I listened to Comrade Milliband's tedious historical revisionism with interest: apparently New Old Labour are to become the party of enterprise and small business in order that wealth can be created and redistributed. With Comrade Milliband's remarks following so closely after Comrade Cable's denunciation of capitalism, I am reminded of Churchill:
Some people regard private enterprise as a predatory tiger to be shot. Others look on it as a cow they can milk. Not enough people see it as a healthy horse, pulling a sturdy wagon.
Comrades seem to understand that there is something wrong with capitalism, but they seem unable to say what it is. Grotesque, long-since discredited Keynesianism, innuendo and ad hominem attacks fall somewhat short, in my view.
Let me try to explain, for if I find myself referring next week to Comrade Osborne's attack on unhampered social cooperation and his call for additional intervention, I shall wonder if we won the Cold War after all...
Allow me to explain with reference to systemic risk, what we want from a bank and regulation.
The brilliant intellectual edifice of Modern Financial Theory is founded on an incorrect assumption: market events do not obey a Gaussian distribution. Events which ought not to happen in the life of the Universe happen every decade or so. The point was made by Mandelbrot in the sixties, but passed over: see his The (Mis)Behaviour of Markets, Dowd and Hutchinson’s The Alchemists of Loss and Taleb’s The Black Swan for more detail.
The consequence of this error is that much of the debate regarding risk is on the wrong terrain. The failure of complex financial instruments intended to spread risk is a testament to the inadequacy of contemporary thinking. This must be revised but, at the very least, institutions should bear the cost of making this mistake.
The debate we ought to have is how we remove the apparatus of the state, which was predominantly responsible for turning local experiments into system-wide problems. Splitting investment and clearing banks is not the answer and the unintended consequences could well make the banking system even more volatile.
If we turn to the apparatus of the state in relation to banking, these are some of the problems we find:
- Central planning,
- Legal privilege including exclusion from general bankruptcy proceedings and otherwise unconventional application of the law of property and contract,
- Socialisation of the cost of failure, including deposit guarantees,
- Government monopoly of currency,
- A medium of exchange which is predominantly electronic bank credit combined with no effective restraint on the extension of credit by banks,
- A vast and inordinately complex system of regulations, not simple, effective law based on property rights and contract,
- Unsupervised, ad hoc intervention by governments in banking crises.
Crucially, the Bank of England’s Monetary Policy Committee attempts to “manage the economy” - the subjective choices and cooperative actions of millions of people - by controlling the rate of extension of bank credit. As with all central planning, this is bound to run into the Socialist Calculation Problem: even setting aside the inadequacy of so coarse a control, the necessary information to coordinate society centrally is simply not available.
- It is impossible to obtain, store and process the vast amount of practical information in the minds of different people.
- Most of the necessary information is subjective, practical, tacit and non-verbal: it cannot be transmitted.
- Information which people have not yet discovered or created and which arises from the market process cannot be transmitted.
- Coercion — that is, regulation — prevents the discovery or creation of the necessary information.
Consequently, we find credit extended far in excess of real savings and the economy dis-coordinated through time as an inevitable result. Contemporary thinking around credit expansion and QE neglects their effects on the structure of the economy and the outcome is our present situation.
In banking and credit, the situation resembles that of the socialist countries of the former Eastern Bloc: central planning and legal privilege are endemic. It is therefore not surprising that we are living through the same inefficiency and failure which plagued command economies, ultimately causing their collapse.
What do we want from a bank?
We need three things from banks:
- A safe and efficient payments system.
- A mechanism for routing real savings into the hands of entrepreneurs, which is the only way to deliver sustainable economic progress.
- Other investment activity, including those activities necessary to meet consumers’ expectations for retail banking, such as interest rate swaps to provide fixed rate savings and loans.
We do not know the optimal size of a bank: that is something the market must decide. We should therefore reduce barriers to entry and allow all mergers. Consider microfinance: the entry costs to banking are low but the barriers are high. The proper role for politicians is to remove those barriers which hamper social cooperation in the market.
Similarly, regarding opening hours and other aspects of customer service, banks must be allowed to judge their customers' preferences and meet them accordingly in an unhampered market.
Finally, it is worth noting that the banks are simultaneously failing both savers and entrepreneurs. This is egregious.
As my Cobden Centre colleague Gordon Kerr - a financial engineer - has not tired of pointing out (1,2,3), financial regulation is doomed to fail. For example, another of my City colleagues told me gleefully that they had figured out how to sidestep BASEL III over a weekend... All of these measures should be abolished: in the context of the problems sketched above, they are a waste of time and probably counterproductive.
It is good that bankers are intelligent, driven and innovative: they are merely operating a flawed system to their own advantage, which is to be expected. As I wrote in the Wall Street Journal(£), explaining the present crony capitalism, it is the power of the state which has corrupted banking and consequently the entire economy. Persecuting bankers for the crisis is no more sensible than criticising farmers for the CAP.
Returning to Churchill, to restore the horse to health and repair a once sturdy wagon, we must introduce capitalism proper to the financial system. The answer is not more and more complex intervention by authority: it is simple, effective law based on property rights, contract and the principle that risks should be borne by those who may benefit from their rewards, not the taxpayer.
You can find ten plans which go in the right direction here. Comrades may be confused about capitalism, but they shouldn't be.
Riegel, The Right-Wing Socialists:
THERE ARE three classes of socialists: the left-wing, or Marxist, group, who believe that the government should own and control everything; the middle-of-the-road socialists, who believe the government should own and operate public utilities; and the right-wing socialists, who believe that the government should control only the monetary system.
The right-wing socialists are by far the most dangerous, because they are not known as socialists and call themselves capitalists, individualists, private enterprisers, etc. They even believe themselves to be anti-socialist and profess full faith in private enterprise. They are not only numerically the largest group of socialists but are also individually the most influential. Among them are the leading industrialists and mercantilists and bankers and statesmen.
The right wing socialists believe that with production and distribution facilities in the ownership and operation of private interests, and with monetary facilities in the hands of government, we can have free enterprise. They might as well believe that if a man owns an automobile, he need not worry about who or what controls the gas....