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Work and prosperity
19 June 2012

The real problem with the banking system

There are three basic responses to the banking crisis.

The first is ‘regulate more!’ – encompassing a range of positions from the restoration of sensible safeguards to wholesale nationalisation.

The second, and opposing, response is ‘don’t over-regulate!’, with positions ranging from appropriate scepticism over the ability of government to regulate effectively to the abject cynicism of a banking lobby that pleads for the purity of free markets while sucking on the teat of state intervention.

The third, and most interesting response, is ‘you’re all missing the point!’ It is espoused by groups like the Cobden Centre who argue that if governments continue to protect bankers from the consequences of their reckless actions, then bankers will continue to act recklessly.

A related argument is made in John Hussman’s superb comment piece on the Hussman Funds website: 

  • "…over the past 15 years, the global financial… has been transformed into a self-serving, grotesque casino that misallocates scarce savings, begs for and encourages speculative bubbles, refuses to restructure bad debt, and demands that the most reckless stewards of capital should be rewarded through bailouts that transfer bad debt from private balance sheets to the public balance sheet.  
  • "What is central here is that the government policy environment has encouraged this result. This environment includes financial sector deregulation that was coupled with a government backstop, repeated monetary distortions, refusal to restructure bad debt, and a preference for policy cowardice that included bailouts and opaque accounting."  

These are vital points that don’t only apply to the issue of the banking system, but to our economic troubles as a whole. As Mr Hussman reminds us, investment capital – the lifeblood of economic growth – is a scarce resource; if it is misallocated then growth will suffer. And yet, around the world, governments of all shapes and sizes are engaged in schemes that enable the misallocation of capital on a gargantuan scale. The Eurozone is an obvious example, but so is the US federal deficit and the grotesque exploitation of Chinese savers by the Chinese Communist Party. In our own country, we’ve seen successive governments connive at the inflation of consumer credit and property bubbles – despite the entirely predictable consequences of doing so.

Unless this stops, then all other so-called ‘growth strategies’ count for nothing. Despite austerity in Europe and stimulus in America, economies across the western world are spluttering. And, no wonder, says John Hussman: 

  • "…we're going into another recession because we never effectively addressed the problems that produced the first one, leaving us unusually vulnerable to aftershocks. Our economic malaise is the result of a whole chain of bad decisions that have distorted the financial markets in ways that make recurring crisis inevitable." 


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