"A Crisis of Political Economy," The Freeman: Ideas of Liberty (May 2009). Published online 24 April 2009.

A CRISIS OF POLITICAL ECONOMY

By Chris Matthew Sciabarra

One of the things that I have long admired about Austrian-school theorists, such as Ludwig von Mises, F. A. Hayek, and Murray Rothbard, is their understanding of political economy, a concept that conveys, by its very coupling, the inextricable tie between the political and the economic.

When Austrian-school theorists have examined the dynamics of market exchange, they have stressed the importance not only of the larger political context within which such exchanges take place, but also the ways in which politics influences and molds the shape and character of those exchanges. Indeed, with regard to financial institutions in particular, they have placed the state at the center of their economic theories on money and credit.

Throughout the modern history of the system that most people call "capitalism," banking institutions have had such a profoundly intimate relationship to the state that one can only refer to it as a "state-banking nexus." As I point out in Total Freedom: Toward a Dialectical Libertarianism:

A nexus is, by definition, a dialectical unity of mutual implication. Aristotle . . . stresses that “the nexus must be reciprocal . . . [T]he necessary occurrence of this involves the necessary occurrence of something prior; and conversely . . . given the prior, it is also necessary for the posterior to come-to-be.” For Aristotle, this constitutes a symbiotic "circular movement." As such, the benefits that are absorbed by the state-banking nexus are mutually reinforcing. Each institution becomes both a precondition and effect of the other.

The current state and the current banking sector require each other. They are so reciprocally intertwined that each is an extension of the other.

Remember this the next time somebody tells you, as New York Times columnist Bob Herbert did, that "free market madmen" caused the current financial crisis that is threatening to undermine the global economy. There is no free market. There is no "laissez-faire capitalism." The government has been deeply involved in setting the parameters for market relations for eons; in fact, genuine "laissez-faire capitalism" has never existed. Yes, trade may have been less regulated in the nineteenth century, but not even the so-called Gilded Age featured "unfettered" markets.

One reason I have come to dislike the term "capitalism" is that, historically, it has never manifested fully its so-called "unknown ideals." Real, actual, historically specific "capitalism" has always entailed the intervention of the state. And that intervention has always had a class character; that is, the actions of the state have always benefited and must always benefit some groups at the expense of others.

No Neutral Government Action

Mises understood this when he constructed his theory of money and credit. For Mises, there is no such thing as a "neutral" government action, just as surely as there is no such thing as "neutral" money. As he pointed out in The Theory of Money and Credit and other works, "Changes in the quantity of money and in the demand for money . . . never occur for all individuals at the same time and to the same degree and they therefore never affect their judgments of value to the same extent and at the same time." He traced how, with the erosion of a gold standard, an inflation of the money supply would diffuse slowly throughout the economy, benefiting those, such as banks and certain capital-intensive industries, who were among the early recipients of the new money.

One reason the gold standard was abandoned is its incompatibility with a structural policy of inflation and with a system heavily dependent on government intervention. (It should be pointed out that a free-banking system need not necessarily entail a 100 percent reserve gold standard, but I leave this discussion for another day.) The profiteers of systematic inflation are not difficult to pinpoint. Taking their lead from Mises, Hayek, and Rothbard and such New Left revisionist historians as Gabriel Kolko and James Weistein, Walter Grinder and John Hagel III point out:

Historically, state intervention in the banking system has been one of the earliest forms of intervention in the market system. In the U.S., this intervention initially involved sporadic measures, both at the federal and state level, which generated inflationary distortion in the monetary supply and cyclical disruptions of economic activity. The disruptions which accompanied the business cycle were a major factor in the transformation of the dominant ideology in the U.S. from a general adherence to laissez-faire doctrines to an ideology of political capitalism which viewed the state as a necessary instrument for the rationalization and stabilization of an inherently unstable economic order. This transformation in ideology paved the way for the full-scale cartellization [sic] of the banking sector through the Federal Reserve System. The pressure for systematic state intervention in the banking sector originated both among the banks themselves and from certain industries which, because of capital intensive production processes and long lead-times, sought the stability necessary for the long-term planning of their investment strategies. The historical evidence confirms that the Federal Reserve legislation and other forms of state intervention in the banking sector during the first decades of the twentieth century received active support from influential banking and industrial interests. . . . ["Toward a Theory of State Capitalism: Ultimate Decision-Making and Class Structure," Journal of Libertarian Studies, 1977]

As Grinder and Hagel explain, "[C]artellization [sic] of banking activity permits banks to inflate their asset base systematically." This has the effect of strengthening the "ultimate decision-making authority" of banking institutions over "the activities of industrial corporations," and, by extension, "the capital market." These banking institutions serve as a key "intermediary between the leading economic interests and the state."

Thus one of the major consequences of inflation is a shift of wealth and income toward banks and their beneficiaries. But this financial interventionism also sets off a process that Hayek would have dubbed a "road to serfdom," for inflation introduces a host of distortions into the delicate structure of investment and production, setting off boom and bust and, in Grinder and Hagel’s words, "a process of retrogression from a relatively free market to a system characterized by an increasingly fascistic set of economic relationships."

Just as the institution of central banking generates a "process of retrogression" at home, engendering additional domestic interventions that try to "correct" for the very distortions, conflicts, and contradictions it creates, so too does it make possible a structure of foreign interventions. In fact, it can be said that the very institution of central banking was born, as Rothbard argues in The Mystery of Banking, "as a crooked deal between a near bankrupt government and a corrupt clique of financial promoters" in an effort to sustain British colonialism. The reality is not much different today, but it is a bit more complex in terms of the insidious means by which government funds wars, and thereby undermines a productive economy.

So where does this leave us today?

Much has already been said about the most recent financial crisis, viewed from a radical libertarian and Austrian perspective, which helps to clarify its interventionist roots. (See, for example, Steven Horwitz's "An Open Letter to My Friends on the Left," and Sheldon Richman's "Bailing Out Statism"). The seeds for this particular crisis were planted some years ago. The origins of the housing bubble can be traced to the creation of Fannie Mae and Freddie Mac, government-sponsored enterprises that extended risky loans to low-income borrowers in the hopes of expanding the "ownership society." But the larger crisis must be understood within the wider political-economic context shaped by inflationary government and Federal Reserve policies that fueled a binge of reckless borrowing. Horwitz explains:

All of these interventions into the market created the incentive and the means for banks to profit by originating loans that never would have taken place in a genuinely free market. It is worth noting that these regulations, policies, and interventions were often gladly supported by the private interests involved. Fannie and Freddie made billions while home prices rose, and their CEOs got paid lavishly. The same was true of the various banks and other mortgage market intermediaries who helped spread and price the risk that was in play, including those who developed all kinds of fancy new financial instruments all designed to deal with the heightened risk of default the intervention brought with it. This was a wonderful game they were playing and the financial markets were happy to have Fannie and Freddie as voracious buyers of their risky loans, knowing that US taxpayer dollars were always there if needed. The history of business regulation in the US is the history of firms using regulation for their own purposes, regardless of the public interest patina over the top of them. This is precisely what happened in the housing market. And it’s also why calls for more regulation and more intervention are so misguided: they have failed before and will fail again because those with the profits on the line are the ones who have the resources and access to power to ensure that the game is rigged in their favor.

This is precisely correct; indeed, there are those of a certain political bent who might seek to place blame for the current financial crisis on the recipients of subprime mortgages, particularly those in minority communities. But if elements of the current housing bubble can be traced to Clinton administration attempts to appeal to traditional Democratic voting blocs, it's not as if the banks were dragged kicking and screaming into lending those mortgages. This is, in a nutshell, the whole problem, the whole history, of government intervention, as Horwitz argues. Even if a case can be made that the road to this particular "housing bubble" hell was paved with the "good intentions" of those who wanted to nourish the "ownership society," their actions necessarily generated deleterious unintended consequences. When governments have the power to set off such a feeding frenzy, government power becomes the only power worth having, as Hayek observed so long ago.

We heard a lot about "change" during the last presidential campaign, and about the necessity to end the influence of Washington lobbyists on public policy. But that influence exists because Washington has the power to dispense privilege. And privileges will always be dispensed in ways that benefit "ultimate decision-makers." That's the way the system is rigged. It is not simply that intervention breeds corruption; it’s that corruption is inherent in the process itself.

It is therefore no surprise that the loudest advocates for the effective nationalization of the finance industry are to be found on Wall Street; at this point, failing financiers welcome any government actions that will socialize their risks. But such actions that socialize losses while keeping profits private are a hallmark of fascist and neofascist economies. They are just another manifestation of "Horwitz’s First Law of Political Economy" ("Capitalists, Capitalism, and the Siren's Song of Stability"): "No one hates capitalism more than capitalists."

It is the government’s monetary, fiscal, and global policies that have created insurmountable debt and record budget deficits, speculative booms and bubble bursts. What is needed is genuine structural change. But the primary battle is an intellectual and cultural one. It requires that we question the fundamental basis of the current statist system.