Friday, March 29, 2013

The Capitalist Road to Serfdom

To some, Friedrich Hayek's book The Road to Serfdom is a cautionary work. To others it is an instruction manual. It answers the question under what conditions free people can be made into serfs.

Just because some people are capitalists (meaning rich people), it does not make them supporters of capitalism. Under certain circumstances, they will act against the principles of capitalism. For example, they will generally not refuse a profit or a new idea for profit just because doing so endangers competition, the markets, and perhaps the very system that made them rich. They do not run their affairs by any particular philosophy but by the rule of always working to increase their store of capital. If the best way to do that seems to be enslaving the population and moving away from capitalism, then they will be sorely tempted to become slavers. If for no other reason, they will do it in self-defense, to prevent other capitalists from striking first and enslaving them instead.

In fact, the notion that free markets are self-regulating for the good of all encourages capitalists to "think outside the box" in order to maximize their capital. That is, capitalism itself encourages them not to let moral or philosophical boundaries restrict their scope of action. Playing by the rules is for losers. After all, the free market itself will restrain them if they go too far.

Or not. This is where philosophies of capitalism break down. Cooperation is not always the "rational" choice (meaning "rational" in economic terms). When the disparity in wealth between rich and poor becomes large enough, the free market is no longer strong enough to regulate the activities of the rich. From the capitalists' standpoint, it is no longer worthwhile to cooperate in poor, weakened markets even if they themselves are the ones who weakened the market. At that point, the rational choice may be coercion rather than cooperation, and the rich may choose to work to make the markets less free, less competitive. So much for Adam Smith's "invisible hand."

These thoughts might be considered theoretical except for the recent examples of Greece and Cyprus. The coercive tactics by the troika of the EU, ECB, and IMF are on public display. In Cyprus, the government has been forced to restrict capital flows and confiscate deposit accounts, all in the name of saving capitalism. And all against the principles of capitalism.

Fortunately for the average Cypriot, the proposal to confiscate funds from "insured" accounts was too raw and was eventually dropped. However, the idea does tell us what European leadership was thinking. They want the money, and they will get it by whatever means they can. The poor dodged a bullet in this case, perhaps.

Unfortunately there is more than one bullet, and the Cypriot people will not dodge all of them. One large bank already is being closed, leading directly to higher unemployment and leading indirectly to economic pressure on the bank's vendors. Capital controls will slow the economy even further and increase the price of doing business. We do not know exactly how things will work out, but it seems likely that the average Cypriot will experience even tougher times in the near future than they have already experienced.

At least the rich "Russians" will take the bigger part of the immediate hit, perhaps losing up to 40% of their deposits above the insured limit of 100,000 euros. For the really rich ones, we can be sure that this is very annoying, but it does not threaten their livings like confiscations would threaten the livings of the poor. In addition, the rich, foreign "Russians" (really, many different entities and not necessarily foreign to Cyprus) are already seeking to blunt the confiscations and make deals so that they recover as much as possible. The rich are never without resources.

We hope that the people of Cyprus will take this incident as a warning that they should take collective action to secure their savings in better ways.

From's point of view, poor Cypriots thought they were depositing their euros in safe, insured accounts, and that bank regulations would keep the banks from investing in risky assets. The truth was that the banks were combining internal deposits and external deposits, insured and uninsured, and using them to invest in highly risky external assets. Poor Cypriots did not realize that their deposits might be considered reserves against the failure of those risky asset purchases. They also did not realize that external "Russian" money was used to multiply the risk.

It all seems especially crazy since the Cypriot bank managers already knew about the banking crises in two other island banking centers by the end of 2008, Iceland and Ireland.

We recommend that Cyprus bring back the pound (a.k.a. the lira) for internal transactions. Except for those in government or working for the government, Cypriots would generally choose which market they want to be in. The risky external market using the euro or the safer internal market using the lira. Those in the internal market will only be allowed to own lira while those in the external market will only be allowed to own euros.

The reason why persons in the government would only be allowed to own lira would be to make sure that their self-interest is to protect the lira. If the interest of the Cyprus government is in the euro, then its interest will be in conflict with the interests of the people (which explains why recently the Cyprus government was considering confiscating "insured" deposits). Even if by some chance the government had the people's interests at heart, the Cyprus government has little power over the euro anyway.

The banks would have an external division and an internal division. The external division would work in euros, would not be insured, and would have light regulation. Deposit at your own risk.

The internal division would work in lira, would be totally insured, and would be heavily regulated. In particular, the reserves of the internal division would not be available as reserves for the external division. The use of different currencies would make this easier to accomplish because no external entity could "vacuum up" all the available cash. The ability of the Cyprus government to print lira would also make sure there was always enough cash.

The tricky part is how to convert euros to lira and vice versa, and how much conversion to allow. The nation of Cyprus would have to earn euros and spend euros for international trade. External debt would be denominated in euros and it would still be possible for the nation to get into debt trouble. However, the economic relationship between Cyprus and the eurozone would be simpler, and simpler to regulate. At the same time, unlike euros, the eurozone could not use Cypriot lira anyway even if they could get hold of them. The temptation to coerce and confiscate would be less.

The Australian economist Steve Keen has criticized the current dominant form of economics ("neoclassical economics") in part because it assumes that capitalist systems are stable. Like him, but for somewhat different reasons, does not at all believe that capitalism is stable by itself. Sure, if markets are free and fair, capitalism is great. The trouble is that the very operation of capitalism produces capitalists who gain the power to coerce the markets. Once the markets are not free any more, the neoclassical models are almost useless. Two current examples of this are Greece and Cyprus, who are suffering because of coercion. The creation of multiple exclusive markets with their exclusive currencies, each market regulated to have better-balanced competition than the single huge market, would help prevent the market distortions that capitalists cannot help themselves from creating.

Socialism for the socialists and capitalism for the capitalists.

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