions, and consequential injustice.

To understand how the process begins, we need to understand the difference between money and money substitutes. Banknotes were originally not money, but money substitutes: paper claims to real money - gold - in the bank.

If there is always 100 per cent gold on deposit to redeem all the banknotes, no issue arises. The problem is when banks issue money substitutes - banknotes or loans, say - in excess of the real money they hold in reserve. Then if everyone claims their real money at the same time, someone must miss out. This is where “bubble” problems originate.

In a market unhampered by government interventionism, banks that issued money substitutes in excess of real money on deposit, without the knowledge or consent of the relevant depositor, would be breaking the laws of contract and fraud. The market would eliminate them through loss, bankruptcy, and depositors withdrawing their deposits.

But to promote inflation, governments use their monopoly powers to permit, encourage, and even require banks to lend out in money substitutes more than the real money they actually hold in reserve.

But it gets worse. Governments have long since (forcibly) replaced society’s preferred real money with fiat paper money - based, not on gold, but on politicians’ promises. Which do you trust more?