We are following the road to perdition

There is increasing awareness that another financial crisis is in the offing, and, of course, everyone has an opinion as to what will trigger it and what form it will take. But there is broad agreement that since the Lehman crisis ten years ago, instead of resolving the problems that led to that crisis, governments and their monetary authorities have allowed the underlying position to deteriorate. 

There have been many negative developments in the ten years following the Lehman crisis. Logically, you would expect the authorities would have been rethinking monetary and fiscal policies to ensure that the errors that led up to the Lehman crisis are not repeated. You would be wrong, both for the current credit cycle and for the next. The problem is one of not knowing who is responsible.

Modern economists insist that the state should have primacy over free markets. They argue that free markets have shown a track record of periodic booms and slumps, which can only be alleviated by the state. This belief has evolved from the Keynesians’ original proposition that the state should run a balanced budget over the business cycle, instead of all the time. The original idea was to increase spending by running budget deficits to create money during the slump in the hope of recouping government finances later when the recovery generates surplus tax revenues. Classic economic theory was replaced by a state theory of economic planning.

Since the Second World War, this has been the intellectual argument behind both fiscal and monetary policies. It has also been the prop behind socialism. In 1945, twelve weeks after the German surrender but before the Japanese surrendered, a Labour government was elected in Britain with a landslide and began a heavily socialist agenda, nationalizing key industries without compensation, extending the welfare state and redistributing (in other words destroying) wealth. The emergency basic rate of income tax in wartime was barely reduced from 50% to 45%, and additional marginal rates increased to an unbelievable 147½% for the highest earners and savers.^[i] Inflationary monetary policies provided cover for ruinous socialist dogmas, cover that concealed the true cost from the electorate that had voted for them.

We know only too well why these policies failed, not only in the UK but in all countries that adopted similar economic and monetary policies, leaving all socializing governments with escalating welfare commitments. The level of government debt already threatens to become beyond all control on just a small rise in borrowing rates, even before unfunded future commitments fall due. 

Some time ago central bankers managed to cast themselves off from direct government control, so they could pursue monetary policy more objectively. But even without their political masters micromanaging them, they still manage to screw things up by deploying ever greater quantities of fiat currency in a vain attempt to manage the business cycle.

Some say the first sign of madness is to believe you are right and reality is wrong. It’s a problem that afflicts central bankers. They call the rhythm of boom and bust a business or economic cycle on the supposition that its origin is in unfettered free markets. The last culprit to be considered is monetary policy itself. Alright, we make mistakes, the central bankers say, but we are refining our monetary policies and tightening bank regulation to bring the business cycle under control. They fail to realize that the cycle has its origins in a cycle of credit, which is entirely their responsibility. 

The state blames the private sector all same, and when it employs experts to support policy, it attempts to make itself unchallengeable. The Fed employs over 300 Ph.D. economists “who represent an exceptionally diverse range of interests and specific areas of expertise”.^[ii] And they still get it wrong. It shouldn’t take a genius to twig that if central banks stopped messing around with money, and stopped banks issuing it out of thin air as bank credit, the credit cycle would disappear and with it the business cycle. It does, however, elude those high-flying PhDs at the Fed and elsewhere. 

But that is slamming the stable door shut, with the horse absent. It is time to remind today’s statist-educated elite that the world is a far better place without them, not least because it is becoming increasingly clear that they are impelling us towards yet another credit-induced crisis. They have kept us on the road to perdition, which sooner or later, like the ending of communism, will lead to the destruction of the status quo.

However, the establishment won’t be dislodged easily. An initial response to the next credit crisis is certain to involve producing yet more money, yet more regulation and yet more state control. Pig on pork. The seventy-three-year post-war drift from well-meaning welfare to a form of communism without the ideological hogwash will be nearing its ultimate conclusion with the next credit crisis. Eventually, the fallacies of state intervention and unsound money will become so obvious, not only to individual governments but also to their electorates, that the tide of government control will begin to recede.

It must do. This was the lesson of the failure of communism in the Soviet Union and the China of Mao. China and Russia now understand this, having experienced it in living memory. These nations have recanted and reformed. But their reformation has been state directed and often flawed. In Russia, an unholy trinity of the Russian leadership, the KGB and organized crime stole ownership of state-owned industries, proving property rights count for little. In China, communist control continued, but under reformed plans, modeled on Hong Kong’s post-war miracle.

Neither of these options are attractive to Western democracies. However, there is nothing like hard cold reality to force people to rethink, and if necessary jettison cherished views. At some point in time, the welfare state model will have to be abandoned, and market-friendly reforms introduced. In this context, the example of Hong Kong’s post-war recovery bears recounting, not only to contrast how an economy can develop with minimal government involvement and a neutral monetary policy, but to illustrate that there can be life after the death of state-managed economies.

The Hong Kong experience is little written about, but it has been truly remarkable. There is no doubt the Chinese leadership compared its sharp contrast with its own failures on the mainland. Same people, different outcome. An attraction was the irrelevance of democracy, which hardly existed in Hong Kong, outside a Legislative Council with limited powers. China, with over forty different ethnic and religious groups, controlled them by not permitting dissent, allowing only communist party representation in Beijing. China doesn’t do proper democracy, and they had that in common.

By emulating the Hong Kong model, China’s economic renaissance has been an incredible repeat performance. The obvious difference between the two is China has a global geopolitical presence, giving it ambitions beyond its territory. Less obviously she differs from Hong Kong in monetary policy, using the expansion of bank credit in her state-owned banks to finance infrastructure improvements at home, in Asia, and elsewhere.

Therefore, could the Hong Kong model offer us a template for economic reconstruction, following the next credit crisis? Or are we condemned to repeat the same mistakes again, until we are the lesser-developed nations, stuck in an Argentinian-style inflationary limbo?

The Hong Kong experience offers us both an alternative and an example of a recovery from Ground Zero. We will recap post-war events in Hong Kong before considering the implications for ourselves.