Carney Falls for the Same Trap

An irony of today’s world is that capitalism is not allowed to operate but yet whenever a problem occurs it is always capitalism’s fault somehow. The most typical example of this is the conventional wisdom today that the recent financial crisis was due to capitalism taking place in the financial world without sufficient regulation. Nothing could be further from the truth.

Besides the fact that there were many regulations, the core of the financial world is based on central planning! The price of money (i.e. the base rate) is decided by the central bank- which is endowed with certain powers by the government- and so is the supply of money through quantitative easing. A capitalist banking system, on the other hand, is a deregulated system and a system with no central bank to distort the price signals. How would this work?

First and foremost, you will have competing base monies – a ‘denationalization of money’ as Hayek argued in 1976. In other words, there would be no national currency. People decide for themselves how they want to make their transactions: some may opt for a commodity based exchange rate like the gold or silver standard (incidentally a pound is called a pound because it used to be equal to a pound of silver); some will opt for foreign currencies; yet others might prefer money printed by certain private institutions (albeit I do not think this would be a particularly popular option) and some might even prefer to barter. This activates the market forces so that the price and supply of money is as close as possible to the equilibrium. Secondly, a deregulated banking system (with an assurance that there will be no bailouts for failed banks) will force the banks to be prudent and selective about those who they lend to and, on the other side of the coin, will force savers to be prudent about those institutions which they trust their money with.

Mark Carney Davos 2010In this context let us revisit the financial crisis. Low base rates (from 15% in 1981 to under 5% in 2006) created cheap credit which led to careless lending which in turn led to a temporary boom followed by a devastating bust when it dawned on everyone that the boom was spurred merely by debt. It was all started when price signals were distorted by the central bank. It is perplexing to see politicians making the same mistake over and over again. Mark Carney has said that he wants to keep interest rates as low as 0.5% until unemployment reaches 7%. What he does not realise is that even if he does achieve that goal it would only be in the short-term and will very shortly be followed by a bust when everyone realises that the growth had been, once again, riding on nothing but debt. What we need to realise is that no matter how smart our Bank of England governor is, he is still one man. A man who has been given an impossible task of determining the price and supply of money – a task only fit for society as a collective through a spontaneous order. What is worse is that the new planned mortgage schemes will further misdirect the credit into the housing market. Business Secretary Vince Cable has himself warned us of a housing bubble if this scheme goes through (he also predicted the last recession by the way!).

When will politicians understand that interfering with the market will only exacerbate things in the long run and have severe unintended effects? When will they understand that we – the people – are better placed to make judgements about our lives than a group of politicians who are designated to make our decisions for us?

The scariest thing is that when the next economic catastrophe occurs, capitalism will most probably be blamed again and more socialism and Keynesianism will be invoked as a solution to our economic problems.


  1. A good post.

    However I make my standard protest against the term gold STANDARD (or silver STANDARD – or anything STANDARD).

    Either the commodity is the money or it is not – this “standard” stuff is an open door to fraud.



  2. There should be a distinction between trading directly with gold, on the one hand, and with a money that represents gold on the other e.g. where £5 actually represents 5 lbs of silver in the bank.

    In a free society people should decide how they want to trade. It may be that some people don’t trust the banks to actually keep their commodities and opt for actual commodity currencies; some may feel it’s safer to have electronic cards so that if it’s stolen it can be cancelled (whereas if your real gold coin is stolen you can’t do much); some banks may actually tell the customer we only keep x% of your commodity and the rest we invest and in return we give you x% of our profits etc etc etc. I don’t know how it would be like but that’s the whole point; no one man knows. Only as a collective can we know the best option- “a voyage of exploration into the unknown” was how Hayek put it.



  3. There is no reason why the ownership of physical commodities can not be transferred by electronic means – so the idea that gold-as-money (or silver-as-money) precludes the use of cards (and so on) is false.

    As for lending out money that DOES NOT EXIST (for example having ten ounces of gold and lending out 100 ounces of gold) this creates a credit BUBBLE (it is called “credit expansion” – pretending to have money that one does not really have).

    Even with fiat (i.e. command) money (i.e. government notes and coins whose only “value” comes from legal tender laws and tax demands) lending out money that DOES NOT EXIST creates a credit BUBBLE – and all such bubbles (eventually) burst.

    Nor is this a system that really exists without government support.

    For example, such Credit Bubble (or Pyramid Scheme) banks demand a “suspension of cash payments” from government (and its courts).

    in an honest system if a bank could not meet its CONTRACTUAL obligations to provide cash, it would be declared insolvent.

    After all nothing stops a bank offering a contract that says “we do not have to honour our paper if we do not want to”.

    But, oddly enough, people tend to demand contacts that say the bank must provide cash to honour its paper within a set number of days (if not on demand).

    Yet when trouble hits these SO CALLED “free bankers” demand that government (and its courts) “reinterpret” or “suspend” their contractual obligations.



  4. Yes, lending out non-existent money will definitely lead to a credit bubble but I did not endorse that. I said a customer can agree that the bank can take some of his money to invest and give him a percentage of the profit. Whether people agree to take this deal is up to them. In any case, people should have a choice which type of bank they want to keep their money.



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