In the second part of the Eyes Wide Shut series we examine how the UK’s economic freedom has come down to a circular relationship between the BoE, the banks, bondholders and householders. Each component threatens to undermine the other leading to a loss of faith in the UK as a currency issuer. Most likely in the aftermath of such event there will be a dialogue on how to reset the system. If the diagnosis of the malaise is not accurately explained the risk of resuming the current monetary system will be high. So we offer the explanation and we offer solutions of our own and those of the Cobden Centre, whilst not exhaustive or detailed, they are an outline for real dialogue.
Nations sustain prosperity by encouraging an openness of society, willingness to permit creative destruction and democratic rule of law. It is the relationship between man-made economic and political institutions that fosters these aspects of the nation. Those institutions that promote real growth through productivity enhancement and encourage progressive innovation will thrive, as opposed to those that move towards repressive institutions of the State will stagnate and fail.
Unfortunately this is where the UK is heading today. Mounting debt that has merely boosted government consumption and transfer payments has undermined the overall productivity growth and has led to economic stagnation and loss of economic freedom. Unfortunately, we believe that a nation will tend to bankrupt its citizens before it bankrupts itself; especially under a fiat currency system when it has the temptation to fund a welfare state through continued deficit financing. This is the case in the UK today.
Friedrich Hayek in The Road to Serfdom wrote:
“To build a better world, we must have the courage to make a new start. We must clear away the obstacles with which human folly has recently encumbered our path and release the creative energy of individuals. We must create conditions favourable to progress rather than “planning progress.”… The guiding principle in any attempt to create a world of free men must be this: a policy of freedom for the individual is the only truly progressive policy.”
A true advocate of individual freedom Hayek recognised this as a core tenet needed for a country to achieve economic freedom. A useful way to observe economic freedom credentials is one compiled by the World Heritage group. Notwithstanding the neoconservative support (we remain apolitical) we believe they rank countries based on several key areas which provide more qualitative understanding of the worth of a nation.
It groups 10 economic freedoms into four broad categories or pillars of economic freedom:
- Rule of Law (property rights, freedom from corruption);
- Limited government (fiscal freedom, government spending);
- Regulatory efficiency (business, labour and monetary freedom); and
- Open markets (trade, investment and financial freedom).
This is the foundation for affluence.
We originally began our Eyes Wide Shut series on the UK with a reference the British psychologist Oliver James who wrote a book some decade ago called ‘Britain on the Couch’ – the low serotonin society. He asked the question, why when we live in a period of unprecedented affluence are people so seemingly more unhappy than before. Oliver has a point. We can answer this simply by saying that an abusive state monopoly on the issuance of money has led to a distribution of money that is not uniform.
In modern societies, when governments or central banks increase the supply of money, they do not do so in a way that affects everyone equally. Instead, new money is created by the government or by banks to be spent on specific goods and services. The demand for these specific goods rises, thereby raising their prices first.
In a Misesian economy as money holdings increase, the marginal utility of money declines so that certain goods are revalued ahead of money via subjective preference scales, pushing the prices of these goods upward. Gradually the new money ripples through the economy, raising demand and prices as it goes. Income and wealth are thereby redistributed to those who receive the new money early in the process, at the expense of those who receive the new money later, or those who live on fixed incomes and receive none of the new money.
It is this impact that has divided developed nations and exacerbated the need for an over inclusive welfare state, which is also a beneficiary of this monopoly of issuance, because monies redirected to fund welfare gaps bolster political re-election to boot.
In a recent HindeSight Letter from April of this year, called Wealth of a Nation we developed our ideas for economic freedom. We delineated how artificial and uninformative GDP is as a measure of the prosperity of a nation. We felt we needed more encompassing observations of an economy such as well-being and that to foster a countries’ well-being we needed to develop economic freedom.
Indeed Prime Minister Cameron himself announced that the Office of National Statistics (ONS) would begin to examine Britain’s. Right now well-being in this country for most middle to lower income families can arguably be described as pretty rubbish. Cameron may well have read Oliver James’s Britain on the Couch, but barring prescribing liberal amounts of pure MDMA to boost serotonin levels, we may all be better off taking liberal doses of ketamine. Perhaps the youth of today have it right.
What is clear that in order to achieve economic freedom and commensurate well-being, money printing and negative interest rates, like drugs, merely offer momentary release from our problems. Like drugs, as the effects begin to wear off, the outstanding issues we have masked come back with a heightened vengeance. Unfortunately continued liberal sprinkling of money will have to be bigger and bigger as its marginal utility lessens.
Monetary Reform Begets Monetary Reform
We believe that to offer a long-term solution to the UK economy (in particular) we need monetary reform which will instigate meaningful political reform, by limiting the impact of the State in the economy as the issuance of money is returned to the free market under an independent judicial system.
In offering solutions we would advocate the tenets amongst others of the Cobden Centre (TCC). TCC was established to promote social progress through honest money, free trade and peace. Based on sound scholarship (primarily the Austrian School) they argue society must primarily be built on honest money. This is the foundation on which a nation can build prosperity, and economic freedom.
Sound money means an end to credit expansion and false booms followed by financial crises with appalling human cost. It means an end to inflation of the money supply and hence prices. Honest money is the key to social progress in the 21st century.
- TCC believe that social progress comes when private property is secure and all people enjoy an increase in their real income. They believe that the reduction of relative poverty and the increase of general prosperity will make society more orderly, stable and free.
- TCC believe that, today, the first condition to secure private property, to diminish widening wealth inequality and to establish a stable, sustainable economy for the benefit of all is honest money.
- TCC believe that the method of increasing real income for all people is a social system of independence, interdependence and mutual cooperation: the free market.
We would dryly note that Cobden’s law should not be mistaken with Coughlin’s Law – ‘Bury the dead, they stink up the place’, which is a very a propos analogy for how most advanced countries are trying to bury their debt and ailing assets under the veiled legality of QE and financial repression.
We would promote a free banking system, one with no central bank monopoly of money, but one where the rule of law resides over private banking. It is probable that commodity money such as gold is economically inefficient but it is trustworthy and honest; whereas fiat money production is monopolistic and open to transgressions (abuse) by government and a weak central bank. Encrypted electronic cash, backed by gold may well come to rival fiat currency systems especially with the rise of mobile payment systems under private enterprise.
A thoughtful piece on limiting fractional reserve banking is given by Toby Baxendale, an Austrian scholar, an accomplished entrepreneur and Chairman of TCC: ‘A day of reckoning: how to end the banking crisis now.’ This is one of ten plans cited for financial reform, by the Cobden Centre staff, fellows and board members who span academia, finance and politics – ‘Ten Plans for Financial Reform’. The objections to limited banking or 100% reserve-banking are covered and although not a definitive they really begin the debate that should never had to occur ie who does your money belong to when on deposit at the bank. Give you a hint – it is not yours. By addressing this basic ‘property’ right we would be beginning the ‘road to economic freedom’, such reform would enable a return to prosperity that is more stable and far reaching and less prone to boom-bust cycles. Although we acknowledge that nature has cycles, they need not be as excessive as the cycles created by credit expansion and contraction.
At present we have a banking system that exists within the framework of the central bank, which promotes monetary inflation and the destruction of the process of real wealth generation through fractional reserve banking. In this system the more unrestricted the banks are the more money out of “thin air” (shadow banking) can be generated and hence greater damage is inflicted upon the wealth generation process. This must be contrasted with genuine free banking, ie the absence of the central bank, where the potential for the creation of money out of thin air is minimal.
For some time we had to get our head around the idea that banks should be regulated to prevent them creating excessive credit, as this would conflict our desire to maintain free markets. Murray Rothbard supplied us the answer to our conundrum:
“Many free–market advocates wonder: why is it that I am champion of free markets, privatization, and deregulation everywhere else, but not in the banking system? The answer should now be clear: Banking is not a legitimate industry, providing legitimate service, so long as it continues to be a system of fractional-reserve banking: that is, the fraudulent making of contracts that it is impossible to honour.”
As Dr Frank Shostak puts it, it was the introduction of financial de-regulation and the dismantling of the Glass–Steagall Act in the 1980s that resulted in fierce competition between banks. The previously fixed margins were severely curtailed. This in turn called for an increase in volumes of lending in order to maintain the level of profits.
In the present central banking framework this increase culminated in an explosion in the creation of credit out of thin air – a massive explosion in the money supply. In the deregulated environment, banks’ ability to amplify Fed’s pumping has enormously increased.
The UK not only needs to adhere to the laws of economic freedom delineated earlier but likewise to it needs to reduce, in of itself, the impact of the State in welfare, which has created an overwhelming sense of entitlement. The social divide has increased most in the UK than any other OECD country.
To reduce the social divide one needs to reduce the welfare state.
• Employment is the most promising way of tackling inequality. The biggest challenge is creating more and better jobs that offer good career prospects and a real chance for people to escape poverty. We need to encourage small business enterprises and make it easy to employ as well as let unproductive workers go.
• Investing in human capital is key. This must begin from early childhood and be sustained through compulsory education. Once the transition from school to work has been accomplished, there must be sufficient incentives for workers and employers to invest in skills throughout the working life. Vocational education should be encouraged and given equal emphasis.
• Reform tax and reduce the size of the welfare state. The benefit system is the most direct instrument for increasing redistributive effects. Large and persistent losses in low-income groups following recessions underline the importance of government transfers and well-conceived income-support policies. However, benefits should be altered so as to provide a minimum safety-net and encourage vocational job skills. Giving payment for such training also gives individuals a sense of purpose and meaning rather than a sense of hopelessness.
(If we move to our vision of a sound monetary system this would allow the UK to easily reform taxation and make more streamline. For income we would then advocate a flat tax. We believe this would encourage entrepreneurship. Our income and savings should be equally taxed, to meet services and minimum welfare needs. In effect entrepreneurs would be rewarded for the creation of real savings through production.)
• The growing share of income going to top earners means that this group now has a greater capacity to pay taxes. It will be tempting for governments to further increase the progressiveness of the tax system to capture a larger share of wealthier individual’s tax gain. But this would be wrong.
(Unfortunately in a fiat currency system, individuals who build and more importantly receive money first (government and associated entities) will accumulate assets which will inflate in price before others receive money. Such entities grow rich at expense of others. It’s not a meritocracy. Occupy Wall Street are right to be angry but they have not comprehended the extent of monetary enrichment. Lobbyists and cronyism is a by-product of a corrupted monetary system. If you can get policy directives changed to promote your business sector you know the money will be readily available, likewise you can employ borrowed earnings to ‘buy’ your cause.)
• Entrepreneurship does not exclude individuals who provide services for the community, nurses, fireman etc. Far from it. Social reforms could encourage community ownership of hospitals, social amenities, along the lines of ‘friendly societies’. Welfare support can be provided by the private community. We would advocate a move to welfare without the state or at least greatly reduced state involvement.
• The provision of freely accessible and high-quality public services, such as education, health, and family care, is important; but one that is created and owned by the community. A form of mutualisation or stakeholder interest. The people own the services not the State. Friendly Societies or mutual organisations can be instated for a number of community businesses including insurance and savings banks (regional or even national).
• Aging demographics needs to be addressed. A lot of equity is in housing for the elderly, perhaps using reverse mortgages they can take out prudent amounts of equity to fund themselves or the next generation; thereby alleviating welfare payments.
Key policy recommendations for creating prosperity:
UK needs to contain its public debt whilst encouraging private-sector investment, which will enable growth. Our tax system suffers from over-burdensome red tape, according to the 2020 Tax Commission, the Tolley’s Tax Guide (complete version) was 11,520 pages long in 2009, more than double the 1997 figure. We would note War and Peace is 1,204 pages. You get the picture.
We agree with the 2020 Tax commission (www.2020tax.org) on their main premises:
“The reality is that families and businesses in the UK are still taxed far too much. The UK has the world’s longest tax code – which has more than doubled in the last 13 years – and the costs of administering this system have soared at the same time.”
“For too long policy in a variety of areas, from welfare to business support, has seen the Government tax people and businesses too much and then hand some of it back as tax credits or grants. The VAT hike has come in, as well as fuel duty; the level of employers’ National Insurance Contributions offers weak incentives for employers to hire more staff and grow their business; hard-working families have less of their own money in their pockets and even face substantial taxes when they die; the complexity of the tax system means that mistakes are all too common.”
The point is to have a structural overhaul of the tax system to make it simpler. Introduction of flat taxes are not regressive they arguably promote meritocracy especially when introduced into a society that reduces its reliance on the welfare state and even creates its own ‘privatised’ community welfare.
• Tax reform to encourage business investment environment in the UK, and growth of medium sized enterprises. Corporation tax has been lowered but we are still less competitive than most.
• Encourage more Richard Bransons – more entrepreneurs and this starts in the classroom.
• Reduce regulation of multinationals. Work with them to encourage them to make long-term investment in the UK. This means controlled but open immigration.
• Improve technology gap by encouraging tax efficient schemes for private enterprises to invest in start-ups and mid-sized firms. This does not mean preferential taxation on private equity groups using loopholes in accounting.
• We need to rebuild our energy infrastructure – encourage investment in exploration, efficiency of usage and production. This has been encouraged.
• We need to rebuild our transport infrastructure. We invite private and overseas investment by providing attractive taxation in return for domestic employment of qualified workers and training of UK workers; but they are subject to usual employment law not a quota system that enforces employment.
• UK health industry needs to migrate to private and community ownership.
• Pension reform and protection of workers’ rights need to be addressed. They have become too inflexible and a drag on efficiency of businesses.
• We should develop healthcare in conjunction with revenue from bioscience and pharmaceutical industry that is growing here based on our expertise and education system.
For the UK financial system the solution is almost certainly some combination of better mechanisms, rules, and prudent business practices aimed at increasing the level of reserves and thus resilience, in the system in the short term. But in the medium term we need to completely overhaul the banking system. Excessive credit cannot be allowed to encourage individuals to create their entire prosperity out of house ownership. Rising prices is not a signal of wealth creation it is a symptom of the rise in credit from monetary expansion in a fiat currency system.
Growth is the best answer to excessive sovereign debt but this is merely wishful thinking at this stage in the debt cycle. The best way to have sustainable growth and hence wealth is not to have so much debt in the first place. If the money supply is stable then prices will be stable and productivity will provide cheaper priced goods. Our purchasing power will go up in tandem.
Economic freedom is the key to the long lasting ‘wealth of a nation’. All other aspects of society will thrive if a nation adheres to this ideal. Unfortunately, as we have demonstrated, excessive imbalances in property cycles have accelerated this loss of freedom in the UK. Property cycles propagated by credit availability, the use of property as collateral, and Western nations’ institutional aversion to countenance deleveraging in the economic system have amplified swings in long-term economic (business) cycles.
We have explored how the UK, saturated in debt, has a stark choice should it wish to prosper in the future, or fail. We reiterate our introduction that we believe a nation will tend to bankrupt its citizens before it bankrupts itself; especially under a fiat currency system when it has the temptation to fund a welfare state through continued deficit financing. This is the case in the UK today. So until such time as we have monetary and political reform in the UK, one’s purchasing power and civil liberties will become ever diminished.