Markets are true democracies. The allocation of resources, capital and labour is achieved through the mechanism of spending, and so based on spending preferences. As money flows through the economy the popular grows and the unpopular shrinks. Producers receive a signal to produce more or less based on spending preferences. Markets distribute power according to demand and productivity; the more you earn, the more power you accumulate to allocate resources, capital and labour. As the power to allocate resources (i.e. money) is widely desired, markets encourage the development of skills, talents and ideas.
Planned economies have a track record of failure, in my view because they do not have this democratic dimension. The state may claim to be “scientific”, but as Hayek conclusively illustrated, the lack of any real feedback mechanism has always led planned economies into hideous misallocations of resources, the most egregious example being the collectivisation of agriculture in both Maoist China and Soviet Russia that led to mass starvation and millions of deaths. The market’s resource allocation system is a complex, multi-dimensional process that blends together the skills, knowledge, and ideas of society, and for which there is no substitute. Socialism might claim to represent the wider interests of society, but in adopting a system based on economic planning, the wider interests and desires of society and the democratic market process are ignored.
This complex process begins with the designation of money, which is why the choice of the monetary medium is critical.
Like all democracies, markets can be corrupted.
Whoever creates the money holds a position of great power — the choice of how to allocate resources is in their hands. They choose who gets the money, and for what, and when. And they do this again and again and again.
Who should create the monetary medium? Today, money is designated by a central bank and allocated through the financial system via credit creation. Historically, in the days of commodity-money, money was initially allocated by digging it up out of the ground. Anyone with a shovel or a gold pan could create money. In the days of barter, a monetary medium was created even more simply, through producing things others were happy to swap or credit.
While central banks might claim that they have the nation’s best democratic interests at heart, evidence shows that since the world exited the gold exchange standard in 1971 (thus giving banks a monopoly over the allocation of money and credit), bank assets as a percentage of GDP have exploded (this data is from the United Kingdom, but there is a similar pattern around the world).
Clearly, some pigs are more equal than others:
Giving banks a monopoly over the allocation of capital has dramatically enriched banking interests. It is also correlated with a dramatic fall in total factor productivity, and a dramatic increase in income inequality.
Very simply, I believe that the present system is inherently undemocratic. Giving banks a monopoly over the initial allocation of credit and money enriches the banks at the expense of society. Banks and bankers — who produce nothing — allocate resources to their interests. The rest of society — including all the productive sectors — get crumbs from the table. The market mechanism is perverted, and bent in favour of the financial system. The financial system can subsidise incompetence and ineptitude through bailouts and helicopter drops.
Such a system is unsustainable. The subsidisation of incompetence breeds more incompetence, and weakens the system, whether it is government handing off corporate welfare to inept corporations, or whether it is the central bank bailing out inept financial institutions. The financial system never learned the lessons of 2008; MF Global and the London Whale illustrate that. Printing money to save broken systems just makes these systems more fragile and prone to collapse. Ignoring the market mechanism, and the interests of the wider society to subsidise the financial sector and well-connected corporations just makes society angry and disaffected.
Our monopoly will eventually discredit itself through the subsidisation of graft and incompetence. It is just a matter of time.
azizonomics 
@Aziz “Anyone with a shovel or a gold pan could create money. In the days of barter, a monetary medium was created even more simply, through producing things others were happy to swap or credit.”
If it is printing money at <1% and handing to your banker mates, so they can buy assets at distressed prices, or stumbling across a massive gold reserve or even worse Or killing a race and shipping back to the homeland, it is still cheating people who have worked hard to earn their commodities.
Perhaps with our technological advances we can earn "Credits" based on what we actually produce. Real Economy.
The economy is actually becoming quite surreal. I believe we are in the end game period. When it resets or how, that is speculation.
Yes, we’re in an endgame. Or the beginning of an endgame.
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A lovely and concise summation of our dilemma. Thank you.
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http://cfapodcast.smartpros.com/web/live_events/Annual/Pettis/index.html
An excellent speech regarding China.
Have two thoughts:
1) Economic equilibrium is a dynamic state. Nothing new, yet many speakers seem stuck on numbers and equations. Yesterdays equation can be applied to today when nothing is constant especially during times of major instability. Explains why, as he points out, that economists underestimated the severity of the crisis in each bubble.
2) During the Q&A regarding the US sales of treasuries and closing of the deficit gap. What he states as unreasonable being that credibility is dependent on a growing current account deficit is not really unreasonable. That is the heart of Triffen’s dilemma. A national currency used as a reserve currency requires ever growing current account deficits, yet growing current account deficits hurt the credibility of the reserve currency. Not unreasonable, just unsustainable. However I do agree that the US does not require any other nation to purchase its bonds. That role is left to the FED and primary dealers.
It’s been awhile mate, how have you been?
Anyway, great post and great post on the fast and furious CNN commentator. I don’t know if it’s worse that people like that think they are real journalists or that many people actually agree with his comments.
My only question regarding this post is who should be in charge of regulating the monetary system?
Welcome back.
In an ideal world, I think the state should be in charge of regulating the monetary system. That’s regulating, not directing or planning. Regulating means “keep regular”; prosecute fraud, cheats, scammers. In an ideal world, the state would recognise competing currencies, and society would decide whether it prefers some kind of commodity money, or some kind of fiat. I imagine such a system would require a society far more educated on financial matters than they are today, but that is not unachievable. Financial crisis is good for financial education, and I see lots of prospective crises on the horizon.
We do not live in an ideal world. Nothing will change ’til the reset (that could be 1 or 20 years away, I don’t know when, but I know a rotten system when I see one). After that, who knows?
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“confirmation bias”
Hell no. I never started out looking for a vindication of the gold exchange standard years. I started out with the idea “shit 2008 was bad, how did we screw up so badly, and why are we just carrying on on the same path?”
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Excellent post!
“Printing money to save broken systems just makes these systems more fragile and prone to collapse.”
Spot on. Most people will never be convinced of this however. The average taxpayer doesn’t think past “more money – must be good”. So they favour what hurts them. Those who benefit from the printing have made unwitting friends of their natural enemies.
See http://www.insofisma.com/wp2/myth-we-can-pay-off-the-public-debt-by-printing-money/ for more on this.
Hence the term
“Gimme dat Obama Cash!”
And that is from an intoxicated banker.
The left often talks about the powerful tricking the ordinary people into acting against their own interests. They don’t seem to apply that critique to the financial system.
Are you serious about Krugman only reading Minsky’s works in 2009!
PLEASE DO A FULL LENGTH POST
Krugman is swimming naked.
Steve Keen already did this.
http://www.debtdeflation.com/blogs/2012/06/30/what-utter-self-serving-drivel-brad-delong/
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The origin of money is what everybody needs to understand. Since it is simply an abstraction of labor-value, it is this wizardry that allows all the fun and games to ensue.
If people understood this process, there would be no paper money, no central bankers, and, perhaps, no bankers what-so-ever. After all, if everybody controlled their labor, what would be their purpose be?
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