It is no surprise that Wayne Swan regularly complains about evil bank profits, and we’re sure the Greens (and other assorted reds) would eagerly agree to more regulation. But while we can understand the political desire for populism, when it actually comes to managing the rules for our economy, we can only hope that Hockey is not serious about his stated desire to have the RBA act as referee on interest rates.

We already know that Joe Hockey wanted to introduce a psuedo-national bank, and he wanted more regulation to ensure that banks gave more risky loans, and also gave fewer risky loans.

Now the issue is whether banks should be able to set their own prices for loans. To be fair, Hockey has only suggested that the Reserve Bank of Australia (RBA) should nudge banks, but given his track record on not understanding finance it’s a dangerous start. It hints very much towards government regulation of interest rates, which is price fixing of some of the most important prices in the economy.

If you’re like many other non-economists (ie normal people) then you might think that the government already does set interest rates. If you’re half an inch more informed, you might think that the independent RBA sets interest rates. That’s not quite right.

The RBA effectively does set one specific interest rate — the “overnight rate” for collateralised loans to major banks. Indeed, there is a big argument about whether they should even be doing that, but that’s a topic for another day. The overnight rate is an important price, but — and this is the most important thing to learn from this article — that is just one interest rate among thousands. All of the other interest rates are set by banks (and other money lenders) in a competitive market, following the laws of supply and demand.

As it should be.

The law of supply and demand can be frustrating sometimes. So can the law of gravity. But in both instances, you cannot legislate your frustrations away. When the government tries to “fix” the naughty market, there are three possible outcomes. Either the government sets the price too low and we end up with shortages (so banks will only lend to the privileged few) or the government sets the price too high and we have excess supply (ordinary people can’t afford to borrow), or the government sees a divine vision from the Virgin Mary, sings kumbaya with Mary Popins, and magically picks the perfect price, even though they have all the wrong information and incentives. What do you think is more likely?

We have learnt from 100 years of trial and error (mostly error) that the government is not good at setting prices. At least, that is what we should have learnt.

Some lefties and Bob Katter still want to set prices for things like milk and vegetables, and that is silly enough. But the idea of the government (or RBA) setting interest rates is another level of crazy. The reason, as we said above, is that there are thousands of different interest rates — depending on the reason for the loan, the collateral available, the length of the loan, the size of the loan, the liquidity of the consequent financial asset, the funding profile of the lender, degree of risk aversion and time value of money, the credit rating of the applicant, and many other variables.

You could try to find a benchmark or average interest rate, but that doesn’t really help our busy-body regulators. Getting the average right means nothing… just as standing with one arm in the fire and one arm in the freezer might give you a good average temperature, but it’s not a good idea.

Specifically, some financial institutions aim at a particular market, that might be more or less risky. That means they will have a totally different strategy, with different interest rates. Will the government be micro-managing their business strategies too, or just guessing at them?

And just to make it all worse, the public choice consequences of interest rate price fixing are also quite dangerous. Instead of being driven by competition, bank strategy and prices will increasingly become political footballs. That will mean some banks will reap windfall profits by playing good politics, while other banks will be sent to the wall due to bad politics. And the lack of price competition will mean less innovation and more lobbying and rent-seeking. That’s not how we want any business sector to work, least of all the all-important financial sector.

This is not good. As we said at the beginning, we can understand why populist politicians promise to run and ruin the economy. But what we really care about is whether they mean it. The two options are that they are liars who spruik populist crap and then become responsible when in power… or that the politicians have actually drunk their own kool-aid, and plan on destroying our economy. We hope they are liars.

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This article was co-written with Joseph Clark. All of the nasty parts of this article were written by Joe, and all the witty and wise parts were written by John. Except for this paragraph.

While all of the remaining candidates have an interesting story to tell, it is the rise of Ron Paul and a growing libertarian voting block that has the biggest long-term consequences. When I wrote about Ron Paul for “the drum” a month ago he was still being largely ignored by the mainstream media (MSM) despite consistent good polling and fund-raising. That is slowly changing. Given that Paul came 3rd in Iowa (with 21% of the vote), is currently polling 2nd in the next voting state of New Hampshire (~20%), and is the only candidate other than Romney with money and campaign infrastructure around the country, some people have started paying attention.

With a higher profile, Paul has started to cop some heat from opponents. He has been attacked over some 20 year old racist articles that were most probably written by James Powell, and the war-mongers have called him dangerous because he doesn’t want to attack Iran. However, these don’t seem to have done much damage in the polls, since Ron Paul is clearly not a racist and most of his supporters are already aware that Paul believes in peace. Over the last month Paul has moved from 8% to 12% in the Gallup daily tracking poll.

Nonetheless, most mainstream commentators continue to say that Ron Paul simply cannot win the nomination. They are probably right. The libertarian message is a hard sell, and most people find it difficult to believe that the party of George W. Bush would endorse a candidate who wants to end the war on drugs, ban torture, close Gitmo, trade with Iran and Cuba, bring home US troops, and protect civil liberties, even if he was the only candidate to have predicted the housing bubble and bust. Recent polling shows that 52% in New Hampshire have an unfavourable view of Paul. But what are the alternatives?

Besides Ron Paul there are five options available for the Republicans. If we consider each candidate on their own, the most obvious conclusion is that they cannot win the nomination. And yet one of them must. The chances of Ron Paul being the candidate are slim, but with the weak field and current economic turmoil, it is worth considering.

In the next few weeks, we are likely to see two more candidates drop out of the race. Jon Huntsman got less than 1% in Iowa, is polling 2% nationally, and has no money or national campaign infrastructure. His main problem is that as a “moderate” who is supported by the Republican establishment (and a Mormon) his niche in the race was already taken by Mitt Romney. Huntsman has put all his hopes in New Hamsphire were he has about 9% support… and if he fails to “surge” in the next few days then he will be out of the contest.

Rick Perry is only in a marginally better position. He got 10% in Iowa, is polling 6% nationally and only 1% in New Hampshire, but he does have a bit of money leftover from his earlier fundraising so he can’t be ruled out of the race just yet. Perry is skipping New Hampshire and putting all his hopes in the South Carolina primary on 21 January, where he is currently polling at 5%. The Perry strategy now is simply to pray for other anti-Romney candidates (especially Santorum) to fall over… and if that fails to happen in the next two weeks then he will be out of the contest.

That leaves us with four potential nominees — Mitt Romney, Newt Gingrich, Rick Santorum, and Ron Paul.

The most obvious option is Mitt Romney. He may well end up being the candidate because, as suggested in a fake Romney ad, “I’m all you’ve got left; game over baby”. Romney won in Iowa with 25%, is currently leading in the national polls with 27%, and leading in New Hampshire with 41%, he does the best in match-ups against Obama, and he has more money and campaign infrastructure than any other candidate. The intrade odds suggest he has an 80% chance of being the eventual nominee, which sounds about right.

And yet the simple truth remains that a majority of Republicans just don’t like/trust Romney. He seems to have a solid floor of about 20% support and also a ceiling of about 30% support in most states, with the other 70% desperately looking for any other alternative. This restless base has jumped from Bachmann to Perry to Cain to Gingrich to Santorum, but they refuse to get behind Romney. This might be because of his pro-choice past, his preference for big government, his religion, or simply a perception that he is “fake“. Whatever the reason, the anti-Romney sentiment leaves open the possibility that another candidate could put together a large enough “anti-Romney” coalition to steal the nomination.

The latest anti-Romney to surge in the polls has been Rick Santorum, after scoring a close 2nd place in Iowa. He has now shot up from 4% to 15% in the Gallup national poll and his numbers continue to climb as he makes the case that he is the real conservative in the race. But there are several reasons to be skeptical of the Santorum surge. First, Santorum has no money or national campaign infrastructure, which makes it very difficult for him to run an effective national campaign. At the same time, his new frontrunner status will attract increased scrutiny as other candidates point out that Rick Santorum believes in big government and bridges to nowhere. Regarding electability, Santorum’s strong anti-gay position makes him unlikely to win over independent voters in the general election, and he does worse than the other Republicans against Obama in polling (except for Rick Perry).

If Santorum doesn’t win, the only other option besides Romney and Paul would be Newt Gingrich. Newt surged to the top of the polls in November, with a peak of 37% in the Gallup national poll. However, since then a lack of money and increased scrutiny on his record have seen his numbers fall steadily so that he is now down to 19% and dropping. He scored a disappointing 13% in Iowa and is polling 9% in New Hampshire, and has one of the highest “unlikeable” ratings of all potential candidates. Gingrich has said that his campaign rests on a good showing in South Carolina, where he has just fallen from 1st to 3rd in recent polls. Like Perry, Gingrich’s strategy now is to pray for other anti-Romney candidates (especially Santorum) to fall over.

Given a field of unpopular and under-funded candidates, it is possible that the vote may stay fractured until the Florida primary (31 January) and beyond, which would be ideal for Ron Paul. It would give him a legitimate chance of winning some states, and further explain his policies and philosophy in the hope of persuading more people towards his libertarian and constitutional approach.

As the “Ron Paul army” grows, this creates an ever-bigger libertarian problem for the Republicans. Either they start to embrace libertarian policies, or they risk alienating a large and growing section of their own support base. This problem was highlighted recently with a national opinion poll that showed Obama on 43% against Romney on 41% and Gary Johnson earning 9% as a potential Libertarian Party candidate. If Ron Paul was the Republican nominee, that libertarian vote would shift to the Republicans.

Under normal circumstances, Ron Paul would have no chance of winning the nomination. But these aren’t normal circumstances.

That doesn’t just mean that I support Andrew Bolt’s right to say whatever he likes about aboriginals, irrespective of who gets offended. And it doesn’t just mean that I oppose all censorship, such as the banning of Mein Kampf in some European countries. It also means I oppose defamation laws, and I believe you should be allowed to say anything about anybody, whether true or false, for whatever reason. It even means I believe that tobacco companies should be free to advertise.

I believe attempts to limit speech “for the public good” will mostly do more harm than good, and that messy and imperfect freedom is better than neat and tidy (but even more imperfect) government control.

Today I was discussing another of the controversial areas of free speech. Yesterday, that crazy old kook of the blogosphere grumpy-Graeme Bird wrote an eloquent rant aimed at me, where he said:

“He must die. John Humphreys must die so that this country can live.  He has betrayed this country too many times and he must no longer live … This is too important a subject to let John Humphreys live. Where does the lying end. I’m convinced that it only ends when John Humphreys is cold and stiff … HE MUST DIE, FOR THE LYING TO END. AND THIS IS A LIFE OR DEATH MATTER … I am accusing Humphreys of being a knowing traitor … SO MY NEW CLAIM IS THAT HUMPHREYS WILL NEVER STOP LYING. THAT HE WILL NEVER BE A SAFE PAIR OF HANDS. THAT HE WILL ALWAYS BE A TRAITOR. WHILE HE YET LIVES.”

My first death threat. Now I know that I’m important. A few friends have suggested I take it seriously, and one kindly offered to call his federal police friend who would call Graeme… but I nixed that idea. For his part, Graeme says that it is not a death threat because he doesn’t plan on doing any killing himself. That’s good to hear. But another friend pointed out that the above sentiments might still be considered incitement to violence… which got me thinking about free speech.

My conclusion, once again, is that death threats such as above should be allowed as free speech.

The moral reason to allow the above sort of rants is that Graeme hasn’t actually directly hurt anybody with his rant, nor has he tried to coerce anybody (by saying “do XYZ, or else”), and so he should be left alone. He has simply stated that he wants me dead. If somebody were to act on Graeme’s death wish, then in my opinion the responsible person is the killer, and not Graeme.

We are surrounded with advertising every time we turn on the TV or go outside. We are more subtly being influenced every time we read a newspaper or book or website, or when we talk with our friends. We are even being influenced when we simply watch strangers on the streets. But ultimately, I believe that each person needs to be held responsible for their own actions, and that responsibility can not be passed on to the people who have influenced the actor. If I say that a book is good, and you go and buy the book… then it is you (not I) who is responsible for your actions. Likewise, if grumpy-Graeme says he wants me dead, and mad-Doug (another freak with an unhealthy fixation on me) actually comes and kills me… then it is mad-Doug (not grumpy-Graeme) who is responsible for the murder.

The idea that advertisers or influential people are responsible for the actions of others undermines individual responsibility, and it sets a dangerous precedent for controlling who is allowed to say what to whom. And once we start controlling speech to only “good speech” we get into dangerous territory.

None of this is to say that all speech is equally ethical or nice. If you spread untrue and nasty rumours about someone, then you’re an asshole according to my view of ethics. If you incite people to violence, or say things with the intention of hurting others, or knowingly defame somebody, or encourage people to do something you think will likely be bad for them — then you’re not a nice person. This is why most people think Graeme & Doug are jerks. But I do not believe that the government should set laws that require us to be “nice”.

The idea that the government should enforce their “correct” ethics on everybody is problematic both because different people have different ethical systems (consider different religions) and also because to impose the “correct” ethics it is first necessary to have a perfect person who knows the divine truth. I doubt that the government is run by such divine perfect people. Indeed, I doubt such a person exists. The best way to encourage ethical behaviour is the natural approach of civil society, where nice people tend to have friends and assholes tend to be excluded, and where people with similar ethics tend to congregate together. This explains why grumpy-Graeme and mad-Doug are the only people who take each other seriously.

There is also a practical reason why the above sort of death threats should be legal. If there actually was some sort of plan to kill me, then it would be very helpful for me to know. Keeping such sentiments underground may protect some delicate sensitivities, but it will not necessarily reduce the sentiment. Now at least if I wake up dead everybody will know where to start the investigation.

Perhaps they were just premature.

Hayek argued that democracy can be slow and messy, but that economic decisions often need to be made quickly and decisively. If the government controls the economy, then the people have a choice between slow and messy economic decisions, or making the government less democratic so that leaders could “get things done”. As we look at the economic problems in Europe and America today, the lessons of Hayek seem very appropriate.

From American towns to the European countries of Greece and Italy, elected leaders are being replaced by technocrats. With growing debt problems, the idea that some Europeans may start to look for a “strong leader” to make “tough decisions” without having to deal with those “meddling and bumbling politicians” doesn’t sound too outlandish. Even in Australia, we have seen one commentator hint at the idea of suspending democracy so that leaders can take strong action.

Now even simpletons like Jeff Sparrow are starting to notice the trend.

Of course, Jeff thinks that “neoliberals” are to blame. Again. He goes on to say that neoliberals are also to blame for Kevin Rudd’s 2020 talk fest, and the idea of Labor Party primaries, and modern democratic campaigns, and anything else you don’t like. It’s actually quite amusing. You can see that Jeff is 100% committed to two causes — opposing “neoliberalism” and also not knowing what the word means. The fact that he remains so proudly ignorant raises some interesting sociological questions, but that’s a topic for another day.

The anti-democratic trends in Europe and America (and to a lesser degree in Australia) should not be a surprise.

The truth is that our current “neo-socialism” is simply unsustainable. It would be easy to point to the unprecedented amount of welfare spending, and business controls, and nanny-state regulations, and police-state intrusion, and show how these are leading the west to fiscal ruin. Greece and Italy know the story all too well, and I have written about this before. However, as Hayek warned, it is also becoming increasingly apparent that our ever-growing government is also culturally and politically destructive.

Even Simple Jeff notes that the golden age for social organisation and civic involvement was the nineteenth century — the same time as the golden age for market capitalism. Since then we have seen a consistent story of growing government, and shrinking community. Instead of actually pursuing social goals, many “non-government organisations” now concentrate on lobbying the government. Instead of people coming together in their neighbourhood to directly fix local problems, we are building a culture of complaint and inaction while we wait for a government solution.

At the same time as the government crowds out community, they are also taking a larger role in trying to “manage” the economy. Keynesians have the world convinced that politicians can solve the business cycle by micro-managing demand. Intellectual leaders debate about how the government should drive growth, or restrict growth, or create sustainable growth, but they all seem to accept the idea that it is the responsibility of the government to do something. And so expectations rise. People assume that the government should “do something” and politicians are eager to offer to “do something” in the hope of picking up a few more apathetic votes.

Each election, politicians promise that big government will solve our problems. This leads to two inevitable results — (1) people become less involved in the broader civil society because they outsource those responsibilities to politicians and bureaucrats, and so government crowds out community; and (2) when the government inevitably fails, people become disillusioned with politics. These factors explain why fewer and fewer people join political parties.

As the government grows, politics becomes big business and playing political games brings more rewards. This creates a power dynamic of “insiders” and “outsiders”. Those outside of political power can neither control their own lives nor control the government (which controls their lives), and so as Frank Furedi has noted they increasingly feel disempowered. With less control comes less responsibility, further undermining civic engagement.

In such a situation it is not surprising that civil society and democratic institutions are decaying. Hayek was right.

These two issues need to be addressed separately. The first is a deontological issue about whether FR-banking is consistent with a free world. The second is a consequentialist issue about whether FR-banking leads to bad outcomes. It is possible that FR-banking is consistent with freedom and yet leads to bad outcomes, and then those libertarians who accept the “non-aggression principle” would have to tolerate FR-banking even if they don’t like those outcomes. But before delving into that debate, it is worthwhile quickly explaining what we are actually talking about with FR-banking.

Vaults, loans & banks

Anything can be money. In jail (and POW camps) cigarettes have been used as money. In the early years of Australian settlement, rum was used as money. In some small island nations, shells have been used as money. Through much of history, precious metals (especially gold and silver) have been used as money. And today, the most common sort of money is “fiat” paper money that is created by government but is intrinsically worthless (ie it has no value except as money). This is not the place to go into a debate about what should be money or who should decide, but the important point is simply that there is some original supply of money that then becomes the standard “unit of account” and “store of value” and “medium of exchange” in an economy. For the sake of this discussion, this original supply will be called “base money” and in Australia it is created by the Reserve Bank of Australia (RBA).

As soon as money existed, people founds ways to store their money. One option is to put it in your wallet. Or under your bed. Or you could put the money in a vault to make it more difficult to steal. These options have always existed, and they still exist today.

And while many religions have frowned on “usury“, the idea of lending money is also an ancient concept. You sister needs to borrow $10 for the bus, and so you give it to her on the understanding that she will pay you back when you see her next.

But providing “vault services” or even “simple non-tradable loans” is not really banking. For all intents and purposes, when people talk about banking they are talking about FR-banking, which involves another important step. The innovation that gave rise to modern banking was the idea that you could have a secondary market for loans. That means that after you lend $10 to your sister, she gives you an IOU$10 voucher. That IOU$10 voucher is a “financial asset” that you can then sell to somebody else.

If the IOU$10 voucher is widely accepted as being worth the equivalent of $10, then it will circulate in the economy similarly to the original $10. This is why some people say that FR-banking allows for the “creation of money out of thin air”. They are partially right. To be more specific, the “IOU$10 voucher” is actually credit (not base money). However, if the credit is traded like base money then it too becomes a “store of value” and a “medium of exchange” and so the base money (created by the original money supplier) and the credit (created by the people who created the loan) are fungible.

If we allow people to voluntarily create and voluntarily trade in financial assets, then we have allowed FR-banking.

Modern banks accept “deposits” from savers, which basically is the creation of a financial asset. The bank now has your $50 deposit, and you now have a financial asset called “IOU$50 voucher” from your bank. If people are willing to voluntarily accept your financial asset as money (for example, when you use EFTPOS or B-Pay) then there is now effectively $100 in the economy — $50 base money held by the bank (which they can then use), and $50 credit held by you (which you can use).

It is worth pointing out that credit is risky. The person (or bank) who owes you money might not pay it back.

So why would you be willing to exchange $50 of base money for $50 of credit? Probably because it is (1) safer from thieves; (2) more convenient for transactions; and (3) the bank may offer you interest. But for whatever reason, when you deposit with a bank you are engaged in FR-banking and the creation of credit. Congratulations. It is this action that Leithner, BHH & friends want to ban.

One consequence of FR-banking is that if the money supplier creates $100, then there will be more than $100 circulating in the economy. Indeed, it is quite easy for the amount of “credit” to exceed the amount of “base money”, and this is the case in all modern economies. The relationship between (base money) and (base money + credit) is called the “money multiplier” or the “credit multiplier”. For example, if the base money supply is $100 and the credit multiplier is 3 then the (base money + credit) is $300.

There is one more small point to note here before going on. It is possible for the same $1 to be spent several times in the same day. If I go out and spend $20 on lunch then there might have been $20 circulating that day. But if the lunch seller then uses that $20 to buy a hat, then actually $40 has circulated. If the hat seller then uses the same $20 to buy movie tickets then $60 has circulated. The multiple use of the same money is called “velocity”. With all of these concepts in mind, we can now define:

Broad money = base money * credit multiplier * velocity

For most of this article we will ignore velocity, but it is important to know that it exists to have a full understanding of monetary economics. As far as I know, not even Leithner, BHH & friends want to ban the same-day re-use of money and so they don’t object to the existence of velocity.

FR-banking as fraud

Since Leither, BHH & friends claim to be strict libertarians, they can only justify their call for a ban by arguing that FR-banking is fraudulent. But here their argument immediately runs into trouble, because people who enter into FR-banking contracts do so voluntarily and then they clearly follow the rules of their agreement. Where is the fraud?

Hoppe responds by saying “two individuals cannot be the exclusive owner of one and the same thing as the same time” (quoted in BHH, 21) and then BHH go on to say “yet this, precisely, is what a fractional reserve agreement between a bank and a customer involves” (22). This is an extraordinary admission of ignorance. Under FR-banking there is no instance where two people own the same thing. When you deposit $50 in a bank the bank now owns the $50 base money and you own the IOU$50 financial asset. They are two different things.

Leithner makes a similar argument, saying: “It’s also logically impossible for two people simultaneously to own the same item of property. They may, of course, say or even certify otherwise — just as I may say, certify and sincerely believe that 1 + 1 = 3 or that I own a kangaroo that can speak Finnish”. Leithner is of course correct that two people cannot simultaneously own the same item, but FR-banking does not involve simultaneous ownership (or talking kangaroos). Like BHH, Leithner is showing that he simply doesn’t understand how banks work.

It is actually astounding that we should even be having this discussion, and it deeply embarrassing for Leithner, Block, Hoppe and Hulsmann.

BHH go on to say that the creation of new credit (which they call “fiduciary media”) does not create any new property. That is true, but also blindingly obvious and totally irrelevant.

At one point BHH imply that the simple act of creating credit is fraudulent, saying that because credit comes “out of thin air” and because it isn’t linked to new property then the existence of credit “in and of itself, constitutes fraud” (22). Wow. They are literally saying that it should be illegal to give somebody a loan, since the act of giving a loan creates credit. Their basic problem here is that BHH don’t understand that “base money” and “credit” are different things, and so they think that credit is fraudulent because it pretends to be base money. But the simple truth is that base money and credit are different things, as explained in the introduction to this essay. This sort of undergraduate mistake makes BHH painful to read and utterly meaningless.

Suffice to say, if two people voluntarily agree to a loan, there is no fraud. This is true under any definition of contract. It also doesn’t matter if you call the newly-created credit a “financial asset” or “fiduciary media” or “widget” or whether we discuss the issue in French or Chinese or Esperanto. Saying that “credit is fraud” is no better than the pointless communist slogan that “property is theft”.

But if BHH allow loans to exist, and they allow people to voluntarily trade in the consequent financial assets, then they have allowed FR-banking. So they really are caught.

That is the end of BHH, but Leithner comes back with one more argument. He claims that putting money in an FR-bank cannot be called “deposit” because that word has some sort of sacred meaning that can never be violated. Consequently to misuse the sacred word is to commit fraud, even if the definition of the word is clearly stipulated in the contract. It is not clear why Leithner thinks he has divine inspiration about the “one and only correct” use of one specific word in the English language, but part of his justification seems to be the rules of Rome 2000 years ago.

This is an amazingly shallow argument, that rests entirely on a pointless semantics game. If every bank did a “find and replace” in their contracts and changed the word “deposit” to “pedosit” (or whatever other word you like) then the exact same system of banking would exist and Leithner could have no more objection. Further, Leithner’s complaint must disappear for the banking system of any country that doesn’t use English (unless Leithner’s divine language powers extend to other languages too). And finally, if we use a standard dictionary instead of the Leithner dictionary, then we discover that the word “deposit” is already accepted to mean money placed in a FR-bank account.

In a final desperate attempt to salvage the “fraud” theme, Conaghan argues that he accepts people’s right to create credit (which he also calls fiduciary media), but his “problem is when that gets traded with someone who isn’t aware, thinks that the promissory note is backed by something and later finds out it’s not”. In other words, Conaghan is worried that when you offer to pay using EFTPOS or B-Pay, the seller may not know that you are using EFTPOS or B-Pay. Once again — wow.

One of the Austrian economists who are caught semi-defending BHH & friends is Stephan Kinsella, who concludes that “the solution is for the bank to be very clear about what they are doing … as long as things are clear, we have no fraud, no problem”. There is nothing particularly wrong with this sentiment, except that banks are already extremely clear about what they are doing. It is in the contract you sign with the bank. It is in every banking and finance textbook. It is blindingly obvious if you think about banks for more than 5 seconds. And if you’re still not sure, you can simply ask your bank, and they will tell you to your face how banking works.

FR-banking as dangerous

While the “fraud” arguments are embarrassingly silly, the arguments about the consequences of FR-banking are more complicated. Allowing people to make and trade in financial assets has a number of consequences, some good and some ambiguous.

The main benefit of allowing trading in financial assets is that it provides more efficient matching between savers and investors. This means lower real interest rates for borrowers and higher real interest rates for savers — which leads to more saving and investing. Basically, FR-banking reduces transaction costs in the inter-temporal market, and so the invention of FR-banking was an amazing economic innovation that allowed for a significant increase in investment and capital accumulation. It is no surprise that the growth of FR-banking is correlated with economic development.

If we were to ban the creation of credit, then there would be no matching between savers and borrowers, and so significantly less investment. Even if we take the watered down “you may make loans, but not trade in them” then there would be much higher transaction costs as you could only borrow from somebody who had the exact same debt-maturity preferences as yourself. This also would significantly reduce investment, therefore reduce capital accumulation and economic growth.

The obvious benefits of FR-banking is further shown by “revealed preference”, where people who have the choice between FR-banks and vaults overwhelmingly chose to put their money in FR-banks. If FR-banks provided no benefit, then why are they so popular? Selgin and White make this point, but unfortunately it was too complicated for BHH to understand. In response, BHH try to draw an analogy between “voluntarily dealing with banks” and “involuntarily having to deal with government”, but amazingly fail to understand that the former is voluntary and the latter is involuntary.

There is another consequence of FR-banking that is harder to assess — and that is the impact on broad money, monetary distortions & the business cycle.

Here it is necessary to quickly review some monetary economics. When the amount of broad money increases faster than the amount of production, then there will be inflation. When the amount of broad money increases slower than the amount of production, there will be deflation. If all prices adjusted instantly then there would be no problem (money neutrality). But prices do not adjust immediately or uniformly around the economy, which leads to mal-investment and artificial boom/bust cycles (also called “monetary distortions”). This is the short version of the Austrian Business Cycle Theory. So far, so good.

Critics of FR-banking point out that allowing credit will mean that broad money is higher than base money (due to the credit multiplier), and that this must be inflationary. The most simple form of this argument rests on a confusion between “stocks” and “flows”. It is true that if you suddenly introduced FR-banking then broad money would increase by the amount of the credit multiplier… but the simple fact is that we already have FR-banking and we already have a credit multiplier. So long as the credit multiplier doesn’t change, then it will not impact on the amount of broad money (and so it will not impact on inflation).

A more nuanced argument is to point out that the credit multiplier does change, and that a sudden and significant change in the credit multiplier will create a sudden inflationary or deflationary distortion. This is true, but it begs the question “why does the credit multiplier change”? Put another way — “why would people/banks be more willing to give loans”?

On this issue, BHH actually agree with Seglin and White and other libertarians that in a free market people/banks will be more willing to give loans because there are more productive investment opportunities. The logical consequence of this is that the increase in the credit multiplier (and consequently broad money) will be related to an increase in production, and so there would be no significant monetary distortion. Indeed, as Seglin and White explain, the growth of the credit multiplier would be necessary to prevent a potential deflationary monetary distortion. But while BHH effectively admit that FR-banking doesn’t cause inflation, they go on to argue that prices adjust instantly and so there is no such thing as “monetary distortion” anyway. They don’t seem to realise that such a situation of money neutrality makes the whole debate irrelevant and FR-banking perfectly benign.

Opponents of FR-banking could perhaps claim that people/banks will start providing more loans due to “animal spirits” or “irrational exuberance” or some other random force, and this is possible. It is certainly true that when you allow people to provide loans (or undertake any activity), they may make mistakes. If enough mistakes are made, then it could create a monetary distortion. However, this potential cost must be weighed against the above benefits. Further, it is worth remembering that monetary distortions can easily be created even without FR-banking (a sudden change in production, or the base money, or velocity) so banning FR-banking will not prevent monetary distortions.

We don’t just have to rely on theory about FR-banking and inflation; we can look at the evidence. During his speech at the Mises Seminar, Chris Leithner claimed that FR-banking caused inflation. He then proceeded to show a graph of price changes over the 19th and 20th century which showed mild deflation over the 19th century and then continued inflation in the 20th century after the introduction of government central banking. What Leithner failed to notice was that FR-banking existed all throughout the 19th century, and yet it didn’t lead to inflation. In other words, he proved himself wrong.

There is one other reason why people may complain that FR-banking is dangerous, and that is the possibility that FR-banks could go bankrupt. That is certainly true, but it is also true for any other business in the world. When you give money to a bank, or any other business, you need to take responsibility for the risks you take. If you give money to a high-risk bank (presumably for higher interest) then you must accept the possibility that you could lose some of your money.

To each their own

The beautiful thing about a free economy is that if people have different preferences, they can buy different things. Under “free banking” there would be competition between different money suppliers, and competition between different banks, each offering their own products. There is no need for BHH to determine the “one true way to bank”, just as we don’t need to determine the “one true way to bake bread”. In a free economy, we can simply allow people to make their own choices, and the more effective system is likely to win out.

There are of course many problems with the current monetary system, and those problems were a significant cause of the American financial crisis. Key among these problems were government mismanagement of money supply (printing too much money) and moral hazard where the government effectively subsidises bad banking decisions, and so they get more bad banking decisions. Austrian economics has a lot to say about these matters, and the economic discussion would improve significantly if Austrian ideas were better understood. Unfortunately, while we have some Austrian economists arguing that “credit is fraud” and wanting to effectively ban banking, it will be hard for the broader economic community to take us seriously.

While sane people have been ignoring the political circus, election junkies have been closely watching the long campaign as various candidates have come and gone. At the beginning of the year the pundits pontificated as a string of potential candidates — Donald Trump, Sarah Palin, Chris Christie, Rudy Giuliani, Jeb Bush, Paul Ryan, Mitch Daniels, Haley Barbour, and Mike Huckabee — all opted out of the race. Tim Pawlenty said “yes” then “no”. Tease.

And so when debate season rolled around, the field had been narrowed to a rag-tag bunch of about a dozen, with the most prominent being the millionaire Mormon ex-Governor of Massachusetts — Mitt Romney. From the start, Romney has consistently been 1st or 2nd in national polls among GOP voters with about 20-30% support, and he has been seen as the frontrunner due to his decent polling, wealthy friends, establishment support, and high media profile. The race has then been seen as a contest between Romney and “anti-Romney”, a mythical creature who has so far taken four human forms — Michele Bachmann, Rick Perry, Herman Cain and now Newt Gingrich. Cain has since dropped out of the race.

(Sadly, the self-described vampire Jonathon Sharkey has also dropped out… and the “rent-is-too-damn-high” candidate Jimmy McMillan has failed to get into the early primaries.)

Now that we’re getting close to voting, the Australian mainstream media (MSM) is starting to pay attention. If you look at news.com.au or the ABC or the SMH or The Australian or the Herald Sun you will see them talking about Gingrich and Romney. Occasionally the chatterati will mention Bachmann or Perry or even Jon Huntsman. But in Australia, just like in the USA, the MSM is strangely silent about the man coming third.

Who is Ron Paul?

Ironically, Ron Paul is perhaps most famous for being the guy that the MSM loves to ignore. Comedian Jon Stewart brilliantly roasted the mainstream media for their blind spot, and see if you can guess who is missing in this headline: “Poll: Romney leads New Hampshire, Huntsman in third, Perry in fourth“. Back in August the Pew Research Centre showed that Ron Paul was only the 10th highest election news-maker, behind many candidates who at the time trailed him in the polls (Pawlenty, Huntsman, Gingrich) and behind people who weren’t even running (Donald Trump, Sarah Palin).

In Australia, there have only been a handful of MSM mentions of Ron Paul — a dismissive reference in The Australian and being called a “kook” by a Young Liberal. Tom Switzer names eight other options, but neglects Ron Paul. The SMH has done marginally better, noting that Ron Paul does well in the twittersphere “even though he’s received relatively little press coverage”, and writing Australia’s only MSM article about the man and his views on banking. Even then, the SMH felt the need to refer to Paul as a “minor candidate”.

If Ron Paul was polling at near 0% (Gary Johnson) or 2% (Jon Huntsman) or 3% (Rick Santorum) then this would be understandable.

If Ron Paul was polling at around 6% (Michele Bachmann) or 7% (Rick Perry) it would be a bit strange, but forgivable.

But Ron Paul is polling at about 10% nationally, and closer to 20% in the early voting states of Iowa and New Hampshire, he wins many straw polls, and has raised the 3rd most in donations (more than Gingrich). There is now a very real possibility that Ron Paul could win in Iowa, given that the state uses the caucus system that rewards candidates with passionate followers (and Ron Paul supporters are by far the most passionate). While Gingrich (~35%) and Romney (~22%) are leading in the national polls, after Iowa and New Hampshire it is possible that Ron Paul will be leading the pack in terms of delegates, and still have money in the bank. And then it’s anybody’s game.

So who is this strange invisible candidate?

Ron Paul is an easy to like at a personal level due to his obvious sincerity and his unwillingness to change his message to suit his audience. However, his consistent libertarianism means that most people can find an area of strong disagreement. If he was a real politician, he’d learn to sell-out more and use buzz words like “moving forward with real action for working families — yes we can”.

• The most contentious issue for Republicans is Ron Paul’s views on foreign policy and civil liberties. He voted against the Iraq war, he voted against the Patriot Act, he wants to stop the current wars, bring American troops home from their bases in ~150 countries around the world, close Guantanamo Bay, end government torture, and stop the war-mongering against Iran (see his 3 minute “what if” speech here). His opponents accuse him of “isolationism”, to which Paul responds that he believes in friendship and trade with the world, but a non-interventionist foreign policy, with the obvious hat-tip to Thomas Jefferson. And then he hits the Republicans where it hurts — and points out that America simply can’t afford to maintain it’s current empire.

• The reason Ron Paul is most liked by conservatives is the reason why lefties object — his belief in small government. While nearly all Republicans talk about “small government” the facts are that nearly all Republicans (and Liberals & Nationals in Australia) vote to increase the size of government. George “Dubya” Bush increased real government spending, even when you remove the absurd trillions wasted on perpetual war. Ron Paul is the only congressman in America who has voted against every tax increase and unconstitutional spending bill. He represents a district with >1000km of coastline, but is against federal-funded flood insurance. He represents a district with many farms, but is against farm subsidies. In response, his district has elected him 12 times since 1976. While other candidates offer catchy slogans and empty promises of unfunded tax cuts, Ron Paul released an economic plan that is honest enough to clearly outline unpopular spending cuts to get the budget out of deficit. Lefties and crony-capitalists won’t like his plan of cutting federal spending on housing, bureaucracy, energy, militarism, foreign aid (including Israel), education, and commerce… but for those worried about US debt and deficits it is the best (only?) solution available.

• Besides being anti-war, Ron Paul is perhaps best known for his views on monetary policy. This is often shortened to something catchy like “sound money”, or “gold standard”, or “audit the fed” or “end the fed” (where “fed” = Federal Reserve, the US equivalent of the Reserve Bank of Australia), but the important point about Ron Paul’s monetary policy is that he believes that the government has printed too much money which is devaluing the currency and driving up prices. Paul’s concern is that printing too much money (artificially low interest rates and quantitative easing) will result in a “boom” of bad investments that will ultimately lead to a “bust” such as the recession of recent years. Still confused? It’s all explained in this “Hayek v Keynes” rap battle. This is a debate that is entirely lacking in Australia since effectively all economic writers in the Australian MSM are Keynesians, and most have never heard of Austrian economics.

• One consequence from Paul’s belief in small government and sound money is that he was opposed to the government bail-outs of the banks. He has been a vocal critic of the current policy (supported by Dubya, Obama, Romney & Gringrich) where banks keep their profits, but taxpayers subsidise their loses. This is the reason you can see Ron Paul posters both at Tea Party rallies and also at Occupy Wall Street rallies, where people are protesting (in very different ways) against crony-capitalism.

• Like most Republicans, Ron Paul is a committed christian, personally very conservative, and anti-abortion. But this doesn’t prevent his libertarian and constitutional positions on civil liberties. Paul opposes the “war on drugs” as an unconstitutional, failed, massively expensive, and intrusive violation of civil liberties and State rights. He also rejects the idea that the federal government should define marriage. On both issues Paul allows that US States should be allowed to make their own laws, and he insists that the federal government should have no role. This makes him the second most progressive candidate running for President (behind Gary Johnson who openly campaigns on marijuana legalisation and gay marriage, but more progressive that Obama).

People who have never heard of “libertarians” (or “classical liberals”) are sometimes confused by the above list of policies. How can somebody want to cut tax and legalise drugs? How can somebody fight against government money manipulation and also be against war? How can somebody be against hand-outs for the poor and also against hand-outs for the rich? Of course, the consistent thread through all of Ron Paul’s policies is that the government should get out of the way, and leave people to interact with each other however we like, so long as it is voluntary. This is a philosophy with a long and strong tradition going back to the dawn of the enlightenment, but it has little popular or media support in the western world today.

Despite occasional rhetoric to the contrary, the last century has seen the western world steadily move towards more tax and spending, more bureaucracy, more regulation, more nanny-state rules, more police-state controls, and generally a much bigger and more intrusive government. The classical liberal ideas of “free markets, peace and civil liberties” are now so alien to our political discussion that even a supposedly free-market commentator calls them “kooky”, and no Australian politician will stand up for the principles.

This is why the rise of Ron Paul is both important and newsworthy.

Even if Ron Paul does not win the nomination and go on to become the 45th President of the United States, he is changing the discussion, and that may be more important. There are now dozens of libertarians elected around the USA, including Ron’s son Senator Rand Paul. While not mainstream, the libertarian position is now part of the policy debate and people are paying attention. There is a growing, young, and passionate voting block out there who are changing the debate in the USA, and perhaps around the world. It’s about time the MSM started to pay attention.

Submission to the Legal Affairs, Police, Corrective Services and Emergency Services Committee

RE: CIVIL PARTNERSHIP BILL 2011

On behalf of the Australian Libertarian Society (ALS), I would like to suggest that the government does not belong in marriage at all. The debate about how the government should regulate our love lives and our personal relationships rests on the idea that the government should be involved in the first place. That starting assumption is flawed. Love and relationships do not become better or worse because you inform a politician. Few married people conclude that their love is real only because it has been approved by Anna Bligh or Julia Gillard.

A marriage or civil union is an agreement between two people, and the only people who should be able to make that decision are the people involved. So long as the people involved are consenting adults, there is no reason for the government to restrict their right to form a contract with each other. The idea that the government should restrict the basic economic freedom to contract, on the basis that the parties to the contract are the same sex, is a perplexing attack on liberalism and the rule of law.

Ideally, the government should fully deregulate “marriage”. But if the government insists on continuing its weird fixation with documenting our love lives, then at the very least they should conduct their kinky hobby without discrimination. Personal discrimination is necessary and normal in everyday life, but government discrimination should never be tolerated because the government has the privileged position of being able to impose their views on others through force, and without direct consent.

In case this isn’t clear, let me state it simply — marriage should be fully deregulated, but if that is considered “too radical” then the government should at least allow for same-sex civil unions.

Defenders of marriage will rightly say that marriage is traditionally a religious concept. If only it had stayed that way. I suggest that religious groups should be free to discriminate according to their beliefs, just as we all discriminate every day regarding who we date, meet, support, visit, like, etc. However, that discrimination must not be done with the backing of government. Churches should always be free to *not* conduct a same-sex marriage or a same-sex union, but that decision should be left to each church, and not imposed by the government.

Freedom is now considered a quaint concept in most of the western world, including Australia. While political talking heads will argue passionately about how the government should run our lives, most people are genuinely perplexed when they hear the idea that perhaps the government should not run our lives at all. Many people now feel comfortable in their gilded cage, debating about the rules that our “leaders” should impose on us. This letter is in support of civil unions, and to let you know that some of us still believe in human self-ownership and reject the idea of government control of our lives.

You may set restrictive laws if you like. I will consider obeying them. Who is Ron Paul?

Kind Regards,

John Humphreys
Australian Libertarian Society
libertarian.org.au

So my suggested approach to the mining/farming debate has been to strengthen the private property rights of farmers so that they have the “right to say no” regarding access to their land. Miners can then deal directly with farm-owners to come to mutually beneficial deals regarding access. Unfortunately, this approach has been ignored by both sides of politics. Until now.

Yesterday Tony Abbott supported the idea that farmers should be able to control access to their land. The Courier Mail reports him as saying: “If you don’t want something to happen on your land, you ought to have the right to say no.” Good stuff.

Abbott goes on to say that he wants a review of foreign investment rules, which I think is unnecessary. But the main point is that the “market solution” is now on the table.

The government immediately came out against the idea, claiming that it would put mining investment at risk and would lead to less revenue for State governments (mining royalties will bring in $2.8 billion for the Queensland government this year). But this misunderstands how a market works. Giving farmers the right to say “no” doesn’t mean that they will say no. Indeed, the likely outcome is that the vast majority of farmers will say “yes”… but only at the right price.

The main consequence of the market solution won’t be less mining; it will be higher payments from miners to land-holders to ensure that everybody is happy with the outcome. Farmers win because they will get the compensation that they are after, and miners win because they will still be able to go ahead with the vast majority of their projects. This means investment will continue and the government will keep their revenue.

In a few cases, land-owners may say “no” at any realistic price. But that’s not a problem. If a farmer values their land more than a mining company, then it is appropriate (and utility-maximising) to have no mine. And if the government really wanted to ensure a mine went ahead against the wishes of the land-holder, then they always have the option to buy the land.

One criticism of the “market solution” is that it is basically giving something to farmers (stronger property rights) for free. That is true, but it’s not a problem. The virtue of private property rights is not that the government gets to earn money by selling them; the virtue comes because a system of private property works best to allocate resources where they are most valuable. Farmers would support this reform because it is good for them personally, but we should all support this reform because it is good policy to strengthen private property rights.

JAMES: There’s a reason why Garnaut added in extra benefits but not extra costs. Only measurable market costs can be modeled, and the costs of a carbon price are all market costs, but most of the costs of climate change are not. Climate change will also undoubtedly have unexpected costs.

I agree that climate change will have unexpected costs. It will also have unexpected benefits. And the policy response will also have unexpected costs. Indeed, given the track record of public policy and unexpected consequences, that is the most likely outcome. It is appropriate to add in non-market climate impacts, but that should be done explicitly and not with an “other” category. Explicitly adding those impacts helps to avoid implicit double-counting (eg you shouldn’t include a revealed preference for environmental amenity *and* a stated preference for environmental amenity). Finally, there are “dynamic” costs of any tax that are often not counted because they are difficult to measure. After saying all of this — you need to remember that I used your preferred number in my benefit-cost analysis, and it still failed.

JAMES: With a high discount rate you could discount the extinction of humanity in 2060.

I doubt it. People today care about future generations and you need to count that (non-discounted) concern. But even if a discount rate gives you uncomfortable conclusions, that is no reason to not use the correct discount rate. After saying that — you need to remember that I used your preferred discount rate in my benefit-cost analysis, and it still failed.

JAMES: We are tracking the IPCC’s highest emissions scenario, which leads to 5 degrees warming. The uncertainty about climate sensitivity is on the high side, and slow feedbacks amplify warming, so it could be more than 5 degrees by 2100, and will certainly be even more beyond that time.

I know the reason for using a high temperature number, but it is possible to come up with reasons to use lots of different numbers. We still have a lot to learn about climate sensitivity and feedback, and when doing economic analysis I think it best to not get involved in the science debate. The safest approach is to use IPCC numbers, and not second-guess what the next report will say. After saying that — you need to remember that I used your preferred temperature change in my benefit-cost analysis, and it still failed.

JAMES: We can certainly stop most of the costs of 5 degrees warming by limiting warming to 1 or 2 degrees.

Perhaps. Though to limit warming to 1 or 2 degrees, then you are certainly talking about a strong binding international agreement, and so it is fundamental to factor in the probability of such an agreement. Simply assuming the agreement is like the proverbial economist on a desert island with canned food deciding to “assume a can opener”.

JAMES: Of course Australia cannot control the world. But if every country made the argument that it was only part of the world, no country would ever do anything. Imagine if we chose not to fight wars on the basis that we “can’t control the world”.

I would be quite happy for there to be fewer wars. You seem to want to avoid the need to make an estimate about our impact on the world. But it is absolutely necessary, because to do otherwise is to include an implicit assumption of 100% world control. Which is wrong. First, there is a non-zero chance that the world will never reach a strong binding agreement, in which case the benefit of Australia’s carbon tax goes to zero. Second, there is a non-zero chance that the world will reach an agreement without Australia’s carbon tax, which means we could simply introduce the carbon tax after the world agreement. To argue (as Garnaut does) that we need to act *before* the world requires that our early action will increase the probability of a binding international agreement. Garnaut is right to say that we do influence the world… but the question is how much? This is the vital question that carbon tax proponents refuse to answer, because they know that to give an honest answer will undermine their preferred policy. After saying that — even if you assume 100% world control in a benefit-cost analysis, the policy still fails.

JAMES: The bottom line is we have to do everything we can to prevent climate catastrophe, even if we are not certain of success.

I’m not worried about certainty of success. I’m worried that we will introduce a policy that has more costs than benefits. I understand the urge to act, but good public policy is about only acting when those actions create a net benefit. If your actions create a net cost, then you’ve just made the world a worse place.