THE
BEAR'S LAIR The Gotterdammerung of central
banking By Martin Hutchinson
standard in 1931, Montagu Norman
did an excellent job at the Bank of England, in an
exceptionally difficult period. In 1931-39 his
policy provided stable prices and facilitated in
Britain an economic performance that relative to
its major competitors was better than any since
Lord Liverpool's time.
In the United
States, Paul Volcker in 1979-87 did a brave and
admirable job in spite of the Fed being an
exceptionally politicized institution by
central-banking standards (his successor Alan
Greenspan when appointed
appeared likely to be as brave and successful, but
wasn't). Bundesbank presidents from Karl Blessing
through Karl Otto Pohl to Helmut Schlesinger made
the Deutschmark the most trusted currency in
Europe during the half-century of its independent
existence.
These three successes were
achieved with very different legal and financial
structures. They shared only one common feature:
exceptional independence from political pressure.
In Norman's case his prestige - he was governor
for 24 years - was huge, and in 1931-39 his
political counterpart Neville Chamberlain was both
capable and sympathetic to his policies.
In Volcker's case, the alternative policy
of sloppy inflationism had been wholly discredited
by failure. In the Bundesbank's case, the
institutional structure worked well; its strength
and independence had been set up carefully by
chancellor Konrad Adenauer, himself no mean
student of monetary discipline.
Independence is not merely statutory; it
must be accepted by the political and banking
system. In Britain, the incoming Labour government
made the Bank of England nominally independent in
1997, but emasculated it in the following year by
removing its banking-supervision powers and
transferring them to the Financial Services
Authority quango.
Why, given its lack of
responsibility for Northern Rock's operations, the
bank should be expected to bail it out is an
interesting question; the system is a horrid mess,
which doesn't represent true independence. A free
marketer might suggest privatizing the Bank of
England and returning it to its pre-1946 corporate
form, but in today's world that would doubtless
result only in its being bought by Dubai, China or
Gazprom, not an improvement.
The US had
two perfectly good central banks in the two Banks
of the United States, but on both occasions
populist pressure led to their being dissolved.
The Fed is a messy compromise, typical of
progressive legislation in that it has been given
several internally contradictory mandates, and is
constrained by an altogether excessive level of
political control.
While the Bundesbank
worked fine, the European Central Bank appears to
work rather less well. In theory, it should be
exceptionally independent, since the various
political factions pulling at it should be
impossible to unite across Europe's strong
national borders. In practice, it appears to be
frightened of stirring up political opposition,
not surprising since politicians have spent the
past decade blaming all economic problems on the
creation of the euro, which it manages.
Its conflicts are likely to become sharper
in the future. The euro in the next few years will
be perpetually overvalued against the rest of the
world's currencies, so deflation in the Eurozone
is almost inevitable. It appears impossible to
create a monetary policy that avoids harsh
deflation in some European countries such as Italy
without causing idiotic housing booms in other
countries such as Spain and Ireland.
Logically, we have now arrived at a
position where no central bank can be trusted
against the twin temptations of the gigantic
financial-services industry and the gigantic
public sector. On the other hand, unraveling a
century of "progress" and returning to a pure gold
standard might be economically damaging as well as
politically impossible.
Setting up a
supervisory committee of top economists is also
unlikely to help much; a feature of the US
monetary expansion and bubble creation since 1995
was the support for Greenspan's folly by the
world's leading monetary economist, the late
Milton Friedman. The only solution is to find
another Paul Volcker or Montagu Norman, but those
don't grow on trees.
Rather than try to
adapt a fiat money system to remove its
deficiencies, it may be simpler to adapt a gold
standard to remove its excessive deflation. The
best way to do this might be that dusty staple of
1890s politics, bimetallism. If gold and silver
were both coined, at a fixed ratio between them,
new discoveries of both would increase the world's
money supply, giving it more flexibility than a
pure gold standard (also, silver supplies could
presumably be increased more rapidly than gold, as
the metal is more plentiful in the Earth's crust).
A world monetary conference could be held once a
decade to make modest adjustments to the coinage
ratio between the two metals or, if necessary, to
debase the coinage slightly.
Such a
mechanism would give just sufficient flexibility
to avoid excessive deflation. More important, it
would provide an automatic check on central-bank
money creation, thereby preventing asset and
stock-market bubbles of more than modest size and
duration. If such a system had been in effect in
the late 1990s, for example, a money flow out of
the US at the time of the Long Term Capital
Management crisis would have brought the bubble to
a halt 18 months earlier than it did, even if such
a flow had not occurred earlier, at the time of
Greenspan's "irrational exuberance" speech. After
2001, a bimetallic standard would have prevented
Greenspan from lowering interest rates so far,
thus preventing the housing bubble, while the
capital inflow in 2001-02, at the time of the
strong dollar, would have avoided deflation.
A new monetary system will be demanded in
the next few years, after the excessive inflation
and moral hazard of the present system have caused
the inevitable major crash. At that point, a
bimetallic quasi-gold standard should be the
alternative to work for against the statist and
inflationary nostrums that will doubtless be
proposed.
Martin Hutchinson is
the author of Great Conservatives
(Academica Press, 2005) - details can be found
at www.greatconservatives.com.
(Republished with permission from PrudentBear.com.
Copyright 2005-07 David W Tice & Associates.)
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