Friday, 24 August 2012

Polleit on Fiat Money and Collective Corruption

In an article in the Quarterly Journal of Austrian Economics (vol 14) titled Fiat Money and Collective Corruption, the author Thorsten Polleit argues that collective corruption is the logical result of government interventionism in the field of money production and can explain why public opinion accepts adherence to an economically and socially destructive fiat money regime. Below are some important arguments from this article which offers explanations to the economic and political problems some countries in Europe and the U.S. are experiencing as we speak.

Polleit kicks of the article with a few references to Ludwig von Mises' work,
In the Austrian Business Cycle Theory (ABCT), Ludwig von Mises explains the recurrence of boom-and-bust cycles by pointing to public opinion, which he maintains falls victim to false economic theories. Public opinion is, Mises says, in support of a monetary policy that brings down the interest rate by expanding the supply of bank circulation bank credit—as such a policy is widely seen as being conducive for raising production and employment; and it considers a policy of lowering the interest rate and expanding circulation credit a remedy against the crisis which has been caused by circulation credit and fiat money expansion in the first place.  
And from Mises book Human Action (1949),
There is no means of avoiding the final collapse of a boom brought about by [circulation] credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further [circulation] credit expansion, or later as a final and total catastrophe of the currency system involved. 
 And explains that "Mises words must be understood in the following way",
If bank circulation credit is increased further and further, through which the supply of fiat money is increased further and further, then it is inevitable that the economic and monetary system will eventually collapse. This we can say is apodictically true: It is actually an inference from the axiom of human action, which forms the centerpiece of Mises’s praxeology—the science of the logic of human action, which is the foundation upon which Austrian economics in the Misesian tradition rests.

He explains that the Austrian Business Cycle Theory (ABCT), as developed by Mises, shows that,

bank circulation credit necessarily lowers the market interest rate to below the rate level that would prevail had the credit supply not been artificially increased. In turn, this must set into motion an unsustainable economic boom. The increase in fiduciary media brings peoples’ savings-consumption-investment relation out of equilibrium—compared with the relation which would prevail had there been no increase in circulation credit: Consumption and investment increase, while savings decline, so that the monetary demand outpaces the economy’s resources.

In attempt to move back towards equilibrium, the market interest rate is driven back from its artificially reduced level towards society’s true (and necessarily higher) time preference rate, through which investment and consumption decline and savings increase. This, in turn, reveals malinvestment, and the boom turns into bust. Investment projects and jobs, which were created as a result of injecting additional circulation credit and fiat money, become unprofitable. As economic adjustment takes time, output falls and unemployment goes up (temporarily).

Polleit argues therefore that Mises "not only offered an explanation of boom-and-bust, he also gave an explanation of the recurrence of boom and bust" and explain that public opinion when the economy heads for recession call upon the central banks to "fight" the losses in production and employment. The central bank the acts through lowering interest rates and expanding credit - which were the reason for the economic problems in the first place.

In the section on Fiat Money Regime and Public Ownership of Government he writes,

Public ownership of government reduces the economic incentive to limit aggression against individuals’ property rights, and it increases peoples’ interest in transfer incomes and reduces their encompassing interest in the market economy. It increases the societal time preference, thereby lowering savings and investment and thus weakening economic and cultural progress. Most important in this context, it is a necessary result of public ownership of government that commodity money will be replaced by fiat money

The control over the money supply actually increases the scope of government aggrandizement and the financial benefits for government collaborators well beyond the boundaries set by commodity money. Fiat money can be expanded in line with political expediency in any quantity and at any time. Perhaps most important, fiat money makes it particularly easy for the government to issue debt, through which resources can be transferred from the ruled to the caretakers of government and its protégées.
If the rise in the supply of government debt is accompanied by a rise in the money stock, the market interest rates can be held low—that is, at a level that is lower than the interest rate which would prevail had the credit and money supply remained unchanged. This, in turn, reduces public resistance against issuing government debt: The market interest rates can be pushed below the societal time preference rate. And so the crowding-out effect caused by issuing government debt, which harms private business, can be kept at bay.
And finally on Collective Corruption he writes,

In his ABCT Mises maintains the view that public opinion is to be held responsible for repeated increases in bank circulation credit which follow from an initial bank circulation credit-fueled boom. He wrote: "In the opinion of the public, more inflation and more credit expansion are the only remedy against the evils which inflation and credit expansion have brought about." However, the crucial question in this context is: What makes public opinion sympathetic to false economic theories in the first place? Mises answer is "(…) that public opinion could favor spurious ideologies whose realization would harm welfare and well-being and disintegrate social cooperation."
However, what explains then the emergence, spreading and acceptance of such false economic theories? Theories emerge from ideas. Ideas are at the heart of human action, and they are developed by "uncommon men." Mises noted: "The masses, the hosts of common men, do not conceive any ideas, sound or unsound. They only choose between the ideologies developed by the intellectual leaders of mankind. But their choice is final and determines the course of events. If they prefer bad doctrines, nothing can prevent disaster."  If these "uncommon men" become "court intellectuals," the door will be opened for effectively spreading of false theories, supporting government-friendly ideas.

"By virtue of their connection with definite parties and pressure groups, eager to acquire special privileges, [court intellectuals] become one-sided. They shut their eyes to the remoter consequences of the policies they are advocating. With them nothing counts but the short run concern of the group they are serving. The ultimate aim of their efforts is to make their clients prosper at the expense of other people." Clearly, those in and close to government power have an economic incentive for seeking intellectual legitimization of their privileged status. They have the financials means to pay "court intellectuals," giving them incentive to create wide spread acceptance of false theories.

I believe the article provides some very good explanations of how certain countries in Europe and the U.S. have run into economic problems with substantial debts and fiscal deficits. Equally important, it explains why they are not bouncing back from these problems (and why it's instead becoming worse) and why economic problems are kicked further down the road by the politicians.

For the complete picture, read the full article

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