When I read Professor Art Carden’s statement from this article,
Far too often, people use terms like "capitalism" and "socialism" sloppily, either because they don't understand them or because the words make for cheap but effective (albeit inaccurate) political rhetoric. The Great Conversation suffers because of it.
It struck me that many arguments supposedly for the so-called advancement of the political philosophy of libertarianism, free markets and or classical liberalism have precisely been anchored on this—rhetoric misrepresented as principles.
And this is exactly the essence of my last article, The Middle Of The Road Policy Of A Local Free Market Group. Where I was earlier disappointed about the issue of principles, I was even more dismayed by the responses.
Given the benefit of the doubt that perhaps my article or my “spin” could have lacked clarity, or that specialization may have lead to the misunderstanding of my message, my argument against the positive relationship between central banking and the free market was certainly not about utility nor was it about market failure.
By utility, I mean it would seem misguided to compare what is essentially is a monopoly—operating on the power of coercion, funded by taxpayer resources and whose decision making process by the authorities are (externality) risk borne by the taxpayers—with private and semi-private enterprises operating mostly on a competitive environment.
By market failure, the standard statist ‘Paul Krugman’ tactic—throw up a strawman, assail or shoot it down with econometric gibberish or economic models, and declare “market failure”, thus justifying government intervention—eludes the question about this relationship between free markets and the central bank.
The fact that the local central bank began only in the Philippines in 1949, goes to show that even in our colonial past the nation has survived without it, thereby, disproving the presumed sine qua non nature of central banking to the local economy.
As my colleague Paul How writes in his 'as-yet unpublished manuscript', the “Philippine Banking And The Business Cycle” about how the domestic monetary system operated, (bold emphasis mine)
During the 19th century, the monetary system had a gold standard in place, where each monetary note was presumed to redeem a fixed amount of gold...
Clearly, people, in their private capacity, preferred the use of a medium of exchange whose value was based not on government decree but on the amount of rare metals contained in the item. Even after the Spanish handed the Philippines over to the United States in December 1898, Filipinos continued using the Mexican coin, much to the chagrin of US officials keen on imposing their culture on the new colony’s inhabitants.
Where half of our transactions are settled for by money which is issued by an institution owned and controlled by the government, this extrapolates to half of our trading activities under the indirect purview of the government. Thus it is very important to put in question the role of such institution under the Free Market precept.
Ultimately, what for stands as the most important issue is through this question:
Do central banks promote or undermine the Free Market Principles?
This brings us back to definition. A free market, according to Wikipedia, is a market in which there is no economic intervention and regulation by the state, except to enforce private contracts and the ownership of property.
If freedom to contract and private property rights are the key pillars of free market principles as stated by such definition, do central bank activities promote these?
As a side note, under classical liberalism I would not say that free market is the absence of intervention or regulation, but instead a free market is self regulated by (mostly non-state) institutions operating under the rule of law.
Nevertheless the entire concept of freedom to contract and private property or even the rule of law are put into a test under the central bank’s operations: (bold highlights under below quotes are my emphasis)
1. Inflation of the monetary system
Thus, credit expansion unavoidably results in the economic crisis. In either of the two alternatives, the artificial boom is doomed. In the long run, it must collapse. The short-run effect, the period of prosperity, may last sometimes several years. While it lasts, the authorities, the expanding banks and their public relations agencies arrogantly defy the warnings of the economists and pride themselves on the manifest success of their policies. But when the bitter end comes, they wash their hands of it.
The artificial prosperity cannot last because the lowering of the rate of interest, purely technical as it was and not corresponding to the real state of the market data, has misled entrepreneurial calculations. It has created the illusion that certain projects offer the chances of profitability when, in fact, the available supply of factors of production was not sufficient for their execution. Deluded by false reckoning, businessmen have expanded their activities beyond the limits drawn by the state of society’s wealth. They have underrated the degree of the scarcity of factors of production and overtaxed their capacity to produce. In short: they have squandered scarce capital goods by malinvestment.
Ludwig von Mises, The Causes of Economic Crisis,
Does price signalling distortion, reduction of purchasing power of money and capital consumption from these forces represent as free market principle? The same question should all be applied on the following aspects shown below.
2. The nature of central bank’s fractional reserve system
As Huerta de Soto points out, the problem of the tragedy of the commons always appears when property rights are defined improperly. In the case of fractional reserve banking, bankers can infringe on property rights because it is not clearly defined who owns the deposit.
When customers make their deposits, the promise is that the deposit is always available for withdrawal. However, the deposits, by the very definition of fractional reserve banking, are never completely available to all customers at one time. This is because banks will take a part of these deposits and loan them out to other customers. In other words, they issue fiduciary media. By issuing more property titles than property entrusted to them, the banks violate the traditional property rights of their customers. (One of the most important contributions of Huerta de Soto's exhaustive book is to demonstrate how banking developed historically and that fractional reserve banking evolved as a perversion of deposit banking.)
Philipp Bagus, The Commons and the Tragedy of Banking
3. Externality costs from the knowledge problem
The odds that 19 men and women (a.k.a. the Federal Open Market Committee) will be able to select the overnight interest rate that keeps the U.S. economy growing at its potential in perpetuity are next to nil.
There would be a huge outcry if the Fed set the price of oil or copper or soybeans. Yet we accept the central bank as a price setter, a monopolist, when it comes to the interbank lending rate.
Caroline Baum Capitalism Still Has Legs That Are Long and Sexy
3. Operates from an environment of arbitrary rules
The concept of the rule of law in jurisprudence and political philosophy has several dimensions. At its core is the classical liberal principle of nondiscretionary governance that stands in contrast to the arbitrary or discretionary rule of those people currently in authority. In shorthand, either we have the rule of law or we have the rule of authorities. Under the rule of law, government agencies do nothing but faithfully enforce statutes already on the books. Under the rule of authorities, those in positions of executive authority have the discretion to make up substantive new decrees as they go along, and to forego enforcing the statutes on the books.
Dr. Lawrence H. White Rule of Law or the Rule of Central Bankers?
Think currency interventions in behalf of exporters and OFWs at the expense of importers and consumers via elevated prices of goods and services.
4. Operate on persistent political pressures
To put it into the hands of an institution which is protected against competition, which can force us to accept the money, which is subject to incessant political pressure, such an authority will not ever again give us good money
Friedrich August von Hayek A Free-Market Monetary System
5. Choosing winners and losers
The real reason for the adoption of the Federal Reserve, and its promotion by the large banks, was the exact opposite of their loudly trumpeted motivations.
Rather than create an institution to curb their own profits on behalf of the public interest, the banks sought a Central Bank to enhance their profits by permitting them to inflate far beyond the bounds set by free-market competition.
Murray N. Rothbard, The Case Against the Fed
6. Crony Capitalism
The answer was the same in both cases: the big businessmen and financiers had to form an alliance with the opinion molding classes in society, in order to engineer the consent of the public by means of crafty and persuasive propaganda.
Murray N. Rothbard, The Case Against the Fed
7. Promote Government Expansion
While, as we shall see presently, government's exclusive right to issue and regulate money has certainly not helped to give us a better money than we would otherwise have had, and probably a very much worse one, it has of course become a chief instrument for prevailing governmental policies and profoundly assisted the general growth of governmental power. Much of contemporary politics is based on the assumption that government has the power to create and make people accept any amount of additional money it wishes. Governments will for this reason strongly defend their traditional rights. But for the same reason it is also most important that they should be taken from them.
A government ought not, any more than a private person, to be able (at least in peace-time) to take whatever it wants, but be limited strictly to the use of the means placed at its disposal by the representatives of the people, and to be unable to extend its resources beyond what the people have agreed to let it have. The modern expansion of government was largely assisted by the possibility of covering deficits by issuing money-usually on the pretence that it was thereby creating employment. It is perhaps significant, however, that Adam Smith [54, p. 687] does not mention the control of the issue of money among the 'only three duties [which] according to the system of natural liberty, the sovereign has to attend to'.
Friedrich August von Hayek Denationalization of money
In my view, the fundamental case for free market capitalism begins with sound money and sound banking institutions (whether it is a 100% gold reserve or a free banking standard).
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