Austrian School – The Burning Platform

Submitted by Alasdair Macleod via The Cobden Centre,

Your country faces a stagnating economy. Let us assume your Prime Minister (or President if that is who holds the executive power) seeks advice from two imaginary economists.

PM: You two economists have different views on what our economic policy should be. What is your advice?

FIRST ECONOMIST (Austrian school): Prime Minister, the reason we face a stagnant economy is your central bank perpetuated the credit cycle by suppressing interest rates when the economy turned down after the banking crisis and lending risk escalated. That has left us with a legacy of under-performing businesses, which should have been left to go bankrupt. Instead they are struggling under a burden of unrepayable debt. Capital is not being reallocated to the new enterprises of the future. The dynamism of free markets has been throttled.

The extra money and credit created by the banking system has not been applied to the real economy. Instead they are fuelling a financial boom in asset prices, which have become dangerously separated from production values.

Eventually, current monetary policy will lead to a fall in the purchasing power of the currency, and the central bank will be forced to raise interest rates to a level that will precipitate the next financial crisis, if the crisis has not already occurred by then. Overvalued assets become exposed to debt liquidation. It happens every time, and if you think the last crisis, which led to the Lehman collapse was bad, on current monetary policies the next one will be much worse, just as Lehman was much worse than the aftermath of the dot-com boom.

A monetary policy that relies on the transfer of wealth from savers to debtors always fails in the end, as certainly as death and taxes exist. It is also the real reason the bankers are getting wealthy while ordinary people become poorer. The time has come to recognise that your central bank, by licencing and encouraging the banks to create credit out of thin air, is the source of the problem.

Sadly, your central bank seems blissfully unaware of the debilitating effect of monetary inflation on your voters’ wages and savings, and if I may say so Prime Minister, your administration pays little regard to the natural injustice of rewarding profligate borrowing and penalising thrift.

I advise you to stop your central bank from manipulating interest rates and to let the markets sort themselves out. Furthermore your central bank must stop debasing the currency as a cure-all. So this is what I suggest.

First, encourage savers to rebuild their wealth directly through tax policy. When someone has paid tax on his income he should be entitled to keep his savings. The evidence from Germany and Japan in the post-war years is that a stable source of low-taxed savings is a prerequisite for a strong, yet stable, economy. And as savers rebuild their personal wealth, the state can scale back its future welfare commitments, which as you must be aware, are in danger of escalating out of control.

Second, I would reform the financial system. Banks should manage their affairs on the basis of reputation, and not hide behind regulation. Instead of looking after their customers, they use their regulated status to game the system. Regulating the banks has led to crony capitalism of the most pernicious sort. In future banks must set their own standards and be answerable to their customers first and foremost, not to a government regulator.

Third, the state must always run a budget surplus, to pay down its high level of debt. In balancing the books it is important to bear in mind that money taken in taxes destroys wealth. For a truly prosperous economy, you should plan in the longer term to reduce the state’s tax take to below 30% of GDP, and lower still in the fullness of time.

You will only put a stop to successively worsening cycles of boom-and-bust in the future if you return to sound money, free markets and small government. Your ministers must stop pretending they can run the economy. They have no basis for making commercial judgements. Government interventions are always politically-driven. Nor should your ministers listen to big business, which always seeks to influence policy in its favour.

I realise all this will take time to implement and must be done in steps so that the private sector can adjust. For this reason I recommend you structure these changes over a ten year period, announcing the legislative schedule in advance. You will find that businesses will reposition themselves to your new policies ahead of their implementation. The benefits to your economy and your voters are more likely to flow smoothly without disruption, and deliver economic benefits much sooner than you think.