The harm of banks: Economic booms and busts

I have argued recently that banks cause economic harm for a few reasons. One of those reasons is that the banks' varying lending moods cause expansion and contraction of the effective money supply. This leads to economic booms driven by malinvestment, as people compete to spend easy credit, followed by economic busts driven by a widespread realization of investment mistakes.

A counter-argument that I've seen more than once is such as made by this correspondent:
I disagree with the underlying premise that volatility is a bad thing and that the goal of "architecting" a financial system is to smooth-out the ups and downs. I have no problem with volatility. There's no law of nature or moral principle that states that the optimal state of the world is an even keel with minimal volatility.
The purpose of my proposal to phase out fractional reserve banking altogether is not to do away with volatility for the sake of itself. Rather, it is to remove the systemic harms and risks of this volatility, which are:
  • On a small scale, when the malinvestment cycle caused by lending trends is small, the economic bust that follows is a form of pollution. Economic stability is a common good that benefits everyone who wants to make solid business plans for the long run. When this stability is distorted by economic busts, a common good is being destroyed just as if a factory spews toxic ash into the air of a residential area. The economic cycles have strong negative externalities, and it is the role of government - even small government - to eliminate such externalities. Just like a factory must not pollute the environment - or else must pay for it - banks must not pollute the economy; or else must pay for it. But they cannot pay, because it would annihilate their profit. Therefore their business model us unviable. This is a principled libertarian argument.
  • Also on a small scale, the economic booms and busts are not something that's valuable for the economy. It's not that the busts are damaging, but the booms are beneficial, so it's all worth it in the end. No: the booms themselves are damaging, because they are widespread malinvestment; booms are valuable resources and human time that are largely being thrown away. The busts, in turn, are recognition of this waste, and a return to saner principles. The economy would have been better off if there was no boom and no bust. This is a pragmatic utilitarian argument.
  • On a large scale, when the boom is too long and the bust too large, this can lead to acute and widespread unemployment, threatening the individual existence of a large proportion of people, which in turn threatens the existence of a libertarian state.
Yes, a libertarian state can permit banks, but at the expense of polluting a common good of economic stability; at the expense of large scale waste of resources during lending booms; and at risk of being toppled, and replaced with a much less desirable regime, when a malinvestment boom that lasted too long results in a bust that's too strong and too large for a large proportion of people to survive without expropriating others.


Anonymous said…
Hi Denis.

I think you need to decide whether you're fundamentally operating off of libertarian principles or utilitarian ones. They're different. Utilitarians primarily look at the "system" as a whole with the goal of minimizing "waste" and maximizing the "common good." For a utilitarian, in any conflict between the "system" goals and individual rights, the system goals win.

On the other hand, a principled libertarian doesn't even recognize the concept of "common good" as philosophically valid (or at least views "common good" as an anti-concept which subverts the concept of an individual right altogether). I disagree that it is the function of a proper government to "eliminate such externalities." The fundamental purpose of government is to protect individual rights. A government that sacrifices my right to enter into a fractional reserve agreement with other individuals in exchange for protecting the "common good" can no longer claim to stand on solid moral ground as a laissez-faire state (i.e. one based on libertarian principles).

The argument by analogy with respect to pollution sounds nice, but it is fallacious because the analogy doesn't hold. Spewing a (provably harmful by objective science) toxic chemical into my air or onto my property can be an act of aggression against me individually because you are initiating physical harm against me, which is a violation of my rights. However, I have no intrinsic right to a stable currency or general economic stability so that planning my business in the long-term is more convenient. Therefore, protecting such "right" can't possibly be in the domain of a proper government. Pollution isn't bad because it affects the "common good," it's bad because it violates the rights of a bunch of individuals by initiating force against them. There's no parallel to bank failure here.

If you start making arguments based on "common good," then you're abandoning libertarian principles as the standard by which you're asking your readers to judge your posts. That's fine if you want to be a utilitarian blogger, although if you were a utilitarian blogger I wouldn't be interested in reading your posts anymore ;-)

Your resident laissez-faire Capitalist,

denis bider said…
Hey Carter,

we may need to take a wider view of libertarianism and why we arrive at this philosophy in the first place.

For me in particular, libertarianism is a way of achieving the greatest common good. It is the political philosophy that follows out of the Silver Rule: do not do to others, what you do not wish others to do to you.

When we talk about what "rights" people have, I think that assuming certain rights as obvious while refuting others makes for a bad logical foundation. What is obvious to me is not obvious to you, and what's obvious to me is that there are no such things as "rights" mandated by nature. The rights we choose to enforce, we choose them because they provide for a beneficial social arrangement. In other words, a libertarian state defines the rights it does in order to maximize common good.

For these reasons, it does not seem obvious to me that a right to an unpolluted economic environment might be any less intrinsically desirable than a right to unpolluted air.

What you could argue, however, is that enforcing a particular right would cause more trouble than it's worth, and thus refute the viability of such a right for practical reasons. In order to show this, however, you need to make a technical argument rather than an ideological one. This would be similar perhaps to the argument made by Wei.
Anonymous said…
Hey Denis.

Okay, so you found me out: I'm not actually a libertarian. I'm a laissez-faire capitalist, but I arrive at laissez-farie capitalism because of my philosophy, which at its essence can be described as the supremacy of reason. Since my philosophy leads me to conclusions in the realm of politics that are similar to libertarian ones, I often sympathize with the libertarian position on issues.

Just to make a few points:

1. Libertarianism isn't a philosophy; it's a political system. You have arrived at libertarianism via your own philosophy, which is different from mine and apparently values the concept of "the common good."

2. Like the Golden rule, the Silver rule is philosophically silly and politically useless because it's not objective. What I don't want others to do unto me is subjective, which means it might not be what you don't want others to do unto you. Therefore, it doesn't materialize into anything ontologically useful by telling us anything about what is proper for humans to do or not do unto each other. I might not want people to criticize me (and in exchange I might be willing to not criticize others), but it doesn't mean that we should set up a government forbidding people to criticize each other. It means I have thin skin. Not everyone does. [I actually don't get offended easily, so maybe that's a bad example.] Because I don't have the same concern about others not "harming" me by crashing the economy via bad lending, using the Silver rule as my guidance I could just as easily argue against your point by saying that I want to be able to set up fractional reserve banking and I'm willing to let others do the same and risk a depression; therefore we should set up a government that allows fractional reserve banking. Since the Silver rule can be used to argue any side of any issue, it's useless.

3. I think it is the realm of philosophy (not politics) to determine what is meant by the concept of a "right." I also think we disagree on this concept, since I don't agree with some very fundamental statements you've made about the concept itself. I do agree that the concept of "rights" shouldn't be based on what I view as "obvious" or what you view as "obvious." That would be silly. However, I didn't take the time to derive my position because that is a much longer and intricate discussion. Instead, I took a chance that you would agree with me about what rights are philosophically valid and what "rights" aren't. I lost my gamble. We apparently disagree on this, although I will say that my assertion about rights is not arbitrary and I think it is philosophically demonstrable via reason, and therefore objectively correct. If you haven't spent a lot of time reading and thinking about what is meant by the concept of a "right," I encourage you to do so.

4. I disagree with the underlying assumption in your last paragraph that there is a conflict between the ideological and the practical. This is only true if one chooses an ideology that is incongruous with reality. With the proper ideology, such a conflict does not exist.

BTW, I hope you don't have a thin skin, either. I've enjoyed this discussion.


denis bider said…
Carter: "Libertarianism isn't a philosophy; it's a political system. You have arrived at libertarianism via your own philosophy, which is different from mine and apparently values the concept of 'the common good.'"

That seems a reasonable assessment.

Carter: "What I don't want others to do unto me is subjective, which means it might not be what you don't want others to do unto you."

The Silver Rule is not a strict logical position, it is a useful heuristic.

Heuristics are useful in life. In fact, among the useful instruments we use daily, we have virtually nothing but heuristics.

By proposing that the Silver Rule is a bad one to follow, you are suggesting that we should ignore a vast majority of ways in which our preferences are similar, for the sake of avoiding a few edge cases where this heuristic doesn't work.

Yes, the Silver Rule is obviously inappropriate for asymmetric situations, such as in voluntary bondage or dom/sub relationships, as well as when a cop is arresting a criminal who has, in fact, done something wrong.

But the Silver Rule is not a law by which to try people. It is a guideline to apply in human interactions.

For me, libertarianism - letting other people be - rather obviously results from this guideline.

Carter: "I will say that my assertion about rights is not arbitrary and I think it is philosophically demonstrable via reason, and therefore objectively correct."

So you're an objectivist. [Unless in any of your conclusions you disagree with Rand, in which case you should burn in hell, you heathen! ;) ]

It would be most useful if you could illuminate me as to the actual details of objectivist reasoning by which you arrive at objective rights.

Please explain also how your concept of objective rights, such as, perhaps the right to property and life, works against a mugger who listens to you explain this for a minute, then shrugs, takes out a club, beats you over the head with it, and disappears into the night with your wallet.

Please explain also how your strict following of these objective rights, such as perhaps the right of a sentient being to its life, has led you to become vegan.

Explain also how lions and sharks should also become vegan, out of respect for these same objective rights.

Carter: " I disagree with the underlying assumption in your last paragraph that there is a conflict between the ideological and the practical. [...] With the proper ideology, such a conflict does not exist."

Show me.

Carter: "I hope you don't have a thin skin, either. I've enjoyed this discussion."

I do not, and I'm enjoying it as well. I hope you respond. :-)

denis bider said…
I am trying to make the point that a utilitarian position is necessary in order to derive a set of principles which everyone can follow in order to maximize the benefit for everyone. At the same time, these principles must not violate our selfish inclinations, or else they will not work.

Money is an example of a principle that works with our nature, rather than against it, to provide overall beneficial results.

You are claiming that objective rights exist regardless of the common good, and that the common good is irrelevant. But absent our concern for common good, if we are standing at a lonely corner in the middle of the night, and I'm anonymous, and you have money, and I have a club, then what's good for me is to take your money after hitting you over the head with a club, while not giving a fig about your "objective rights".

If actions mandated by "objective rights" differ in any measure from what a person would do from a strictly selfish standpoint, and a person acts to respect the "rights" rather than follow their self-interest, then that person is being irrational.

Therefore, out of necessity, it makes sense to talk about objective rights only from a system-architecture standpoint, where you get to make rules that people are supposed to follow. It only makes sense to talk about objective rights if you are going to be changing reality so as to shift people's incentives to align with those rights.

If we assume you're doing so, then what sense does it make to setup people's incentives in ways that lead to conflict and inefficiency?

When we're setting up a system, then by design, we are leaving ourselves (the designers) and our own selfish interests out of the picture. When subjective motivation is so removed, what other motivation remains, other than to maximize the common good?

However you define the common good.

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