“What, then, are the causes of periodic depressions? Must we always remain agnostic about the causes of booms and busts? Is it really true that business cycles are rooted deep within the free-market economy, and that therefore some form of government planning is needed if we wish to keep the economy within some kind of stable bounds? Do booms and then busts just simply happen, or does one phase of the cycle flow logically from the other?Strangely, it never seems to have occurred to Rothbard that the idea that the cause of business cycle lies within capitalism is actually a view of Hayek:
The currently fashionable attitude toward the business cycle stems, actually, from Karl Marx. Marx saw that, before the Industrial Revolution in approximately the late 18th century, there were no regularly recurring booms and depressions. There would be a sudden economic crisis whenever some king made war or confiscated the property of his subject; but there was no sign of the peculiarly modern phenomena of general and fairly regular swings in business fortunes, of expansions and contractions. Since these cycles also appeared on the scene at about the same time as modern industry, Marx concluded that business cycles were an inherent feature of the capitalist market economy. All the various current schools of economic thought, regardless of their other differences and the different causes that they attribute to the cycle, agree on this vital point: that these business cycles originate somewhere deep within the free-market economy. The market economy is to blame. Karl Marx believed that the periodic depressions would get worse and worse, until the masses would be moved to revolt and destroy the system, while the modern economists believe that the government can successfully stabilize depressions and the cycle. But all parties agree that the fault lies deep within the market economy and that if anything can save the day, it must be some form of massive government intervention.” (Rothbard 2009 [1969]: 12–14).
“we can … see how nonsensical it is to formulate the question of the causation of cyclical fluctuations in terms of ‘guilt,’ and to single out, e.g., the banks as those ‘guilty’ of causing fluctuations in economic development. Nobody has ever asked them to pursue a policy other than that which, as we have seen, gives rise to cyclical fluctuations; and it is not within their power to do away with such fluctuations, seeing that the latter originate not from their policy but from the very nature of the modern organization of credit. So long as we make use of bank credit as a means of furthering economic development we shall have to put up with the resulting trade cycles. They are, in a sense, the price we pay for a speed of development exceeding that which people would voluntarily make possible through their savings, and which therefore has to be extorted from them.” (Hayek 2008: 102).According to the logic of the ABCT, since capitalism has an endogenous/elastic money supply, not only from fractional reserve banking, but also from things as simple as bills of exchange and promissory notes, it will be hit by perpetual cycles.
It is no surprise that, when Hayek was propounding his business cycle theory at the LSE in the 1930s, his theory was even attractive to socialists, as Skidelsky notes:
“Hayek, like Keynes, hoped to prevent a slump from developing by preventing the credit cycle from starting. But his method was very different. It was to forbid the banks to create credit, something which could be best achieved by adherence to a full gold standard. He was quite pessimistic, though, about this being practical politics, so his conclusion, like Keynes’s, was that a credit-money capitalist system is violently unstable – only with this difference, that nothing could be done about it. One can understand why Hayek’s doctrines attracted a certain kind of socialist: they seemed to reach Marx’s conclusions by a different route. Because of the Austrian school’s close attention to the institutional and political setting of a credit-money economy, Hayek’s picture of the capitalist system in action was altogether more sombre than that of conventional Anglo-Saxon economics, with its story of easy adjustments to ‘shocks.’” (Skidelsky 1992: 457).In other words, Hayek would have said exactly what Rothbard denied: for Hayek, “business cycles do originate somewhere deep within the free-market economy.”
The Rothbardians attempt to evade what was plainly stated by Hayek by blaming fractional reserve banking (FRB), and arguing that FRB is fraudulent and immoral.
This line of argument shows the most astonishing illogic and ignorance, and I have refuted it before:
“My Posts on Fractional Reserve Banking (Updated),” December 19, 2011.The cult of Rothbard stands as one of the most ignorantly anti-capitalist ideologies imaginable, with its gross misunderstanding of, and hostility to, fractional reserve banking – a fundamental institution of capitalism.
BIBLIOGRAPHY
Hayek, F. A. 2008. Prices and Production and Other Works: F. A. Hayek on Money, the Business Cycle, and the Gold Standard. Ludwig von Mises Institute, Auburn, Ala.
Rothbard, M. 2009 [1969]. Economic Depressions: Their Cause and Cure. Ludwig von Mises Institute, Auburn, Ala.
Skidelsky, R. J. A. 1992. John Maynard Keynes: The Economist as Saviour, 1920–1937 (vol. 2), Macmillan, London.
Okay Lord Keynes, lets not be too aggressive here.
ReplyDeleteI would find a hard time believing that the Austrian Business Cycle Theory is "anticapitalist" when, one, Ludwig von Mises said that gold inflows could cause a business cycle and as a result moving his trade cycle theory section in Human action to voluntary exchange. Hell, even Rothbard admits this in America's Great Depression when he says he disagrees. Your "discovery" really isn't much on an enlightenment to anyone who is familiar with the Austrian literature on some sophisticated level and doesn't have an axe to grind and twist every comment into a supposed error.
Secondly, in a free banking situation, banks will limit pyramiding based on other banks calling in excessive credit. Pyramiding will occur to the extent that new "base money" is mined.
Even if one takes the position that the free market can create a boom bust cycle (such as myself), one would certainly have the theoretical knowledge by applying ABCT, the "anticapitalist theory", that the cycle would be much much less severe than one induced by government since the expansion in the money supply would be considerably less.
Admitting bad things can happen in a free market does not make you an anticapitalist. For example, the free market operates on profit and loss. Losses are bad though, since they misallocate resources. And just like profit, losses will forever occur on the free market. Anticapitalist!
"Secondly, in a free banking situation, banks will limit pyramiding based on other banks calling in excessive credit. Pyramiding will occur to the extent that new "base money" is mined."
DeleteEven in such a system there nothing to stop banks from using the banknotes of the largest, most stable bank as the effective equivalent of gold/commodity money, and as an elastic base money.
Patch:
DeleteForgive my ignorance, but I'm a little confused:
Even if one takes the position that the free market can create a boom bust cycle (such as myself), one would certainly have the theoretical knowledge by applying ABCT, the "anticapitalist theory", that the cycle would be much much less severe than one induced by government since the expansion in the money supply would be considerably less.
Okay, so let's suppose that we've eliminated the state. We are now living in the Rothbardian ideal condition of "anarcho" capitalism. However, by your account (and that of many others) there will still be business cycles. So... how on earth is one to "apply" ABCT to ameliorate said cycles? Have we not already done away with all the levers, as it were?
If the conclusion of ABCT is that it's best to let things sort themselves out, and if we're still bound to have cycles at the top of the "self-sortiness" curve, then what are we really getting out of ABCT other than some theoretical assurance that we're doing the right thing and therefore should continue to eat out of dumpsters until conditions improve?
"Even in such a system there nothing to stop banks from using the banknotes of the largest, most stable bank as the effective equivalent of gold/commodity money, and as an elastic base money."
DeleteTechnically not, though one would have to prove that it would be the most profitable scenario. A banking cartel always faces the same external and internal constraints that ruin "cartels":New competitors entering in and inside businesses lowering prices because it becomes too profitable.
"Okay, so let's suppose that we've eliminated the state. We are now living in the Rothbardian ideal condition of "anarcho" capitalism. However, by your account (and that of many others) there will still be business cycles. So... how on earth is one to "apply" ABCT to ameliorate said cycles? Have we not already done away with all the levers, as it were?
If the conclusion of ABCT is that it's best to let things sort themselves out, and if we're still bound to have cycles at the top of the "self-sortiness" curve, then what are we really getting out of ABCT other than some theoretical assurance that we're doing the right thing and therefore should continue to eat out of dumpsters until conditions improve?"
Because, the money supply would not expand nearly as much as it would if government intervened in the economy, and laissez faire policies would allow the economy to properly adjust.
(Again, obviously I know people disagree with this, but applying Austrian theory and ABCT one would reach this conclusion).
Patch:
DeleteThanks for your response, but I don't know if it helped. Your answer assumes I had asked "why is ABCT better?" However, I had asked no whys; just a how and a what.
In your parenthetical remark at the end, you say the same thing I had originally questioned: "applying Austrian theory and ABCT, one would reach this conclusion."
So is "applying" in this case purely a deductive exercise? I usually think of that word as meaning "to implement," i.e., to create these ideal conditions in the real world. But then I just find myself wondering about the original thing I had asked, considering that there is no way to 'apply' ABCT as such, since only policies can be applied and ABCT would instead suggest an absence of policy.
And once there is no state activity to countervail the market, would not a crisis - even one mitigated by a stunted boom - be all the more brutal for those reduced to poverty, who now have no recourse whatsoever? For them, it can no longer be rationalized away as a glitch within one of several sectors, with some hope yet to be found elsewhere; instead, the singular, totalizing factor of human social and material existence just declared some ten percent of the population unfit to eat.
That is pretty heavy, when you get right down to it. I don't know if any Austrian or other laissez-faire advocate has made an argument for the superiority of such a society that I find particularly convincing. Can you?
"Thanks for your response, but I don't know if it helped. Your answer assumes I had asked "why is ABCT better?" However, I had asked no whys; just a how and a what.
DeleteIn your parenthetical remark at the end, you say the same thing I had originally questioned: "applying Austrian theory and ABCT, one would reach this conclusion."
So is "applying" in this case purely a deductive exercise? I usually think of that word as meaning "to implement," i.e., to create these ideal conditions in the real world. But then I just find myself wondering about the original thing I had asked, considering that there is no way to 'apply' ABCT as such, since only policies can be applied and ABCT would instead suggest an absence of policy."
In a thought experiment applying an example business cycle and letting the economy correct itself. This is what I mean. Using the tools deduced by Austrian theory, one can show that a given boom would be less than one with government intervention in the money supply, and the resulting economic correction faster than one with active government intervention
"And once there is no state activity to countervail the market, would not a crisis - even one mitigated by a stunted boom - be all the more brutal for those reduced to poverty, who now have no recourse whatsoever? For them, it can no longer be rationalized away as a glitch within one of several sectors, with some hope yet to be found elsewhere; instead, the singular, totalizing factor of human social and material existence just declared some ten percent of the population unfit to eat.
That is pretty heavy, when you get right down to it. I don't know if any Austrian or other laissez-faire advocate has made an argument for the superiority of such a society that I find particularly convincing. Can you?"
This doesn't really seem to deal with ABCT per se, but more free markets in general. Yes, a correction in utilized resources will result and they will have to be reallocated. But then assuming that 10 percent of the population will not have enough money to eat is populist pandering. At the beginning of a capitalist society early in its industrial phase, because everyone is closer to the bare subsistence some people may be reduced to starvation. But this early phase of industrialization was better than before the Industrial Revolution, when there were massive amounts of vagrants and impoverished people. As industrialization progressed, those displaced from work will be better taken care of (more charity, cheaper better quality consumer goods, etc). It is important to remember that Austrian economics makes the assumption that labor is scarcer than land and idle capital, and as a result all labor can be employed at a positive wage. If the population suddenly trebled in a year, then even with wages plummeting it seems likely that some portion of the population cannot find work. The free market, or government intervention in general, can do nothing about this except allow for additional savings to create more capital goods to employ labor.
Patch:
DeleteThis doesn't really seem to deal with ABCT per se, but more free markets in general.
Does not the former insist upon the latter?
But then assuming that 10 percent of the population will not have enough money to eat is populist pandering.
Assuming that the outcome I've described is impossible is far more risky, and far less epistemologically sound. We can't predict the future; as Mises correctly noted, if we could, then action would be impossible. What you are calling populist pandering, I would suggest is more a caution about the role of Black Swan events. Of course, if we agree that crisis is intrinsic to capitalist production, then it doesn't even need to be a Black Swan, strictly speaking.
Further, the existence of bread lines is an undeniable fact of life. Whether or not we can argue that n% of the fault lies with the government is immaterial, particularly in light of the above.
At the beginning of a capitalist society early in its industrial phase, because everyone is closer to the bare subsistence some people may be reduced to starvation. But this early phase of industrialization was better than before the Industrial Revolution, when there were massive amounts of vagrants and impoverished people.
To say nothing of the help the underclass had in reaching this state of privation.
As industrialization progressed, those displaced from work will be better taken care of (more charity, cheaper better quality consumer goods, etc).
There is no charity fairy; ultimately, all of that care-taking will have originate from the actions of individuals, right? It is a mind towards this, paired with the limits of time, space, and information, that would convince someone (such as myself) to vote for stronger social safety nets at a point of higher coordination. I also volunteer my time and money, but again, I only have so much of either of those.
If we're already willing to assume, as per your remarks, that there will be an appropriate level of resources allocated to the poor, then it seems to me that there's no harm in safety net programs.
It is important to remember that Austrian economics makes the assumption that labor is scarcer than land and idle capital, and as a result all labor can be employed at a positive wage.
I find this assumption interesting; if we are able to simply assume that all labor can be employed, then surely the system can support a job guarantee program without being shaken to bits by price distortions? The idea that some level of unemployment is a necessary outcome (even pro tempore) to maintain proper calculation seems to be at odds with the assumption you've listed.
The free market, or government intervention in general, can do nothing about this except allow for additional savings to create more capital goods to employ labor.
Or, as I implied above, the latter can hire all unemployed labor at a minimum wage.
“Does not the former insist upon the latter?”
DeleteYes, but its not a criticism of ABCT per se, but rather free market economics in general.
“Assuming that the outcome I've described is impossible is far more risky, and far less epistemologically sound. We can't predict the future; as Mises correctly noted, if we could, then action would be impossible. What you are calling populist pandering, I would suggest is more a caution about the role of Black Swan events. Of course, if we agree that crisis is intrinsic to capitalist production, then it doesn't even need to be a Black Swan, strictly speaking.
Further, the existence of bread lines is an undeniable fact of life. Whether or not we can argue that n% of the fault lies with the government is immaterial, particularly in light of the above.”
It is hard to argue that 10% of the population suffer from involuntary unemployment (not voluntary unemployment, which can certainly happen) as part of some prolonged adjustment. Given that labor is nonspecific and labor is scarcer than land and idle capital, wages will fall and workers receive employment opportunities. Labor is different than other goods because it always has downward mobility and nonspecific, not to mention it can train itself to move upward in different factor markets.
Certainly 10% unemployment could occur in a free market for a brief period of time. Society rapidly changes their spending patterns and 10% unemployment results for a brief period of time as resources readjust. A hurricane hits and destroys an economy, etc etc.
Bread lines are certainly a fact of life. But as said before, when these crisis hit, in the early phases of a capitalist economy the workers will be worse off while later they can handle the situation better (higher real wages and savings, more charity, etc).
“To say nothing of the help the underclass had in reaching this state of privation.”
This only proves my point that this discussion is just about capitalism and not ABCT. I’m not going to get into a debate about the beginning of the Industrial Revolution here, its well accepted that urbanization occurred and was better than the rural farmland where the workers were before. Enforced displacement didn’t occur in America, and yet with all of the abundant land people still choose to go to cities. Living standards in the beginning of England’s industrialization may have not increased because of the Napoleonic wars (inflation, diversion of materials for war instead of private sector, leading to the poor buildings we hear about, high taxes, etc) and the fact that while some workers living standards might have stayed at poor, more and more people were brought up from starvation to poor. Regardless, this is all besides the point of the actual discussion.
“There is no charity fairy; ultimately, all of that care-taking will have originate from the actions of individuals, right? It is a mind towards this, paired with the limits of time, space, and information, that would convince someone (such as myself) to vote for stronger social safety nets at a point of higher coordination. I also volunteer my time and money, but again, I only have so much of either of those.”
DeleteYes, and as capitalism progresses charity will become easier to do. And who says the social net will help them better? It diverts resources away from the private sector, which could have used it to produce better quality consumer goods at a greater quantity and lower price. And again, your not voting with your own money, but instead deciding to appropriate someone elses.
“I find this assumption interesting; if we are able to simply assume that all labor can be employed, then surely the system can support a job guarantee program without being shaken to bits by price distortions? The idea that some level of unemployment is a necessary outcome (even pro tempore) to maintain proper calculation seems to be at odds with the assumption you've listed.”
It is assumed because it relates to the world we live in. No it is not at odds, because this “necessary outcome” is frictional (i.e speculative and voluntary) unemployment. Consumer wants and production plans are always changing, so doesn’t it make sense to assume that certain workers are estimating their most profitable line of production, unprofitable firms laying off workers, and profitable firms hiring them?
The free market, or government intervention in general, can do nothing about this except allow for additional savings to create more capital goods to employ labor.
“Or, as I implied above, the latter can hire all unemployed labor at a minimum wage.”
And have them do what? There isn’t enough capital to sustain them. You need savings for that.
"And who says the social net will help them better? It diverts resources away from the private sector, which could have used it to produce better quality consumer goods at a greater quantity and lower price."
DeleteThe logic of this is basically: we should let those people who have no means to starve to allow others to enjoy a slighter better designed Ipods or mp3 players.
If this is where human beings rank in your value scales, then further argument is a waste of time.
" -“Or, as I implied above, the
Delete- latter can hire all unemployed labor
- at a minimum wage.”
And have them do what? There isn’t enough capital to sustain them. You need savings for that."
What absolute garbage. Do you think every economy on earth runs constantly at full employment equilibrium?
The capital stock of an advanced capitalist nation like, say, Germany, France, or Canada is vast, productive and often underutilized (e.g., capacity utilization rates rarely go above 90%). Often capital goods are sometimes idle. Stocks of factor inputs are unsold.
The ability to import goods from other nations is also vast: in China and East Asia generally there is manufacturing overcapacity in various sectors, while many enterprises are ready and willing to ship real goods for US dollars or other foreign exchange.
In general, there is no reason why production cannot be increased to cover basic needs of most humans, as well as to provide considerable amounts of consumer goods too, when people are employed in government programs in industrialized nations.
“The logic of this is basically: we should let those people who have no means to starve to allow others to enjoy a slighter better designed Ipods or mp3 players.
DeleteIf this is where human beings rank in your value scales, then further argument is a waste of time.”
My logic is this: Let people do what they want with their own resources. A better question to ask would be: why are they starving?
“What absolute garbage. Do you think every economy on earth runs constantly at full employment equilibrium?
The capital stock of an advanced capitalist nation like, say, Germany, France, or Canada is vast, productive and often underutilized (e.g., capacity utilization rates rarely go above 90%). Often capital goods are sometimes idle. Stocks of factor inputs are unsold.
The ability to import goods from other nations is also vast: in China and East Asia generally there is manufacturing overcapacity in various sectors, while many enterprises are ready and willing to ship real goods for US dollars or other foreign exchange.
In general, there is no reason why production cannot be increased to cover basic needs of most humans, as well as to provide considerable amounts of consumer goods too, when people are employed in government programs in industrialized nations.”
Lord Keynes, I encourage you to actually read what I wrote. Was I talking about current economies on earth? Simple investigation you neglected would say otherwise:
“It is important to remember that Austrian economics makes the assumption that labor is scarcer than land and idle capital, and as a result all labor can be employed at a positive wage. If the population suddenly trebled in a year, then even with wages plummeting it seems likely that some portion of the population cannot find work. The free market, or government intervention in general, can do nothing about this except allow for additional savings to create more capital goods to employ labor.”
So, what I was talking about was an economy where labor was more abundant than land and idle capital. Imagine if the population of the world suddenly trebled, or quadrupled. That’s the world I am talking about. So quit with your nonsense.
"If the population suddenly trebled in a year, then even with wages plummeting it seems likely that some portion of the population cannot find work. The free market, or government intervention in general, can do nothing about this except allow for additional savings to create more capital goods to employ labor."
DeleteSo with Africa's surging population, there's nothing the governments can do accept allow for additional savings?
Your a complete fool.
"So with Africa's surging population, there's nothing the governments can do accept allow for additional savings?
DeleteYour a complete fool."
Huh? Africa definately requires additional capital to allow for proper industrialization, but it also is extremely abundant with rich natural resources. So labor isn't more abundant than land and idle capital. The most important thing the governments could do is allow for the existence of better property rights so those resources could be utilized and increase the incentive to save (allowing for capital accumulation).
Whats your plan?
"So labor isn't more abundant than land and idle capital."
DeleteThe population is surging rapidly, and many countries there don't have an abundance of natural resources, though to be fair many countries happen to have a good deal.
Very soon, it will be a catastrophe.
"Whats your plan?"
HA..A good plan, I think, could be modeled after Botswana's approach since the late 60s. They invested the resources in public services like education and health care. They expanded infrastructure. Other countries simply did not bother or failed outright.
They have the highest per-capita income in sub-Saharan Africa.
I think you are being harsh on Rothbard. His views were:
ReplyDelete- No state = no FRB
- No FRB = no cycles.
I dis-agree with him on FRB but I don't think he is being inconsistent in the way you suggest.
On the other hand: I have not seen a workable model of endogenous money that does not also require a CB to underwrite the whole operation - so I counter-challenge that post Keynsian's who claim that FIH proves capitalism's inherent instability have themselves got things the wrong way round.
"I have not seen a workable model of endogenous money that does not also require a CB to underwrite the whole operation"
DeleteThen you've not looked hard enough: Australia in the 19th century and America (for most of that period) had no central bank, yet the money supply was undoubtedly elastic/endogenous to a significant degree.
Even if you have bills of exchange and promissory notes, you already have an elastic money stock.
The ABCT is a terrible theory and should be rejected out of hand.
ReplyDeleteSee, China had a rapidly growing money supply, and a higher proportion of capital spending to the overall economy. It has not faced financial catastrophe, due to strong regulations.
The theory is a pathetic, unequivocal joke.
"Australia in the 19th century and America (for most of that period) had no central bank, yet the money supply was undoubtedly elastic/endogenous to a significant degree."
ReplyDeleteI will grant that this is true (though these systems were certainly not free from state control). But my point is that to generate the huge levels of debt needed to create a great depression or a great recession one needs a central monetary authority (and a fiat money) to provide the reserves to back up the lending.
Wrong again. Australia had a depression under its free banking system:
ReplyDeletehttp://socialdemocracy21stcentury.blogspot.com/2012/05/free-banking-in-australia.html
That depression in terms of real output loss was worse than Australia's 1930s contraction:
http://socialdemocracy21stcentury.blogspot.com/2012/05/tale-of-two-depressions-1930s-and-1890s.html
While the Australian experience is hardly a ringing endorsement of Free Banking I think you would equally struggle to fit it into a FIH framework.
ReplyDeleteThere is no particular evidence that the large banks lent recklessly (as measured by reserves and capital ratios) and there was clearly a real "supply-side" shock that would have led to an economic downturn no matter what banking regime was in place.
There is also evidence that - left to the market - the banking crisis would have led to a health restructuring of the banking system - but this was prevented by the intervention of the authorities.
The free banking disaster is Australia in the 1880s and 1890s fit the FIH perfectly.
DeleteThe evidence that they lent recklessly is quite clear.
And as for state intervention, the action by the New South Wales state government clearly stabilised the financial system there.
Everything you say is refuted here:
http://socialdemocracy21stcentury.blogspot.com/2012/05/free-banking-in-australia.html
And what's more the country was already in the grip of a severe debt deflationary depression before the financial crisis in 1893:
DeleteYear | GDP
1888 | $14,685
1889 | $15,953 | 8.64%
1890 | $15,402 | -3.45%
1891 | $16,586 | 7.69%
1892 | $14,547 | -12.29%
1893 | $13,748 | -5.49%
"The free banking disaster is Australia in the 1880s and 1890s fit the FIH perfectly."
DeleteDo you have figure on debt/GDP ratios to back up this statement ?
My view is that the recession was caused by a sharp decrease in capital inflows from Great Britain which put a strain on an immature banking system and led to a banking crisis and this then gave the opportunity for opponents of free banking to undermine and eventually end the free banking era.
I see no strong evidence that debt deflation played a major role - and I stand by my claim that there are no examples of FIH in practice without a CB to orchestrate things.
"Do you have figures on debt/GDP ratios to back up this statement ?"
DeleteThe fact that private debt absolutely soared relative to GDP in 1880s Australia is well known. Steve Keen has a graph here:
Figure 1: Australian Private Debt to GDP Ratio and Inflation Rate, 1880-2009, p. 19 (at the bottom of the page).
http://www.debtdeflation.com/blogs/wp-content/uploads/papers/JAPE2009V64_04_Keen%20_2_.pdf
As you can see in the graph, price deflation hit the Australian economy from about 1890 and lasted until c. 1897/8.
America had no central bank in the 1890s either, and yet it clearly also
had a financial crisis and debt deflation recession around 1893.
Very interesting.
DeleteKeen's numbers show GDP/Debt ratio's increasing sharply to around 100% by 1890 and then falling sharply before the banking crisis hit in 1892/3.
So accepting and applying the debt/deflation hypotheses to this era I would like to make the following points:
1. Debt/GDP ratio of 100% is rather low compared to levels seen before both the Great Depre4ssiona and Great Recession in the US where the ratios were 300-400%.
2. Under free banking in Australia even ratio's of 100% were unsustainable and caused a banking crisis. Larger more mature banks generally did not expose themselves to so much lending risk as smaller ones. It is likely that had bank restructuring been allowed to take place in 1893 without interference then a free-banking regime less susceptible to boom/bust type lending may have emerged.
3. In any case the fact that under Free Banking even 100% debt/GDP ratio proved unsustainable , while in the lead up to the Great Depression and the Great Recession levels 3 or 4 times greater than this is clear evidence that a CB is needed to allow a deep debt/deflation bubble to emerge (Keen himself makes the point that had the bubble been allowed to burst in 1987 rather that being sustained - then the ensuing recession would have been much milder than we eventually got - and debt levels even then were well over 100% of GDP in the US).
5. The Depression in Australia during the 1890's likely had causes both relating to the drop in capital inflows from Britain and banking instability. Nevertheless it looks (I don't have good data) that this depression was less severe than both the Great Depression and Great Recession (seen globally, not just in Australia where it is clear things played out differently). Also it seems likely that the role played by debt was smaller in the case of Australia in the 1890s due to the relatively lower debt-ratios and the clear evidence of real supply-side factors.
So: This episode does perhaps show evidence of free banking instability that led to growing debt levels and a panic. It also shows that the level of debt is bounded under Free banking in a way it is not under a CB regime.
I would still like to see stronger evidence of FIH demonstrated under free banking.
(1) "Debt/GDP ratio of 100% is rather low compared to levels seen before both the Great Depression and Great Recession in the US where the ratios were 300-400%."
DeleteA 100% private debt to GDP ratio is both large and significant, despite your desperate special pleading.
(2) "Nevertheless it looks (I don't have good data) that this depression was less severe than both the Great Depression and Great Recession"
I've already given you the real GDP data above. From 1891 to 1893, under a free banking system, Australian GDP fell by 17.11%. From 1889 to 1893, it plunged by 13.82% (despite the recovery in 1891).
Real output loss was higher in 1890s Australia than Australia's 1930s recession. Australia had no great recession in 2008-2009 thanks to swift Keynesian stimulus.
Real output loss was certainly higher in 1890s Australia than the US great recession 2008-2009. The US 1929-1933 was higher but that doesn't mean that 1890-1893 Australia was wasn't in a debt deflationary depression.
You are clearly a fool if you think 13.82% isn't huge by historical standards and a full blown depression.
(3) "It also shows that the level of debt is bounded under Free banking in a way it is not under a CB regime. "
It shows nothing of the sort. There is no reason a priori why it couldn't have been higher than 100% if more money had come in from overseas and debt-levered speculation had been more intense.
I don't really understand the FIH well enough to really know if 100% GDP/debt ratio is considered high enough to cause a debt/deflation recessions of that magnitude but surely there must be a correlation between that ratio and the length of the recession or the whole theory would be totally unanchored?
DeleteKeen says
"Had central banks around the world not intervened in 1987, it is quite
possible that we would have had a mild depression back then—a
depression because de-leveraging would have depressed economic
activity, and a mild one because inflation would have helped reduce the
debt burden. Instead, the rescues encouraged financial institutions across
the globe to move from one debt-financed bubble to another, with the
consequence that for most of the OECD, private debt has risen
substantially faster than GDP for the past 3 decades"
In 1987 the US ratio was already over 150% - so I was basing my comment on that.
Looks I may have under-estimated the depth of the Australian recession - but I am still skeptical of the claim that the depth was entirely down to debt/deflation for 2 reasons:
- It is clear that capital inflows were very key in the economy and they clearly fell at the time
- Despite what you say I see no evidence that 100% debt to GDP ratio normally correlates to a depression as deep as this one.
Do you have other examples where under free banking debt/gdp levels rose above 200% - and induced deep recessions?
(BTW: This paper http://www.rba.gov.au/publications/rdp/1999/pdf/rdp1999-06.pdf makes the same points as you but has the debt ratio at 70% not 100%)
I think the pro-and anti- FRB advocates completely miss the point. I don't think Fractional reserve banking is itself immoral or fraudulent., but what I do think is that problems occur when bills of exchange and promissory notes have fixed rates of exchange to the physical currency base money. In a modern economy, this is no problem, as the Treasury and central bank can accommodate any desire for physical currency. but with commodity money this is a problem. If bills of exchange and promissory notes are fluctuating with regards to gold/silver at a rate of 10:1, then the exchange rate should reflect that not be fixed 1:1. So, while I don't think its fraud, i do think its price fixing and I oppose price fixing and fixed exchange rates
ReplyDeleteBills of exchange and promissory notes are discounted for whatever you get for them, and then repaid when they fall due, as promised original debtor.
DeleteIn short, what are you even talking about here.
Sorry i kind of misspoke,
DeleteWhat you said is true, but what i meant is fractional reserve banking in general, B.E. and P.N. are just one part of FRB. Say I deposit 100 ounces of gold at a a local bank in the 19th century I have an open checking account, a demand deposit. If my local bank has more demand deposits than physical gold on hand to pay for them, say 5 to 1, than its vulnerable to a bank run. It can do two things, (without a central bank_ one, it can borrow in the inter bank market, and normally this works. The problem is when there is a massive economy depression, and banks start failing en masse.
The second option is for the bank to close its doors, to suspend payments. If its done ad hoc, this can be chaotic, but its a legitimate way for banks to protect themselves against an irrational mob demanding their mon ey now. What tends to happen is that banks who suspend payments get their banknotes and cheques depreciated, just like a country that de values its currency.
What I am saying is: Let this happen, its okay, but make it formalized into law. (If we have a free banking system) We don't need to have a central bank to prevent catastrophe, all we need is for the demand deposits and banknotes of Bank A, which 1 dollar of gold on hand for every five dollars of its own DDs to have DDs have an exchange rate of 1/5th relative to gold. The same thing goes for Bank B which has 1 tenth of physical gold to every ten of its Bank B notes in circulation. Treat DDs as its own separate floating exchange rate currencies.
Edward, Your suggestion is very similar to Lawrence Kotlikoff’s, far as I can see. See Ch 5 of his book “Jimmy Stewart is Dead”.
DeleteHe advocates that where those depositing money in banks want a significant rate of interest, they have to put their money (via the bank) into mutual funds (unit trusts in the UK). And those funds, as with existing unit trusts fluctuate in value. I.e. there is no guarantee that for every £X put in, depositors will get £X back.
In contrast, where a depositor definitely wants £X back for every £X deposited, they put their money into what he calls “cash mutual funds”. That money is invested only in ultra-safe stuff like government bonds (or maybe it’s just deposited at the central bank). As he says, “These cash mutual funds would thus represent the demand deposits (checking accounts)…” The he says, “In requiring that cash mutual funds hold just cash, limited purpose banking effectively provides for 100 percent reserve requirements on checking accounts.”
The basic advantage of that system is that it forces depositors to come clean. That is if they want interest (i.e. if they want to act in a commercial manner) then they have to face the normal consequences of acting in a commercial manner: face the possibility of making a loss.
Under our current system, we let depositors act in a commercial manner, while shielding them from the occasional adverse consequences. But someone pays for this “have your cake and eat it” charade: the taxpayer.
Jan said :It is 70 years since Nicholas Kaldor´s famous refusal of whole ABCT in his "Professor Hayek and the Concertina Effect" Economica
ReplyDelete-New Series, Vol. 9, No. 36 (Nov., 1942), pp. 359-382
http://www.jstor.org/discover/10.2307/2550326?uid=3738984&uid=2&uid=4&sid=5627798989
It´s sad that ABCT is taken serouis by anyone after such massive load of empirical evidence that falsified it.Even more surpricing since it seems not only Hayek´s adept Kaldor rejected it,also Hayek´s close collaborator at LSE, Lionel Robbins turned away from ABCT,and embraced a great part of the Keynsian framework in later.The ABCT have been debunked so many times by so many different schoolars from Milton Friedman Gordon Tullock to Richard Goodwin,and many others.ABCT is buried under so much scholarly objections,so one wonder how anyone manages to keep this dead failure at life.