Crisis and Conflicts – the Legacy of Central Banking


We are in yet another financial crisis and involved in yet another war. How long will it last? Who will be the winners and who will be the losers? What can we do about it? The politicians, bureaucrats and experts all have a view on how to solve the problem now and how to prevent the problem from re-occurring in the future. For the most part they propose more of the same statist solutions that brought us to this point in the first place. In a speech given Tuesday July 9, 2008 at an FDIC forum on mortgage lending held in Arlington, Virginia Federal Reserve Chairman Ben Bernanke called for more Fed responsibility and regulatory authority over the financial industry. Then within a week after making that statement the Fed and the US Treasury nationalized Fannie Mae and Freddie Mac, the nation's two largest funders of residential mortgages.

Few if any place the blame where it belongs – government intervention in the private economy and society – and fewer still call for drastic scaling back and elimination of government laws, regulations and spending. Virtually no one advocates getting rid of the central bank monopoly of the Federal Reserve System in the United States or central banks in other countries which are one of the primary causes of our financial crisis as well as our international conflicts.

The establishment is beginning to question whether or not a private system makes more sense then the current system. In an article published in the Financial Post November 8, 2007, Benn Steil, Director of International Economics for the Council on Foreign Relations, says that private money is a real possibility if the United States does not "return to long term fiscal discipline."

As for the United States, it needs to perpetuate the sound money policies of former Federal Reserve chairmen Paul Volcker and Alan Greenspan and return to long-term fiscal discipline. This is the only sure way to keep the United States’ foreign creditors, with their massive and growing holdings of dollar debt, feeling wealthy and secure. It is the market that made the dollar into global money – and what the market giveth, the market can taketh away. If the tailors balk and the dollar fails, the market may privatize money on its own.

Mr. Steil goes to on to say

…private gold banks already exist, allowing account holders to make international payments in the form of shares in actual gold bars. Although clearly a niche business at present, gold banking has grown dramatically in recent years, in tandem with the U.S. dollar’s decline. A new gold-based international monetary system surely sounds far-fetched. But so, in 1900, did a monetary system without gold. Modern technology makes a revival of gold money, through private gold banks, possible even without government support. (See the complete article in Steil, Benn "The End of National Currency.")

While it is arguable whether or not the monetary policies of Messrs. Volcker and Greenspan were sound (many point the finger of blame at Greenspan for today's financial problems), it is wishful thinking to believe for one second that government and their financier, their central banks, will maintain long-term (or even short-term) discipline in spending and creating money. Their track record to date is relatively poor. The appetite of politicians, bureaucrats and governments for expansion of power and spending is too great to resist and the bureaucrats at central banks are all too ready to accommodate the demands of the government and the politicians. It is the reason the World's economy has been on a course toward economic disaster since the flood gates of fiat currency (paper money and electronically created money) were opened in 1913 with the passage of the Federal Reserve Act in the United States.

The creation of money and management of the monetary system should be returned to a free (free from government intervention) private marketplace in the United States and other countries. Our property, our wealth and our lives should not be entrusted to government bureaucrats who bow and bend to special interests rather than satisfy private consumers' demands. Let the private free market determine what consumers want, what will be money and how the monetary system will function as the private market does with other products and services provided in the private marketplace. We would not think of the government providing our groceries so why do we allow the government to provide and manage something as important as our monetary system? It is time to privatize money and close down government sponsored central banks in the United States and other countries and end the government monopoly of creating and managing the monetary system which has brought the world financial system to near collapse and allowed the previous century to be one of the bloodiest in the history of mankind.

Just as many of the businesses and assets of the state and state-owned enterprises have been privatized around the world as political leaders accept the obvious – state ownership and operation of business is inefficient and is not capable of meeting consumer demands in a growing globalized economy. So why not privatize money and banking? Historically money and the monetary system have been private (using gold, silver and other precious commodities) with periods of government intervention to bail out less reputable bankers engaged in fractional reserve banking and fiat credit creation.

It was not until the Twentieth Century that the world abandoned almost entirely private money in favor of a government-sponsored central-bank-operated monetary system consisting of numerous national fiat currencies (paper currency with little or no backing by tangible assets such as gold) and fractional reserve requirements (banks having less than 100% of their demand deposit reserve requirements). Not surprisingly we have had one central-bank-created crisis after another in the Twentieth Century – the Great Depression which began in 1929 and lasted well over 10 years, the devaluation of the US Dollar in 1971, the Latin American crisis in the 1980s, the American stock market collapse in 1987, the American savings and loan crisis of the late 1980s, the Asian crisis in the 1990s as well as the Russian and Turkish crises, the dot com crisis of 2000 and now the sub-prime crisis which began in 2007 as well as many other lesser-known financial crises, not to mention a history of international and regional wars in the Twentieth Century made possible through central bank credit expansion.

Historically banks and bankers were entrusted with the storage of an individual's or company's money (usually gold) just as grain silos were entrusted with a farmer's grain harvest. The depositors were issued pieces of paper (receipts) evidencing the quantity of money being deposited with and held by the bank. The receipts were then used as substitutes for the gold on deposit to make payments for goods and services. The banks were obligated to have 100% of the depositors’ money available on demand (demand deposits) and insulated from liability (the money on deposit belonged to the depositor not the bank) in the event of a bank’s insolvency. These are called demand deposits. In addition banks borrowed money in the form of time deposits and the depositors became creditors of the borrowing bank. When bankers began to issue receipts evidencing more on deposit (demand deposits) than had been deposited at the bank (fractional reserve banking) without approval of the depositor, the bank had in effect borrowed the depositor's money without the permission of the depositor and used it for the purposes of the bank or the banker. When the unauthorized borrowing became evident to all or many of the depositors the bank most likely collapsed as all the depositors sought to demand the gold on deposit at the bank.

With the advent of the Federal Reserve System, fractional reserve banking became systemic and the norm in the United States, and banks were no longer required to have 100% reserve backing for demand deposits (banks have less than 10% reserves). The unauthorized borrowing by the bank was made legal. As many Americans found out during the Great Depression in the 1930s and during the savings and loan crisis in the late 1980s, banks simply did not have reserves sufficient to cover all the money deposited in demand deposit accounts. Rather than identify the cause of the problem and implement the cure by eliminating the Federal Reserve and fractional reserve banking, the politicians and the bureaucrats in 1933 came up with another government program and agency – the Federal Deposit Insurance Corporation (FDIC) which would ensure a fraction of the deposits at banks in the banking system in the event of a bank's insolvency. But the FDIC is not capable of insuring all the demand or other deposits on deposit at the nation's banks either.

No end of money has been available to finance through fiat currency the huge expansion of governments around the world for social welfare programs and to finance one of the bloodiest centuries in our history – two world wars, countless regional wars including the Korean conflict, the Vietnam war, the Gulf war, the war in Bosnia, wars in Africa, the Afghanistan wars involving the former Soviet Union and now involving the countries of Europe, the United States, Australia and other nations, the war in Iraq and the international war on terror. The list goes on and on in country after country. Such a huge waste of human life and unnecessary destruction of human society and property. Had the citizens of any of the countries involved been asked to vote on financing these wars through payment of substantially higher taxes (rather than the stealth taxation of central bank fiat credit and the resulting inflation) or substantially higher prices for goods and services (resulting from inflation of the money supply) what would have been the obvious answer? No truly private free market monetary system would have been capable of defying such consumer reaction.

Anyone who knows economics, in particular the Austrian economists, and knows the history of banking knows the inevitable result of credit expansion perpetuated by central banks especially the central bank of the world's largest economy – a continual international financial crisis and expansion of government. The great worldwide depression of the thirties, the Nixon devaluation of 1971, the stagflation of the seventies, the American savings and loan crisis of the late 1980s, the Latin American and Asian crisis of the nineties, the bursting of the dot com bubble in 2000 and now the sub-prime crisis are just a few of the better-known financial crises of the Twentieth and Twenty-First Centuries. Unless there is a change we are sure to have more financial crisis and more wars.

In his treatise on the subject entitled Money, Bank Credit and Economic Cycles, Jesus Huerta De Soto describes in detail the history of banking from ancient Greece to modern day bankers. In example after example down through the ages he describes the attributes of the reputable banks and bankers who maintained 100% reserves of demand deposits and the less reputable banks and bankers, who often with the assistance of government central banks, sail close to the edge using fractional reserve banking and central bank printing presses to artificially inflate the supply of money. The less reputable bankers frequently encouraged by the state to inflate almost always ended up insolvent and sought state protection. As de Soto says

When bankers first began using their depositors' money, they did so shamefacedly and in secret,…. At this time bankers were still keenly aware of the wrongful nature of their actions. It was only later, after many centuries and vicissitudes, that bankers were successful in their aim to openly and legally violate the traditional legal principle, since they happily obtained the governmental privilege necessary to use their depositors' money (generally by granting loans, which initially were often given to the government itself).

The state central bank always makes things worse as they expand (inflate) the money supply which inevitably causes the economy to collapse. Asset values and the prices of goods and services rise vis–vis the fiat currency as it falls in value. For example in August 2007 when the malinvestments (in particular what is referred to as the sub-prime investments) caused by the credit expansion became obvious, asset values began to immediately correct and fall temporarily (except US real estate values which continued to fall as a result of massive loan defaults resulting from the sub-prime fallout), stopped only by the actions of the Federal Reserve in coordination with other central banks which made more money available to the financial system to prevent financial institutions from going into insolvency. In other words the central bank policy was to continue with the action that caused the problem in the first place and not allow the correction (which is required to eliminate the malinvestments) to occur. Not surprisingly the prices of international commodities continued to skyrocket as a result of the central banks' actions while the politicians avoided reality by blaming the speculators.

While there are any number of excuses to explain the financial crisis, the failure of the banking system and the contraction of the economy, it is only the Austrian economists who provide a real understanding and explanation of the cause of the problem – government central bank fractional reserve banking, the inevitable fiat currency expansion (inflation) which follows and the just as inevitable correction (recession or depression) which follows the inflation. It is only the Austrian economists who provide the solution – return to private money and private banking in a free market without government intervention and without government central banking.