Economic Myths #5 – Banking is Capitalist

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By both mainstream economists and the general public alike the cycle of “boom and bust” is believed to be a tendency inherent in any capitalist economy. The fact that the latest such cycle, resulting in the seemingly endless stagnation that we are enduring now, originated in the banking sector and that large banks and bankers ratcheted up huge earnings and bonuses only to cause disaster has implicated banking to represent the very worst aspects of capitalism, motivated by uncontrollable greed that ends in destruction.

Unfortunately this popular view of the mainstream could not be further from truth. In fact with its intimate ties to government 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 government meddling such as energy; that simply because the participants in the industry are private individuals or entities and are not officially part of the government means that 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 facing part of what is essentially a government operation or a government controlled cartel. Britain’s railways, for example, are owned by Network Rail, a statutory corporation with no shareholders; the train operations are parcelled out into geographic monopoly franchises that are awarded to private bodies by the government. The network is, therefore, under the de facto control of the government. And yet when you are stranded for two 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 for and who – and, by extension, which economic system – gets all of the blame for the problems? This is just as true in the banking sector as it is in the railways. Banking is nothing more than a government run cartel operated in front of the public by private bodies.

The supporting pillar of this government cartel is the central bank. Although this body is not always government 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 and unbacked 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 the very thing 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 purchases and exchanges of individuals but rather by the aegis of government. This institution would not exist in a genuine, capitalist economy as its powers rely not upon free exchange but upon government enforcement. Money would not be a centralised, government issued ticket on worthless 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 they, 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 and not by the arbitrary decree 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. 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 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 its risky ventures.

This short description indicates that banking is woefully far from being a capitalist industry. Rather it is an industry that is well and truly in bed with government, relying on government 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!

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The Choice Illusion

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In the mainstream debate both for and against a free market, one argument that appears continuously is that the free market is predicated upon choice and the ability of the individual to choose. Those in favour will argue that more choice promotes competition and increases the freedom of the individual to meet his ends, and so the increasing of choice and stifling of monopoly wherever it appears is a good thing. Opponents will counter that choice can be wasteful, costly, inefficient and overwhelming particularly when it concerns supply of provisions as basic as water, and, furthermore, that often the appearance of choice is merely an illusion conjured up by private companies that basically operate in a profit-maximising cartel.

Wading into this debate as a libertarian we can see that the basic statements on each side are not incorrect. However they either overlook or misunderstand the true nature of choice in a free society. The kernel of truth in the pro-choice argument is that voluntary behaviour, expressed through choice, leads to market outcomes that provide the most benefit to the consumer. But such an advocacy is formal only – people choose voluntarily not only which suppliers they are willing to patronise, but also the extent of choice itself in a particular industry is the outcome of voluntary action. In some industries, for example, particularly those that are growing and innovative, consumers are willing to support multiple suppliers with a large range of different products and all of these may be viable. We might say that smartphone manufacturing is representative of this kind of industry. In other industries, however, which are perhaps maturing or consolidating and reaching the end of their innovative stage, the benefits to be gained from economies of scale and simple and straightforward products with little differentiation might be what consumers desire. This is particularly true of the supply of commodities where the only differentiation is price and the only benefit to consumer can be reduced costs. This kind of supply naturally lends itself to one or only a bare handful of suppliers and choice in such an environment may be reduced to minor differences in customer service but is otherwise likely to be stressful, wasteful and unnecessary.

However, pro-choice advocates often are not arguing in favour of this formal meaning of choice, but rather they assume and press ahead for a choice that is substantive. In other words, for every single industry there must, necessarily, be several suppliers from which a consumer can choose, however basic the product and however costly the splintered operations. We have already examined the economic fallacies of this belief from the point of view of competition law and the shibboleth that increasing competition is always a boon to the consumer. However, it is also a dangerous ruse that can be used to create nominal or illusive choice while preserving an overarching government monopoly or control that allows government favoured private companies to line their pockets, at the same time allowing all of the blame for the waste and inefficiency to be directed not to the governmental element but to the “free market” vestige of the particular industry. In the UK the privatisation frenzy of the Thatcher and Major governments was often justified by the need to give “choice” and “competition” to the consumer. Britain’s railways for example, are now “privatised” and whenever you board a train there will be a private company’s logo emblazoned on the carriage and you will see front line members of staff wearing uniforms that indicate their representation of these private companies. But the track, stations and signalling are wholly owned by Network Rail, a statutory company that has no shareholders and is under the de facto control of the government. The train operations themselves are not subject to the forces of natural competition but are parcelled out by the government into geographical monopoly franchises to private companies chosen by the government and who, with the government’s blessing, are allowed to operate the franchise for a set number of years before they must retender. This cauldron of public and private activity blended together led to the UK’s railways being judged the worst in Europe from the point of view of cost and efficiency in early 2012. Yet it is “privatisation” and “competition”, those fancy public-facing corporate logos on the timetables and uniforms, that are lumbered with the blame, rather than the government string-pulling. The energy industry is just as bad, if not worse. The electricity infrastructure is owned by National Grid, with six dominant, government-licensed suppliers sending their product through the same wires in what is a ridiculously regulated and cost-heavy sector that is not only seeing rising prices for consumers and talk of fuel poverty but is also on the verge of collapse. Indeed the Soviet-style description of the regulatory framework by Energy UK, the industry’s trade association, only scratches the surface but it is a succinct summary:

The electricity and gas markets are regulated by the Gas and Electricity Markets Authority, operating through the Office of Gas and Electricity Markets (Ofgem). Ofgem’s role is to protect the interest of consumers by promoting competition where appropriate. Ofgem issues companies with licences to carry out activities in the electricity and gas sectors, sets the levels of return which the monopoly networks companies can make, and decides on changes to market rules.1

All of this is before we even go near the odious and destructive high street banking cartel.

Given all of this is, is it any surprise that people lay the blame for poor service, for high costs, for inefficiency, for waste, and for private companies lining their pockets at the door of free marketers’ obsession with choice and competition? Is it any surprise that, not realising that it is the underlying control and forcing of substantive choice to the benefit of its favoured friends in “private” industry, that there are calls for renationalisation of public communications networks and utilities? There is a strong case to be argued, not only from the point of view of its danger to the reputation of the free market but also from that of the level of service offered to consumers, that private companies operating government controlled services is often worse than explicit and outright nationalisation.

As libertarians who cherish the free market our devotion to choice is encapsulated by our commitment to voluntary behaviour and interaction and is only a subset of this wider concept. We do not mean a controlled and enforced, substantive choice in every industry, nor do we mean the illusion of choice created by the government that rips off the consumer and leaves the free market to bear the brunt of their ire. Leave the consumers alone entirely to express their preferences through voluntary action. Leave them alone to determine how much choice they want. Only then will we see industries that are genuinely able to meet the needs of consumers with ranges of products that are suitable to their ends at prices that they are able to afford.

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1http://www.energy-uk.org.uk/energy-industry/the-energy-market.html. Emphasis added.

Leave me out of it!

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Debates between libertarians and those who advocate any kind of statist intervention, whether it be relatively minarchist or all the way up to full blown socialism, frequently take the form of “X should not happen vs X should happen”. For example a budding libertarian might argue “the post office should be privatised” whereas his opponent would concentrate on saying “the post office should be state owned.” Lost in these kinds of exchanges are the fact that libertarianism, and all political philosophy in general, is a set of norms concerning the application of violence and nothing more (or more specifically, all political philosophies are theories concerning where, when and by whom the violent enforcement of rights over property is permissible). Libertarians are not, therefore, against any kind of organisation such as Government per se, or even against socialisation or communism. Their strenuous objection is to the fact that these institutions use violence to enforce their ideals in ways that contravene the libertarian prescriptions. There is nothing wrong with anything the Government does, merely the fact that people are forced to obey it and pay for it through their taxes.

With this in mind then, let us suggest some novel retorts in debates that may cause one’s opponent, whether they are part of the statist intellectual bodyguard or merely the average Joe expressing an opinion, to sharpen his/her mind towards consideration of the fact that what they are really asking for is unilateral, violent enforcement by the State.

1. Healthcare.

Statist: “All healthcare should be run by the Government. It should be free. The NHS is a great thing”.

Libertarian: “I have no problem whatsoever with you paying into something called the “National Health Service” if you want to alleviate the burden of you falling ill. But why do you want to force me to do it as well when I don’t want it?”

2. Roads

Statist: “Of course we need Government to build the roads!!!”

Libertarian: “If you want to pay the Government to build your roads then go ahead and do so. I, however, would like to patronise privately built roads and I won’t go anywhere near the roads that you are paying for. Why do you want to force me to pay for the roads that you want when I don’t want to force you to pay for the ones that I want?”

3. Railways

Statist: [Ignoring the fact that Britain’s railways are emphatically not privatised]: “Bring back British Rail! The railways should be Government owned!”

Libertarian: “I’m perfectly happy for you to choose to pay this organisation that you call “Government” to run railways you want to travel on. But I don’t want to travel by train. Why must I be forced to support them?”

4. Police

Statist: “Of course you need Government! What would happen to crime if there wasn’t the police!”

Libertarian: “If you wish to make contributions to the Government’s policing so that they will protect you from crime then go right ahead. I really don’t want to stop you at all, it’s your money. But I would rather pay someone else to protect me from crime. Why do you want to force me to pay for your preferred provider and not mine?”

5. Taxes

Statist: “Taxes should be raised to provide vital funding for important Government functions”.

Libertarian: “If you want to write a cheque to the Treasury then go right ahead, the freedom is all yours. But why are you forcing me to pay for an organisation that I despise and want to have nothing to do with? I’m perfectly happy to let you spend your money just the way you want it, but when I want to spend my money just the way I want it you’re saying I should be thrown in jail! Why?!”

6. Industry

Statist: “All industries should be nationalised and run for the people, not for greedy profit-seeking shareholders”.

Libertarian: “It’s perfectly fine for you to pool all your money and your possessions and set up socialised industry with like-minded people. There is absolutely nothing wrong with mutual organisations, co-operatives, or even communes if that’s what you want to do with yourself. But I want to invest my money in profit-making industry and earn a return on my investment. I’m more than willing to leave you alone to do what you want with your money, just leave me alone to do what I want with mine.”

No doubt many other examples could be imagined by the reader, but in short your reply to all of them is “just leave me out of it!” The key effect is to cause your opponents to realise that, whereas you, the libertarian, are advocating peaceful co-existence and have absolutely no problem with organisations that they may advocate, they, on the other hand, are arguing for the violent imposition of what they want on you. Probably not many who argue in favour of statist intervention understand that they are, in fact, proposing a solution of violence to society’s alleged ills and that they are, therefore, thoroughly violent people. So next time you, as a libertarian, are stuck in such a debate, see how kindly your opponent takes to the realisation that, when laid bare and shorn of any fanciful rhetoric, their arguments are advocating nothing more than for society to be run by guns pointed at the many by the few.

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