Archive for the ‘Fractional Reserve Banking’ Category

We Should All Be Misesians Now

April 28, 2012

After several centuries of experimentation with boom-and-bust monetary and fiscal policies, we need to give the Austrian school a chance.

Written by SUSANNE LOMATCH

Free market capitalism is under assault. Framed as the culprit for the global financial crisis by the popular media, politicians and ideological opportunists alike, who expediently blame the United States for igniting the crisis. The irony is that we haven’t had true free market capitalism in the U.S. for a very long time. Plagued with recurring financial panics, recessions and downright depressions, the real culprit is the federal government management of money and credit that is quite antithetical to free markets.

Article I, Section 8 of the U.S. Constitution clearly gives Congress the enumerated right “To coin money, regulate the value thereof…” But in 1913, Congress decided to outsource monetary management to the Federal Reserve Banking System. And it did so for purely political reasons [1-4]: to charter an ‘independent’ body with the power to print paper money when the needs of government or special interests arose. More to the point: to finance government debt and perpetuate government spending habits; to rescue banks that become illiquid and insolvent due to risk mismanagement and/or instabilities in a fractional reserve banking system; and most insidiously, to inject inflation into the economy when prices fall below a certain point (price controls). None of these actions belong to free market measures in a capitalist society.

The stark reality is that the U.S. abandoned free market principles when it adopted fiat currency manipulation strategies and promoted a fractional reserve banking system that lends out many more dollars than exist in real deposits. A fiat currency (e.g., U.S. Dollar, Euro, Sterling, Yen) by itself is not the problem; it is the abusive government regulation of the value of the fiat currency that is anti-free market. Purposefully driving interest rates to zero instead of allowing for market determination of rates is anti-free market manipulation. Likewise, lending money created from thin air instead of from a rational measure of deposits undermines the supply and demand of resources that are natural to a free market and distorts healthy business cycles, not to mention the high risk of high leverage if loans default. The U.S. did not invent this brand of money and credit misregulation – it was adopted from millennia of central banking history in Britain and Europe [1,5,6]. The U.S. has become perhaps uniquely addicted to the easy money and credit binges promoted by our central bank, the Fed – especially since demand for Treasurys by foreign creditors (i.e., China and Japan) is limited. Runaway government spending, off-balance sheet entitlement liabilities and easy credit promises made to voters have throttled this modus operandi. And the crony capitalism of government welfare (bailouts, “subsides”) to large corporations and financial institutions has only made the addiction worse.

Consider the following basic examples to further illustrate. In a free market, interest rates are set by the supply and demand of the market, not artificially by a central bank. “When the Fed lowers rates artificially, they no longer reflect the true state of consumer demand and economic conditions in general. People have not actually increased their savings or indicated a desire to lower their present consumption. These artificially low interest rates mislead investors. They make investment decisions suddenly appear profitable that under normal conditions would be correctly assessed as unprofitable. From the point of view of the economy as a whole, irrational investment decisions are made and investment activity is distorted” [3]. Artificially low rates are used to “stimulate” the consumer driven economy and interest rate sensitive investments, but the damage is borne in a misallocation of resources and a distortion of healthy free market driven business cycles. Consumers save less and consume more resources, and businesses that choose to invest will not only find resources limited and even more expensive as time progresses, but lending supply limited unless banks relax their reserve requirements. Modern fractional reserve banking answers this problem: banks lend from checkable demand deposits as well as timed deposits (such as CDs). Money that is lent can be multiplied by lending out on a basis of fractional reserves – for every dollar in checkable deposits, a dollar lent is deposited in checking and loaned again, up to the legal reserve limit. In a loose monetary environment, credit expansion means greater risk, as we have seen just recently in the credit boom of the last decade. In the worst case, artificially low rates and the artificial growth in lending supply (credit expansion though the creation of money in fractional banking) end in a business recession or depression: businesses cannot complete all of the invested projects due to the scarcity and/or inflationary expense of specific resources, and consumers cannot continue to spend what they don’t have. Natural supply and demand of the business cycle is disrupted.
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An Interview with LVMI President Doug French on Austrian Economics

April 30, 2010

Doug French on Mises, Rothbard and the Advancement of Free-Markets with Scott Smith and the Daily Bell

Introduction: Douglas French is president of the Mises Institute and author of Early Speculative Bubbles & Increases in the Money Supply. He received his Masters degree in economics from the University of Nevada, Las Vegas, under Murray Rothbard with Professor Hans-Hermann Hoppe serving on his thesis committee.

Daily Bell: Can you give us some background about yourself? Where did you grow up and how did you become interested in Austrian economics?

Douglas French: I grew up in Abilene, Kansas and like Dwight D. Eisenhower, was an average student at Abilene High School. Sports was my primary interest in school. I lettered in three sports, and went on to play football at Washburn University in Topeka, Kansas.

I dropped out of college in my third year out and worked as a bartender and bar manager for ten years. During that time I returned to college to finish my undergraduate degree with a major in economics and finance.

After moving to Las Vegas in 1986, I took an entry-level job at a bank and ultimately worked in the banking business in Nevada for 22 years. In the fall of 1989 I decided to enroll at the University of Nevada at Las Vegas (UNLV) and pursue a masters in economics. In the fall of 1990 I took “History of Economic Thought” with Murray Rothbard and my life was changed forever. I took “U.S. Economic History” with Murray as well and wrote my masters thesis under his direction. While researching and writing my thesis on early speculative bubbles I became interested in Austrian Economics, especially Austrian Business Cycle Theory.

Daily Bell: Tell us what you do at the Mises Institute and how you came to your important free-market role.

Douglas French: I serve as the President of the Institute. Lew Rockwell and the late Burt Blumert asked if I would come to work for the Institute in the fall of 2008. Along with being a student of Murray’s I had been a donor to LvMI and had attended a number of events as well as speaking at a few conferences. So I feel like I’ve been closely involved with LvMI’s mission for a number of years.

Daily Bell: You studied under Murray Rothbard and with Professor Hans-Hermann Hoppe. Can you give us some background and anecdotes about them? What has made them such famous proponents of free-markets and human action?

Douglas French: Murray was the happiest person I’ve ever met. Especially considering that the UNLV economics department did all it could to discourage students from take his classes and classes from Hans. He was generous with his time and his students would wait long periods just to chat with him. Thankfully, someone eventually found a chair and put it outside his door so we didn’t have to keep sitting on the hard tile floor in the hallway.

The first night of class I remember Murray walking through the door and he started talking immediately about the crazy politicians wanting to fix gas prices. Anyone who has taken classes with Murray will tell you he was a walking bibliography. His lectures were filled with endless reading suggestions. And not just book titles but author, publisher, date published. Of course, as a thesis advisor he was the best: references, strategist, and cheerleader.

Of course Murray selected the rest of my thesis committee for me and professor Hoppe was at the top of his list. However, I never had the opportunity to take classes from him.

My thesis defense lasted for more than a couple hours as I remember. Sitting through my oral defense had to seem like the longest two hours of my committee members’ lives. But none of the Keynesian faculty members who dropped by to comment chose to stick around long enough to critique me.

Since I had no background in Austrian economics or Libertarianism, at the time, I had no idea how lucky I was to be studying under the man who is considered the father of the modern libertarian movement and was the dean of the Austrian school until his death, not to mention having one of the most important scholars of our time and the current dean of the Austrian school as a thesis committee member.

Daily Bell: Give us a historical – economic – framework for Ludwig von Mises. How did his thinking evolve?

Douglas French: When Mises went to college he described himself as a statist “through and through” like most of his fellow classmates. However, he was anti-Marxist, writing that the “platitudes of Marxist literature repelled me.” Mises believed that all the Marxist scholars he met were mediocre, except Otto Bauer.

By his fifth semester he began to have doubts about government interventionism. His work on housing conditions in Austria revealed to him that taxation hindered capital investment and limited supply leading to higher rents. But, reductions in these taxes didn’t reduce rents and led the government to impose other taxes to replace the taxes that landlords had been paying: early insight that one government intervention leads to a series of others due to the unintended consequences of this intrusions.

In 1903 Mises read Carl Menger’s Principles of Economics and from that book, he wrote, “I became an economist.” Mises attended Eugene Böhm-Bawerk’s seminar in Vienna until 1913 and witnessed continuous debates between Böhm and Bauer over Marxist theory. Mises applied Menger’s marginal utility theory to money and the business cycle and these were the subjects of the seminar the last two winter semesters that he attended. The finished manuscript for The Theory of Money and Credit was in the hands of the publisher in early 1912.

Daily Bell: Mises is one of the greatest men who ever lived for his insights into what he called “human action.” How did the concept of human action evolve in his mind and why is it one of the most profound statements about the human condition ever uttered?

Douglas French: It was actually Carl Menger who developed a complete theory of social institutions arising from interactions among humans, each with his own subjective knowledge and experiences. It is the spontaneous evolution of these human actions that create institutions whereby individuals discover certain patterns of behavior that aid each person in attaining his goals more efficiently. Menger, and then Mises, applied this insight to the development of money which in turn makes the division of labor possible and satisfaction of wants attainable. This reasoning is the bedrock for understanding how societies and human progress advance. Conversely, this same understanding reveals how government intervention causes society to devolve.

Daily Bell: Can you summarize his great work, Human Action for our readers? Can you recommend some other books by von Mises?

Douglas French: I remember Murray talking about Human Action in class. He said that after he had read it, someone asked him what the book was about, he replied, “Everything!” So, can I summarize a book about everything? Not adequately. To quote from the Introduction to the Scholar’s Edition, Human Action is “a comprehensive treatise on economic science that would lay the foundation for a massive shift in intellectual opinion that is still working itself out fifty years after publication.”

Mises explained why he wrote Human Action:

Economics does not allow any breaking up into special branches. It invariably deals with the interconnectedness of all phenomena of acting and economizing. All economic facts mutually condition one another. Each of the various economic problems must be dealt with in the frame of a comprehensive system assigning its due place and weight to every aspect of human wants and desires. All monographs remain fragmentary if not integrated into a systematic treatment of the whole body of social and economic relations.

To provide such a comprehensive analysis is the task of my book Human Action , a Treatise on Economics. It is the consummation of lifelong studies and investigations, the precipitate of half a century of experience. I saw the forces operating which could not but annihilate the high civilization and prosperity of Europe. In writing my book, I was hoping to contribute to the endeavors of our most eminent contemporaries to prevent this country from following the path which leads to the abyss.

Bob Murphy, writing in the preface to his, Human Action Study Guide, “Suffice it to say, one cannot really claim to be an Austrian economist – certainly not a Misesian! – without reading Human Action.

In an essay written about Mises, Murray wrote that Human Action is “one of the finest products of the human mind in our century.”

One can’t go wrong reading any books by Mises. For those interested in booms and busts, I leaned extensively on a book that is now titled The Causes of the Economic Crisis when writing my thesis. For those who wonder why intellectuals and opinion makers hate capitalism, The Anti-Capitalist Mentality is very revealing. Want to understand big government? Read Bureaucracy. Theory and History was Mises’s favorite next to Human Action.

Of course the big three are Human Action, Socialism, and The Theory of Money and Credit.

Daily Bell: Tell us how Mises and FA Hayek expanded and finalized the concept of the business cycle.

Douglas French: As I mentioned, Mises applied marginal utility analysis to the money and the problem of the business cycle which became Austrian Business Cycle Theory (ABCT). As Murray Rothbard wrote in an essay about Mises, “At long last, economics was whole, an integral science based on a logical, step-by-step analysis of individual action. Money was fully integrated into an analysis of individual action and the market economy.”

Mises exposed the fallacies of the quantity theory of money and Irving Fisher’s “equation of exchange.” Mises put individual choice into monetary theory and dispensed with the “distorted concentration on mechanistic relations between aggregates.” Mises’s Regression Theorem showed that money can only be established by the market, beginning with barter, not by government construct. This of course has been proved right as every fiat currency in history has ultimately been made worthless.

Mises formulated his ABCT during the 1920s out of three elements; the boom-bust model from the Currency School, Swedish “Austrian” Knut Wicksell’s delineation between bank interest rates and the “natural” rate, and Böhm-Bawerk’s capital and interest theory.

“Mises’s remarkable integration of these previously totally separate analyses showed that any inflationary or created bank credit,” wrote Rothbard, “by pumping more money into the economy and by lowering interest rates on business loans below the free market, time-preference level, inevitably caused an excess of malinvestment in capital goods industries remote from the consumer.”

Hayek’s ABCT work continued from Mises’s explaining the origin of the business cycle in terms of bank-credit expansion.

Daily Bell: Did John Maynard Keynes know Mises? Keynes knew Hayek, but we wonder if he avoided Mises somehow or was in some way reluctant to engage him.

Douglas French: I can’t find any evidence that Keynes knew Mises personally. But Keynes did review the German version of The Theory of Money and Credit for the Economic Journal and dismissed it as being unoriginal. But as Donald Boudreaux pointed out in a letter to the Wall Street Journal, “in his 1930 book Treatise on Money, [Keynes] confessed that ‘in German, I can only clearly understand what I already know – so that new ideas are apt to be veiled from me by the difficulties of the language.'”

Daily Bell: Were there differences between Hayek and Mises intellectually and otherwise. Was Hayek Mises’ favorite pupil?

Douglas French: Hayek attended Mises’s Privateseminar, be he didn’t necessarily consider himself a student of Mises. He wrote in the introduction to Mises’s Memoirs that he was closely associated with Mises. But he came to Mises, “not as a student, but as a fresh Doctor of Law and a civil servant, subordinate to him, at one of those special institutions that had been created to execute the provisions of the peace treaty of St. Germain,” Hayek wrote. “The letter of recommendation by my university teacher Friedrich von Wieser, who described me as a highly promising young economist, was met by Mises with a smile and the remark that he had never seen me in his lectures.”

Murray writes in Keynes, The Man that Hayek was charmed by Lord Keynes but he didn’t succumb to Keynes’s ideas. However, Hayek never wrote a critique of The General Theory. And Mark Skousen speculates that Hayek backed off of Keynes in the 1940’s not wanting to interfere with Britain’s financing of the war effort.

So while Hayek may have been politically pragmatic, Mises never was. Mises’s widow Margit described her husband’s character, quoting the words Mises wrote about Benjamin Anderson. “He never yielded. He always freely enunciated what he considered to be true. If he had been prepared to suppress or only soften his criticism of popular, but obnoxious policies, the most influential positions and offices would have been offered to him. But he never compromises.”

“Of all the Misesians of the early 1930’s, the only economist completely uninfected by the Keynesian doctrine and personality was Mises himself,” Rothbard wrote. “And Mises, in Geneva and then for years in New York without a teaching position, was removed from the influential academic scene.”

Hayek was able to secure teaching positions at the London School of Economics and the University of Chicago, and in 1974 was awarded the Nobel Prize. Mises would never secure such positions, was driven from his own country and had to fight for students and a chance to teach at all. While Henry Hazlitt wrote in Barron’s, “If ever a man deserved the Nobel Prize in economics, it is Mises,” he of course was never awarded the prize.

Daily Bell: Mises was a proponent of a gold standard was he not?

Douglas French: He was, and wrote: “The superiority of the gold standard consists in the fact that the value of gold develops independent of political actions.” (more…)

Who Pays the Federal Reserve? Cui Bono?

January 19, 2010

Murray Rothbard discusses the operations of the banking interests and the roles that Rockefeller and J P Morgan played in setting up the central bank in 1913.

Today almost one hundred years later the Fed goes from crisis to profit in an instant:

The LA Times: The Federal Reserve reported a side benefit to its massive intervention into the financial system a record profit of $46.1 billion last year on the central bank’s investments.

CNN: The Federal Reserve banks made a $52 billion profit in 2009, reaping extra income on the government securities they bought in an effort to stabilize the financial system.

High risk, but easy money in the meantime:

Much of the higher earnings arose due to the Fed’s aggressive program of buying bonds, aiming to push interest rates down across the economy and attempting to stimulate growth. As 2010 begins, the Fed owns $1.8 trillion in U.S. government debt and mortgage-related securities, up from $497 billion a year earlier. The interest income on those investments was a major source of Fed profits — though that income comes with risks, as the central bank might lose money if it later sells those securities in order to attempt to reduce the money supply.

The Fed also made money on its emergency loans to banks and other firms and on special programs to prop up lending, such as one that supports credit cards, auto loans, and other consumer and business lending. Those programs impose interest and fees on participants, with the aim of ensuring that the Fed does not lose money.