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DESTROYING CAPITALISM BY SOCIALIZING CAPITAL

Marx and Engels wanted socialist governments to control financial capital. The Communist Manifesto’s fifth of ten planks calls for “Centralization of Credit in the banks of the state, by means of a national bank with state capital and an exclusive monopoly.”¹ Capitalism cannot exist in any meaningful sense without private capital markets. One of the chief virtues of capitalism—indeed, perhaps the chief virtue—is that economic resources are constantly allocated and reallocated according to the wishes of consumers, which private lenders have to take into account. It was private capital markets, for instance, that funded the personal computer revolution, betting, correctly, that consumers would prefer computers to typewriters. Capitalists in a free market assess risk and demand a thousand times every day and are rewarded with profits or punished with losses depending on how well they serve consumers.

Socialists distrust all this spontaneous economic activity. They want a “planned” economy, designed by bureaucrats. And today, every government in the world has adopted the socialist platform to at least to some degree, most especially with national banks that centralize credit.

HOW SOCIALIST ARE U.S. CAPITAL MARKETS?

Ever since the creation of the Federal Reserve Board in 1913, the United States has met the first requirement of plank five of The Communist Manifesto calling for “a national bank.” There were two other national banks in American history—the First (1791-1811) and Second (1816-1836) Banks of the United States, but the Second Bank was vetoed out of existence in the late 1830s by President Andrew Jackson, who charged the bank with corrupting politics; subsidizing a wealthy, politically connected class; and destabilizing the economy.²

The Fed has the ability to print money (or these days, create it electronically) to purchase government bonds. Not only does it put billions of dollars into circulation, but interest earned on the bonds goes to pay the salaries and perks of Federal Reserve employees, giving the Fed an obvious bias towards monetary inflation.

The Fed also indirectly subsidizes the private banking industry with its “reserve requirements” of how much currency a bank must hold in its vaults or with the Federal Reserve. These requirements are usually set between 2 percent and 10 percent. A 10 percent reserve requirement, for example, means that a bank can lend out $10 million by keeping $1 million in reserve.

Prior to the establishment of the Fed there were periods of competing currencies: some banks held higher levels of reserves (usually in gold or silver) than others, signifying to the public that the currency they issued was more stable and reliable. Banks with minimal reserves were suspect and were not very profitable or went bankrupt. Under the regime of competing currencies the more stable and responsible banks were rewarded with profits, while the less responsible ones incurred losses or bankruptcy. The Dix (“ten” in French) was a currency issued by a New Orleans bank in the nineteenth century that was so trusted that it was even used in Minnesota. This is where the word “Dixie” comes from—land of the Dix.

The Fed ended competing currencies by imposing a single reserve “requirement” on most banks (and was assisted by the National Currency Act of 1863 and 1864 that taxed currencies other than the greenback dollar). In essence, the Fed became the enforcer of a banking cartel, which, if it had been done by the banks themselves, would have violated federal antitrust laws prohibiting “conspiracies in restraint of trade” and the banks’ managers could have been sent to prison.³

The Fed, like all central banks, is essentially a socialistic central-planning agency that claims to “stabilize” and “fine tune” the economy. No such central planning agency existed for much of American history. In the 124 years from the ratification of the U.S. Constitution in 1789 to the creation of the Fed in 1913, a national bank existed only for twenty years, or about 16 percent of the time. There was some regulation of branch banking, and the government periodically stopped banks from redeeming currency with gold or silver, but for the most part, the United States enjoyed a free market capital system, with no army of central planners.

Even though the Fed is charged with “stabilizing” the economy, it has in fact generated numerous boomand-bust cycles. At the outset of the twenty-first century, the Fed flooded the markets with currency to drive interest rates toward zero. The Fed’s easy-money policies were largely responsible for both the 2000 stock market bubble (and bust) and the housing bubble that exploded into the Great Recession of 2008. Even the Great Depression of the 1930s came on the heels of the Fed’s expansionary monetary policies of the late 1920s that generated a stock market bubble followed by the famous crash of October 1929.⁴

The Fed’s low-interest-rate policy is an attempt to impose price controls on interest, which in turn, inevitably encourages too much investment in houses, cars, the stock market, and many other industries that is not justified by the market or consumer demand. The Fed does this because it inflates economic growth, at least in the short term, but it does so at the cost of an incredible misallocation of resources or what Austrian School economists call “malinvestment.” At some point reality sets in as supply far outstrips consumer demand, and the “bust” occurs, whether in housing or some other industry, throwing thousands, or tens of thousands, or hundreds of thousands, out of work and the economy into recession.

The Fed also contributes to what economists call “fiscal illusion”—making the cost of government seem much lower than it really is. If the public realized the true costs of government, it might oppose many more government programs than it does now. Every federal government program can be financed through either direct taxes, borrowing, or the Fed’s creation of money. Tax finance is the most visible, for obvious reasons. Government borrowing defers the presumed cost of current government spending programs to the future, while simply printing more money through the central bank, creating the impression that government programs are free. As Adam Smith said, with tax finance there would be fewer wars, and wars that were fought would be shorter-lived. The same can be said of all other government programs financed by money created by the Fed.

There is also a large literature in economics on what are called “political business cycles.”⁵ By at least partially financing government programs through printing money, the Fed assists incumbent politicians by pumping up government spending just before elections. Every congressional district is showered with federal grants to build new schools, repair roads, hire more police and firefighters, and so on. This generates even more instability in the economy, contrary to the hollow claims by central bank apologists that it “stabilizes” the economy. There is a false sense of growth and prosperity before the elections, and then often an economic retrenchment afterwards. Then the cycle repeats itself in the next election year.

Monetary economists George Selgin, William Lastrapes, and Lawrence H. White assessed the Fed’s performance over its first one hundred years and concluded the following: the Fed’s history is characterized by more rather than fewer episodes of economic instability than in the decades leading up to the creation of the Fed; the Fed’s performance is inferior to the banking system that preceded it, known as the National Banking System; the U.S. dollar lost 95 percent of its purchasing power since the creation of the Fed, compared to a stable purchasing power of the dollar from the late eighteenth century to 1913; the Fed has eliminated deflation, which was a happy occurrence in the eyes of consumers for the entire period from the end of the American Civil War to the turn of the twentieth century; and recessions have been more severe and longer-lasting since the creation of the Fed.⁶

In addition to all of these failures, after the “Great Recession” of 2008, the Fed financed massive bailouts of financial firms that had made billions of dollars of bad business decisions. Capitalism is a profit-and-loss system, not an “I-keep-all-the-profits-but-the-publiccovers-all-my-losses” system. Socialized losses and privatized profits is a corruption of markets and was a hallmark of twentieth-century economic fascism, an economic model to which western socialists seem eager to return.⁷

The Fed regulates virtually every aspect of America’s financial markets. For example, in one of the Fed’s publications entitled “The Federal Reserve System: Purposes and Functions,” the central bank boasts of its responsibilities to regulate bank-holding companies, state-chartered banks, foreign branches of member banks, edge and agreement corporations, U.S. state-licensed branches, agencies, and representative offices of foreign banks, nonbanking activities of foreign banks, national banks, savings banks, nonbank subsidiaries of bank holding companies, thrift holding companies, financial reporting procedures, accounting policies of banks, business “continuity” in case of economic emergencies, consumer protection laws, securities dealings of banks, information technology used by banks, foreign investment by banks, foreign lending by banks, branch banking, bank mergers and acquisitions, who may own a bank, capital “adequacy standards,” extensions of credit for the purchase of securities, equal opportunity lending, mortgage disclosure information, reserve requirements, electronic funds transfers, interbank liabilities, Community Reinvestment Act sub-prime lending demands, all international banking operations, consumer leasing, privacy of consumer financial information, payments on demand deposits, “fair credit” reporting, transactions between member banks and their affiliates, truth in lending, and truth in savings.⁸

Financial markets in the United States are also regulated by the Federal Trade Commission, Consumer Product Safety Commission, Commodity Futures Trading Commission, Farm Credit Administration, Federal Deposit Insurance Corporation, U.S. Consumer Financial Protection Bureau, Securities and Exchange Commission, Securities Investor Protection Corporation, Small Business Administration, National Credit Union Administration, Comptroller of the Currency, Financial Stability Oversight Council, Office of Financial Research, and the Financial Industries Regulatory Authority.⁹

If that weren’t enough, there are dozens of state and local government regulatory agencies that also regulate financial market transactions.

In addition, the 2010 “Dodd-Frank Wall Street Reform and Consumer Protection Act” mandated (for starters) 243 new regulatory rules affecting financial markets in the U.S.¹⁰

The United States has no shortage of financial regulations. What it has is a shortage of truly free markets in finance and banking.

DISTORTING MARKETS WITH SOCIALIZED LENDING

Beginning with the now-defunct Reconstruction Finance Corporation, created by the Herbert Hoover administration in 1932, the federal government has been heavily involved in directly extending loans and loan guarantees to myriad businesses and individuals, including banks, to the tune of hundreds of billions of dollars each year. (A loan guarantee is when the government promises to pay off the loan if the borrower defaults, thereby reducing the interest rate on the loan by eliminating the risk to the lender.) By definition, whenever government extends a loan or loan guarantee to a business, it is expanding the activity of that business beyond what private capital markets would do. The subsidy involved is the difference between the free-market rate of interest that the borrower would pay and the government-guaranteed rate, which is always lower. In such instances the government is effectively vetoing the opinions of consumers, who are not purchasing the product or service in great enough numbers (if at all) to justify any loan. Politics inevitably replaces economics and plays the predominant role in determining who gets the government-subsidized loans, which are essentially used as vote-buying and campaign-contribution-soliciting tools by members of Congress and by presidents.

The amount of loans and loan guarantees handed out by government, substituting political preferences and whims for economic viability as the main lending criterion, is staggering. For example, in less than two years the Obama administration guaranteed $100 billion in loans to its pet “green energy” businesses. One of them, Solyndra, a solar panel manufacturing company, went bankrupt in 2011 after receiving a highly publicized $536 million loan guarantee by the Obama administration in 2009.¹¹ Democratic fundraisers, given jobs in the Obama administration, routinely steered “green” loan guarantees to businesses they had been associated with prior to joining the administration.¹² Unlike in a free-market, their private capital wasn’t put at risk, the taxpayers’ money was.

A hallmark of socialist countries is that one must be politically “connected” to have any hope of succeeding in “business.” Capital markets are organized according to political, as opposed to economic, criteria. It should be no surprise then that socialist economies, for all their “rational” planning, are inevitably irrational and bankrupt. The more America socializes its capital markets through Federal Reserve central planning, regulation, and politically favored loans and loan guarantees, the more it will destroy its heritage of prosperity.