Sin of Omission Empowers Banksters’
Weapons of Mass Destruction
Morgan Reynolds – October 30, 2008
Mainstream thinking blames the financial meltdown and recession on capitalism, greed run amuck and deregulation. Laissez faire policies, naturally, get the blame. The solution? Why, spend a few trillion more in tax dollars, expand regulation and, in some cases, replace private enterprise by bureaucratic methods outright. Our ailments, once again, are said to stem from insufficient government intervention and control.
The ideological bias here is obvious. Yet a moment’s reflection reveals that every economy in the world is a political economy, a so-called mixed economy, part socialist interventions and part capitalist. This admixture is nowhere more obvious than in the heavily regulated banking and finance sector. From an impartial point of view, the source of the financial crisis could stem from a failure of capitalism, socialism, or some kind of joint causation.
The mainstream intuition that something is terribly corrupt in the relationship between banks and government is surely right but the prevailing diagnosis is wrong. The mainstream overlooks the fact that forcible intervention can take two forms: 1) overt government interference, or 2) granting of privilege and immunity. The latter technique—exemption from traditional legal principles—stays hidden from most observers and hence its evil consequences are easily misdiagnosed. Yet the exemption of banks from traditional legal principles—also known as common law—granted by government for its own greedy purposes is the deep source of regular financial crises.
Bankers have throughout history violated traditional legal principles in their mishandling of so-called demand or checkable deposits. Bankers have betrayed contract law and their role as agents acting on behalf of their principals, the depositors, but instead have taken most of the money “deposited,” i.e., posited or placed with them for immediate use, and used it for their own profit. Bankers retain only fractional reserves to back demand deposits, usually under 10 percent of deposits, and therefore are thieves, scamsters, misappropriators and embezzlers. To illustrate, consider a recent non-bank example reported by the Arkansas Democrat-Gazette:
Little Rock businessman Frank Whitbeck, 61, pleaded guilty in May to a mail-fraud charge, admitting that he illegally ‘borrowed’ millions of dollars from his insurance company, Signature Life Insurance Co. of America, to prop up another of his businesses, Winrock Grass Farm Inc., jeopardizing Signature policyholders. When Metropolitan National Bank foreclosed on the grass farm and hired an appraiser who Whitbeck said undervalued the farm, his plan to replenish the insurance company through profits from selling the farm backfired.
The temptation to abuse the trust and the money of policyholders is obvious and powerful here, and a similar allure tempts bankers. “No one may enjoy the privilege of loaning something entrusted to him on demand deposit,” writes Spanish economist Jesus Huerta de Soto. Consider another example: I pay a storage facility to safeguard my RV “toy hauler” and I want it available on demand, not rented out by the storage owner for his own profit. That would be an abuse of our “demand deposit” contract, and therefore would violate the principle of safekeeping. The same is true of bankers’ reserve policy of less than 100-percent against demand deposits.
How do banksters get away with this? Governments created a legal immunity for them. Governments have granted immunities from civil law suits to itself (“sovereign immunity”), to industry for its various harms in the name of industrial development, to charities in the name of charitable development, and to unions in the name of protecting downtrodden workers from greedy employers. But the exemption for deposit banks has been the most destructive immunity of all because it is the source of the artificial credit inflation unbacked by voluntary savings. Such artificial credit expansion throughout the banking system accompanied by artificially low interest rates causes the boom-bust economic cycle, squandered saving and malinvestment, and general impoverishment.
This breach in the legal structure of the so-called mixed economy, with its all-too-elastic supply of money and credit, can be termed a failure of society’s regulatory mechanisms, as leftists and “centrists” insist. But the failure is clearly one of government: “Far from endeavoring to scrupulously defend property rights, they [governments] supported bankers’ improper activity almost from the beginning and granted exemptions and privileges in order to take advantage of this activity for their own uses.” This is the hidden, deep source of “the legally corrupt origin of fractional reserves in monetary bank deposits,” as Professor de Soto says.
Policy analysis has three components: state the problem, its causes and solution. An accurate diagnosis of the cause(s) of the boom-bust cycle leads to its natural solution. As de Soto concludes:
1) ensure complete freedom of choice in currency, based on a metallic standard (gold) which would replace all fiduciary media [demand deposits presently unbacked by physical money] issued in the past;
2) establish a free-banking system; and most importantly,
3) insist that all agents involved in the free-banking system be subject to and comply with traditional legal rules and principles, especially the principle that no one, not even a banker, can enjoy the privilege of loaning something entrusted to him on demand deposit (i.e., a free-banking system with a 100-percent reserve requirement).”
I wonder when the “summits” to solve the global financial crisis will invite Professor de Soto to present his analysis.
Reference: Jesus Huerta de Soto, Money, Bank Credit, and Economic Cycles, Mises Institute, 2006.