RG6: The Deceptive Case for Free Markets

This is a sequence of posts which goes through Charles Goodhart’s book on Evolution of Central Banking. The previous post is: RG5 Evolution of Economic Systems

Chapter 2 opens with a discussion of the views of Walter Bagehot (pronounce as badge-it), author of Lombard Street, which has received a lot of recent acclaim as masterpiece on central banking. After the Global Financial Crisis, Martin Wolf asked “Doesn’t what has happened in the past few years simply suggest that [academic] economists did not understand what was going on?”. Larry Summers responded by naming Lombard Street (1873). There are many articles which examine how a 150 year old book provides insights into the financial crisis which modern economists do not understand!. See, for example, Brad De-Long’s This Time is Not Different. (For a more realistic and clear-sighted appraisal of Bagehot for modern Central Banking, see Misreading Walter Bagehot.)

As also discussed in the first chapter, Walter Bagehot supported free banking as a normative ideal, but recognized that it would not be practical or possible to create the radical changes required to move from Central Banking towards that ideal. Why then is it worth going over dead arguments of a dead economist from 150 years ago? As in a game of whack-a-mole, these arguments keep getting whacked down, and they keep popping up again and again. In practice, today, the shadow banking industry is close to a re-creation of the free banking idea. So, it is worth going over these ideas from their origins. In this post, we will discuss the general arguments for “laissez-faire” – let everyone do whatever they want to do – which is at the heart of many arguments for free banking. The general idea is that all type of regulations tie the hands of free markets and lead to less than optimal outcomes. The best system is a free market system without any regulation, where everyone is free to do whatever they want. In fact, this idea is disastrously wrong, and this can easily be proven theoretically, and backed up by many many empirical examples where free markets have led to major disasters like the Great Depression and the Global Financial Crisis. So ,question is: Why does this hopelessly bad argument keep popping up over and over again, like the whack-a-mole puppets, impervious to any number of blows? In this post, we attempt to provide an answer.

All economic policies hurt some classes and help others. No class has by itself sufficient power to control the outcomes. Thus, powerful classes must depend on persuasion to convince other classes that actions they want to take are in the common interest of all. Karl Marx said that capitalism depends on the willing compliance of the laborer with his own exploitation. Why do the bottom 90% strongly support a system which generates increasing inequality and siphons more than 50% of economic gains into the pockets of the top 1%? Their willing consent is based on the dominance of deficient economic theories (See ET1% Blindfolds Created by Economic Theory). To see how this works, we start with an example from ancient times.

Mazdak was an ancient Persian philosopher who preached against private property, and argued in favor of communal ownership of all resources. This would obviously appeal to the poor, who would thereby acquire a share of ownership in the palaces, wealth, and luxuries of the rich. However, the practical effect of the philosophy was the opposite of this egalitarian dream. The rich and powerful were able to defend their properties, and also were able to occupy and take over the property – including wives and children – of the poor, because they had the power to enforce their will upon others. The philosophy provided a cover for their actions because it deprived the poor of their rights to their own property. This is exactly how ET1% works: by appealing to the poor, while working against their interests.

Among the most powerful of the theories of the top 1% is the idea of “freedom” – let everyone be free to pursue his/her dreams. This matches the individualist and hedonistic spirit of the age, and appeals to everyone. Milton Friedman’s book “Free to Choose” has been a popular bestseller, and defends capitalism by selling dreams of freedom. The essential trick to selling these dreams is by creating a phantom enemy. The bottom 90% is initimately familiar with being oppressed – this is part of the life experience of the labor class. However, very few have understanding of the causes of this oppression. Therefore, free market demagogues can provide a simple enemy. For example, Trump appealed to the oppressed masses by telling them that it is the “immigrants” who are taking away your jobs and wealth. Similarly, free market economists blame everything on big government. They sell the “Horatio Alger” dream to the masses – if we move to a free market system, there will prosperity for all, and everyone will have a chance to become a millionaire. The reality of very low social mobility is hidden from sight. If you are born poor, you live poor, you have poor children, and you die poor. Of course, there are always a few who break free, and these people are glamorized and celebrate to create the dream that this is possible for everyone, and the only obstacle to the realization of this dream is the big government.

If you can successfully sell these dreams, as Trump did, you can make the masses focus on the wrong enemies, like immigrants, WMD of Saddam Hussein, Islamic terrorism, or the demon-of-the-month. That way, the people being exploited by the system do not recognize what is going on and are unable to unite to fight their common enemy. (See my post on “The Shifting Battleground” for more details about this analogy.). Over the course of the 20th Century, there has been revolution in techniques of persuasion – the selling of dreams. Our minds are shaped by the “hidden persuaders” in ways we are largely unaware of.


Date posted: April 27, 2020
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