The Austrian Way: How the economy could be so much better

There are many great deformations in our economy today, ranging from over-grown finance, real-estate and insurance sectors to other smaller scale, less obvious perversions.

The deformation to be chewed over today is the speculative financial part of economy.

It’s not that I’m some anti-capitalist, soft-headed socialist, I feel this way because this sector results in huge misallocations of capital and only exists because of an oft-unrecognised great enabler.

I don’t seek to blame bankers, hedgies and brokers – they’re merely agents seeking to advance their cause in the game. What I dislike is the monetary system that enables all of this bollocks, time-wasting, pumping and dumping to occur, when better things could be done with this time and money. This system often insulates the speculative sector from its own mistakes too, making it ever more maladaptive.

There have always been rises and falls in the prices of things, but today’s money system opens the door to great speculative opportunity by ensuring larger and faster rises and falls. Speculators need volatility in prices to make their gains by buying and holding as assets rise, or shorting them as they fall. Cheap debt enables greater leverage to these price trends too, enabling generations of wealth to sometimes be collected in months. These investment super-gains are rare though, but only serve to attract more capital to the casino with its spreads, fees and margins. Today’s financial markets have ceased to be locations of considered price discovery amongst savers and investors and are in fact gargantuan algorithm lined gambling halls.

Our great experiment in fiat money today allows great changes to occur in the money supply which means big changes in how much, or little, money is chasing houses, stocks and bonds. Prices then tear off accordingly.

It is this Keynesian justified but hugely distorting phenomenon which creates the giddy bull markets and crushing bear markets (when the later have occasionally been allowed to happen!) we’ve witnessed since 1913 and even more acutely since 1971.

However, things were not always thus.

A better base to build from

As plenty of you Bogpaper readers are already aware, other monetary systems have functioned with very different records when it comes to moderation of the money supply.

These systems, with their slower growth in the money supply, exhibited lower levels of price volatility and thus never enabled the growth of such huge speculative classes and speculators.

Steadier trends in prices, whether up or down, enabled better long-term planning, investment and the economy did not slowly trudge on without these apparently essentially and irreplaceable hot money sectors.

What did happen is that all these bright, smart, striving people who gravitate to various areas of the City, Wall Street and other currently rich seams, ventured elsewhere.

Where did they go?

I used the word ‘ventured’ above because these hustlers largely got down and dirty in the task of enterprise. They started companies, invented better ways of doing things and very often made up an impressive entrepreneurial cadre.

It’s not that we don’t have entrepreneurs today, we do, it’s just that we have less of them and often they are applying their great talents in high-finance, enabled by Bernanke and his brethren and cheap debt.

Which do you want more of?

If I could offer you a future economy with a huge constituency of entrepreneurs and few speculative playgrounds, or one with less entrepreneurs and great hubs of high-finance and speculation, which one would you prefer?

I’m opting for more entrepreneurs and the sound money basis that causes it.

I’ll take long-term wealth creators, a thriving Mittelstand and a respect for saving and prudence over fast buck merchants, debt fuelled hedge funds, private equity mega-structures and ever larger Leveraged Buy Outs (LBOs).

Some of the great Austrian economists mused that once you corrupt a nation’s money, you corrupt its morals as well as its financial patterns. I’m with them on this one.

The vast majority of today’s great deformations come from our long since corrupted money.

Fiat money has enabled a vast rent-seeking financial sector, which extracts capital from Main Street and channels too much talent and money into speculation where the attractions of greater and faster gains are sought over the steadier building of great companies.

This madness has been going on for quite a few decades now, but I’m with Bogpaper favourite, Jim Rogers, in believing great change is afoot – given the great debt levels in the developed world and our depleted savings, our economies are being forced to change and re-invent themselves. The tech revolution is helping this change unfold.

Hopefully all this change does indeed mean another rising of the entrepreneur and the fading of the speculator.

We’ll all be better off for it.

11 comments on “The Austrian Way: How the economy could be so much better

  1. Maneno
    September 24, 2013 at 2:20 pm #

    I think a brave banker/hedgie might say that their work provides easier funding at cheaper rates combined with risk management to enterprises. The effect of this is to encourage business activity.
    I know its a bit rich to mention risk protection after events in 2007, nevertheless that is the rationale no ?

    • Honey Badger
      September 24, 2013 at 3:56 pm #

      If people want to risk their cash/assets by speculating then they should be free to do so. Speculators are a key compmonent of the market. The problem as always is with government. Government should have let the banks go bust and government should not provide deposit insurance. If these 2 basic principles were observed then the population would be a lot more careful where they deposit their cash therefby preventing much of the activity that is complained about in this blog.

      • Honey Badger
        September 24, 2013 at 3:59 pm #

        Keep up the good work by the way – I am a big fan of the Austrian Way!

      • Honey Badger
        September 24, 2013 at 4:05 pm #

        … sorry about this, but I forgot to make my actual point … My actual point is that you are right about the “Great Enabler” but wrong about who/what it is – it’s not the system or cheap money but the government. For example, money would not be anywhere near as cheap if government wasn’t currently in the bond market via the BoE monetising debt.

      • theaustrianway
        September 24, 2013 at 4:33 pm #

        Hi Honey Badger,

        Welcome back and thanks for reading more and commenting more too!

        I’m with you on most of this – failure should be a vital part of the market process – but for me, money that can be created from thin air gives the governments of the world a far greater ability to bail out and remove our agreed vital markets process of bankruptcy, failure and renewal.

        Speculators are indeed also valuable, like scavengers in the wild – perhaps I hadn’t articulated that part well enough. I never have a problem with the ‘evil speculators’ – they are the messengers to fools in Washington, Westminster and Europe and in no way the cause. George Soros is one of my greatest heroes and I’ve read pretty much everything he’s ever writted. The problem with lots of the speculating today, as you say, is that IMHO it has morphed into a drug fuelled super storm by too many years of removing the market’s vital checking mechanism.

        IMHO it is also this phenomenon that enables even more distorting levels of deposit insurance and government’s general intervention in finance.

        I’d also humbly urge that it is this fiat money system that allows such scales of governments buying of debt, MBS and other such assets btw, as newly printed dollars (in the case of the Fed) are used to buy government bonds.

        It’s rather more difficult to bail out, intervene and buy your own debt when you have to sell your limited and precious gold bullion reserves to do so. Creating money and adding to the money supply is all too easy alternative, hence the dollar and pound losing >96% of their value since 1913 during decades of quiet printing.

        Thanks for your kind comments. We hope to unveil a couple of more financial writers shortly! Any keen finance nerds wanting to throw their hat in the shout out here or on Twitter: @TheBogpaper.

      • Honey Badger
        September 24, 2013 at 9:07 pm #

        Thanks for such a comprehensive reply! I hope I can do it justice with my response.
        If I understand you correctly, in your piece you are specifically referring to speculation associated with quantitative analysis, algorithmic trading and high frequency trading (please correct me if I am way off-beam). I think the greatest contributors that make this possible are the availability of large amounts of real time and accurate data coupled with the high-speed computers that are able to run the algorithms designed by the mathematical boffins with their huge pulsing brains. Of course, large amounts of cheap cash are also a key ingedient.
        The thing with this kind of speculation is that it must be conducted on an exchange – that is, it cannot operate in the OTC derivatives market or other OTC market places (for the uninitiated OTC = over the counter i.e. you have to physically telephone somebody for them to give you a price). My point is, that this behaviour must be acceptable to the exchange concerned, whether the LSE or whatever. The question as to why the exchange would allow this, to my mind, is that this kind of trading must provide significant liquidity to whichever market it is operating in, plus of course the amount of fees these traders would have to pay to the exchange for the amount of trades that are being undertaken. It may seem that these guys are making money for nothing but they will be losing money too. Does this type of speculation provide any socially useful function? Probably not. Would these brains be better employed somewhere more productive? Absolutely! These are the brains that were putting men on the moon. We haven’t put a man on the moon since banking bonuses took-off – coincidence? I don’t think so! But the fact is, that if this was that much of a problem, Ed Miliband would have made a speech pledging to tax or ban it by now, instead he seems to be focusing on the energy companies and landowners.
        I want to condemn these speculators, really I do, but I can’t. Take George Soros as a prime example – he probably even took a few quid off me (as well as every other taxpayer) when he broke the BoE, but he, more than anybody is responsible for keeping us out of the Euro. It may have seemed harsh at the time, but what a favour he did us – I would personally contribute £100 if he could pull the same stunt with our membership of the EU! Furthermore, I would argue the only difference between George Soros and this modern day speculation is just time i.e. he would be all over it if he was still cutting a dash in the markets.
        In respect of fiat money, again, it’s the government that’s screwing it up and destroying confidence in it. They should have absolutely no control of money supply. The BoE should have a mandate whereby it can increase supply when the economy expands and withdraw the excess when it contracts – by definition the inflation target should be 0%!! Why should money be allowed to buck the supply/demand rule? By increasing the supply during the economic expansion then increasing it by more during the contraction it has set the conditions for some serious price inflation as soon as the economy picks-up. When the “Great Rotation” finally begins in earnest, and we see a huge sell-off of Gilts, speculators will be the last thing on our minds, our main concern will be how governments will be dealing with the inevitably termed “crisis”. Hopefully they won’t do anything silly like confiscating wealth, but will just let inflation do the heavy lifting, allow the correction to take its course and raise interest rates accordingly. Unfortunately the precedents are not good.
        I support your prescription for getting us back on track. People save their earnings, the earnings get loaned to business, business grows, the economy grows, people earn more wealth etc … the solution may be to cut out the banks entirely by lending directly to business. As you pointed-out tech/the internet is a great enabler for this but people will have to take more control. We should teach it at school. It won’t happen though because the last thing government wants is the population seeing through their ponzi scheme.
        When things do start to get interesting I will be turning to Bogpaper to stay informed – there’s not many sources that can be trusted to firstly know what they are on about and secondly tell the truth.
        P.S. Thanks for clarifying your position on ‘evil speculators’ you seemed to be sailing too close to One Nation Labour’s “predatory capitalism” wind for my liking. Glad you set the record straight!

    • theaustrianway
      September 24, 2013 at 4:17 pm #

      Thanks for reading Maneno and of course for the comment!

      I agree that a certain type of banker will always exist and always add some value. A corporate finance banker advising entrepreneurs/owners/operators on an international transaction for example. Or even a private wealth adviser. These banker profiles have existed for centuries due to fair need.

      The type of banker I might be thinking of here is a transaction services/prime brokerage guy, whose numbers have swelled massively over the last decades as these bank departments have also grown rapidly to service new needs arising from the great speculative machine.

      Thanks for your continued readership.

  2. silverminer
    September 24, 2013 at 9:14 pm #

    We’ve got the worse of all monetary systems, i.e. fiat currency along with a fractional reserve banking system which allows private bankers to create debt money out of thin air and lend it out at interest, pocketing the profits but socialising the losses because they’ve become “TBTF”. Nothing could be worse.

    What to do about it? Break up the banks with full Glass Steagall separation of retail and investment banking and make it clear there will be no more bail outs. Abolish the central bank and take the issuing power of the national currency into the Treasury, i.e. a Greenback Pound issued as credit and spent into existence meaning the end of National Debt. Allow banks to lend only against time deposits, ending fractional reserve credit creation which is fraudulent. New currency would be provided by the Government running a deficit of 2 to 3%, approximating the real trend growth rate of the economy, financed via the printing press.

    What if they go wild and print too much money creating inflation and debasing the currency? Remove all taxes and restrictions on the ownership of gold and silver giving citizens an alternative store of value and remove the legal tender laws so metals can be used for payments of debts. Gold and silver grams can circulate as alternative currencies accessed with a debit card. If the Government starts printing too much money, people will just use metals or some other alternative.

    All this could be easily done if our government wasn’t controlled by City of London interests.

    • Honey Badger
      September 25, 2013 at 9:53 am #

      Rather than legislate to regulate banks we should legislate to regulate government intervention in the banks.

      First law – Bank bailouts to be made illegal and a wind-up pathway to be determine to limit contagion/damage. This will send out a clear message that banks are on their own and will not be able to socialise any future losses.

      Second law – Bank of England to be entirely independent with a clear and strict mandate that allows very little room for manoeuvre. That is, no new money created unless it matches the wealth created in the real economy. And definitely no purchasing of government debt – ever. If the government can’t raise money in the market then they can’t have the money. This will mean that they will have to have responsible policies that mainain market confidence.

      • silverminer
        September 25, 2013 at 10:02 pm #

        If money is by fiat, i.e. created by decree of the State, then why does the State borrow it from third parties and pay them interest? This is absurd and I’d like someone to explain the logic of it to me! Some party in the system is creating new money from nothing and profiting from it and in our system this is the perogative of the privately owned banking system. Most of the new money in the system is created as debt by private banks not as base money in the B of E. If we are to have a fiat currency, with the risk of inflation that it entails, then at least the benefit of the issuing power should rest in the Treasury, so that we all indirectly benefit, not with private bankers.

  3. Apparent bigot
    September 25, 2013 at 9:19 am #

    Austrian Way – great recommendation last week of the Great Deformation. 200 pages in and have to agree – Stockman is a total genius. Beautifully written, factual, technical, but all well explained too. He’s one if those rare things – an insider who’s done very well and made a stack load of money, yet sees certain key things that helped it all happen that aren’t good for the economy.

    Please keep the articles coming!

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