Has the Market Failed?

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The end of the law is not to abolish or restrain, but to preserve and enlarge freedom. For in all the states of created beings capable of laws, where there is no law, there is no freedom. For liberty is to be free from restraint and violence from others; which cannot be where there is no law: and is not, as we are told, a liberty for every man to do what he lists.

~ Second Treatise on Government, John Locke (1690)

With a certain weary inevitability, the cries of pain emanating from those seeing their aspirations ground to dust amid the current upheaval in financial markets have been interspersed with the shrill descant of those all too eager to proclaim a "crisis of capitalism."

The implication that it is now time for those far-seeing, disinterested Solons in government to step forward once more and to put right what mere "market forces" have again so woefully failed to correct.

High finance, we are told, has become a business of "privatizing profit and socializing losses," a thoroughly inequitable mechanism which the state now has a duty to redress by erecting a whole new framework of Do’s and Don’ts in order to rein in the 21st century’s version of the Robber Barons.

With a breathtaking degree of effrontery, we are even being asked to take seriously the idea that the very institution which has been one of the most culpable in laying the groundwork for the disaster — the Federal Reserve of pre-ordained, baby-step rate rises and skyscraper-ledge rate reductions — should, henceforth, be accorded unparalleled powers of oversight and direction over every facet of our everyday business!

While the initial diagnosis is fairly unexceptionable — since the game of "heads-I-win-tails-you-lose" is precisely what financial market institutions have long been conditioned to play — the corollary is not. Nor is this just because politically opportune Witchfinders General tend to be more guilty of fighting the last war than even the most hidebound of generals; nor because the analogy is decidedly unfair to the original Robber Barons, many of whom grew rich by creating genuine wealth and not simply by living, often obscenely high on the hog, off that generated by others.

No, the whole concept of a "market failure" is a hoary old canard which it is vitally important to dispel for fear that an eager Leviathan will again exploit its subjects’ understandable present anxieties in order permanently to increase its power over their lives and liberties.

If the basic tenets of free-market "capitalism" include the full recognition of property rights, the sanctity of voluntary contract, and the relegation of government to a minimalist role as arbiter — and, reluctantly, as enforcer — of last resort, it can hardly be argued that we have ever actually lived under such a regime.

Indeed, the roots of today’s woes — as of those suffered innumerable times in the past — lie not in whether this or that regulation was sufficiently well-crafted or implemented, but rather go deeper into the issue of whether banking as currently instituted is — in any way, shape, or form — an activity consonant with such principles.

If the very act of asking such a question sounds insupportably radical to modern ears, we would say, in our defence, that we are only following in an honourable, republican tradition which stretches all the way from Jefferson and Jackson to Ron Paul.

Firstly, the ability of banks to create money simply by making a book entry in favour of a borrower, without first asking whether anyone else would be willing to place their previously earned cash at the latter’s disposal, is nothing other than a legalized act of counterfeiting or, if you prefer, an act of "watering" the stock of claims upon the totality of private property; of diluting the existing "shareholders" rights to the social product without their prior consent.

That such a practice of issuing monetary substitutes willy-nilly is the fons et origo of inflation (at least in countries where similarly forcing government liabilities into circulation does not predominate) should need little explanation. What might bear emphasis, though, is that if one considers the state’s indulgence in such crude coin-clipping as a "tax" — i.e., as a legal, if unethical (and often unconstitutional), act of expropriation, one is forced to conclude that the banking equivalent is nothing less than an unauthorised expropriation — in other words, a theft.

Such a crime is no less worthy of outrage simply because it has long been officially sanctioned, even encouraged. Nor is it pardonable because there is no one, single, identifiable victim, for the truth is that we all suffer from such depredations — or, at least, all of us excluding the initial borrower (able to spend the new money before the rest of us realize it should buy fewer goods than it does) and the issuing bankers themselves.

Secondly, the fact that depositors are led to believe that they do not relinquish any rights over the funds they entrust to the banks — when, in fact, they are no more than the unsecured creditors of a commingled holding — leads to the reprehensible business of promising demand account customers instant access to "their" cash, while being fully aware that such a promise is wholly fraudulent since the bulk of this "cash" will be rapidly deployed to "fund" any number of the long term, potentially illiquid ventures being undertaken by the bank’s lending department.

That this "cash" can therefore only be repaid by luring other dupes into the scheme means that the whole businesses has its foundations in a further falsehood, one which seeks to make profit from what is little more than a typically lucrative, if undeclared, actuarial subterfuge.

The fact is that, by some twisted thread of history, banks have been accorded the unjust privilege of being allowed to ignore the absolutely crucial lines of demarcation between four, wholly beneficial, but utterly distinct, roles.

Monies given into their possession in their guise as "giro," or transmission, agents, or as the custodians of what are, today, largely virtual safety deposit-boxes, are one thing: quite another are the resources entrusted to them in their equally laudable function as asset managers whose job is profitably to invest their customers’ term deposits in a range of what are presumed to be creditworthy ventures.

A third — individually irreproachable — business is that of facilitating the raising and transfer of capital between customers; mobilizing savings, large and small, in order to fund entrepreneurial attempts at wealth creation, whether through arranging trade finance or by bringing issues to the bond and stock markets.

Finally, there is no intrinsic demerit to bankers speculating either with their own capital or, indeed, with that of those clients who are fully cognizant of the fact that their money will be used to bankroll an attempt to outguess other traders and to pre-empt changes in the valuation of securities, currencies, or commodities.

The underlying problem is that banks have been granted the right indiscriminately to mix all four of these often incompatible activities. This gives rise to an unhealthy promiscuity, corrupting their fiduciary duties, introducing irreconcilable conflicts of interest, and opening up countless opportunities for a wholly legal embezzlement which has a small, but significant, chance of going horribly awry — as today’s events have once more forcibly brought home.

Moreover, this is a world in which banking "capital" is a veritable Cheshire Cat of insubstantiality (since banks are unique in having little but their own debauched "money" on both sides of the balance sheet). That "capital" is most easily increased by means of the notional profit booked on a deal — a profit which is often no more than a deliberately optimistic, upfront reckoning of many future years’ prospective income and, so, is one which is subject to a whole array of possibly unjustified, "modelling" assumptions.

As ethereal as this gain might turn out to be, the fact is that, for as long as this fiction can be maintained, it strongly induces banks to lend and re-lend against the collateral afforded by the very same assets which have most appreciated under the influence of their original loans, thus ensuring that they re-attain the maximum permissible degree of leverage and hence most flatter their returns on equity.

This powerful positive feedback — one whose underlying fuel is the banks’ unnatural ability to create money, simply by granting loans — means that they are rewarded (at least while things are in the upswing) for reinforcing any resulting instabilities. Thus, they frequently find themselves turning the most innocuous of convective puffs into a raging hurricane of wasteful malinvestment.

What this implies is that fractional reserve banking not only gives rise to a fall in the value of money, per se, but it is also the well-spring of that thoroughly avoidable and widely destructive bipolar disorder we know as the business cycle — i.e., the boom and the bust itself — and so gives the main impulse to those periodic, lemming-like waves of folly which so mar the history of material progress.

While this indictment would seem to suggest that — as those now waving pitchforks and mattocks on the intersections of Wall St. are noisily demanding — banks should be subject to an unusually strict scrutiny in place of the rather lax regime prevalent of late, the truth is that no special rules whatsoever are necessary: on the contrary, all that is needed is for the same basic principles of law to apply to banks as to any other commercial enterprise, in a manner that they have never done heretofore.

Those who would deny the validity of this last contention might reflect upon the fact that the very existence of legal tender laws, government-administered deposit insurance schemes, and — a fortiori — public sector "lenders of last resort" reveals the inherent invalidity of the banks’ logical, economic, and jurisprudential position, despite centuries of positivist legal precedent and state-sanctioned privilege.

It should be obvious by now that none of this has anything to do with "capitalism," properly defined, but rather is something more common to the practice of rent-seeking despots — whether those of the ancien rgime, or of our modern elective dictatorships.

Without the honest money which presupposes a system of 100% specie reserve, free banking with no second recourse — should bankruptcy still occur — to its victims’ property via forced taxpayer restitution or compensatory central bank inflation, there can be no truly free market and hence no "capitalism" to let us down so badly. Instead, what we are suffering is yet another demonstration of the perils of state intrusion into the sphere of private relations, with all the perverse disincentives it entails and with all the faulty signals it gives off to businessmen and consumers alike.

In fine, what we are having to endure is the latest example of the many crises brought on by financial corporatism — a sorry situation which will neither be remedied nor prevented from re-occurring in future by succumbing to the panic and taking measures which will only serve to strengthen the stranglehold already exerted upon our lives by a voracious, interventionist bureaucracy; measures which would only come at the expense of that genuine freeing of the economic realm which would most rapidly heal our present hurts and so assure our continuing prosperity.

Sean Corrigan [send him mail] writes from Switzerland.

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