In Defence Of Free Markets

Why is it that no one defends free markets, and socialism, despite all the evidence of its failures, comes back again and again? Unsurprisingly, the answer lies in politics, which have always led to a boom-bust cycle of collective behavior. Furthering our understanding of this phenomenon is timely because the old advanced economies, burdened by a combination of existing and future debt, appear to be on the verge of an unhappily coordinated bust. But that does not automatically return us to the free markets some of us long for.

Cycles of collective behavior

Throughout history, there have been few long-lasting periods of truly free markets. Contemporary exceptions are confined to some small island states, forced to be entrepreneurial by their size and position vis-à-vis the larger nations with which they trade. The governments of these islands know that the state itself is not suited to entrepreneurship. Only by the state guarding the freedom of island markets and the sanctity of property rights can entrepreneurs serve the people in these communities and create wealth for all.

This is not the normal condition for larger nations. Before the Scottish enlightenment which nurtured David Hume and Adam Smith, the benefits of free trade were barely understood. Since then, the wealth created by free trade and sound money has nearly always been the springboard for detrimental change. Sometimes a political strongman, like Mao or Lenin dictates to the people what they can and cannot do. Alternatively, a leader courts popularity by taxing heavily the few for the alleged benefit of the masses. This is the model of welfare states today. Debasement of the means of exchange is an extension of these socializing policies, furthering the transfer of personal wealth to the state.

To understand why free markets are more often than not unpopular, we must put them into a context of human behavior. In this regard, we can stylise a cycle of collective behavior into three characteristic phases. The first is a lawless condition of no secure ownership of property rights; in the absence of enforceable law the means of possession are necessarily violent and uncertain. It is the natural condition of tribalism and pre-civilisation societies. It is the condition to which humanity returns when the cycle completes.

The second phase is the consolidation of property ownership, with enforceable laws to define and protect it. Out of the chaos that fails to advance the condition of the people comes order and with it the aggregation of the means of production. Capital in all the forms necessary for production accumulates, and being scarce, is used most efficiently. The backbone of this phase is freedom for the individual to dispose of his or her resources at will. The pace of improvement in the human condition is governed by the level of accumulated wealth and technological innovation.

The third phase is the abandonment of free markets in favor of state control. The state, whose primary function in economic terms is to act as provider and facilitator of the law, increasingly suppresses commerce by extracting escalating levels of tax. Taxes are imposed to redistribute wealth from those that earned and conserved it to those that did not. The state takes control of money, issuing its own currency which it can print at will. The damages to the economy are covered up by all the artifices available to the state.

The state regulates. The state confiscates. The state deprives its people of their freedom. The state’s demands become so insatiable, so counterproductive, so impoverishing that the economy collapses back into the first phase of the next cycle.

That is our theoretical cycle of collective behavior. Out of chaos is created progress. Out of progress lies the course to destruction. The best of these times is the free markets of the second phase. No one defends them.

Empirical evidence of the cycle.

The assembly of German states into a unified nation in 1871 gave credence to a new socializing phenomenon, whereby Bismarck, Germany’s first Chancellor, promoted the state as a socializing entity, superseding free markets. He was the first politician to create a welfare state, introducing accident and old-age insurance and socialized medicine. Shortly after unification, in the mid-1870s Bismarck abandoned free trade and introduced trade protectionism.

His policies echoed the principles of the German Historical School, which drove intellectual thought in the Prussian administration. The Historical School rejected the classical economics of Smith, Ricardo, and Mill in favor of a controlling state, backed up by analysis of historical events, hence the name. These lessons were applied to the changing conditions at that time. Workers were moving from the land into new factories, and it was the German establishment’s outdated response to an entirely new social phenomenon.

The creation of a new German socializing state and the denial of economic liberalism inevitably led to the founding of Chartalism, the state theory of money, which stated that only the state has the right to determine the currency used by the people. Georg Knapp published his State Theory of Money in 1905. He handed Bismarck the key to unlocking constraints on state spending. The state was then able to consolidate its potential, both in its bureaucracy and military armament. We all know what happened: it fed into the First World War and in 1923 resulted in the collapse of the currency.

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Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not reflect those of Goldmoney, unless expressly stated. The article is for general information ...

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