Credit crunch basics

  • Forget all about Keynes. Anybody who believes that “If you save five shillings you put a man out of work for a day" is economically illiterate. Saving is spending – on capital goods not consumer goods. A switch of consumer preference from drinking beer to drinking wine has employment effects identical to those from a switch from drinking beer to building a brewery.
  • Liquidity and credit and market interest rates are all a matter of supply and demand. There is no credit “seizure"; there is simply a shortage of savings due to artificially low interest rates.
  • Market interest rates represent consumer preferences for saving versus consumption. Artificial rates throw a spanner in the whole structure of production; an artificially low rate signals that consumers are prepared to save for little reward, so entrepreneurs start to build breweries rather than provide more immediate beer. Once this error becomes clear, all projects dependent on artificially low interest rates must be cancelled as unviable. Hence the unavoidable recession.
  • Government can only make matters worse and more prolonged by ignoring this. Furthermore since paper money has no intrinsic worth government cannot create wealth; it can only redistribute it – take and give with a hefty cut for itself.
  • Banks cannot borrow short and lend long without risking defaulting. But if they borrow short and do not lend long, they can pay no interest. Only free market banking, as practised in Scotland for the first half of the 19th century, can resolve this dilemma. (No, Walter Bagehot was not against free market banking; he advocated a Lender of Last Resort because the Bank of England had an absolute monopoly of note issue.)  The bank of England must be abolished or sold.
  • Borrowing and lending does not require the preservation of bankrupt banks. The banking industry is the greatest example of corporatism, in which government and banks form unholy alliances for their mutual gain, with government holding the ring. It is difficult to imagine anything more remote from “laissez faire".

Terry Arthur is the author of Crap: A Guide to Politics. Buy it here.