While America's one-party media strive to convince the population that a new and wonderful economic dawn is about to break, many economic observers are more inclined to see twilight. The awful truth is that the so-called mainstream media is so hopelessly corrupt they cannot even be trusted to tell the truth about the time of day. This is the result of the left's relentless efforts to politicise every aspect of American life. That this situation is a threat to democracy should go without saying. It is the free flow of information that makes for an informed public. Where the public has been badly informed — or even deceived — the results can have disastrous political and economic consequences. Fortunately the emergence of the net has gone a long way to countering the statist propaganda that the so-called media try to pass off as news.
More and more Americans are coming to realise that there is no quick fix for the economy. Furthermore, they instinctively feel that the Obama administration's policy of greater spending, borrowing and massive interventionism is not going to put the country on the road to prosperity. But what people need to learn right now is not just how America, but also the rest of the world, got into this mess. Unless the lesson is learnt, the process will repeat itself. In this sense the old joke about not being able "to get there from here" has some substance in that most of the economic commentariat have yet to discover where "here" is.
The following chart was sent to me by a reader who wanted to know whether it has any significance from an Austrian perspective. It most certainly has. In May of this year Andrew Haldane, Executive Director for Financial Stability at the Bank of England, addressed the Federal Reserve Bank of Chicago's Annual Conference. (Small Lessons from a Big Crisis) (.pdf).
Haldane asked his audience to imagine having put a £100 hedged bet in 1900 on UK financial sector equities along with a £100 short bet on UK equities. By 1985 the investor would have received a capital sum of £500, an annual average return of about 2 per cent. For the period 1986 to 2006 he would have received a capital sum of more than £10,000, an annual average return of over 16 per cent. Haldane gave seven lessons that needed to be learnt. Missing from the seven was the correct one.
It is evident from the chart that it was not until 1960 that returns to the banks began to pick up. So what happened in that year? Nothing. We actually need to go back to the 1940s. The UK is the home of Keynesianism and no one was more Keynesian than British governments, Labour or Tory — and full-blooded Keynesianism is what the country got. In 1948 the bank rate was 2 per cent. Ten years later it was 7 per cent, thanks to Keynesian policies. During the 1950s the same policies also produced the stop-go cycle. First the Bank of England would put its foot down on the monetary accelerator only to quickly slap on the monetary brakes.
After "13 years of Tory misrule" the UK got a Labour government in 1964 under the leadership of Harold Wilson, a Keynesian who gave us — yes, I was there — another Keynesian boom that culminated in the devaluation of the pound in 1967. Labour lost the 1970 election to Ted Heath whose Keynesian-inspired "dash for growth" policy gave the country a 25 per cent inflation rate. In short, the country was flooded with bank-created credit. The election of Margaret Thatcher did not put an end to this destructive policy. Under the next Labour government the situation has deteriorated to the point where some observers now think the UK is on the brink of financial ruin.
Sound economic reasoning as taught by the Austrians tells us that money is not neutral, a fact recognised by some of the classical economists. As such, monetary expansion, particularly in the form of credit expansion, changes the pattern of production, not only in manufacturing but also in the financial sector, a fact that is completely overlooked by the economic commentariat. The effect of ever-increasing doses of bank credit is to artificially inflate the number financial transactions. Moreover, not only do the number of these transactions rise but newer financial activities and intermediaries also emerge to exploit the abundance of credit created by the banking system. (Think of this as part of the Cantillon effect). The Weimar inflation provides a vivid example of this process.
At first inflation stimulated production . . . [then it] annihilated thrift; it made reform of the national budget impossible for years. . . it destroyed incalculable moral and intellectual values. It provoked a serious revolution in social classes, a few people accumulating wealth and forming a class of usurpers of national property, whilst millions of individuals were thrown into poverty. . . . it poisoned the German people by spreading among all classes the spirit of speculation and by diverting them from proper and regular work, and it was the cause of incessant political and moral disturbance. (The Economics of Inflation: A Study of Currency Depreciation in Post-War Germany, John Dickens & Co LTD, 1968, p. 404).
The increase in financial activities caused the number of bank employees to jump from 100,000 in 1913 to 375,000 in autumn 1923. (Ibid. 216). As Bresciano-Turroni observed:
The increase in banking business was not the consequence of a more intense economic activity. The work was increased because the banks were overloaded with orders for buying and selling shares and foreign exchange, proceeding from the public which, in increasing numbers, took part in speculations on the Bourse. The banks did not help in the production of new wealth; but the same claims to wealth continually passed from hand to hand. (Ibid. 216).
I believe we have experienced a similar phenomenon where massive credit expansion over several decades created excessive expansion not only in the financial sector but also in services at the expense of manufacturing. This is why the chart shows returns to banking starting to increase in 1960 and then accelerating until they collapsed. But this was predicted in 1932 by Friedrich von Hayek* in his article Capital Consumption (See Money, Capital and Fluctuations: Early Essays, Routledge & Kegan Paul, 1984, pp. 150-2).
Therefore the idea that economic growth has been stymied because the banks have tied up the supply of credit is a false one. It was massive bank credit expansion that created the mess in the first place. Growth comes out of real savings, not phony bank deposits. And real savings always equal forgone consumption. Savings that exceed investment always equal inflation because they are obviously the product of credit creation.
*The eighteenth century Anglo-Irish banker Richard Cantillon wrote a brilliant analysis of how inflation distorts the price structure and the pattern of production." (Richard Cantillon, Essay on the Nature of Commerce in General, Transaction Publishers, 2001, written about 1734 and first published in 1752).