Hyperinflation or Great Depression II?

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Western Europe has invented two institutions that have taken over the world: the university and the central bank. Today, both are under fire as never before. At the same time, both are in their respective driver’s seats. The greater the criticism, the better they do for themselves.

We are finally seeing articles on the bubble in higher education. It isn’t a bubble. Government money still flows in by the hundreds of billions a year.

We hear that college isn’t worth the money. Well, if it isn’t, why are parents paying it? Because they are buying a consumer good: social acceptance. They are buying off peer pressure. They are unwilling to say to their friends, “Billy Bob is going to become a plumber.” Yes, Billy Bob will always have a good income, but Billy Bob’s parents are unwilling to accept this. Billy Bob will get his hands dirty . . . with “filthy” lucre. Oh, the horror! Better that he should be an unemployed B.A. in sociology with $23,000 of student debt, and his parents $50,000 to $150,000 poorer.

That is to say, people have priorities that are different from what the journalists (with B.A. degrees in a field with a dismal future) write about in their articles. The parents will not admit to their children what they are really buying: social acceptance. “You have to go to college.” Why? “Because it is the pathway to success.” Not any more, it isn’t, but it is the pathway to social prestige in the circles in which parents move.

The fact that any student can earn an accredited B.A. in the liberal arts in four years, and maybe three, for under $15,000, is never mentioned in the “college costs too much” articles. The journalists have never looked at the alternatives. They do not report on them. They just write their cookie-cutter articles that few parents will read and most will ignore.

If blindness is this bad in a field where parents have $50,000 to $200,000 on the line – after-tax money – consider the situation with central bankers. If the colleges still get a free ride, totally immune from criticism, think of the sweet deal that central bankers have, where people neither understand what is going on or can do anything about it.

Central banks today are the beneficiaries of a familiar law of government-run economics: failure is regarded with increased budgets. Massive failure is rewarded with budget increases and increased responsibility and power.

When it comes to civil government, nothing succeeds like failure.


Ron Paul writes a book, End the Fed. It sells well. We hear echoes of this on the Web. Yet what was the result of the FED’s disastrous policies, 2001-2007, which caused the recession in 2008-9? An increase in the FED’s supervisory powers over the banking system.

On March 10, 2010, Ben Bernanke testified before the Committee on Financial Services, U.S. House of Representatives, Washington, D.C. This was three days after the initial version – later revised – of the Dodd-Frank banking reform bill was released to the media.

Bernanke’s testimony is one of the classic cases of institutional self-puffery. Here is a man who oversaw the big bank bailouts. He engineered the swap of T-bills with toxic debt at face value, bailing out otherwise insolvent banks – had the Financial Accounting Standards Board’s rules not been reversed after the swap. Here are some highlights from his testimony.

The financial crisis has made clear that all financial institutions that are so large and interconnected that their failure could threaten the stability of the financial system and the economy must be subject to strong consolidated supervision. Promoting the safety and soundness of individual banking organizations requires the traditional skills of bank supervisors, such as expertise in examinations of risk-management practices; the Federal Reserve has developed such expertise in its long experience supervising banks of all sizes, including community banks and regional banks.

Here is the Ph.D.-holding expert whose relied on data and analysis supplied by hundreds of other Ph.D.-holding experts. None of them had seen the recession coming. But Austrian School economists had, and said so repeatedly. I was one of them.

What is needed? Why, more of the same!

But the supervision of large, complex financial institutions and the analysis of potential risks to the financial system as a whole require not only traditional examination skills, but also a number of other forms of expertise, including macroeconomic analysis and forecasting; insight into sectoral, regional, and global economic developments; knowledge of a range of domestic and international financial markets, including money markets, capital markets, and foreign exchange and derivatives markets; and a close working knowledge of the financial infrastructure, including payment systems and systems for clearing and settlement of financial instruments.

None of this had helped the FED to foresee the recession. But, have no fear! Tomorrow is a better day. The FED is so much wiser now, so much better informed.

In the course of carrying out its central banking duties, the Federal Reserve has developed extensive knowledge and experience in each of these areas critical for effective consolidated supervision. For example, Federal Reserve staff members have expertise in macroeconomic forecasting for the making of monetary policy, which is important for helping to identify economic risks to institutions and markets. In addition, they acquire in-depth market knowledge through daily participation in financial markets to implement monetary policy and to execute financial transactions on behalf of the U.S. Treasury. Similarly, the Federal Reserve’s extensive knowledge of payment and settlement systems has been developed through its operation of some of the world’s largest such systems, its supervision of key providers of payment and settlement services, and its long-standing leadership in the international Committee on Payment and Settlement Systems. No other agency can, or is likely to be able to, replicate the breadth and depth of relevant expertise that the Federal Reserve brings to the supervision of large, complex banking organizations and the identification and analysis of systemic risks.

What was the proper conclusion? Could anyone doubt it? Extend greater supervisory authority to the FED.

In summary, the Federal Reserve’s wide range of expertise makes it uniquely suited to supervise large, complex financial institutions and to help identify risks to the financial system as a whole. Moreover, the insights provided by our role in supervising a range of banks, includingcommunity banks, significantly increases our effectiveness in making monetary policy and fostering financial stability. While we await enactment of comprehensive financial reform legislation, we have undertaken an intensive self-examination of our regulatory and supervisory performance. We are strengthening regulation and overhauling our supervisory framework to improve consolidated supervision as well as our ability to identify potential threats to the stability of the financial system. And we are taking steps to strengthen the oversight and effectiveness of our supervisory activities.

The final version of Dodd-Frank bill increased the regulatory power of the FED. The FED got new control over the banks. We read in the detailed entry on Wikipedia:

Title III, or the “Enhancing Financial Institution Safety and Soundness Act of 2010” is intended to streamline banking regulation and reduce competition and overlaps between different regulators by abolishing the Office of Thrift Supervision and transferring its power over the appropriate holding companies to the Federal Reserve, state savings associations to the FDIC, and other thrifts to the Office of the Comptroller of the Currency.

This bill was signed into law on July 21, 2010. Dodd did the decent thing and went away. He decided not to run in 2010. Frank came back.


Lest you think that the law of government failure is confined to the United States, consider the original central bank, founded in 1694. It followed Greenspan’s inflationary policies, with the same results: bubbles. A recent article in the “London Telegraph” surveys the carnage and the results. The government has quietly transferred extensive new regulatory authority to the Bank of England.

Note: this ancient institution has long been referred to as the Old Lady of Threadneedle Street. This makes as much sense as referring to the Mafia as the Old Men from Sicily.

It’s a grand experiment in macroeconomic management the like of which has never been tried before. In addition to its existing powers to set interest rates and manage the money markets, the Bank of England will acquire responsibility not just for banking supervision but for controlling the credit cycle in the round – a function known as “macroprudential regulation.”

Bankers will once more be forced to jump to attention before the Old Lady’s command, while with a nod of the head the Bank’s newly formed Financial Policy Committee – which meets for the first time on June 24 – will be able to adjust the supply of credit like water through a sluice. After 30 years in which the collective will of financial markets has dominated the commanding heights of the economy, the Bank is being put firmly back in the driving seat.

Members of Parliament do plan to hold hearings on this transfer of power. The author is presumably trying to persuade members to ask tough questions. Parliament does ask tougher questions than Congress does. It is an old British tradition to ask tough question. Then it does what the Bank of England says, just as every other Western government does what its central bankers say.

The Bank’s refusal to accept any degree of culpability in the crisis is already well known. But to general astonishment, it has emerged that there hasn’t even been so much as an internal inquiry at the Bank as to what went wrong.

The article surveys what took place. This parallels the Greenspan years like a glove.

For the first 10 years of its reign as an independent monetary authority, it was hard to fault the Bank’s performance at all. Inflation was tame, and the UK economy entered one of its longest ever periods of uninterrupted growth. Some called it the Great Moderation. Mervyn King, the Governor, christened it the NICE decade, standing for non-inflationary-continuous-expansion. These were halcyon days for the Bank. Rightly or wrongly, the Old Lady got much of the credit for delivering an apparently golden age of economic stability and prosperity.

The glory years of monetary inflation were followed by the crash that overwhelmed Wall Street, the U.S. Treasury, and the Federal Reserve.

Many will think the mere fact of the downturn, and its gruelling aftermath, evidence enough of bad policy. Some Treasury insiders still bitterly blame the Bank for the supposedly botched way in which the crisis was initially handled. The Bank had to be dragged kicking and screaming into doing the right thing, one said, a version of events supported by a number of Financial Services Authority (FSA) accounts.

Both the FSA and the former Chancellor, Gordon Brown, have been widely blamed for the catastrophe, yet the policymaker which must be judged to have been more at the centre of things than any other, the Bank of England, has emerged from the storm not just unscathed, but with even greater powers than it had before.

The article goes on to survey five areas of criticism that have been lodged against the BoE. They are all reasonable, though not based on the gold coin standard, the evils of fractional reserve banking, or any of the other products of the boom bust cycle. The author even blames the BoE for not re-inflating fast enough.

When the European Central Bank and the Federal Reserve responded to the initial stages of the credit crunch by flooding the system with cheap liquidity, the Governor’s inclination was to dismiss the move as an overreaction. Just two days before it emerged that Northern Rock had requested lender of last resort support, he wrote a letter to the Treasury Select Committee in which he said that not enough regard had been given to the dangers of moral hazard.

So, the Bank of England receives no criticism that goes to the bottom of the problem: fractional reserve banking. So, it trudges forward, now armed with new powers.

Yet somehow the Bank has emerged from the wreckage, if not quite smelling of roses, grudgingly thought of as the only way forward. All things considered, it’s an astonishing escape, for which the Governor has justifiably earned himself a notable place in the history books.


The more things change, the more things stay the same. The more havoc the central banks cause, the more power that governments transfer to them.

There is no turning back. The central banks will keep centralizing power, and the result will be a far greater swath of destruction when, at last, they must decide: hyperinflation or Great Depression II.

June 1, 2011

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

Copyright © 2011 Gary North