Financial and economic crises have become more frequent since the late 1990s. The Asian and Russian crises, the failed speculation by the Long Term Capital Management hedge fund, the bursting of the internet bubble, the collapse of the US property market, the Lehman Brothers bankruptcy, the excessive debt levels of the major developed countries and the euro crisis have emerged in quick succession in recent years. The crisis has become permanent – a clear indication that there is something fundamentally wrong in the current financial and economic system. However, before hastily holding capitalism responsible for the crisis, we should examine the teachings of the Austrian school of economics.
1. The Austrian school of economics: the key to understanding the current crisis
Ludwig von Mises (1881 – 1973) and Friedrich August von Hayek (1899 – 1992) were some of the best-known economists of the Austrian School of Economics. Ludwig von Mises' book "The Theory of Money and Credit" is the Austrian school's most important work. His pupil Friedrich August von Hayek is probably the best-known representative of this economic theory. He was awarded the Nobel Prize for Economic Sciences in 1974.
The Austrian school states that capitalism is not at the root of the crisis; rather, capitalism no longer exists in the sense of a free market economy because the central banks have disabled the basic rules of capitalism using the fiat paper money system. Without a system of fiat paper money, which is controlled by central banks, a financial crisis would not be possible as a permanent situation.
The basic concept of the Austrian School is that price determination by the free market – in other words, the free interplay between supply and demand – is the most important prerequisite for a functioning market economy. This rule also applies to the price of goods as well as to the price of money, namely the interest rate. If one believes in the free market economy, one therefore believes that the interest rate generated from the free interplay between savers and investors is the "optimum" interest rate for the economy; in other words, the interest rate that leads to the "optimum" allocation of capital in society. If the interest rate is distorted by external factors, the probability of capital appropriation that leads to greater imbalances increases significantly.
One of the best examples of sub-optimum capital allocation – triggered by external factors – was the US property bubble between 2004 and 2006. If interest rates had not been kept artificially low by the Federal Reserve, this type of capital misallocation would not have been possible.
The fallacy of a fiat paper money system
If free market forces try to trigger a recession in order to correct the misdirected investments, the central banks have the opportunity to prevent this type of corrective recession in an fiat paper money system. They can do so by lowering interest rates and massively influencing money flows via intervention on the capital markets using the electronic printing presses or regulatory measures. The central banks therefore provide an incentive for further misdirected investments, which in turn lead to increasingly severe economic cycles and financial crises. As the necessary "corrective crisis" becomes ever more painful, a vicious circle emerges in which an increasingly large proportion of the population and companies demands even more state intervention. The system therefore gradually develops into a type of state capitalism, which increasingly restricts personal and entrepreneurial freedom and further inhibits growth. Ultimately, additional growth only emerges as a result of public debt funded by the central banks' electronic printing presses. It is therefore inevitable that a fiat paper money system will, sooner or later, end in a debt crisis.
The Austrian school of economics is the key to understanding the current debt crisis. However, since it uncovers unpleasant truths for politicians and central bankers, this theory is deliberately kept out of the public domain as far as possible. Nevertheless, the internet provides a convenient opportunity for critical engagement with the Austrian school. The websites of the Ludwig von Mises Institute in the US (http://www.mises.org) and Germany (http://www.misesde.org) offer an excellent introduction to the subject.
2. The lie about capitalism
The tragedy of the current financial crisis is that politicians and central bankers managed to attribute the cause of the financial crisis to capitalism. Yet a crisis of this magnitude could never occur within capitalism in the sense of a free market economy. In a free market economy, investments that are not in line with society's requirements lead to a recession. If the central bank does not stop the recession, it sets in motion a clearing process – albeit a painful one – and therefore prevents a far-reaching permanent crisis from emerging such as the one we are experiencing now.
State intervention in market events is often explained by the fact that public pressure does not allow the politicians to permit a clearing process to take place. Even though this is undoubtedly the case (especially if a crisis has advanced as much as it has today), it represents only half the truth. There are other reasons why politicians and central banks try to suspend the laws of economics.
The manipulation of financial markets for political ends
The main reason is that politicians and central bankers are increasingly using the financial markets to pursue political aims against the will of the people. If this were not the real reason for the numerous bad economic decisions of the last few years, it could be insinuated that most leading politicians and central bankers were lacking in expertise. However, this is highly unlikely, given their biographies and those of their advisors.
The diktat of the "Troika"
The euro crisis is one of the most obvious examples of financial markets being manipulated in pursuit of political objectives. When the numerous referendums on the Lisbon Treaty between 2005 and 2008 saw the people of Europe conveying their opposition to Brussels expanding its powers at the expense of national parliaments, the "United States of Europe" project was advanced in a more subtle manner. Following the outbreak of the crisis in Greece, bond markets in Southern European countries collapsed in sequence, hindering these countries from raising capital on financial markets. The crisis had been triggered by the sudden news of significantly higher Greek budget deficits. In this regard, the role played by investment bank Goldman Sachs in concealing Greece's real budget deficits is, at the least, highly questionable and the extend to which the former Goldman Sachs vice-president responsible for "corporates and governments in Europe" between 2002 and 2005 and current European Central Bank president Mario Draghi was involved is also unclear. However, further investigations on this matter could not be pursued, as a controversial ruling by the European Court of Justice prevented any further insight in this dossier as "the disclosure would haveundermined the protection of the public interest". The countries without access to the capital markets had no other option but to accept the terms of the so-called Troika, comprising the IMF, the European Commission and the European Central Bank, to avoid national bankruptcy. Accepting these terms is nothing other than relinquishing national sovereignty.
The US housing market crisis tolerated or even desired...
Similarly, the US property crisis cannot have developed in the manner outlined by politicians and central bankers. At the end of 2005, Ben Bernanke, president of the US Federal Reserve, explained that the rising property prices were not a result of the low interest rate policy but were a reflection of fundamental economic strength ("House prices have risen by nearly 20 percent over the past 2 years. Although speculative activity has increased in some areas, at a national level these price increases largely reflect strong economic fundamentals."). The overheating of the property market was so obvious that Bernanke, a highly gifted school pupil, graduate economist from Harvard University and holder of a doctorate from the Massachusetts Institute of Technology, with access to dozens of highly-qualified academics, could not have overlooked a bubble of this nature, which statistically occurs only once every 100 years (see graph). The only possible conclusion one can draw from this is that this development was tolerated or even desired by the central bank.
U.S. existing house price (Case-Shiller) divided by median family income
Source: I.S.I.
The Federal Reserve: the most powerful institution in the world
This conclusion is all the more logical since the Fed has been the biggest beneficiary of the financial crisis. The Lehman bankruptcy triggered a sovereign debt crisis that significantly curtailed the financial flexibility of all industrial nations. The elected members of parliament are increasingly dependent on financial support from the central banks, since the individual countries are finding it increasingly difficult to mobilise funds on the capital markets. The central banks, on the other hand, have unlimited access to funds in a fiat paper money system thanks to the electronic printing presses. This is particularly true of the Federal Reserve, since it has the privilege of issuing the international reserve currency, which is accepted practically everywhere in the world. The Federal Reserve occupies a special position thanks to its ability to create US dollars out of nothing. The crisis undoubtedly turned the Fed – which is not a state enterprise but was established in 1913 by private US banks and is still owned by them today – into the most powerful institution in the world.
The central banks make the decisions
Because of the financial crisis and the regulatory measures introduced as a result, capital allocation is determined less and less by the markets – i.e. by the free interplay between savers and investors – and increasingly by central banks. This also explains why Goldman Sachs' current CEO Lloyd Blankfein got carried away in an interview with the Sunday Times in 2009, in which he justified his high salary by stating, "We are doing God's work". The central banks and their satellites, which include the large investment banks, are the real decision-makers in the current fiat paper money system with regards to who receives funds and who does not. Lloyd Blankfein's flippant answer to a somewhat provocative question expressed a far-reaching truth of which the general public is hardly aware.
3. The abolition of the fiat paper money system is the key to returning to the free market economy.
The financial crisis means that we are living in a state capitalism model in which central banks determine capital flows. The flow of money to countries – i.e. to the people – is turned on or off depending on their willingness to bow to the will of the central banks. Real power is therefore not wielded by parliament or politicians but by the central banks. The fiat paper money system allows the money supply monopolists to overturn democracy.
The easiest way for people to return to democracy and the free market economy is to demand an end to the system of fiat paper money. In a system in which money supply can neither be reduced nor expanded at will, it is impossible to bring about a crisis artificially. The central banks will no doubt vehemently oppose such a demand, as they will never voluntarily give up their unrestricted position of power. However, this is the only way to put a definitive end to the financial crisis. If the fiat paper money system remains in place, there is a strong probability that the central banks will rob ordinary people of their savings via a currency reform to relieve the countries of their debt and start the game all over again.
There are indisputably alternatives to the fiat paper money system, even though the central banks have skilfully kept this out of the public eye up to now. I doubt that a return to the classic gold standard is the best possible solution. However, the gold standard would undoubtedly represent a better solution than the fiat paper money system, which the central banks exploit at the people's expense. It is not surprising that the followers of the yellow precious metal, gold, claim that – unlike fiat money – it is the only real money. Since money supply tied to gold cannot be manipulated, they refer to gold as the money of freedom.
