Thursday, 25 September 2008

Horray for the end of capitalism as we know it

Is this the end of capitalism as we know it?

Eamonn Butler, of all people, hopes that it is. Once he explained his reasoning, however, I could see his point.

"Capitalism as we know it is a creature of the regulatory authorities, who've messed it up good and proper" he argues. But frankly, that's just the start of it. Our supposedly capitalist system often looks more like Corporate Statism than any free market that our liberal forebears in the C18th and C19th would have recognised or welcomed. Big businesses larded with subsidies; investors insured by the taxpayer against bad investment; bankers bailed out to the tune of hundreds of billions of pounds.

The sooner that that sham capitalism is swept away and replaced by free exchange of goods, services, capital and labour without interference, impedence or assistance from politicians the better we will all be.

I would like to see Government's role in the economy limited to three things: ensuring the rule of law; protecting property rights (which as Tristan reminds us, includes one's own person); and providing sound money. In fact, make that two things.


Joe Otten said...

Hmm, fair enough in the 70s or early 80s to write something like that paper of Hayek's, what with rampant inflation and all.

But point me to the rebuttal of the simple observation that while there is some incentive for the issuers of private currencies to maintain their value, there is also a whacking great incentive to inflate it away, for much the same reason that governments have also faced that incentive.

It is a bad time to emphasise the importance to banks of a sound reputation, and all that, when they have shown by their recent behaviour that reputation can go hang if there is a quick buck to be made.

So you'll forgive me if I say the suggestion seems just a bit whacky.

Tom Papworth said...

But Joe. The Bank of England was a private company for two and a half centuries and during that it maintained an largely stable currency. Banks incentive would come from customers' ability to abandon the use of their currency if it got a bad reputation and to use a more reliable currency instead.

Our problem is that by law we are obliged to use the Pound Sterling, which the Government has been slowly devaluing through inflation for the past decade in its efforts to keep interest rates artificially low and so trigger an unsustainable housing- and consumption-boom.

Joe Otten said...

Tom, I already mentioned that incentive. And inflation is an odd issue to bring up in an era of low inflation. There is a reason that paper was written in the 70s. And low inflation is better than zero for various reasons.

And are you telling me my account at is illegal?

Tom Papworth said...

I utterly refute the idea that low inflation is better than none. Government may have slowly undermined the value of money of the past decade, but undermine it they have. The idea that low inflation is somehow beneficial to the economy is a Keynesian lie.

Take one example. Had the Bank of England been obliged to target zero inflation instead of 2% inflation (which, I would note, halves the value of money every 36 years), they would have run interest rates higher than in recent years (say, for argument, a couple of interest points higher). This would have had two effects:
1) It would have made credit more expensive and so would have prevented the housing bubble from emerging
2) It would have promoted saving and so would have created sustainable investment-led growth instead of an unsustainable consumption-led boom ( our history on this debate notwithstanding)
3) It would have discouraged un-secured loans that led to the same unsustainable level of consumption and masses of household debt.

By targeting a deliberate (albeit low by historical standards) inflation policy the Government created easy money that led to the very mess we are in now.

To be honest, I only threw in the Hayek article as an amusing aside to the overall point. While I think that Hayek’s suggestion is interesting I would be perfectly happy it a Government or “independent” central bank could provide truly stable money. The problem – based on undeniable historical evidence – is that in a modern political-economic context, fiat money is always devalued by kings who cannot resist debasing the coinage to pay for foreign wars (for which read governments inflating the currency to pay for unaffordable welfare programmes).

That is the cause of our boom-and-bust cycles.

As for your Goldmoney account, I’m not saying that it is illegal, but I do wonder if it is an intrinsic recognition by you that inflation is an inevitable result of Government-managed fiat currencies. Is Goldmoney backed by… well… gold, by any chance? Perhaps the Gold Standard isn’t so crazy after all!

Joe Otten said...

The account is really only there because I did some business with a goldbug - and because it is cheaper than using banks for international money transfers. I have long since spent all the gold. :(

I'm not going to reprise the inflation debate this time, but I will say that I am about half as skeptical of this sort of thing as I am of the funny money trends in ALTER. Which means very skeptical indeed.

FWIW my view is that boom and bust cycles are a natural thing. It is natural for my confidence to reflect that of those around me, and therefore to have a certain lemming-like quality. So when I hear explanations of boom and bust in terms of broken policy, they have a big mountain to climb.

And like the economic cycle, inflation also has the psychological advantage that it will allow wages to fall in real terms when the market demands it, when falls in cash terms would be unpalatable. (Socialist interlopers should note that I am not saying that you hard-working people deserve to be paid less: it is not a normative, moral demand from the market that I am talking about, but a change in the economic circumstances.)

Tom Papworth said...

Is that a concensus on the horizon? Well, maybe some common ground.

You are probably right to avoid opening the inflation / nonflation debate. There is a whole seperate post in the offing where we can do that :O)

I do agree that economies would probably be naturally cyclical. It is hard to tell, however, as no economy has been allowed to funciton naturally for a century, and inflation has been the standard tool of government monetary policy since at least the end of the First World War. Whether economic cycles need to become boom and bust cycles is debatable, however. Just take my point above about higher interest rates reducing borrowing and increasing saving. At the very least our current situation would be less extreme.

As for the psychological effect of inflation, there is a slight air of "Treating the workforce like idiots" about that argument (which was not, I hasten to add, invented by you). But as Milton Friedman pointed out, organised labour spotted this trick pretty early on and now unions demand above inflation pay rises, which undermines that effect. In a zero inflation world, the only reason to raise a person's wages would be if their productivity rose or if the demand for their services rose. And of course, in a free market it would be very easy for workers and employers to shop around.

(Socialist interlopers might want to bear in mind that this would benefit both parties, as employers would be more willing to "take a punt" on an employee as they would have nothing to lose, and so there would be far more work overall and it would be easier to grasp opportunities if the worker wished).

Oranjepan said...

"my view is that boom and bust cycles are a natural thing."

Natural perhaps, but definitely not necessary - only a function of failure (and not necessarily a bad thing either). Cyclical is probably a better description.

I thought for a second there that the discussion of the desirability of inflation/nonflation might also include the various controls and effects of currency/commodity etc markets available, but it didn't quite get there.

I'm also surprised that there is so little discussion on the ability to influence the length of cycles.

Tom Papworth said...

I'm fascinated.

State your thinking, my orange friend. and lets see what we can learn.

Oranjepan said...

So where'd you like to start?

I like the meteorological view which provides an infinitely complex matrix of rules relating one sector to another.

Surely the ideal is to align sectoral cycles to balance each other out and create a continuous virtuous spiral which prevents the whole thing from tipping into extremities.

By understanding the means at our disposal for influence (for example to encourage Opec to adjust oil production volumes, or to encourage the Chinese to adopt a more free-floating currency, in world trade talks etc) we can introduce effective and proactive planning at every level to be able to manage the transitions between each various cycle without experiencing any unexpected or damaging shocks induced from areas left off the radar.

In this I think the weather is a good metaphor considering the ongoing changes in our climate and global eco-system. Barometer of change anyone?

I have to give some credit to Brown for his time in the Treasury where he did apparently attempt to grapple with these different factors, even if he was ultimately unsuccessful after 1999 when he began railroading himself into manipulating perceptions (such as in unemployment and RPI/CPI statistics) at the expense of influencing events.

It was all well and good for him to talk about micromanagment and macroeconomics, but this completely ignored the wider picture (the mega economy?) of global diplomacy which would soon hit home and force him to waste resources (budgetary savings and political capital) on a war (or series of conflicts, whichever you prefer) which could have been prevented.

I have an inherent problem with a permanent situation of zero-inflation in that it means zero transition and zero growth, however I also have a problem with artificially stable and artificially low inflation because that means volatile markets, volatile employment, and volatile interest rates.

So my question is how do you ensure steady fluctuation and how do you define the acceptable parameters of movement?

Tom Papworth said...

“I have an inherent problem with a permanent situation of zero-inflation in that it means zero transition and zero growth”

There is no reason why zero inflation should mean zero growth. Growth is created by investment that create additional physical or human capital, which in turn improves productivity. Inflation is merely caused by increases in the money supply that outstrip the rise in productivity. It is perfectly possible to combine positive growth with zero inflation.

I’m not sure what you are referring to by “transition” unless you mean the ability with inflation to slowly erode nominal wages, thus enabling employers to adjust real wages while apparently raising everybody’s wages nominally. As I noted above, employees are not stupid and they know when they are getting below-inflation pay rises. In unionised workforces this causes industrial strife.

Overall, I am deeply sceptical of the ability of governments to manage economic cycles as you suggest. In particular, the idea that they can “encourage Opec to adjust oil production volumes” has been proven to be false time and again. OPEC follows its own self-interest at the best of times, but at present there is no more capacity on the supply side, so OPEC could not significantly raise oil production even if they wanted to.

Oranjepan. said...

Well, considering Opec's last decision was to cut supplies to prevent any sharper falls in the price of oil I don't think it it healthy to second-guess what is in their interest.

I think there is a sizeable body of opinion within Opec which sees mutual interest as a form of enlightened self-interest, which can be encouraged. But we must remember this is a two-way street. It is perfectly liberal to be able to balance the benefits of trade so it is both free and fair.

There is a problem with a fixed zero-inflation because it requires all investment to be met from savings - which can be impractical. Our overrestrictive monetary policy has contributed to the current liquidity crisis, for example, which earlier and more decisive action could have prevented (and the government is now paying a higher political price in the polls than it might have done otherwise).

The problem is with FIXED and CONTINUOUS zero-inflation, not zero-inflation per se. In some cases it is certainly desireable, just as in some cases deflation is desireable.

Equally I'd argue the requirement for the BoE to target a FIXED range of CONTINUOUS inflation has proved damaging. Instead I'd prefer to see a flexible floating target which can be adjusted.

Both good inflation and bad inflation exist in relation to the balance of money flows and whether our budgets are spent on effective means of making real gains.

I think it is folly to abandon one of the strongest economic tools which have been created, and though I admit it has been left in the hands of fools who've turned the tool into a dangerous weapon I'd still argue that it is more helful to include it in the armoury at our disposal than to ignore it's applications.

Tom Papworth said...

Let’s not get distracted by the OPEC example. Your point reinforces mine. OPEC will adjust supply to ensure a high price as much as possible – the only part of the cycle they seek to prevent is the downward trend. My point was that we may not be able to “second-guess what is in their interest” but neither are we in much of a position to encourage them to increase output to reduce the high prices from which they benefit.

The more interesting point is the one about inflation. I disagree that basing investment solely on savings is impractical. Interest rates would then adjust to represent the real value of capital rather than being massaged down by governments.

I am particularly concerned with the thought that inflation can be used to fund investment. This presents two problems.

Firstly, inflation is not, as is often suggested, money for nothing. It is to all intents and purposes a tax, and one that does not discriminate between rich and poor. 2% inflation is the same as 2% income tax, except that tax is not cumulative whereas inflation is. So like all government investment, it replaces investment-through-saving with investment-though-coercion. I do not consider this to be a desirable policy.

Secondly, even if the above was desirable in the context of a Keynesian ivory tower, free from the real world, in practice it always ends badly. You talk about inflation as “one of the strongest economic tools which have been created” and then “admit it has been left in the hands of fools who've turned the tool into a dangerous weapon”. But you ignore the fact that those fools are every single government in every single country in living memory. Even if inflation could fund investment, every single government that has used it to “smooth the economic cycle” has boosted the economy when the downturn began and then failed to deflate when the cycle turned to boom. In fact, the only cycle that democratic governments have shown any interest in is the electoral cycle. Government has proved through countless examples that it cannot be trusted to use monetary policy wisely.

I believe that only a fixed, zero-inflation policy can create the stable economic conditions in which perpetual growth can be achieved and individuals can safely operate in the economic sphere without fear that government will destroy their work.

The idea of “good inflation and bad inflation” is simply alien to me.

Oranjepan said...

Err, have you ever heard of using borrowing to fund investment?

I get the feeling that you've started from the assumption that a good liberal would be in charge of the economy and that it is on an even keel to start with.

The first is self-evidently untrue and the second would be unlikely even were the first ever to come true.

This is why I it is important to understand what 'transition' is, what it requires and how to direct it. Sometimes a kick-start is helpful.

Tom Papworth said...

Err... yes. But our conversation above was about inflation.

I have not started from any assumption about who our leader might be. Rather I have tried to set out what any leader's ideal policy should be.

Any time over the past decade it would have been easy to move to a zero inflation policy. Even now it would be preferable to allowing inflation to spiral so as to fund multi-billion pound bail-outs to failed banks.

I don't agree that a "kick-start" is helpful. On the contrary, I think it is how governments look like they are "doing something about the problem" while in fact making it both longer and deeper.

I note that the Times today reports that taxes will have to rise to pay for the government's bail-out and its decision to nationalise the bad debt. No chance of a fiscal stimulus, then.

Oranjepan said...

I guess you are just living up to your name as a polemicist by advocating idealist positions.

Tell me, how do you intend on going about getting there without splitting the internal coalition?

Tom Papworth said...

Have you started talking party now?

Generally, I am interested in discussing policy and am not too concerned with intra-party squabbling.

I would like the party to be more liberal, of course, just as some would like it to be more socialist (I recall a conference delegate calling for the collectivisation of industry a couple of years ago!).

I hope that through honest debate conducted in a spirit of openness and in a manner that shows respect for one's interlocutors that one can change positions without causing rupture. Of course, individuals will join and leave the party as the result of positions it takes on various issues but that is true of all parties at all times.

In fact, I wish we could put the concept of an "internal coalition" behind us. It subsumes the viewpoints of 60,000 individual members into a putative bipolar system between "Liberals" and "Social Democrats" that wasn't even true before it became outdated. What it does do is add fuel to our opponents and those who mistrust us on the grounds that we are not a “united” party (as though New Labour and the Conservatives were not coalitions as well).

Oranjepan said...

I don't recognise any difference between so-called social democrats and liberals, the merger was 20 years ago and we're all liberal democrats now anyway.

No, the coalition I was talking about was between the realists and the idealists - which exist and coexist within every stream of thought.

It is A Good Thing that we aren't fully united because I think that would stifle debate and weaken our resolve.

I was particularly won over to our current line when Vince made a statement during the NR nationalisation that it is unhelpful to get dogmatic when your course of action is limited.

Therefore I'd be happy to split a hair with you and agree that there are instances where zero inflation can be desirable if I can also get you to admit there are circumstances where it would be damaging: surely it's better to avoid being trapped by insistance?

So let me ask you about the current state of affairs - how do you propose to lessen the economic pain without loosening the controls on inflation?

Tom Papworth said...

I agree that we are all Liberal Democrats (hurrah! Common ground!).

I see the relationship between idealists and pragmatists as a conflict rather than a coalition, but one that divides every party and is probably healthy. Idealists seek to keep pragmatists on the straight and narrow, while pragmatists ensure that at least some of the party get elected!

My concern with Vince’s line (and the general belief that lies behind it) is that one man’s dogmatism is another man’s solution. I guess I am an idealist, but I am deeply suspicious of those who say “I believe this to be true and just but in the current circumstances I’m going to do that.” I have noted before how often one hears this. Whenever anybody says something like this it puts me in mind of the expression “I’m not racist but…”

On the specific question of “the current state of affairs” and how I would “propose to lessen the economic pain without loosening the controls on inflation”, I would start with a joke:

An economist is lost for ideas in the country. After driving around for some time he sees a farmer. Pulling up beside the farmer, our economist winds down his window and says “Excuse me, sir. Can you tell me how I would get to a stable economic situation?” The farmer looks at him, shakes his head slowly and says “Well, I wouldn’t start from here.”

Zero-inflation should be the policy of every government, so we should not be in this mess in the first place. As I mentioned, above, had Gordon Brown targeted zero instead of 2% inflation, we would have had higher interest rates and therefore the housing bubble would have been averted and savings would have been greater in relation to debts. We would still suffer fall-out from the US financial system, which is itself a result of American toleration of inflation so as to achieve low interest rates (as well as Government-induced sub-prime and securitisation problems) – though in my “ideal” world the US Government would have been targeting zero inflation too and so their house price and sub-prime problems would not have arisen either.

But we are where we are. I still don’t accept that we should try to inflate away our problem. To use the old metaphor, that is simply hair-of-the-dog. We can only delay the hangover that we are due for the binge we went on during Gordon Brown’s perpetual Friday night [I quite like that. I might use it again!]. Sooner or later, we have to accept that the economic system needs to shake out the chaff; to chop off the dead wood. Jobs will be lost (I am far from immune in this regard); investments will be wiped out (ditto in spades); and houses will be repossessed (Oh God! What have I done!!). However, if we seek to avert this problem with inflationary policies, we will simply perpetuate the agony as the Americans did in the 1930s, creating a depression out of a recession. I hope it won’t lead to war as it did last time – one can take a parallel too far – but it will lead to Japanese-style stagnation or German-style inflation, calls for greater and greater state control of the economy, economic protectionism, price and wage controls…

No. I’m sorry. I’d rather accept the short, sharp shock of withdrawal than the long destruction of inflation addiction.

It’s not about realism verses idealism. It’s about what I believe works and what I believe doesn’t. I guess we’re just going to disagree.

Oranjepan said...

I'm sorry Tom, I don't think we are in disagreement.

I agree that perpetual inflation is damaging in the long run, but on the other hand I also think it is impossible to maintain strict zero-inflation. So am I wrong in detecting a subtle shift in your position from advocacy of a strict imposed zero-regime to a target of zero inflation? If so we are closer than it might appear (though I am tempted to add "over the course of the economic cycle").

I also agree that a singular focus on an inflationary monetary policy is no way to solve the current crisis, which is why Vince Cable has set out some ideas on ways to improve the balance of the market and the way it functions. Furthermore however, I disagree that it is sensible to take the opposite course and look soley at regulation as the means to solve the problems.

We need a dual approach which accepts the virtue in the necessity of keeping the market afloat and liquid while also supporting greater social justice by introducing reforms to make future operations fairer. To do otherwise risks creating huge and immediate suffering among the more vulnerable among us.

I'd urge caution when advocating any shock treatment to counter the assumed inevitability of long-term practices, so I'd return to take another look at the conventional orthodoxy of those economic cycles: just like with regard to the weather, there are multiple cycles all working concurrently over differing periods and which can each be impacted by different influencing factors - it is a matter of judgement how we cope with their ebbs and flows and how we adjust the fiscal regime to shift the burden to create a more equal society as the changes take effect, but to ignore the opportunity benefit that can be gained by transformational processes threatens both rich and poor alike.

So ultimately a political platform of empowering the voiceless is the only way of ensuring decisions aren't taken in the interests of the established few and don't stoke up the problems which can arise when a crisis comes about (which is why I think we are both LibDems - because we are all pulling in the same direction, albeit from slightly different angles).

We don't and cannot 'agree to disagree' when we are working to find solutions for real problems of this sort, we must continue discussing until we can reach a mutually satisfactory conclusion.

The dual approach? Is this the right way forward?