By James Henry
With storms clouds looming over the economy, evidence of over-heated, over inflated markets are forming. Many analysts believe we are on the edge of a bubble that’s about to deflate. Having lived through these booms and busts before should make us step back and ask… where do these bubbles come from? Clearly not all entrepreneurs are successful all the time but why is it that periodically, all of a sudden, they all go bankrupt? Who or what is behind this economic mystery variously labeled the economic cycle, the business cycle, the trade cycle, booms and busts, bonanzas followed by bankruptcies?
The answer to this question lies at the heart of how our banking and monetary system works. In the past people used all variety of things as money, but typically settled on gold and silver, as they had the most money-ish qualities. These qualities being acceptability, portability, divisibility, fungibility and store of value. Over time people started storing their money with goldsmiths for safe keeping who gave them paper receipts in return, IOU’s to pick up their money at a later time (bailment contract). Overtime, the goldsmiths became bankers and began issuing more IOU’s than actual money deposited. This practice, legalized by the monarchs of Europe (in return for lots of loans of course) can be termed the fractional reserve banking system. It’s called this because when you deposit money in a bank, they only keep a fraction on hand and loan the rest out and the interest on that loan is their profit. Over time, banks became the masters of the economy and society, replacing the church, monarchies and aristocracy.
That’s wonderful and all but what about the bubbles you may ask?!?!
The answer is as follows. When banks loan out someone’s checking account deposit to others to buy houses, car etc. both of these people think they have use of that same money. As more money is dished out into the economy as a result of bank credit expansion, where ever that new money is spent, prices rise, materials prices rise and we have a boom on our hands. Prices begin to rise and entrepreneurs calculate they can make some serious money in these booming industries. But at some point, prices outstrip what the market can bear and eventually we have a bust on our hands. The house of cards falls and depression sets in. Governments, egged on by banks, rush to plug the holes with more, you guessed it, borrowed money, for guess who, the banks, and nothing improves.
The business cycle plays havoc on the price system, makes it hard for entrepreneurs to forecast their probability of success and inhibits regular people’s ability to save for the future. To truly put an end to this cycle of crisis, distorted prices (which only rise of course) and economic chaos, we must fundamentally reform the banking system. Money must return to a means of exchange, not a parasitic means to an end.