Sydney launch at Portico bookshop, 10 June 2011
Thank you Tony Abbott for your kind words. Thanks also to Christine and Bill Cannon for providing this wonderful space and to all of you for coming today.
Capitalism is the greatest wealth creating system ever devised. Wealth enables nations to alleviate poverty, develop science, nurrture new ideas, new industries and new medical treatments and defend themselves, so we need make no apology for supporting capitalism.
Capitalism is largely self-regulating but needs some regulation – including the rule of law and simple, clear and sensible economic policies.
Economic policies in the western nations have failed the test of simplicity and good sense, and the Global Financial Crisis of 2007-08 is clear evidence of that. In the early days of the crisis, production, trade and asset prices fell as quickly as in America in 1930. America’s great asset bust of late 1929 went on for several years and helped to produce the Great Depression of the 1930s.
As I said to a distinguished engineer here tonight, look at the time series of asset prices and ask yourself whether it denotes a system out of control. Asset booms and busts have been coming more frequently and with larger fluctuations.
Rampant consumerism is a thirty year problem of developed nations. The great philosopher of capitalism, Adam Smith, pointed out that it is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.
This seems to endorse naked self-interest, but Smith’s other great book, The Theory of Moral Sentiments, written well before The Wealth of Nations, said men of the ‘middling’ kind were concerned about the ‘good opinion of their neighbours and equals’.
Rachael Bishop, from whose essay cited below I am reading, goes on: This is not the case, Smith argues, with “superior stations of life” (e.g., princes) who aren’t accountable to such restrictions on vice in their pursuit of wealth.
I fear there is far less concern for the good opinion of one’s neighbours and peers now, especially among the titans of Wall Street, the modern version of ‘Princes’. Possibly also there is less concern for reputation among many men, compared with acquisition of money and ‘things’ in general. This lack is a serious threat to capitalism and somehow needs to be reinstated.
Apart from such fundamental matters, there are the more technical matters of economic policy. Unhelpful economic policy actions during the Global Financial Crisis included:
- Near zero interest rates in the USA plus ‘quantitative easing’ (= printing money). This misguided policy is laying the basis for serious global inflation, is reinforcing the great Greenspan-Bernanke asset bubble and will be a primary cause of the next great asset bust.
- Massive, largely wasteful, programs of government spending were introduced in advanced western nations in 2008 in a panicked response to the crisis. Now, just a bit over two years later the world has angst and hand-wringing about the size of government debt in major nations.
- The willingness to bail out all the major financial institutions in trouble but one, Lehman Brothers, was a clear sign of scary inconsistency in the thinking of America’s leaders. This inconsistency created a massive crisis of confidence in global finance which fortunately was overcome before the world was plunged into depression.
The history of capitalism includes many great asset boom and busts. The Dutch Tulip boom, the Mississippi Bubble, the South Sea Bubble, the up and downs in the nineteenth century, and the many asset booms and busts of the twentieth century.
I mention in particular the Mississippi Bubble, engineered by a Scottish economist, one John Law. His great contribution was the idea of paper money. Following a duel in which he murdered his opponent, Law traveled Europe to find a ruler who would let him try out his great idea. Finally he landed in France, struggling under a massive public debt and with metallic currency that had been clipped as a form of theft of the people by the ruler. A smallish currency issue improved the state of trade, and Law and the French Regent made a great mistake. If a smallish issue of paper money helped, a large issue should help far more. Right? No, completely wrong, Mr Law. A great asset bubble was followed after a period of frenetic speculation by a great asset bust. This is a fundamental mistake that has frequently been repeated.
The nineteenth century was the first golden age of capitalism, with great development of new industries, new lands and the massive growth of the industrial revolution spreading from Europe to new lands including America and Australia. Yet financial stability was maintained far better than in the second half of the twentieth century, and in the earlier asset booms and busts, by the skilled use of the gold standard by the Bank of England.
Issue of paper money was limited by the need for banks to maintain adequate reserves of gold bullion, and everyone understood these rules of engagement. Banks failed, especially in the frontier societies of the USA and Australia, but people took their medicine and worked their way back to prosperity. There were many booms and busts, but far smaller in size than in the classic examples from the eighteenth century, in the 1920s in America or in the second half of the twentieth century throughout the capitalist world. (The boom of the 1880s in Australia was followed by a Great Depression, and I devote a whole chapter to this episode and its aftermath.)
In the massive boom of the twenties of the USA, banks and speculators avoided the constraints of the gold standard by sharp practices – commercial banks borrowing from the US Federal Reserve at low rates of interest and lending to speculators at high rates, while speculators purchased shares on margin – a great way to generate paper wealth while share prices rise but extremely risky when share prices began to fall. The Fed was weak and indecisive, not wishing to be blamed for ending the great asset boom. Once prices stopped rising the whole game was over and the process of wealth creation went into reverse, doing great damage to normal economic processes and leading (in ways not fully understood – which is a nagging problem economists rarely acknowledge) to the Great Depression of the 1930s.
War, boom and bust, depression, war again was the fate of capitalism in the first half on the twentieth century. Following World War II, the UK pressed for a return to the gold standard, but America insisted that the dollar (itself linked to gold) would serve as the de facto global currency. For twenty years, this system worked well, but then America over-reached in its ambitions, created inflation of the US dollar, and in 1971 President Nixon cut the link to gold. The result was commodity inflation, consumer goods inflation and a chronic tendency to asset inflation. History shows that every asset inflation is followed by asset deflation. Boom and bust is a generic feature of capitalism and should not be legislated out of existence as a lot of good things get done in the booms. But society needs to impose regulations that limit the froth and bubble of the booms when excessive and wasteful expansiveness sows the seeds of depression.
My chief conclusion is that modern capitalism needs a modern version of the gold standard, a system with steady growth of a basket of commodities which major nations agree to hold sufficient amounts of to support non-inflationary growth of their national money supplies. I accept this is controversial and may be an idea ahead of its time. I have discovered that the People’s Bank of China also supports this idea, and other thinkers are beginning to discuss such a system.
I also recommend other reforms of monetary and fiscal regulation. Fiscal policy should be more reliant on so-called automatic stabilizers. Dynamic but rule-based prudential control of bank lending with required asset ratios that rise in booms and fall in busts. The return of the Glass-Steagall Act (requiring the separation of commercial banking and investment banking and other relatively speculative financial institutions) would minimize the creation of excessive financial froth and bubble. Appropriate controls over remuneration practices (or strong guidance by regulators) would encourage long-term thinking rather than get rich quick practices among financiers.
The general proposition is that, with economic policy generally, the world needs more use of stable, well understood rules, with less reliance on supposedly ‘inspired’ acts of discretionary action.
But I also see the need to get back to basics in matters cultural, somehow reintroducing Adam Smith’s concern for the good opinion of one’s fellows among the titans of capitalism as well as the middling toilers of capitalism as a crucial part of the ethos of modern capitalist nations.
In conclusion, I note that one of the great ironies of the modern world is that China is America’s banker. Equally dramatic is the fact that China is to the right of America in its views about global monetary policy.
I realize that my ideas about reform of economic policy are controversial, especially my call for a modern version of the gold standard.
My fear is that if these or equivalent reforms are not implemented there will be a general return to protectionism, draconian controls over trade, financial flows and freedom generally. This would make our futures, and our children’s futures, far poorer than they need be.
Rachael Bishop, Reconnecting with Smith: Understanding the Virtue and Vice of Capitalism through The Theory of Moral Sentiments, 04/26/10.
‘Because the success of these middling stations requires hard work, professional ability, accountability to the law (because they cannot afford to break it), and the “good opinion of their neighbours and equals,” virtue is simultaneously cultivated on the road to prosperity’.