Blame the RBA for the Economic Crash

Chris Leithner’s new book, The Evil Princes of Martin Place: The Reserve Bank of Australia, the Global Financial Crisis and the Threat to Australians’ Liberty and Prosperity not only has a long title, but is also extremely lengthy in number of pages. At 654 pages, a casual reader interested in understanding the recent financial crisis might wonder whether it’s worth buying Leithner’s hefty work. My answer is a resounding ‘yes’. Every Australian should read this book to understand how the government’s involvement in money and banking has diminished their living standards.

Leithner’s goal is simple: to challenge conventional wisdom in the field of monetary economics. Along the way, he also demolishes a variety of other fallacies surrounding the State and its interventions. Harvard-educated academics – the same people who did not foresee the crisis – have blamed the crisis on capitalism and greed, but Leithner is here to defend the free-market perspective against the Keynesian onslaught.

According to Leithner, government intervention, not market failure, is the underlying cause of recessions and depressions. Government’s interventions are manifested through such measures as fractional reserve banking (FRB), legal tender laws, and central banking. Leithner argues that these forms of meddling in monetary affairs create economic turmoil. Though few people discuss the merits or otherwise of FRB and legal tender laws, central banking is already prominent in mainstream debates.

Central banks are a relatively recent phenomenon. For many years, Australians prospered without a central bank in an environment where private banks issued paper currencies. The pre-1901 era in Australia was a time of free banking, i.e. a situation where government gave no special privileges to banks. ‘Australian banking was relatively free for almost a century from the establishment of the first banks until well into the twentieth,’ explains Kevin Dowd in Laissez Faire Banking, ‘and fully fledged central banking arrived only with the establishment of the Reserve Bank of Australia at the comparatively late date of 1959’.

Nowadays, central bankers are highly praised and government intervention is taken for granted. Leithner questions this naïve faith:

In Australia, economists, investors and journalists babble endlessly about the level at which the Reserve Bank should “set” the “official interest rate”…Alas, almost nobody bothers to ask why it should be set, or whether it actually can be fixed…[F]or reasons rarely discussed and never justified, virtually nobody baulks at the notion that a short-term money market rate of interest must be “set” by a committee of price-fixers and central planners in Martin Place, Sydney.

How does monetary central planning bring about recessions? To answer this question Leithner turns to Austrian Business Cycle Theory (ABCT). ABCT suggests that economic downturns are the price paid for prior (artificial) credit expansion. When central banks lower the market rate of interest below the natural rate this leads to distortions in the structure of production, excessive borrowing and speculation. The central bank’s loose money policy misleads investors into starting projects that appear profitable, but in hindsight are not.

In The Evil Princes of Martin Place, Leithner presents data supporting the ABCT. According to Leithner, the Reserve Bank started the artificial boom that led to the ‘genuine bust’. It began the boom by pursuing a policy of high inflation. Leithner shows that from 1991-2007, though consumer prices remained deceptively low, the money supply rose rapidly. By Leithner’s reckoning, inflation (the M1 measure) increased by 404% between 1991 and 2007, at an annualised compound rate of 10.2%. Much of the credit created by the Reserve Bank was pumped into the housing market, creating an asset price bubble. Stock prices were inflated. The crash comes because investors foolishly think that the boom will last, and leverage themselves too highly as they were not prudent in their accumulation of debt. Leithner writes:

The trouble with the gilded boom of the Keating-Howard era is that it has sowed the seeds of a genuine bust. Alas, misperceptions of “the fundamentals”, together with the moral hazards these confusions spawned, prompted many Australians to conclude by 2007 that “Goldilocks” conditions are normal rather than exceptional, and therefore that they would be permanent rather than transient. Moral hazard and the apparent success of ever-riskier investment strategies obscured the less-than-pleasant memories of the 1970s, early and late 1980s, and early 1990s. They also encouraged Australians to think that they could always get a cheap loan, their rulers were omniscient and omnipotent and – in the unlikely event that anything untoward ever occurred – they would ride quickly and effectively to the rescue.

For Leithner, however, the bust has not yet arrived – hence the reason why the Australian recession was not as severe as its American counterpart. Australian house prices are still overvalued.

Leithner has covered a variety of fields and excelled in all. Lawyers will enjoy the legal analysis of Roman law and more recent judgements surrounding banking. Economic historians will appreciate the careful analysis of financial crises beginning with the panic of 1907. Political scientists will glean insights from the anti-democracy chapter, where he points out its many shortcomings. Philosophers will learn something about the ethics of monetary policy.

Overall, The Evil Princes of Martin Place is an outstanding study of money and banking; a libertarian blockbuster filled with insights into the shady dealings of politicians and bankers. I would highly recommend it to anyone interested in understanding the causes and consequences of the GFC.

9 thoughts on “Blame the RBA for the Economic Crash

  1. What about structural issues such as FHA PMI and other macro issues such as fiscal irrectitiude under Bush?

    If you sift through US BLS data, it is also clear the war drained the US economy. Labour and total factor productivity were going down for a while – labour demand would inevitably fall.

    The GFC was like a perfect storm. Australia did not have the debt, structural issues or a as pronounced credit boom/asset cycle.

    “Australian house prices are still overvalued.”

    I don’t think this is a sign of a boom. Land prices are too high, partly due to taxation, and further taxes make investment a very poor prospect. Land is artificially scarce and investment is driven away. Not really a boom.

  2. ‘The Evil Princes’? Who’s going to take a book with that title seriously? I could understand ‘The Bumbling Bureaucrats’ or something but this just sounds like conspiracy theory nonsense.

  3. Let me put it a different way – the title will discourage people who may otherwise be open to reasoned criticism of central banking. I would imagine that the kind of people who will buy it don’t need much persuading.

  4. “Australia’s free banking era did not involve any prohibition of fractional reserve banking.”

    And what a disgraceful circumstance that was!!!!! It lead to the life-destroying Melbourne real estate crash, preceded by the wealth-destroying mis-allocation of resources that was what the real estate boom was all about.

    You might think these booms and busts are okay Taya. But they are not okay. They are criminally wasteful at every stage of the banking (erroneously referred to as the “business”) cycle.

    Just the transfer of wealth subsidy to the banks that money creation represents is bad enough. But its only the beginning of the costs. The unemployment and the investment spending distortion is an even greater source of loss of wealth then the money-creation parasitism.

  5. “Let me put it a different way – the title will discourage people who may otherwise be open to reasoned criticism of central banking. I would imagine that the kind of people who will buy it don’t need much persuading.”

    But to be paradoxical … this is a legalized-criminal operation, whose purpose is to cash out the banks ponzi-money. We don’t want to be soft-pedaling a treasonous scam of these dimensions.

    The Chairman gets one million a year to go along with this unbelievable racket. He winds up in a Swiss town begging on one knee for concessions from manifest failures, when the concessions ought to be about domestic policy alone.

    Worst of all the bank appears to be beholden to international interests in terms of the amount of new cash they allow to be created.

    So central banking is a conspiracy. A conspiracy most foul. One which impoverishes the community, makes ludicrous the notion of efficient capital markets. And one that arm-twists the nation into the bondage of debt.

  6. Fractional Reserve Babking is fraud enough now look at “foriegn investment” and you see that in the description of H. W. Herbert consulting economist Queensland yet another RBA restriction on Australian investment he says;
    “Using overseas money is every bit as much “printing money” as Government spending or enlarging the Budget deficit or expanding trading bank advances.Mr Fraser and his Ministers allow the Reserve Bank to create an extra $100 million of new money for a foreign company to start a mine. but will not allow the Bank to introduce $100 million of new money to an Australian company to do so”
    The $100 million from overseas actually stays overseas and the Reserve Bank issues corresponding funds in AUD, the “foreign capital” becomes part of the RBA international reserves, large foreign companies can own our own mineral reserves this way, our own considered too risky? or just our governments favouring the elite ownership of all resources? all new money is also new deposits and new debt in our economy.

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