Austrian Business Cycle Theory

I’ve long promised a post on Austrian Business Cycle Theory, and here it is. For those who would rather get straight to the conclusion, it’s one I share in broad terms with most of the mainstream economists who’ve looked at the theory, from Tyler Cowen , Bryan Caplan

and Gordon Tullock at the libertarian/Chicago end of the spectrum to Keynesians like Paul Krugman and Brad DeLong.

To sum up, although the Austrian School was at the forefront of business cycle theory in the 1920s, it hasn’t developed in any positive way since then. The central idea of the credit cycle is an important one, particularly as it applies to the business cycle in the presence of a largely unregulated financial system. But the Austrians balked at the interventionist implications of their own position, and failed to engage seriously with Keynesian ideas.

The result (like orthodox Marxism) is a research program that was active and progressive a century or so ago but has now become an ossified dogma. Like all such dogmatic orthodoxies, it provides believers with the illusion of a complete explanation but cease to respond in a progressive way to empirical violations of its predictions or to theoretical objections. To the extent that anything positive remains, it is likely to be developed by non-Austrians such as the post-Keynesian followers of Hyman Minsky.

Update There’s a fascinating discussion linking to this post here. In French, but clear and simply written. Anyone with high school French and a familiarity with the issues should be able to follow the main points.

First, some history and data. Austrian Business Cycle Theory was developed in the first quarter of the 20th century, mostly by Mises and Hayek, with some later contributions by Schumpeter. The data Mises and Hayek had to work on was that of that of the business cycle that emerged with industrial capitalism at the beginning of the 19th century and continued with varying amplitude throughout that century. In particular, it’s important to note that the business cycle they tried to explain predated both central banking in the modern sense of the term and the 20th century growth of the state. The case of the US is of particular interest since the business cycle coincided with a wide range of monetary and banking systems: from national bank to free banking, and including a gold standard, bimetallism and non-convertible paper money.

This NBER data goes back to 1857, but there was nothing new about the business cycle then (Marx, for example, had been writing about it for a decade or more). The US experienced serious “panics”, as they were then called in 1796-97, 1819 and 1837 [1] as well as milder fluctuations associated with the British crises of the 1820s and 1840s.

The typical crisis of the 19th century, like the current crisis, began with bank failures caused by the sudden burst of a speculative boom and then spread to the real economy, with the contraction phase typically lasting from one to five years. By contrast, recessions since 1945 have generally lasted less than a year, and have mostly been produced by real shocks or by contractionary monetary and fiscal policy.

According to the theory, the business cycle unfolds in the following way. The money supply expands either because of an inflow of gold, printing of fiat money or financial innovations that increase the ratio of the effective money supply to the monetary base. The result is lower interest rates. Low interest rates tend to stimulate borrowing from the banking system. This in turn leads to an unsustainable boom during which the artificially stimulated borrowing seeks out diminishing investment opportunities. This boom results in widespread malinvestments, causing capital resources to be misallocated into areas that would not attract investment if price signals were not distorted. A correction or credit crunch occurs when credit creation cannot be sustained. Markets finally clear, causing resources to be reallocated back towards more efficient uses.

At the time it was put forward, the Mises-Hayek business cycle theory was actually a pretty big theoretical advance. The main competitors were the orthodox defenders of Says Law, who denied that a business cycle was possible (unemployment being attributed to unions or government-imposed minumum wages), and the Marxists who offered a model of catastrophic crisis driven by the declining rate of profit.

Both Marxism and classical economics were characterized by the assumption that money is neutral, a ‘veil’ over real transactions. On the classical theory, if the quantity of money suddenly doubled, with no change in the real productive capacity of the economy, prices and wages would rise rapidly. Once the price level had doubled the previous equilibrium would be restored. Says Law (every offer to supply a good service implies a demand to buy some other good or service) which is obviously true in a barter economy, was assumed to hold also for a money economy, and therefore to ensure that equilibrium involved full employment

The Austrians were the first to offer a good reason for the non-neutrality of money. Expansion of the money supply will lower (short-term) interest rates and therefore make investments more attractive.

There’s an obvious implication about the (sub)optimality of market outcomes here, though more obvious to a generation of economists for whom arguments about rational expectations are second nature than it was 100 years ago. If investors correctly anticipate that a decline in interest rates will be temporary, they won’t evaluate long-term investments on the basis of current rates. So, the Austrian story requires either a failure of rational expectations, or a capital market failure that means that individuals rationally choose to make ‘bad’ investments on the assumption that someone else will bear the cost. And if either of these conditions apply, there’s no reason to think that market outcomes will be optimal in general.

A closely related point is that, unless Say’s Law is violated, the Austrian model implies that consumption should be negatively correlated with investment over the business cycle, whereas in fact the opposite is true. To the extent that booms are driven by mistaken beliefs that investments have become more profitable, they are typically characterized by high, not low, consumption.

Finally, the Austrian theory didn’t say much about labour markets, but for most people, unemployment is what makes the business cycle such a problem. It was left to Keynes to produce a theory of how the non-neutrality of money could produce sustained unemployment.

The credit cycle idea can easily be combined with a Keynesian account of under-employment equilibrium, and even more easily with the Keynesian idea of ‘animal spirits’. This was done most prominently by Minsky, and the animsal spirits idea has recently revived by Akerlof and Shiller. I suspect that the macroeconomic model that emerges from the current crisis will have a recognisably Austrian flavour..

Unfortunately, having put taken the first steps in the direction of a serious theory of the business cycle, Hayek and Mises spent the rest of their lives running hard in the opposite direction. As Laidler observes, they took a nihilistic ‘liquidationist’ view in the Great Depression, a position that is not entailed by the theory, but reflects an a priori commitment to laissez-faire. The result was that Hayek lost support even from initial sympathisers like Dennis Robertson. And this mistake has hardened into dogma in the hands of their successors.

The modern Austrian school has tried to argue that the business cycle they describe is caused in some way by government policy, though the choice of policy varies from Austrian to Austrian – some blame paper money and want a gold standard, others blame central banks, some want a strict prohibition on fractional reserve banking while others favour a laissez-faire policy of free banking, where anyone who wants can print money and others still (Hayek for example) a system of competing currencies.

Rothbard (who seems to be the most popular exponent these days) blames central banking for the existence of the business cycle, which is somewhat problematic, since the business cycle predates central banking. In fact, central banking in its modern form was introduced in an attempt to stabilise the business cycle. The US Federal Reserve was only established in 1913, after Mises had published his analysis.

Rothbard gets around this by defining central banking to cover almost any kind of bank that has some sort of government endorsement, such as the (private) Bank of England in the 19th century, and arguing for a system of free banking that would avoid, he asserts, these problems. But, on any plausible definition of the term, the US had free banking from the Jackson Administration to the Civil War and that didn’t stop the business cycle (Rothbard offers some historical revisionism to argue that the Panic of 1837 didn’t really happen, but that wasn’t what US voters thought when they threw the Jacksonians out in 1840). And free banking in late 19th century Australia (our first quasi-central bank was the Commonwealth Bank established in 1915) didn’t prevent a huge boom and subsequent long depression around 1890. Overall, the US was much closer to free banking throughout the 19th century than in the period from 1945 until the development of the largely unregulated ‘shadow banking’ system in the 1990s, but the business cycle was worse then (how much worse is a matter of some controversy, but no serious economist claims it was better).

To sum up, the version of the Austrian Business Cycle Theory originally developed by Hayek and Mises gives strong reasons to think that an unregulated financial system will be prone to booms and busts and that this will be true for a wide range of monetary systems, particularly including gold standard systems. But that is only part of what is needed for a complete account of the business cycle, and the theory can only be made coherent with a broadly Keynesian model of equilibrium unemployment. Trying to tie Austrian Business Cycle Theory to Austrian prejudices against government intervention has been a recipe for intellectual and policy disaster and theoretical stagnation.

373 thoughts on “Austrian Business Cycle Theory

  1. As I said over at catallaxy:
    I just wish that Murphy would think about lines like this

    when banks are allowed to issue paper money (or increase customers’ electronic bank deposits) without an actual act of saving by somebody in the economy

    before going to print. Banks cannot do this and all that arguing that they can do this does is make him look like he does not know what he is talking about.
    Besides, as previous arguments at catallaxy have demonstrated (to my satisfaction at least) attempts to ban FRB can only succeed in the absence of freedom on the part of banks.
    Banning fractional reserve cannot be consistent with a libertarian framework.

  2. It may not be consistent with libertarianism but whats wrong with a re think on lowering that fraction?

    Banks are clearly at the epicentre of risky excessive lending of the past few years..that has now collapsed. Clearly, lending prudence isnt necessarily going to be there “naturally” in a libertarian world – its a real freedom to be able to gamble with savers money if you get the chance and there is less risk to the individual to gamble other people’s money and unfortunately a pool of other people’s money gets stored in banks – so temptation is there.

    Adjusting the fraction would seem an obvious remedy. Restrict what can be lent. I agree with ABOM on that but he may want even more restrictions that I would suggest to start with.

  3. Yes Alice, I suppose heavy regulation of the financial services sector, breaking up the collusive duopoly in Australia (there’s only Cth Bank and Westpac left, as the ACCC has recently acknowledged), increasing required reserves of the commercial banks to 20% (minimum) and forcing the government/RBA to make an announcement that no non-depository institution will ever be bailed out by the central bank or by government. Investors must guard themselves against loses.

    This would (sadly) require capital controls and a ban on foreign ownership of banks, because any economy that restricts its financial services sector faces (1) capital flight and (2) a deflationary environment that is ripe for predatory takeovers by foreign bank agents such as hedge funds and “private equity” (which is Orwellian-speak for bank agents stuffed with bank debt – there’s no “equity” ever to be seen!).

    To the idealistic Austrians who will scream “Blasphemy!” and who are waiting for the Second Coming of Free Markets and Gold Money:

    Would you allow your daughter to raped in front of your own eyes because you were an advocate of non-violence?

    Then how can you tolerate what the banks have done to our economy?

  4. “I support”. I’m still drinking as I watch the US bond market slowly collapse. God help us all if it really starts to crumble. The collapse would be shocking and sudden and destroy every Western economy, precipitating a new Dark Age.

  5. Terje,
    The relationship is causational, not ironic. The way the old Basel I standards were implemented in the US combined with the blunt instrument of the FDIC leverage ratio made the system less stable (IMHO) than it would have been if economic capital had been the guiding principle.
    To me, the reason why the Australian banks have weathered this period a lot better is fairly simple – we have a better regulatory system. Not ideal – but better. Our single regulator is not applying blunt instrument (at least, not much). It is mostly principles based and not using black letter regulation – if you look at the regulatory framework on the APRA website it is comparatively short.
    The US has multiple conflicting regulators enforcing multiple conflicting regulations with few of them risk based. The incentives in there to “game” the system are huge.
    For example – home loans. Under the US version of the Basel I accords, most home loans attract a 50% risk weighting. Transform the same home loans into a AAA instrument and the risk weighting on the loans so transformed drops to about 1%. The difference in capital cost is huge.
    Once you have these structures set up the loan issuer is being paid up front to sell loans into the markets, regardless of the risk.
    Whose fault is it really? The banks, for trying to cut costs so they can sell more home loans? The people who take out loans they know they cannot afford? The writers of the mortgages who take advantage of a flawed system? The regulators who set the rules up and then ignored the warnings?
    There is blame everywhere, but surely part of the solution is to try to get rid of the stupid incentives built into the regulatory system. This will not be achieved by adding more blunt instruments and meaningless ratios, as ABOM seems to want to do.
    As for the rest of his comment – it is much more offensive than any of the stupid “pwed” comments above it.

  6. John Quiggin,

    You quote Bryan Caplan favorably yet he says the following:

    “The objection is simple: Given that interest rates are artificially and unsustainably low, why would any businessman make his profitability calculations based on the assumption that the low interest rates will prevail indefinitely? No, what would happen is that entrepreneurs would realize that interest rates are only temporarily low, and take this into account.”

    I’m wondering from this statement if Caplan even understands price controls at this point. After all the interest rate is a price. Would he make the same objection to other price controls such as price floors and ceilings?

    Austrians understand that prices serve a purpose in the economy. Apparently all you Keynesian types don’t get it.

    It’s a well know fact that both producers and consumers respond to price controls. Does Caplan expect consumers to refrain from consumption under a regiment of below market prices because they know that they will eventually have to pay some other way such as higher taxes or reduced future consumption?

    Does Caplan expect the producers receiving higher prices due to the government interventions to all of the sudden set aside their balance books and let the competition reap high prices while they wait for the government to remove the price floors, and the inevitable bust?

    Why is he making such an inane argument? Is it to waste our time?

    Producers have no magic ball into which they can peer. They are in the exact same position as central planners when the price structure has been disrupted exogenously by the government. It’s ridiculous to believe that producers know the true market price in such a situation. How are producers suppose to operate on the basis of an incentive that doesn’t exist?

    This is not some sort of prisoners dilemma as Caplan claims. It’s price controls and that’s economics 101 if well taught. What on earth does Caplan think prices are for, our amusement? Market participants certainly don’t coordinate their plans based on psychic powers and telepathy. The only thing they can use to communicate is prices.

    Interest rates are the time cost of money and when a price ceiling is set it causes the market participants to miscoordinate their plans. Savers are the producers in this case and the price ceiling causes them to save less. Borrowers are the consumers and the below market prices cause them to over consume.

    Saving and borrowing is about capital goods (not money which is only claims against such goods) so there is a large stock of goods over which such miscoordination can be buffered and hidden. Interest rates are a price that allows coordination of plans over time. Therefore it takes time to reveal the miscoordination of the plans.

    Why should businessmen be able to figure this out? Most economists apparently can’t do so. Even when it is explained to them in simple language.

  7. From John:
    “Have you ever wondered why Austrian economics is largely seen as the domain of cranks? Comments like (most of) the last dozen or so above provide a pretty good illustration of the reasons.”

    This is nonsense. Our reaction is in direct reponse to your slights. Yes, John, your article was rife with subtle quips against the “unpopularity” of Austrianism. But you knew this, that’s why you wrote it in the first place. There wasn’t an ounce of genuine interest in refutation, merely getting on the popular bandwagon of trying to knock Austrianism off it’s high horse because they actually understand this “economy” business.

    Regardless, your expiry date is up. Soon you’ll realize the emptiness of your redundancy.

  8. Enlightening article.

    Modern ABCT is little more than Social Credit for reactionary libertarians, pseudoscience used to rationalize a conspiracy theory of history (like Murray Rothbard’s) where the bankers are to blame for everything that’s wrong with the world.

    No prizes for guessing what the types at think of Israel, or even “cosmotarians” like myself. I’m no fan of big government, central banks, or the state of Israel, but I know code when I read it. And I’m not even Jewish.

  9. To An Ottawa Reader, #311

    I think you’re being unfair and demeaning. Are some libertarians using the old Austrian theories of the 20th century as reactionary talking points? Sure, but I think people like Robert Murphy, Roger Garrison, and Don Boudreaux – among many others influenced by the “Austrian” theories – are more than reasonable men with good heads on their shoulders.

    Just because you think the “Austrian” business cycle is wrong is no excuse to be so rude.

    Now, I myself see some problems with the “Austrians,” but I think it’s just intellectually dishonest to say there are not some interesting or plausible components to think of.

    Robert Murphy’s response adequately expresses my feelings about the argument, in fact.

    “I am not here to tell you the Mises-Hayek theory of the business cycle is a work of art that has no flaws. If I said that, then I would be living up to Quiggin’s caricature. What I will say is that the Austrian explanation of the boom-bust cycle makes more sense than any other explanation I’ve seen.”

  10. Nationalism is the last refuge of the scoundrel.

    Name-calling and denigrating rational thought and argument by effectively labelling the whole discussion racist is the last refuge of the desperate embezzler who knows his time is up. Like a cornered rat.

    If you think this collapse “just happened” and no one is to blame, then you belong at the Bank of England, working on econometric models.

  11. ABOM,
    I do not believe that a discussion of peadophiliac rape is appropriate in a discussion about ABCT. Perhaps I am just old fashioned.
    An Ottawa Reader,
    Like most other areas of thought there are several threads to libertarian theory. The Rothbard School, while being the most vocal, is not (IMHO) the more correct. I have pointed out many times (as you do above) the parallels between social credit and Rothbard. In this you are correct. You are not, howeve, correct in believing the the Rothbard lot are all there is the ABCT.
    While I do not entirely agree with ABCT, I find it more convincing than many explanations of why the business cycle happens.

  12. Yes, you’re old fashioned. Or at least not very well read.

    In hyperinflationary Weimar Republic the situation got so bad that mothers were willingly selling their daughters into prostitution in the back streets of Berlin and teenage sisters and mother-daughter combinations were lined up selling themselves for foreign currency (see this excellent, timely and detailed exposition of the social effects of monetary debasement: Widdig, Bernd (2001). Culture and Inflation in Weimar Germany. University of California Press. ISBN 0520222903).

    If you don’t think monetary debasement amounts to selling your children you don’t know your history.

    Or the future, the way we’re going.

  13. “Sukrit, you might want to reread the comments you’re defending, and note the string of juvenile personal attacks and snarks

    What a marooooooooon.”


    are you going to make the quite serious mistake of supporting Krugman in his misunderstanding of labor dollars. In fact this is not an example of a personal attack. Krugman really does not understand money. Just go look up his article on babysitting script. He does confuse labor dollars with money in that article, among other errors.

    I laugh that the commenter with the handle “reason” thinks Krugman’s babysitting example carries any weight.

    My calling Krugman a maroooon for making this mistake is no more juvenile than your own behavior in this article and through out this tread. You wrote the article based on a very shallow understanding (actually a misunderstanding) of Austrian theory. Your article and comments are full of ad hominem attacks.

    Likewise Krugman if you’ve ever read his juvenile articles in the NYT. As a specific example his calling Greg Mankiw evil for claiming that Obama’s economic forecasts are overly optimistic.

    It ought to be obvious to you that allies like this aren’t doing you any good. It’s not the juvenile stuff that’s most important either. It’s the miscomprehension of economics.

  14. #311 An Ottawa Reader

    One problem with incredibly stupid conspiracy theory is that most of the famous Austrian economists are jews. Mises, Hayek, Rothbard, Kirzner, … are all jews.

    Perhaps you are the antisemite?

  15. ABOM,
    The “deflationary contraction” you identified above, the massively intrusive regulation, the increased size of government and huge market distortions required to make 100% reserve work would (IMHO) cause much more economic disruption possibly even than a currency debasement – even one on the scale of Weimar or Zimbabwe.
    I covered my arguments on this a year ago over at ozrisk.

  16. I agree.

    I don’t deny or shy away from the (massive and disruptive) negative consequences you’ve outlined. Hence my slight drinking problem (which is worse? which is worse? which is worse? Argh!)

    Either choice (re-regulation/contraction of the money supply or deficit spending/currency debasement/bailouts) now results in extremely negative consequences.

    I trust you would agree with the following proposition: THERE REALLY IS NO SOLUTION.

    I recommend Macallan Scotch 18 year old. The complex flavour is really intoxicating.

  17. Personally – Laphroig 10 Year Old. A nice dose of Islay peat for me, please.
    I try to avoid regulations wherever possible. A free banking model (to me at least) nicely balances the risks and rewards while avoiding the extreme regulations needed to get 100% reserve system working.
    A large of banks, able to offer deposit insurance through private insurers as well as choosing their own supervisors (or having none at all) and then allowing depositors and investors to determine the outcome. Just about perfect and no need for Rothbardian regulation.

  18. Nah…sorry…I hate those peaty single malts. They taste too much like medicine to me. Or dirt.

    I agree the free banking model would work extremely well once we got there (see Murray Rothbard, Mystery of Banking). How do we get from here to there? Virtually every option proposed (re-regulation of commercial banking, free banking, fullRB) is better than the current ridiculous suicidal system.

    Then why the H*ll do we have the current stupid dysfunctional system and how the H*ll do we get from here to there????

  19. ABOM,
    To me the way we got here is fairly simple. Where there is a problem the government thinks that more regulation is the solution. When all you have is a hammer…
    As for how to get there that would have to be the subject of a little more than a short blog comment.

  20. A non regulated banking system can perfectly deal with the fractional reserve banking problem. The fundamental reality isthat absent government involvement, they do not have the necessary reserves to cover deposits. The market would eventually weed them out. Let’s not also forget reserve requirements would also effect value of bank specific notes.

    But really, the answer to the libertarian problem is, and always will be, the ability to resist coercion. In otherwords, weapons.

  21. TStew,
    If you look at the history of free banking you will see that 100% reserve requirements have not been the general outcome. Reserves normally ended up in the 12 to 15% range.
    That said – provided there is no requirement for 100% reserves then I have no problem. Let the consumers decide.
    On the other matter – like peadophiliac rape I see this as a non-issue to questions on business cycles.

  22. You obviously don’t think the Weimar Republic-levels of deficit spending in the UK, the US and Australia will result in a breakdown in social order.

    I admire your optimism. Or banal stupidity.

  23. I mean deficit spending, not widespread monetary-induced peadophilic rape (obviously).

  24. And I mean to cause no offence by the clarification – there was a genuine ambiguity which needed to be corrected.

  25. They may be an example of why you may not want a government monopoly of fiat issue. Trying to say they are a good reason to believe in ABCT or Rothbard is another matter entirely.

  26. 319 and 320

    While you two discuss which fine wine or scotch has relatively more attractions…can I possibly ask Andrew Reynolds – how it is possible to a have a free unregulated banking model when the banks are (or were) getting fatter every day on our highly regulated income streams (superannuation?) Isnt that a conmtradiction in terms ???…and yes I am inclined to think the banks raped us and our children!

  27. Well said Alice.

    You’re sensible (and sober) so I know you make sense (unlike most of what I write!).

    Super is just a net income transfer to the parasitic “financial services” industry. Labor was duped into privitizing the Cth Bank and pushing 10% super contributions.

    I saw this in NZ in the early 90’s. The bankers screwed over NZ first as a test case, then screwed the world. They seduced the politicians with high-minded rhetoric about the efficiency of free-markets over conferences and lunches, pushed a few corrupt “Nobel” (there is no real Nobel in economics) winners to awe them with equations, and then raped the country and left them broken.

    They are the barbarians, not gold standard advocates.

    They are the barbarians.

  28. Andrew Reynolds,

    If FRB is fraud then it should be outlawed by whatever legal structure is in place. It doesn’t matter how hard it is to do. One could argue that making most other crimes illegal requires “massive government intrusion”. If that is the case then so much for anarchist fantasies.

  29. Alice,
    There is a reason why regulated businesses make a lot of money. Regulating something typically involves making it both difficult and expensive to get into the industry. For decades the big four have had no effective competition because foreign entry was banned and governmetn policy stopped anyone else getting big enough. Result – 4 large profitable banks. Again – what is at fault here? The banks or the regulations that allowed them to do this?
    If your problem is with super contributions? Guess what – they are regulatory in nature. Strange how often we come back to that issue – but you seem to want more regulations to fix the problems with the old ones. Once those ones are in then yet more to fix the problems that the new ones come up with. And then more for the next lot and so on ad nauseum.
    Spoken like a true fundamentalist. And FRB is fraud because … umm … all parties to all financial contracts know what their rights and obligations are – no, that can’t be it. What was it again?

  30. 336# Actually Andrew….you have me correct on one thing..regulating banks but the way I would want to see them regulated is far harsher than what you may think..

    a) Dont feed them regulated income streams (super).

    b) cut them up

    c) restrict the amount they can lend without reserves behind them to do it.

    d) dont let them touch the sharemarkets.

    I like the idea of small banks….that help to grease the wheels of real production and serve a functional useful purpose, not large gilded monoliths that grease their own wheels and those of their masters..

    ABOM who I hope by now is enjoying a lovely cuppacino, has made the comment before…..

    “how do we get from here ……to there?”

    We shouldnt preclude regulation to get back to a state where we dont need it.. (scissors, paper, rock?) – Im all for scissors.

  31. #337 Alice,

    One reason we try to regulate the banks is that we know the money system is open to abuse. It all comes back to the Lombard system of increasing the money supply by lending more than you have to lend. We have to increase the money supply but increasing it by allowing people to lend money they do not have has proven year after year to have serious issues.

    A solution is to deregulate the banks and only let them lend money if they have it on deposit.

    To do this we have to think of other ways of increasing the money supply but that is simpler than trying to fix an unfixable system by constraining it even more with even more regulation.

    This should also make Andrew Reynolds happy as there will be less regulation.

  32. I had noticed that it seemed to me the keynesian business cycle theory (markets aren’t rational, filled with overinvestment) is very similar to the austrian (markets overinvest because of inflationary booms), with the only real difference being that austrians blame more credit, and keynesian believe it’s just a flaw of capitalism.

  33. Kevin,
    Banks cannot lend out funds they do not have. It is a simple fact, but one that even Rothbard managed to get wrong.
    If you think they can, show me how – and I will show you where you are wrong.
    To start the discussion, look here.

  34. Alice,
    If you want smaller banks then you should be calling for more competition. The record of regulation is simple – fewer, bigger, banks. Less regulation produces more, smaller banks.
    Statistically, it really is that simple.

  35. 341# Andrew – I thought I was (calling for more competition in banks). Thats why I suggested getting out the scissors and starting again……..and add dumping the “too big to fail” ethos.

    I feel less regulation has resulted in the growth of these monoliths that are gambling with other peoples savings rather than prudently managing it.
    Wasnt it Adam Smith who suggested that the natural state of capitalism is the growth of monopolies over time? Didnt Menzies feel that the people should be protected from Monopolies?

    I dont think you can count “competition regulation”…which clearly hasnt had enough teeth or willingness to acknowledge unproductive concentrations if market power, in recent decades… as the sort of regulation (burden on husiness etc) that you refer to. I agree with less burden on business type regulation but I dont agree that when the banks grow disproportionately…that their outcomes should just be left to the market.(if it were truly so…none would be too big to fail or need propping up).

    There is a choice here and it seems we have applied the ugly bybrid offspring of two competing ideological remedies (more regulation or less?) and we are no better because of it.

    The financial crisis has bankrupted, or will in years to come, lots of the small businesses that make for the libertarian paradise of lots of competition and large global financial institutions were at the core of it. Many thought their savings were being invested in Park Lane or Mayfair only to find they were really being invested in a gross oversupply on Old Kent Rd.

  36. Alice,
    Adam Smith is often selectively quoted that way. If you read the very next sentence, though, you will see his true feelings on this and they accord with mine – that regulation only serves to help the process of cartelisation by bringing together all of the people in one industry into a single forum. He also (correctly) points out that this sort of regulation increases costs to enter the industry – leading to (drum roll) monopolies.
    As for ditching the “too big to fail” ethos I would agree – a point I made a while back.
    As for the “Old Kent Road” analogy – the point I am making (and you seem to be trying to ignore) is that regulation only serves to allow (and at least partially to cause) this sort of thing. The whole reason why Old Kent Road was packaged in the first place was because of the regulations.

  37. Andrew…I guess we are not seeing it the same way. What do we do about those large financial firms that were at the epicentre of the crisis…that got bailed out?

    We should have let them fail. The Bank of Scotland is a case in point. Its assets are being auctioned off in an orderly process to the highest bidders (but these are not necessarily the small “libertarian” style banks who are buying Andrew??).

    My question and ABOMs question remains unanswered. Despite what you think caused the concentration in financial banks (too much regulation)….how do we precisely, get from the here and now ie large uncompetitive financial institutions (undesirable) to there…small competitive banks (more desirable?) without anti monopoly regulation???.

    A one eyed approach to “non regulation” appears somewhat fallible here.

  38. I’ve come to the considered view that Andie “deregulate even more and see if that works!” Reynolds is myopically narrow-minded, and pro-FRB anti-Austrian. To say that the recent history of post-Glass Steagall Act USA (Citigroup anyone?), the post-1990 Paul “I was duped by Treasury but can’t admit it” Keating Oz (where are the building societies again? Bank of Melb, Bank of SA, State Bank of Vic, etc etc?), and the 1990s UK experience (merger after merger) shows unambiguously that:


    To think that “de-regulation” of banking (without REAL deregulation of monopoly money, having gold and silver circulate in competition with “toilet paper”) would not NECESSARILY result in concentrated power is mind-blowingly ahistorical and factually wrong.

  39. Well I agree with ABOM. There is a clear distinction between reasonable regulation to protect competition in markets (to keep eg banks in the small business friendly libertarian style)…versus useless and inhibiting “t crossing and i dotting” regulation which burdens business and impinges on their growth and development…and particularly small business sustainability…and its a distinction I think some are not drawing here.

  40. Alice,
    Let the ones that have got it wrong fail. If you had followed the link I gave you would have seen my position on this.
    Can you give a good example of a situation where banking monopolies or cartelisation actually increased as under reasonable free market conditions? Any example would do. I am not aware of any. AFAIK every single example of large market power emerged under regulated conditions.
    If my position is “ahistorical” you should be able to find more than one position easily.
    The removal of Glass-Stegall is not a good example as the remaining regulation (there remained volumes of it) was swiftly augmented by piles more.

  41. Andrew,

    You’re annoying so much I’m reaching for my Macallan again.

    First, you hypothesize a “free market” that hasn’t existed since 1913 (certainly not since 1971). Monopoly paper has been strictly (and I mean strictly) enforced since 1971 worldwide.

    Second, there is a difference between REDUCED REGULATION and NO REGULATION.

    I’m Austrian. In principle (in theory) I support free banking and the Hayek/Mises thesis on a free market in money 100%.

    However, when Alice and others are begging for PRACTICAL REAL WORLD solutions to current problems, I do NOT support “decreased” regulation as a way of getting from here to there. I support INCREASED regulation.

    In the absence of a free market in money PRODUCTION (allowing gold and silver to compete with toilet paper), regulation of FRB is crucial for financial stability.

    The recent disastrous experience with “partial” or “incremental” deregulation has been a complete and utter failure.

    This nuanced approach has been implemented by the modern-day Jefferson, Ron Paul.

    Ron Paul is the paradigm free-marketeer, but when it came to removing Glass-Steagall, he voted against it, saying effectively “I’m for deregulation, just not THIS deregulation.” He realized in the absence of sound money “deregulation” of banking simply meant giving more counterfeiting power to the Fed.

    See Conza88’s considered response to my rants in the comments section of the “sister” article to this JQ entry at here:

    Andie can’t see the damage of partial deregulation. So he gets raped by the bankers every single time (just like Keating).


    P.S. If the removal of Glass-Steagall wasn’t partial deregulation because it was augmented by piles (please list the SPECIFIC legislation passed AFTER the removal of GS that you’re referring to?) more, then communism in the USSR didn’t work because they just didn’t try hard enough. Marxism can work, it just hasn’t been given a full go.

  42. Alice,
    If I may observe – a “one eyed” regulate more position has got us here. Perhaps we should try a “regulate less” positon for a while. It has not happened for a very long time.
    It is easy for the proponents of more regulation to point the finger and say “look – a disaster! We need more regulation!” Very easy. But, for a start, there is very little more regulation that can be brought in. All of the major components of a bank are already regulated. Credit ratios are regulated (in Australia – one of the lighter regimes) under APS 112 and 113. Liquidity ratios under APS 210 and its associated AGNs. Market trading and risk under APS 116. Credit quality? APS 220. Governance? 510. Large exposures – 221. It goes on and on and on. That is just under the Banking Act 1959.
    Add in the corporate regulations (ASIC), the stock exchange (ASX), the Reserve Bank (fairly incidental these days in regulatory terms), the ATO (reporting purposes mainly) and then the various state regulations (for example the UCCC which restricts how they can market to retail consumers).
    Each of these visits the banks on a regular basis. I know – I have been in those meetings.
    Somehow this is not enough?

  43. “Capital ratios are regulated”?????

    The US, the UK and Australia have NO published, black line minimum reserve ratios for commercial banks. What the Hell are you talking about?

    You cannot see the damage of partial deregulation in a monopoly currency environment.

    You’re one of the idiots that got us here.

    Alice, run. Run for your life. He’s one of “them”.

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