Why central banks can't manage our money
[This column ran in the National Post, September 17, 1999, on the occasion of the Mises Institute conference "Austrian Economics and Financial Markets"]
Our fiat money system--the one currently in worldwide use--does not work. Although admittedly managed by sophisticated individuals called central bankers, fiat money--or managed money--has proven again and again to be an unmitigated disaster.
Here is a partial inventory of such disasters following World War II: the global inflation of the late 1960s and the entire decade of the '70s, caused by central bankers allowing money supply to grow at high double-digit rates, and the aftermath, the severe recessions--actually credit deflations--of 1974 and 1982. The 1986-87 stock market boom, caused by exceedingly easy money, and the aftermath--the crash of 1987.
The ensuing mini-boom of 1988-89, courtesy of the Federal Reserve Board, and the tightening and inevitable bust of 1990-91 that gave the final coup de grace to the U.S. S&L industry and a goodly portion of the banking industry in Massachusetts and Texas. Of course, the cleaning crews called on U.S. taxpayers, who shelled out hundreds of billions of dollars to help them clean up the mess.
We need not restrict ourselves to the U.S. Does anyone remember the U.K. inflationary episode of the mid-1970s and the destruction of its secondary banks? The runaway inflation in Latin America in the late '70s and early '80s as its central bankers struggled in vain to escape first, the clutches of a slowdown in the recycling of oil capital, and then the drying up of international liquidity, courtesy of the get-tough-on-inflation policy of then Fed chairman Paul Volcker?
These bouts of hyperinflation destroyed Mexican and Argentinian banking systems, causing widespread failures and untold poverty. And what about the collapse of the Nordic banking system in the '80s, which cost 10% to 20% of GDP to "fix?" Or the disastrous Japanese Bubble of the mid-to-late '80s, courtesy of central bankers unaware--or so they admit today--that it was a bubble, followed by the most painful postwar asset and credit deflation anywhere, one that still mires them nine years later? In the meantime, Japanese taxpayers have been kindly asked to save the country by mortgaging the future of their children and grandchildren and, who knows, their great- grandchildren.
Need I mention Mexico 1995, Thailand, Korea, Indonesia and Malaysia 1997-1998, and Russia 1998--all the product of easy money, exported out of the U.S. and Europe and underwritten by the imperatives of a fiat money system that not only creates too much money but also guarantees that fast and loose private lenders will not be allowed to fail? All in the name of avoiding systemic risk.
So there we are. Booms and busts, created by money and credit policies of well-meaning central bankers who have cost the civilized world literally trillions of 1999 dollars. No wonder these booms and busts come at repeated and short intervals, each time, it seems, amplified, more threatening, more terrifying.
Busts are not allowed to run their course, lest they bring down the entire economy. Calls for easy money, just for this once, become deafening. Central bankers, human beings that they are, restart the boom. Isn't that what happened in the U.S. after the crash of 1987, the recession of 1990- 1991, the Mexican tequila crisis, the Russian crisis? Isn't this about to happen in Japan? Indeed, haven't some of the world's most respected economists pounced on the Bank of Japan for not adopting quantitative targeting -- that is, reflation? Does anyone really believe that Mr. Greenspan will allow credit deflation to bring down the largest U.S. banks, investment banks, hedge funds?
But, why, you may ask, can't these intelligent government bureaucrats manage our money to lead us to Paradise without going through Hell? The great Austrian economist Ludwig von Mises, who so well exposed the pitfalls of socialism almost 70 years before the fall of the Berlin Wall, gave us the answer. Managing the quantity of money is no different than managing the quantity of shoes or shirts that a modern economy requires to satisfy its consumers.
Can a centralized economy provide the right amount of consumer goods? The socialist and Communist economies proved unable: Goods were either overproduced or underproduced. Millions of pairs of shoes were left in warehouses, tons of steel were abandoned while consumers queued for eggs, bread and cars. By the same token, our central bankers are unable to judge the right amount of money and credit required to satisfy the needs of a modern and sophisticated economy. At times they will overproduce, and at times underproduce. The first leads to booms-- more correctly, credit inflations--the second to busts and credit deflations.
Central bankers appear to know what they are doing. They debate endlessly, in private and in public, about the appropriate rate of interest to set. Can you think of a more idiotic exercise? It is like a gigantic marketing board in the U.S. deciding on an appropriate price for bananas based on their knowledge of consumer tastes, population numbers, etc. How often do you think this marketing board would get the amounts right? You can be sure: never.
This is why most developed countries have abandoned their efforts to manage their agricultural sectors. Thankfully, we no longer suffer from the wasteful grain surpluses of the '50s that enriched producers at taxpayers' expense. And yet we manage, quite comfortably, to feed a hungry world, year after year. The price set by the free market has been the best regulator of supply and demand. For some reason, however, when it comes to money, we abandon our senses and believe in the omniscience of a select group of bankers. A more appropriate monetary system exists, and it does away with central banking.