The Free Market's Slow Death
Much has been made in the press of the manipulation of LIBOR, without much explanation of the consequences for prices of all things that depend on supply and demand for bank credit. Outrage focuses on the activities of avaricious bankers, which is why the connection never gets made between relatively minor manipulations of credit pricing by banks and far larger manipulations by central banks.
It is the latter that should really concern us. Central banks persistently intervene in markets to keep interest rates below where they would otherwise be. This leads to artificially high prices for all assets, since they are bolstered by cheapened credit. The idea that we have a capitalist economy, where assets are priced on the basis of their productive value is untrue.
We are far removed from free markets, or prices that are fairly agreed between parties without state intervention. It is now impossible for any business to rely on market pricing, which is why there has been explosive growth in derivatives. Every derivative exists to hedge the risk in a transaction, and while that transaction is often another derivative, ultimately they all exist to hedge risk in real business activities. Some of this is sensible in free markets, such as a farmer selling his crop ahead of the harvest to maximise prices, or a mine selling its product forward in the knowledge it will have it to deliver; but the bulk of these derivatives only exist to hedge market uncertainties that are the consequence of government interventions.
According to the Bank for International Settlements, derivatives for non-financial customers world-wide totalled $46 trillion at the end of last year, 65% of world GDP, or about 100% ex-government. This is evidence that genuine entrepreneurial activity is being suffocated by interventions and manipulations, because an entrepreneur, by definition, is someone who exploits price differences, not one who seeks to hedge them.
We should extend our condemnation of government intervention from interest rates to government-issued money itself. There can be no certainty in its future value, making it impossible for a businessman to calculate margins. An obvious example is the uncertainties facing any business involving the euro. No one knows who will be in the eurozone and who will be out of it next year, nor do they know if it will still exist, let alone whether the euro will be up or down. Uncertainties resulting from government interventions are economically damaging.
So all prices are no longer simply set by buyers and sellers but are manipulated by governments and central banks. The system that is failing is not capitalism, but price-rigging by governments. Governments will always try to persuade us that it is markets, and not them at fault. They have been doing this to varying degrees for a hundred years, ever since the abandonment of the gold standard. We are now on the last lap of this delusion.
We face the economic calculation problem identified by von Mises. It was the eventual undoing of the Soviet Union, and we have fallen into the same trap.