FLC175, Free Markets and the Financial Collapse, Sean Gabb, 19th September 2008
Free Life Commentary,
A Personal View from
The Director of the Libertarian Alliance
Issue Number 175
19th September 2008
Free Markets and the Financial Collapse
by Sean Gabb
I was called earlier today by someone at the BBC to comment on the collapse of the financial system. I have no particular qualifications for commenting on this. I do not know how long it will last, or how the recovery will begin. I certainly have no detailed advice on what should be done by anyone during the next few days.
The reason I was thought worth contacting, though, was obvious. The narrative in the establishment media is that markets were too lightly regulated after about 1980, and that the consequences were a ruthless and short term greed that has now reached its natural conclusion. This being so, the answer is how much regulation should now be introduced to prevent all this from happening again. I am a libertarian. I believe in markets. If markets are now being denounced, I am the right sort of person to approach for a defence.
The problem, the researcher discovered, is that I was not the right sort of person to approach. I think, for most people, it is a matter more of ignorance than of intellectual dishonesty. But there is a general tendency to identify free markets with any set of institutional arrangements that allow things to be bought and sold.
When it comes to the Private Finance Initiative, or the privatised utilities, or the internal market in the National Health Service, I do grow impatient. These are not examples of free markets, but of corporatism: they have been called into being by the State, and are at every step regulated and privileged by the State. Where the financial markets are concerned, the identification is more reasonable. After all, these are dynamic and highly efficient markets. Perhaps more so than any others, they conform to the neoclassical concept of perfect competition. Many people who work in finance are sympathetic to libertarianism. The markets are often discussed and defended in libertarian terminology.
What I tried to explain to the researcher was that, for me and for many other libertarians, markets are to be defended not according to how efficient they may be, but according to whether they are or would be part of a voluntary order.
What libertarians want is a society in which people come together only in uncoerced relationships. Some of these - marriage and partnership agreements, for example - might be hard or even impossible to dissolve. Some others - the main example being parents and their children - might involve some coercion for a limited period. But we do require, so far as reality permits, that no one should be compelled into any relationship.
When we defend markets, we mean those relationships, outside the circle of our friends and loved ones, than involve exchanges of legally binding promises, usually with a price attached. We do not defend priced relationships that are based on any degree of coercion. Therefore, we denounce slavery and trading in slaves. We denounce the collection of taxes to pay for services provided by the government. We denounce regulations that limit the range and nature of relationships that people can choose.
And we denounce patterns of indirect coercion that herd people into relationships they might not otherwise have chosen.
The financial system, as it currently exists, is based on this last type of coercion. Consider:
First, we have taxes and a monetary framework that make prudence, as traditionally known, unwise. It used to be that people would save for emergencies by putting money into savings accounts or contributing to mutual insurance schemes. For their old age, they would save money for purchase of annuities on retirement. But we have long had levels of inflation that eroded capital values, and taxes that depressed real returns. We can respond to this by playing the markets. But this requires more time and understanding than most people are willing to give; and there is the problem - at least in Britain - of capital gains tax when securities are sold at a profit.
The answer has been to put our savings with groups of professional speculators. These claim to understand the markets better than ordinary people. Undoubtedly, they have more time to follow the markets. And there are tax laws that privilege such companies.
The result has been to concentrate most savings into the hands of people whose job is look out for short term profit, and who are inclined to welcome exotic new products that no ordinary investor would ever dare touch.
Second, there are the company laws that allow easy incorporation and limited liability for debt. These have allowed giant business organisations to rise up and flourish. The result here has been to increase the number of securities that can be bought and sold, and to call into being whole armies of professional speculators, employed by multi-national banks and other organisations.
Third, there is fractional reserve banking and fiat money. Ever since the development of modern finance, bankers have been tempted circulate more notes than they could honour. What kept this in bounds was knowledge that the monetary base was a certain amount of gold that could not quickly be changed in size. Nowadays, if bankers cannot finance all the lending they would like to make, at prevailing interest rates, from the stock of savings, they can simply create more money. They still have an obligation to redeem their promises. But they operate in circumstances where the monetary base can be increased at will.
I do not say that there would be no financial markets in a voluntary order. There would be intermediation between lenders and borrowers. There would be trade in bonds. There would be securitisation of debt. There would be speculation on future values of commodities and securities.
I do not even say that the financial system we have is wholly useless or malign, given the highly corporatized nature of business. Fears of shortselling or takeovers provide a check on corporate sloth or greed. The endless speculation enables those of us who have some money not to have it all stolen by our government through taxes or inflation.
But the financial system, as it does now exist, would not exist as part of a voluntary order. It would not be the huge global casino that it is. It may be efficient. It may be plausibly claimed as an instance of the free market in action. But it is not part of a voluntary order, and therefore has at best only partial legitimacy to libertarians.
Moreover, if the financial system is a creature, directly or indirectly, of government, its current problems have been wholly caused by government. I do not know when the inflation started. It may have been to float us out of the last recession, back in the early 1990s. It may have been to avoid the expected panic of the Millennium Bug. It may have been to pay for the War on Terror. It may have been the product of all of these and others. But for many years, money has been lent that was not first saved. The gap between savings and loans was bridged by money creation. It is testimony to the skill of regulators and the sophistication of the markets that the speculative bubble was able to grow so large. But, however long delayed, its bursting was inevitable. The media can blame crooked mortgage sellers in the American ghettoes, or coke-fuelled graduates in the London dealing rooms. But financial collapse was always a matter of when and not if.
When I gave a potted version of this to the BBC researcher, I could almost hear her eyes glazing over. For the second time this year, I was not called into the studio to defend the City. I understand why I was not called in. What I am saying does not fit into the establishment narrative of what has happened.
And though I never got to tell the researcher, I also have no idea of what should now be done. Perhaps the bank of England should raise interest rates sharply and stand back while much of the financial system goes insolvent. This would get things over and done with, and move us reasonably fast into the recovery stage of the next bubble. Or perhaps it should flood the City with fresh money, in an effort to bring about a soft landing. I really do not know.
Something I do know reasonably well, however, is how to stop these bubbles from starting. If I ever came to power as the front man for a military coup - somewhat unlikely for several reasons, but still worth hoping for - I would do the following:
First, I would cut taxes and government spending by at least two thirds. The remainder should pay the interest on the national debt and honour the pension commitments made to those over about the age of fifty. I would then end the tax privileges of the investment funds. This would, among much else, allow people to plan for their future without having to sit behind the institutional equivalent of a compulsive gambler.
Second, I would repeal the Companies Acts and declare the directors of existing corporations the true owners with joint and several liability for their debts. This would put an end to the impersonal, bureaucratic nature of modern business. It would also reduce the number of securities to be bought and sold and reduce the number of people employed to buy and sell them.
Third, I would move to a fully-convertible gold standard, with the heads of every bank made jointly and severally liable for redemption in gold of all obligations, unless contracted otherwise
As said, even a stateless voluntary order would still have financial markets. And the semi-statist system I am recommending would have not only financial markets, but also some room for speculative bubbles. But neither would be anything like the world in which we actually live.
The shame is that what we have is largely what we shall have. Sooner or later, the present collapse will be over. Then, whatever "tough regulation" the politicians may have brought in will be circumvented by a new generation of clever speculators, and the next bubble will begin to inflate.
It could be worse, however. We are not talking about Soviet Communism here, but a corporatism that, if neither stable nor just, does enable the creation of vast amounts of real wealth. And, I might say, I have done rather well personally out of the late bubble. I am assured I shall not lose disastrously now it has burst. This means I am well placed to benefit from the next bubble.
As the Good Book says: "Unto every one which hath shall be given...."