The Age of Central Banking

2007-2008 changed the fabric of the world, not because it was the largest financial crisis since 1929, but because it woke people up to the fact that something subtle yet pervasive is wrong in our world. Contrary to what most believe, it did not create problems. Instead, it only represented and exacerbated existing ones. This is an important insight to grasp. Be it economic inequality, financial and economic fragility, indebtedness, or political polarisation, the events of and following the GFC is just the beginning of the fifth epoch of the age of Central Banking. In this article, I put forward the case that the institution that is Central Banking and the role it plays within our socio-economic systems have led to the unmooring of our world. Led by a philosophical, political and economic revolution in the 1930s and 1940s, central bank's increasing importance within our economies has fused intellectual economics and governments into a feedback loop of socio-economic iatrogenesis.

Market fundamentalism, championed by most, exists itself in contradiction to Keynesian or Monetarist economic policy. Unfortunately, most try and champion both with egregious consequences. Our economic systems today are ones of Keynesian/Monetarist structure where market fundamentalism also reigns, inevitably, then, these two incompatible systems head-but, causing systemic issues that we think are perennial problems. These two ideas are the south poles of two Magnets meeting. Alas, we are trying to force the magnets, that are organically trying to repel, together.

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The dominance of Central Banking is a risk, for the contradictions within its own mandate means it proposed goals were doomed to failure from the very outset. Yet, we have pursued the path of iatrogenic economic policy emphatically. The risk is not the eventuality that Central Banking makes inevitable, namely, a deflationary recession. The risk, instead, is what may replace or grow from the age of central banking. A lesson of history is despotic totalitarians rise out of the ashes of socio-economic crisis. We return this at the end of this article, but explore it much further in another one of my articles 'Free Money, Free Markets, Free Speech, and Freedom'.

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A reading of Ludwig Von Mises allows you both to unpack the causes of the Great Financial Crisis, but also understand the deeper context of the decades that preluded it. There was no such thing as the ‘great moderation’. To explain this, I simply ask the question, is it really an enjoyable sky-dive if you don’t have a parachute?

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In my other articles I often spoken on the role of history. Mervyn King said he learned more from economic history than economic theory during the Great Financial Crisis. This is no mere notional detail. It represents how the Keynesian-Monetarist age of Central Banking has unmoored our world, and the hopeful problem solvers need to stop listening to the technocrats and instead turn to the lessons of history if we want to truly create solutions, rather than mere responses (that aren’t solutions) to our problems.

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Ludwig Von Mises would have correctly predicted the inevitability of the Great Financial Crisis, just like he did in 1928 with the Great Depression. The economic historian, which I am trying to be, would be wise to utilise Mises’ theory of the business cycle. I think ‘big history’ is now what is necessary, and the application of Mises’ breakthrough theory is a fundamental lens in which to understand the vicissitudes at work in our world.

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What does ‘big history’ mean? By this, I mean, one must take a step back. The Keynesian age rose from the doldrums of the 1930s, where unemployment ravaged and stagnation stank. Keynes, in the 1930s, with his ‘modern approach’ to economics free from the strait-jacket of sound money came as "a flash of light on a dark night", as Friedman described it. But what are the foundations of the rise of Keynesianism? And how has the Keynesian revolution gone? I divide the ‘era of Central Banking’, as I define it, into 5 epochs.

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1.???? The first epoch of Central Banking (1921-1939) created distortion and malinvestment in the period 1921-1929 (the boom years) and economic crisis (the great depression, 1929-1939). Mises explained so clearly the causes of the Great Depression, along with all other recessions prior and in future, as I explained very briefly in my other article, titled ‘What is Going on?’. In short, in the example of the Great Depression, the Fed oversaw an expansion of the money supply (for various reasons) averaging about 7% in the middle years of the 1920s, allowed to occur by the inability of the post-war pseudo-gold standard to prevent the over-issuance of bank credit via gold redemption. This monetary inflation distorted the economy and created what Mises termed as malinvestment. When the Fed began its tightening cycle in the final years of the 1920s, it exposed and caused this malinvestment to fail, onsetting the economic downturn that developed into the Great Depression. The first epoch of central banking created the most severe economic crisis since economies existed, however, shockingly, the more egregious error was to follow in the next epoch.

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2.???? The second epoch in the age of Central Banking (1929-1971) is the most egregious for it holds the rise of Keynesianism, or the ‘Keynesian Revolution’, along with the creation of the even weaker gold standard than the Gold Exchange Standard of post-World War One, namely, the Bretton-Woods system. The Bretton-Woods system gave the US dollar the privilege of being the global reserve currency. Under the agreement, the dollar was redeemable in gold at $35 an ounce. Foreign currencies were fixed at exchange rates to ensure currency stability, and foreign currencies remained redeemable in gold through the dollar, that is, the Bank of England could exchange pounds for dollars, and then dollars for gold.

The Bretton-Woods system, then, enforced strict monetary constraints onto the US government, namely, to not expand the money supply. If they did, then foreign central banks would exchange their dollars for gold and the US would lose stocks of their monetary gold.?To the dismay of some of the Federal Reserve bankers and other Americans who realised that gold, and nothing else, was money, the idea to not expand the US monetary base were all but ignored by the US government and gold began to flow out of the Fed as soon as the system was launched in 1945.

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A case can be made that JFK truly sealed the deal on the fate of the Bretton-Woods system by going so far as adopting pro-cyclical monetary and fiscal stimulus, as opposed to the bad enough counter-cyclical policy. However, even the so-called fiscally conservative Eisenhower ran 5 budget deficits in his 8 years in office, albeit with a generally well-behaved Fed. Regardless of naming names and pointing fingers, whether the president was democrat or republican, the policy of deficit spending and inflationism was followed. Needless to say, then, over the period 1945-1971 gold didn’t just ebb and flow out from the U.S. Government, it rushed out. In the short 26 years of the Bretton-Woods systems operations, the US lost about half its gold stock to foreign redemption.?

The post-war embracement of heavy interventionism was as much an economic beast as it was a political one. Prevailing economic opinion, swept in the Keynesian wave, that our world will be richer, fairer and more stable with managed economies, gave what seemed to be a purely scientific assurance of an “unparalleled, unprecedented, and uninterrupted” economic expansion (as Okun put it). This scientific support gave the politicians of the West the confidence and justification to expand further and further into their economies. When the necessary eventuality came, namely, painful stagflation (which Keynesian theory said was simply impossible), the Keynesians blamed politics. It seems they threw out both the baby and the bathwater.

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Henry Hazlitt was one of few who continually highlighted the contradictions within the Bretton-Woods system and exposed what it really was, and what it made inevitable. As explained above, the Keynesian paradigm of managed economies and managed money meant the policy of inflationism was followed with the inevitable eventuality, the Nixon Shock and the creation of, for the first time ever, a global fiat standard.

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3.???? The third epoch in the age of Central Banking (1971-1982) is one of the most interesting. It is the period of stagflation, which we have already exploded briefly, and part of the Volcker era.

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Volcker was born and bred in the sound money tradition. Those who worked with him to end the Bretton-Woods system said he really was not in a good mood that week. Quite.

Despite his plain and frank attitude toward politics and central bank independence (after his first meeting with President Carter he said his plain natured speech about the requirement to run tight monetary policy “blew any chance of becoming Fed chair”) Volcker was appointed Fed chairman and underwent his “anti-inflation crusade”, as he called it, to end the period of stagflation. This re-settled the monetary volatility that the breaking up of Bretton-Woods unleashed in the form of stagflation, and brought order and direction to the completely hopeless Fed under Burns and Miller in the 1970s.

To be honest, I have no idea what to think of Volcker. He was an advocate for price controls, but a staunch defender of sound money. He helped create the global fiat currency standard, whilst warning that it is a very dangerous tool. Maybe this is kind of the point. Volcker knew Fiat currencies were dangerous, and knew what money was, therefore he acted very decisively to ensure people understood that the Fed still was committed to its most important policy goal of ensuring price stability. It was in attempt of pursuing this goal and showing that the Fed meant business that Volcker induced 2 deep recessions in attempt to “break the back of inflation”. Before Volcker, confidence in the Fed and therefore in the US dollar was weaning dangerously. Volcker’s policies, however, instilled confidence in the Fed that it could control the US dollar and a Weimar style or Assignat style inflation was not going to happen now the dollar was no longer linked to gold. In doing so, Volcker bought the Fed critical public confidence, and lay the red carpet for the flourishment of growth the age of Central Banking.

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4.???? The fourth epoch regards the neo-liberal age and the Greenspan era up until 2008 (1982-2008), in which I say the flourishment of Central Banking occurred (flourishment in deeply negative sense). In my article titled ‘The Big Short’, I make the case that Central Banks are reducing economic and financial volatility by conducting expansionary monetary policy, which, when applying the Misesian theory of the business cycle, only increases volatility tomorrow. Instead of de-scaling, we are adding snow onto the sides of an avalanche prone mountain and telling the skiers to keep on skiing. No better example of this exists than the Greenspan era, and the Great Financial Crisis that was to follow it.

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An understanding of US monetary policy and its consequences in this period cannot be explained without understanding the red carpet that Volcker laid out for the US government and the Fed. Thanks to Volcker, confidence in the Fed and the dollar was returned. In my other article, titled 'Information dissemination, Informational frictions, Money, Debt and Economic Systems', I explored the difference between monetary inflation and CPI inflation, the role of inflationary expectations and money demand. In short, as it is relevant, significant monetary inflation can occur (and has occurred) without much increases in CPI because people remain confident and therefore demand to hold dollars, soaking up any new issuance of dollars into their cash balance. This is all a bit technical, simply, the confidence Volcker bought the Fed meant Greenspan and the Presidents of this era could pump high levels of newly created money into the economy without much increases in CPI, fuelling the boom period that is erroneously called ‘the Great Moderation’.

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Reagan ran a monetarily Keynesian administration under the flag of neo-liberalism. Running huge deficits and allowing the Fed to create huge volumes of money. Not very Neo-liberal of him. The consequences of these policies were subtle but pervasive.

The outcome of Reagan's promise to return the US to the gold-standard was sealed as soon as he appointed archenemies of gold to lead the commission on the whether the re-instatement of the gold standard was in the interest of the country or not. Of course, their recommendation was not to return to the barbarous relic and the matter was closed. No one, however, is more to blame for the economic volatility that was to follow than Alan Greenspan.

Earlier we mentioned the damaging policy of the Fed during the 1920s, growing the money supply by a shocking 7% annually, and the consequences this had for the world. Fresh on the job, Greenspan increased the money supply of the US by the same 7% in a single week. Greenspan continued to pump money into the economy at an increasing rate, and as explained by the Misesian theory of the business cycle, made economic crisis inevitable. It came. First in 1990, then again gently in 1995, then again in the period 1997-1998, and then the first large apparent happenstance of the Greenspan era, the bursting of the .com bubble. At all the above dates, Greenspan eased policy for, often, totally unnecessary reasons and often far too aggressively fuelling a rampantly inflationary bubble - giving birth to the idea of the ‘Fed put’. When the .com bubble was deflating, to reduce the pain and risk of a deflationary economic downturn, Greenspan simply transferred the bubble in equities into a housing bubble creating more malinvestment and more future volatility. The pent-up volatility exploded only a handful of years later. I write on this Greenspan Era at length in my forthcoming book, and I am most eager to release this specific section, for understanding the contradictions of neo-liberalism and of the Greenspan era is fundamental to understanding why our world is one in malfunction.

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5.???? The final epoch of Central Banking is the post-GFC world. The stagnating, warring (culturally, politically, economically and kinetically), and unequal domestic and international condition is one that needs fresh thinking. I leave commenting any further on this epoch, for I believe it is plain for most to see that something subtle, yet pervasive, is occurring. It is the role of economic history and sound economic theory to work out why.

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As Systemanticist John Gall warns, complex systems tend to produce complex responses (not solutions) to problems, and I think that is an insight that cannot be missed. This insight can be applied to many realms, however, its best applied to the dominance of Central Banking. Their (at least in appearance) complex problem solving attempts through Quantitative Easing, Reverse-Repurchase Agreements or Troubled Asset Purchasing Programmes are a growing dominant, and iatrogenic, power within our socio-economic systems. The dust of the GFC has not yet settled, as the dust of the .com bubble still has not, as hasn’t the dust of the Long-Term-Capital-Management and Asian crises have not, as hasn’t … and so on until we work right our way back to the causes of the Great Depression and the intellectual misdiagnosis of its causes. I make the case it is all linked.

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Fresh thinking is necessary. Often, these meta-problems are solved via kinetic wars. Needless to say, this must be avoided at almost all costs. Growing protectionism and militarism is an outgrowth of throwing a spanner in Mises’ Law of Association. Money is the fulcrum around which the global society organises itself. If this is muddied via monetary policy, which is what has been occurring, then the economic volatility and currency competition managed monies necessarily create undermine this law of association, and ultimately, if pursued to the very end, turn country against country, and peoples against peoples.

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The rise of socialist thinking, as an alternative to what is known as ‘capitalism’, is a dangerous feedback loop. If central banking is socialism, which it most emphatically is (control of cash and credit was one of Marx’s planks of the Communist Manifesto, setting of the interest rate is the central planning of a price), then the consequences of a socialistic policy, namely, recession, lower growth, economic inequality etc, are simply being misdiagnosed instead as consequences of “capitalism”.

If this is capitalism, then I don’t want it. We need a free monetary and economic system that ends the boom-and-bust cycle, that distributes wealth via both profit and the “productivity dividend”, a system that brings people together rather than turns them against each other. The issue lies in disseminating the information (please see my other article, titled Information dissemination, Informational frictions, Money, Debt and Economic Systems) to individuals who think we live in a free market, and therefore want anything but a free market. We most emphatically do not live in a free market, which is why our system is one in crisis.

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We must use history and Austrian economic theory to take a step back and re-think the systems at work within our economies, and use that to educate politicians and voters, or else watch the world remain in terminal state of intellectual and systemic malfunction. ?