Banks, economic interventionism and the cause of the credit crisis

(This post is a precis of Huerta de Soto’s Money, Bank Credit and Economic Cycles pp650-653, presenting an argument which was famously expounded by von Mises in Socialism.

Among the young idealists who were attracted to socialism after the Great War, who came through these arguments expressed in full to understand that they “had been looking for improvement in the wrong direction”, was F A Hayek, Author of The Road to Serfdom, Nobel Prize winner and proponent of the denationalization of money.)

To attempt to coordinate society through coercion is an intellectual error: it is impossible for an institution to obtain the information needed to establish social coordination by decree. There are four reasons:

  • It is impossible to obtain, store and process the vast amount of practical information in the minds of different people.
  • Most of the necessary information is subjective, practical, tacit and non-verbal: it cannot be transmitted.
  • Information which people have not yet discovered or created and which arises from the market process cannot be transmitted.
  • Coercion — that is, regulation — prevents the discovery or creation of the necessary information.

These are the arguments developed at length by von Mises in Socialism. Von Mises demonstrates the impossibility of socialism and of effective state intervention in the economy. His thesis explains theoretically why the socialist economies of the Eastern Bloc failed. It also explains the growth of the tensions, maladjustments and inefficiencies in western economies which have led to our present crisis.

Crisis is the inevitable outcome of the application of coercion and privilege by government, which systematically worsens social maladjustments, hinders the creativity of entrepreneurs, distorts economic information, encourages irresponsibility, corrupts individuals and encourages the underground economy.

These arguments are directly applicable to the financial and banking system which has now failed. The system is characterized by private banking with a fractional reserve, controlled by a central bank which determines monetary policy and which has a monopoly on the issue of legal tender. The system shares characteristics with a socialist economy in that:

  • The whole system is planned by the central bank.
  • Banks are commonly excluded from general bankruptcy proceedings.
  • Bank failures are prevented by socializing the costs of their failure.
  • The entire system rests on the government monopoly on currency.
  • The system is based on the privilege granted to banks of creating loans out of nothing by holding only a fractional reserve on deposits.
  • Legally, banks enjoy privileges otherwise only granted to governments.
  • A vast and inordinately complex set of regulations applies to banks.
  • There is little or no supervision of government intervention in bank crises and in many cases, intervention is determined ad hoc, disregarding principles of rationality, efficiency and effectiveness.

[That is, banks enjoy special privileges and suffer intrusive regulation and yet, when they fail, the terms of their rescue are invented on the hoof at the expense of the hard-pressed taxpayer and, it turns out, future generations of taxpayers.]

In banking and credit, the situation resembles that of the socialist countries of the former Eastern Bloc. Central planning is endemic in banking and finance and it is therefore not surprising that we are living through the same inefficiency and failure which has plagued command economies, ultimately causing their collapse.

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