BOOK REVIEW News Weekly
Never far from disaster
, July 9, 2011
Great Crises of Capitalism
by Peter D. Jonson
(Victoria: Connor Court Publishing)
Paperback: 319 pages
Reviewed by Jeffry Babb
Capitalism is the only economic system in the history of mankind known to produce sustained prosperity and a decent standard of living for the great majority of people. This fact is accepted everywhere these days, with a few exceptions such as Zimbabwe, Cuba and North Korea — not a group many other countries would aspire to join.
Capitalism, is, however, propelled by what economist Joseph Schumpeter called a process of “creative destruction”. When a business or industry fails, its resources are reallocated into new emerging firms or industries. If you are one of those “reallocated resources”, it’s rarely pleasant, but that’s how economies grow. Some businesses are destroyed so that others can be created.
Crises are an inevitable element of capitalism. The American financial system seems to devote a great deal of energy to inventing new ways of going broke, be it the “can’t lose” margin loans that greatly magnified the effects of the 1929 Wall Street stock market crash or new financial instruments that nearly brought down the world’s financial system in 2007.
Dr Peter Jonson, a former chief economist at the Reserve Bank of Australia, is incorrect in saying that Lehman Brothers was allowed to fail while other institutions survived. Bear Stearns went under, as did others, and America’s biggest brokerage, Merrill Lynch, lost its independent existence when it was taken over by Bank of America.
It would have been very satisfying if the Vampire Squid — Goldman Sachs — the cause of much of the chaos, had gone under too; but it survived, probably not unconnected to the fact that its former boss, Henry Paulson, had been appointed Secretary of the Treasury in the George W. Bush Administration and was in charge of running the bailout operation.
The banking system has one primary function — preserving the savings and capital of the nation, and putting it to work to promote economic activity. It is often said that a fool and his money are soon parted, and no amount of regulation will stop greedy and foolish people from doing stupid things with their money, as several recent cases in Australia have demonstrated.
However, where a central bank exists, such as Australia’s Reserve Bank or America’s Federal Reserve, savers should have a reasonable expectation that their money, if deposited in a sound institution, will be secure, and policy should be conducted towards that end. What’s more, it is reasonable to expect that their savings will not be destroyed by inflation.
The current crisis is almost entirely the result of gross irresponsibility by American policy-makers, first, by former chairman of the Federal Reserve, Alan Greenspan, who lowered interest rates to artificially low levels and kept them there, causing a housing bubble that has yet to fully deflate, and second, President Bill Clinton, who promoted and signed into law legislation that encouraged people with few economic resources to buy houses they couldn’t afford, which led to disastrous results for themselves and the world.
One of America’s enduring political debates is the role of the central bank, or, indeed, whether to have one at all. Another enduring debate is what constitutes money.
The relationship between gold and silver, known as bimetallism, dominated U.S. politics for decades. When
Richard Nixon closed the gold window in 1971, meaning dollars could no longer be converted into gold, it meant that the only thing supporting the U.S. dollar was a “promise to pay” by the U.S. government. Thus, the U.S. dollar became what is known as fiat money. As the U.S. dollar was, and remains, the world’s reserve currency, all the world has to rely on is a promise by the U.S. government — in particular the Federal Reserve — that the dollar will hold its value.
Take, for example, China. The U.S. has been devaluing the dollar so its exports will be cheaper and its imports from China will be dearer. In fact, all devaulation has done is export inflation to China.
Many parts of China have been in the grip of a severe drought. Inflation exported from America, combined with the drought, means people are going hungry. America is exporting hunger.
China is refusing to play America’s games. Why should she? If American policy-makers are deluded enough to think they can solve their nation’s problems by debasing the currency and stealing their people’s savings by inflating them away, that’s their business.
Thus, it is hard to take seriously Jonson’s suggestion that the world needs a global central bank. The head of a global central bank would be no more likely to resist financial mob rule than the current head of the U.S. Federal Reserve.
The current global financial crisis is the result of an institutional failure of U.S. leadership. Similarly, credit creation should be in the hands of commercial lenders, not governments.
Although he is not a great literary stylist, Jonson seems to be a good economist and, unlike most of us, has played a central role in managing the nation’s finances. However, the book contains little original research, and very little in it will surprise anyone with an interest in the history of finance.
If you are new to the subject, however, he covers the main themes well and shows we are never far from disaster.