The new MP for Wycombe, Steve Baker MP, writes his first CentreRight contribution.
Since my arrival in Parliament, the Chamber has been characterised by a torrent of self-righteous indignation from Labour and their thoroughgoing lack of remorse about the state of the public finances. There is a sense that Labour think they are on the side of the angels.
Giving our opponents the benefit of the doubt, I can think of two premises which might support their attitude.
The first is that the government has an inexhaustible horn of plenty which could be forever poured out, if only the Tories had the will. The second is that the crisis was an automatic feature of the global economy which the Labour government could not have avoided.
The Government does not have an inexhaustible horn of plenty. Government has nothing to give without first taking. Government funds itself by taking today, by borrowing against a promise to take a greater sum tomorrow and by debasing the currency. We have reached the limits of all three.
Thanks to something called the Laffer Curve, it now seems likely that increasing taxes will reduce revenues. People, especially people with plenty of choices, adjust their behaviour to pay less tax. This is reasonable and predictable.
We are at the limits of government borrowing. As Liam Halligan wrote in the Telegraph in November 2008, Gordon Brown’s borrowing was “reckless in the extreme”. Furthermore, as John Redwood argued recently in the Commons, "The reason we have not yet got into the Greek situation is that the whole of last year's massive borrowing requirement was simply printed."
Historically, rulers have always debased the currency to pay for their escapades. When they clipped coins of intrinsic value, the immorality of it was obvious. Today, the immorality of debasement is hidden because it is achieved by something which sounds terribly technical (“quantitative easing“) and by the nature of the banking system (private banking with a fractional reserve, controlled by a central bank).
Currency debasement is a stealth tax, one which redistributes wealth towards those who receive the new money first: it is primarily a tax on savers and those with low and fixed incomes. At its extremes, currency debasement ends in a "crack up boom" which finally destroys the currency.
Labour's legacy is therefore a choice between unpleasant cuts in public spending, a sovereign debt crisis or currency debasement. A bailout would only postpone the debt crisis. Quantitative easing would ultimately destroy the currency.
So, there must be unpleasant cuts in public spending, but was all this predictable?
As I explained in my maiden speech, the banking crisis and the wider economic and fiscal consequences are not attributable to the free market but to government interference in the system of money and bank credit. Our present circumstances were horribly predictable for those who understood two concepts missing from contemporary mainstream economics.
The first concept is an understanding of the origin of interest rates. Interest rates arise from people's time preferences for consumption. The subjective value of consumption today is greater than that of consumption in the future. That difference in subjective value has a price. This price is called the rate of interest. Interest rates should work to coordinate the economy through time by matching the time preferences of savers and investors. When interest rates are suppressed by authority, the economy is deliberately dis-coordinated through time.
Now, unlike the situation in respect of any other commodity, price controls in credit do not drive the product off the market. Artificially lowered interest rates increase the demand for credit and decrease the supply of savings, but credit keeps flowing. The legal privilege granted to banks of treating depositors' money as their own means that they can meet demand by extending credit that is not backed by real savings.
It should be obvious that cheap credit encourages consumption. Less obvious is that cheap credit encourages investment in projects for which the savings necessary to make the project pay later do not exist. This is the second missing concept: an understanding of the structure of capital.
Real productive resources are not fungible. It does not make sense to lump together mining equipment, foundries, manufacturing plants and assembly lines before giving them a single aggregate value, as if mining equipment could be used to assemble cars. The point is that entrepreneurs invest credit in something specific. If they are systematically misled by artificially low interest rates, they are bound to waste productive resources.
All this is arguably the cause of the boom-bust cycle, excessive consumption and misdirected business investment.
Labour’s premises are wrong. There is no inexhaustible horn of plenty from which a benevolent government can dispense unlimited gifts. This crisis is not an automatic result of the operation of the free market, but a result of government intervention in a system of bank credit built on bad law.
The past boom was an illusion sustained by cheap money. Labour taxed this illusion and enjoyed a profligacy sustained by economic poison. Structures of activity were created which were only sustained by credit expansion yet credit expansion must come to an end if the currency is not to be destroyed.
It is no good the opposition wailing and pointing as they oppose cuts to unaffordable Government spending: they are not on the side of the angels. If we are serious about human well-being, prosperity and social progress for everyone, then we need to face the world as it really is and find a way through. This is the task facing George Osborne and the Coalition.
The following may be downloaded free or bought from the usual range of online stores:
* Huerta de Soto, "Money, Bank Credit and Economic Cycles"
* Mises, "The Causes of the Economic Crisis"
* Butler, "Ludwig von Mises - A Primer"
* Hayek, "Prices and Production"