F.10 Would laissez-faire capitalism be stable?

Unsurprisingly, right-libertarians combine their support for "absolute property rights" with a whole-hearted support for laissez-faire capitalism. In such a system (which they maintain, to quote Ayn Rand, is an "unknown ideal") everything would be private property and there would be few (if any) restrictions on "voluntary exchanges." "Anarcho"-capitalists are the most extreme of defenders of pure capitalism, urging that the state itself be privatised and no voluntary exchange made illegal (for example, children would be considered the property of their parents and it would be morally right to turn them into child prostitutes -- the child has the option of leaving home if they object).

As there have been no example of "pure" capitalism it is difficult to say whether their claims about are true (for a discussion of a close approximation see the section F.10.3). This section of the FAQ is an attempt to discover whether such a system would be stable or whether it would be subject to the usual booms and slumps. Before starting we should note that there is some disagreement within the right-libertarian camp itself on this subject (although instead of stability they usually refer to "equilibrium" -- which is an economics term meaning that all of a societies resources are fully utilised).

In general terms, most right-Libertarians' reject the concept of equilibrium as such and instead stress that the economy is inherently a dynamic (this is a key aspect of the Austrian school of economics). Such a position is correct, of course, as such noted socialists as Karl Marx and Michal Kalecki and capitalist economists as Keynes recognised long ago. There seems to be two main schools of thought on the nature of disequilibrium. One, inspired by von Mises, maintains that the actions of the entrepreneur/capitalist results in the market co-ordinating supply and demand and another, inspired by Joseph Schumpeter, who question whether markets co-ordinate because entrepreneurs are constantly innovating and creating new markets, products and techniques.

Of course both actions happen and we suspect that the differences in the two approaches are not important. The important thing to remember is that "anarcho"-capitalists and right-libertarians in general reject the notion of equilibrium -- but when discussing their utopia they do not actually indicate this! For example, most "anarcho"-capitalists will maintain that the existence of government (and/or unions) causes unemployment by either stopping capitalists investing in new lines of industry or forcing up the price of labour above its market clearing level (by, perhaps, restricting immigration, minimum wages, taxing profits). Thus, we are assured, the worker will be better off in "pure" capitalism because of the unprecedented demand for labour it will create. However, full employment of labour is an equilibrium in economic terms and that, remember, is impossible due to the dynamic nature of the system. When pressed, they will usually admit there will be periods of unemployment as the market adjusts or that full unemployment actually means under a certain percentage of unemployment. Thus, if you (rightly) reject the notion of equilibrium you also reject the idea of full employment and so the labour market becomes a buyers market and labour is at a massive disadvantage.

The right-libertarian case is based upon logical deduction, and the premises required to show that laissez-faire will be stable are somewhat incredible. If banks do not set the wrong interest rate, if companies do not extend too much trade credit, if workers are willing to accept (real wage related) pay cuts, if workers altruistically do not abuse their market power in a fully employed society, if interest rates provide the correct information, if capitalists predict the future relatively well, if banks and companies do not suffer from isolation paradoxes, then, perhaps, laissez-faire will be stable.

So, will laissez-faire capitalism be stable? Let us see by analysing the assumptions of right-libertarianism -- namely that there will be full employment and that a system of private banks will stop the business cycle. We will start on the banking system first (in section F.10.1) followed by the effects of the labour market on economic stability (in section F.10.2). Then we will indicate, using the example of 19th century America, that actually existing ("impure") laissez-faire was very unstable.

Explaining booms and busts by state action plays an ideological convenience as it exonerates market processes as the source of instability within capitalism. We hope to indicate in the next two sections why the business cycle is inherent in the system (see also sections C.7, C.8 and C.9).

F.10.1 Would privatising banking make capitalism stable?

It is claimed that the existence of the state (or, for minimal statists, government policy) is the cause of the business cycle (recurring economic booms and slumps). This is because the government either sets interest rates too low or expands the money supply (usually by easing credit restrictions and lending rates, sometimes by just printing fiat money). This artificially increases investment as capitalists take advantage of the artificially low interest rates. The real balance between savings and investment is broken, leading to over-investment, a drop in the rate of profit and so a slump (which is quite socialist in a way, as many socialists also see over-investment as the key to understanding the business cycle, although they obviously attribute the slump to different causes -- namely the nature of capitalist production, not that the credit system does not play its part -- see section C.7).

In the words of Austrian Economist W. Duncan Reekie, "[t]he business cycle is generated by monetary expansion and contraction . . . When new money is printed it appears as if the supply of savings has increased. Interest rates fall and businessmen are misled into borrowing additional founds to finance extra investment activity . . . This would be of no consequence if it had been the outcome of [genuine saving] . . . -but the change was government induced. The new money reaches factor owners in the form of wages, rent and interest . . . the factor owners will then spend the higher money incomes in their existing consumption:investment proportions . . . Capital goods industries will find their expansion has been in error and malinvestments have been inoccured." [Markets, Entrepreneurs and Liberty, pp. 68-9]

In other words, there has been "wasteful mis-investment due to government interference with the market." [Op. Cit., p. 69] In response to this (negative) influence in the workings of the market, it is suggested by right-libertarians that a system of private banks should be used and that interest rates are set by them, via market forces. In this way an interest rate that matches the demand and supply for savings will be reached and the business cycle will be no more. By truly privatising the credit market, it is hoped by the business cycle will finally stop.

Unsurprisingly, this particular argument has its weak points and in this section of the FAQ we will try to show exactly why this theory is wrong.

Let us start with Reckie's starting point. He states that the "main problem" of the slump is "why is there suddenly a 'cluster' of business errors? Businessmen and entrepreneurs are market experts (otherwise they would not survive) and why should they all make mistakes simultaneously?" [Op. Cit., p. 68] It is this "cluster" of mistakes that the Austrians' take as evidence that the business cycle comes from outside the workings of the market (i.e. is exogenous in nature). Reekie argues that an "error cluster only occurs when all entrepreneurs have received the wrong signals on potential profitability, and all have received the signals simultaneously through government interference with the money supply." [Op. Cit., p. 74] But is this really the case?

The simple fact is that groups of (rational) individuals can act in the same way based on the same information and this can lead to a collective problem. For example, we do not consider it irrational that everyone in a building leaves it when the fire alarm goes off and that the flow of people can cause hold-ups at exits. Neither do we think that its unusual that traffic jams occur, after all those involved are all trying to get to work (i.e. they are reacting to the same desire). Now, is it so strange to think that capitalists who all see the same opportunity for profit in a specific market decide to invest in it? Or that the aggregate outcome of these individually rational decisions may be irrational (i.e. cause a glut in the market)?

In other words, a "cluster" of business failures may come about because a group of capitalists, acting in isolation, over-invest in a given market. They react to the same information (namely super profits in market X), arrange loans, invest and produce commodities to meet demand in that market. However, the aggregate result of these individually rational actions is that the aggregate supply far exceeds demand, causing a slump in that market and, perhaps, business failures. The slump in this market (and the potential failure of some firms) has an impact on the companies that supplied them, the companies that are dependent on their employees wages/demand, the banks that supplied the credit and so forth. The accumulative impact of this slump (or failures) on the chain of financial commitments of which they are but one link can be large and, perhaps, push an economy into general depression. Thus the claim that it is something external to the system that causes depression is flawed.

It could be claimed the interest rate is the problem, that it does not accurately reflect the demand for investment or relate it to the supply of savings. But, as we argued in section C.8, it is not at all clear that the interest rate provides the necessary information to capitalists. They need investment information for their specific industry, but the interest rate is cross-industry. Thus capitalists in market X do not know if the investment in market X is increasing and so this lack of information can easily cause "mal-investment" as over-investment (and so over-production) occurs. As they have no way of knowing what the investment decisions of their competitors are or now these decisions will affect an already unknown future, capitalists may over-invest in certain markets and the net effects of this aggregate mistake can expand throughout the whole economy and cause a general slump. In other words, a cluster of business failures can be accounted for by the workings of the market itself and not the (existence of) government.

This is one possible reason for an internally generated business cycle but that is not the only one. Another is the role of class struggle which we discuss in the next section and yet another is the endogenous nature of the money supply itself. This account of money (proposed strongly by, among others, the post-Keynesian school) argues that the money supply is a function of the demand for credit, which itself is a function of the level of economic activity. In other words, the banking system creates as much money as people need and any attempt to control that creation will cause economic problems and, perhaps, crisis (interestingly, this analysis has strong parallels with mutualist and individualist anarchist theories on the causes of capitalist exploitation and the business cycle). Money, in other words, emerges from within the system and so the right-libertarian attempt to "blame the state" is simply wrong.

Thus what is termed "credit money" (created by banks) is an essential part of capitalism and would exist without a system of central banks. This is because money is created from within the system, in response to the needs of capitalists. In a word, money is endogenous and credit money an essential part of capitalism.

Right-libertarians do not agree. Reekie argues that "[o]nce fractional reserve banking is introduced, however, the supply of money substitutes will include fiduciary media. The ingenuity of bankers, other financial intermediaries and the endorsement and guaranteeing of their activities by governments and central banks has ensured that the quantity of fiat money is immense." [Op. Cit., p. 73]

Therefore, what "anarcho"-capitalists and other right-libertarians seem to be actually complaining about when they argue that "state action" creates the business cycle by creating excess money is that the state allows bankers to meet the demand for credit by creating it. This makes sense, for the first fallacy of this sort of claim is how could the state force bankers to expand credit by loaning more money than they have savings. And this seems to be the normal case within capitalism -- the central banks accommodate bankers activity, they do not force them to do it. Alan Holmes, a senior vice president at the New York Federal Reserve, stated that:

"In the real world, banks extend credit, creating deposits in the process, and look for the reserves later. The question then becomes one of whether and how the Federal Reserve will accommodate the demand for reserves. In the very short run, the Federal Reserve has little or no choice about accommodating that demand, over time, its influence can obviously be felt." [quoted by Doug Henwood, Wall Street, p. 220]

It could be argued that because central banks exist, the state creates an "environment" which bankers take advantage off. By not being subject to "free market" pressures, bankers could be tempted to make more loans than they would otherwise in a "pure" capitalist system (i.e. create credit money). The question arises, would "pure" capitalism generate sufficient market controls to stop banks loaning in excess of available savings (i.e. eliminate the creation of credit money/fiduciary media).

It is to this question we now turn.

As noted above, the demand for credit is generated from within the system and the comments by Holmes reinforce this. Capitalists seek credit in order to make money and banks create it precisely because they are also seeking profit. What right-libertarians actually object to is the government (via the central bank) accommodating this creation of credit. If only the banks could be forced to maintain a savings to loans ration of one, then the business cycle would stop. But is this likely? Could market forces ensure that bankers pursue such a policy? We think not -- simply because the banks are profit making institutions. As post-Keynesianist Hyman Minsky argues, "[b]ecause bankers live in the same expectational climate as businessmen, profit-seeking bankers will find ways of accommodating their customers. . . Banks and bankers are not passive managers of money to lend or to invest; they are in business to maximise profits. . ." [quoted by L. Randall Wray, Money and Credit in Capitalist Economies, p. 85]

This is recognised by Reekie, in passing at least (he notes that "fiduciary media could still exist if bankers offered them and clients accepted them" [Op. Cit., p. 73]). Bankers will tend to try and accommodate their customers and earn as much money as possible. Thus Charles P. Kindleberger comments that monetary expansion "is systematic and endogenous rather than random and exogenous" seem to fit far better the reality of capitalism that the Austrian and right-libertarian viewpoint [Manias, Panics, and Crashes, p. 59] and post-Keynesian L. Randall Wray argues that "the money supply . . . is more obviously endogenous in the monetary systems which predate the development of a central bank." [Op. Cit., p. 150]

In other words, the money supply cannot be directly controlled by the central bank since it is determined by private decisions to enter into debt commitments to finance spending. Given that money is generated from within the system, can market forces ensure the non-expansion of credit (i.e. that the demand for loans equals the supply of savings)? To begin to answer this question we must note that investment is "essentially determined by expected profitability." [Philip Arestis, The Post-Keynesian Approach to Economics, p. 103] This means that the actions of the banks cannot be taken in isolation from the rest of the economy. Money, credit and banks are an essential part of the capitalist system and they cannot be artificially isolated from the expectations, pressures and influences of that system.

Let us assume that the banks desire to maintain a loans to savings ratio of one and try to adjust their interest rates accordingly. Firstly, changes in the rate of interest "produce only a very small, if any, movement in business investment" according to empirical evidence [Op. Cit., pp. 82-83] and that "the demand for credit is extremely inelastic with respect to interest rates." [L. Randall Wray, Op. Cit., p. 245] Thus, to keep the supply of savings in line with the demand for loans, interest rates would have to increase greatly (indeed, trying to control the money supply by controlling the monetary bases in this way will only lead to very big fluctuations in interest rates). And increasing interest rates has a couple of paradoxical effects.

According to economists Joseph Stiglitz and Andrew Weiss (in "Credit Rationing in Markets with Imperfect Knowledge", American Economic Review, no. 71, pp. 393-410) interest rates are subject to what is called the "lemons problem" (asymmetrical information between buyer and seller). Stiglitz and Weiss applied the "lemons problem" to the credit market and argued (and unknowingly repeated Adam Smith) that at a given interest rate, lenders will earn lower return by lending to bad borrowers (because of defaults) than to good ones. If lenders try to increase interest rates to compensate for this risk, they may chase away good borrowers, who are unwilling to pay a higher rate, while perversely not chasing away incompetent, criminal, or malignantly optimistic borrowers. This means that an increase in interest rates may actually increase the possibilities of crisis, as more loans may end up in the hands of defaulters.

This gives banks a strong incentive to keep interest rates lower than they otherwise could be. Moreover, "increases in interest rates make it more difficult for economic agents to meet their debt repayments" [Philip Arestis, Op. Cit., pp. 237-8] which means when interest rates are raised, defaults will increase and place pressures on the banking system. At high enough short-term interest rates, firms find it hard to pay their interest bills, which cause/increase cash flow problems and so "[s]harp increases in short term interest rates . . .leads to a fall in the present value of gross profits after taxes (quasi-rents) that capital assets are expected to earn." [Hyman Minsky, Post-Keynesian Economic Theory, p. 45]

In addition, "production of most investment goods is undertaken on order and requires time for completion. A rise in interest rates is not likely to cause firms to abandon projects in the process of production . . . This does not mean . . . that investment is completely unresponsive to interest rates. A large increase in interest rates causes a 'present value reversal', forcing the marginal efficiency of capital to fall below the interest rate. If the long term interest rate is also pushed above the marginal efficiency of capital, the project may be abandoned." [Wray, Op. Cit., pp. 172-3] In other words, investment takes time and there is a lag between investment decisions and actual fixed capital investment. So if interest rates vary during this lag period, initially profitable investments may become white elephants.

As Michal Kalecki argued, the rate of interest must be lower than the rate of profit otherwise investment becomes pointless. The incentive for a firm to own and operate capital is dependent on the prospective rate of profit on that capital relative to the rate of interest at which the firm can borrow at. The higher the interest rate, the less promising investment becomes.

If investment is unresponsive to all but very high interest rates (as we indicated above), then a privatised banking system will be under intense pressure to keep rates low enough to maintain a boom (by, perhaps, creating credit above the amount available as savings). And if it does this, over-investment and crisis is the eventual outcome. If it does not do this and increases interest rates then consumption and investment will dry up as interest rates rise and the defaulters (honest and dishonest) increase and a crisis will eventually occur.

This is because increasing interest rates may increase savings but it also reduce consumption ("high interest rates also deter both consumers and companies from spending, so that the domestic economy is weakened and unemployment rises" [Paul Ormerod, The Death of Economics, p. 70]). This means that firms can face a drop off in demand, causing them problems and (perhaps) leading to a lack of profits, debt repayment problems and failure. An increase in interest rates also reduces demand for investment goods, which also can cause firms problems, increase unemployment and so on. So an increase in interest rates (particularly a sharp rise) could reduce consumption and investment (i.e. reduce aggregate demand) and have a ripple effect throughout the economy which could cause a slump to occur.

In other words, interest rates and the supply and demand of savings/loans they are meant to reflect may not necessarily move an economy towards equilibrium (if such a concept is useful). Indeed, the workings of a "pure" banking system without credit money may increase unemployment as demand falls in both investment and consumption in response to high interest rates and a general shortage of money due to lack of (credit) money resulting from the "tight" money regime implied by such a regime (i.e. the business cycle would still exist). This was the case of the failed Monetarist experiments on the early 1980s when central banks in America and Britain tried to pursue a "tight" money policy. The "tight" money policy did not, in fact, control the money supply. All it did do was increase interest rates and lead to a serious financial crisis and a deep recession (as Wray notes, "the central bank uses tight money polices to raise interest rates" [Op. Cit., p. 262]). This recession, we must note, also broke the backbone of working class resistance and the unions in both countries due to the high levels of unemployment it generated. As intended, we are sure.

Such an outcome would not surprise anarchists, as this was a key feature of the Individualist and Mutualist Anarchists' arguments against the "money monopoly" associated with specie money. They argued that the "money monopoly" created a "tight" money regime which reduced the demand for labour by restricting money and credit and so allowed the exploitation of labour (i.e. encouraged wage labour) and stopped the development of non-capitalist forms of production. Thus Lysander Spooner's comments that workers need "money capital to enable them to buy the raw materials upon which to bestow their labour, the implements and machinery with which to labour . . . Unless they get this capital, they must all either work at a disadvantage, or not work at all. A very large portion of them, to save themselves from starvation, have no alternative but to sell their labour to others . . ." [A Letter to Grover Cleveland, p. 39] It is interesting to note that workers did do well during the 1950s and 1960s under a "liberal" money regime than they did under the "tighter" regimes of the 1980s and 1990s.

We should also note that an extended period of boom will encourage banks to make loans more freely. According to Minsky's "financial instability model" crisis (see "The Financial Instability Hypothesis" in Post-Keynesian Economic Theory for example) is essentially caused by risky financial practices during periods of financial tranquillity. In other words, "stability is destabilising." In a period of boom, banks are happy and the increased profits from companies are flowing into their vaults. Over time, bankers note that they can use a reserve system to increase their income and, due to the general upward swing of the economy, consider it safe to do so (and given that they are in competition with other banks, they may provide loans simply because they are afraid of losing customers to more flexible competitors). This increases the instability within the system (as firms increase their debts due to the flexibility of the banks) and produces the possibility of crisis if interest rates are increased (because the ability of business to fulfil their financial commitments embedded in debts deteriorates).

Even if we assume that interest rates do work as predicted in theory, it is false to maintain that there is one interest rate. This is not the case. "Concentration of capital leads to unequal access to investment funds, which obstructs further the possibility of smooth transitions in industrial activity. Because of their past record of profitability, large enterprises have higher credit ratings and easier access to credit facilities, and they are able to put up larger collateral for a loan." [Michael A. Bernstein, The Great Depression, p. 106] As we noted in section C.5.1, the larger the firm, the lower the interest rate they have to pay. Thus banks routinely lower their interest rates to their best clients even though the future is uncertain and past performance cannot and does not indicate future returns. Therefore it seems a bit strange to maintain that the interest rate will bring savings and loans into line if there are different rates being offered.

And, of course, private banks cannot affect the underlying fundamentals that drive the economy -- like productivity, working class power and political stability -- any more than central banks (although central banks can influence the speed and gentleness of adjustment to a crisis).

Indeed, given a period of full employment a system of private banks may actually speed up the coming of a slump. As we argue in the next section, full employment results in a profits squeeze as firms face a tight labour market (which drives up costs) and, therefore, increased workers' power at the point of production and in their power of exit. In a central bank system, capitalists can pass on these increasing costs to consumers and so maintain their profit margins for longer. This option is restricted in a private banking system as banks would be less inclined to devalue their money. This means that firms will face a profits squeeze sooner rather than later, which will cause a slump as firms cannot make ends meet. As Reekie notes, inflation "can temporarily reduce employment by postponing the time when misdirected labour will be laid off" but as Austrian's (like Monetarists) think "inflation is a monetary phenomenon" he does not understand the real causes of inflation and what they imply for a "pure" capitalist system [Op. Cit., p. 67, p. 74]. As Paul Ormerod points out "the claim that inflation is always and everywhere purely caused by increases in the money supply, and that there the rate of inflation bears a stable, predictable relationship to increases in the money supply is ridiculous." And he notes that "[i]ncreases in the rate of inflation tend to be linked to falls in unemployment, and vice versa" which indicates its real causes -- namely in the balance of class power and in the class struggle. [The Death of Economics, p. 96, p. 131]

Moreover, if we do take the Austrian theory of the business cycle at face value we are drawn to conclusion that in order to finance investment savings must be increased. But to maintain or increase the stock of loanable savings, inequality must be increased. This is because, unsurprisingly, rich people save a larger proportion of their income than poor people and the proportion of profits saved are higher than the proportion of wages. But increasing inequality (as we argued in section F.3.1) makes a mockery of right-libertarian claims that their system is based on freedom or justice.

This means that the preferred banking system of "anarcho"-capitalism implies increasing, not decreasing, inequality within society. Moreover, most firms (as we indicated in section C.5.1) fund their investments with their own savings which would make it hard for banks to loan these savings out as they could be withdrawn at any time. This could have serious implications for the economy, as banks refuse to fund new investment simply because of the uncertainty they face when accessing if their available savings can be loaned to others (after all, they can hardly loan out the savings of a customer who is likely to demand them at any time). And by refusing to fund new investment, a boom could falter and turn to slump as firms do not find the necessary orders to keep going.

So, would market forces create "sound banking"? The answer is probably not. The pressures on banks to make profits come into conflict with the need to maintain their savings to loans ration (and so the confidence of their customers). As Wray argues, "as banks are profit seeking firms, they find ways to increase their liabilities which don't entail increases in reserve requirements" and "[i]f banks share the profit expectations of prospective borrowers, they can create credit to allow [projects/investments] to proceed." [Op. Cit., p. 295, p. 283] This can be seen from the historical record. As Kindleberger notes, "the market will create new forms of money in periods of boom to get around the limit" imposed on the money supply [Op. Cit., p. 63]. Trade credit is one way, for example. Under the Monetarist experiments of 1980s, there was "deregulation and central bank constraints raised interest rates and created a moral hazard -- banks made increasingly risky loans to cover rising costs of issuing liabilities. Rising competition from nonbanks and tight money policy forced banks to lower standards and increase rates of growth in an attempt to 'grow their way to profitability'" [Op. Cit., p. 293]

Thus credit money ("fiduciary media") is an attempt to overcome the scarcity of money within capitalism, particularly the scarcity of specie money. The pressures that banks face within "actually existing" capitalism would still be faced under "pure" capitalism. It is likely (as Reekie acknowledges) that credit money would still be created in response to the demands of business people (although not at the same level as is currently the case, we imagine). The banks, seeking profits themselves and in competition for customers, would be caught between maintaining the value of their business (i.e. their money) and the needs to maximise profits. As a boom develops, banks would be tempted to introduce credit money to maintain it as increasing the interest rate would be difficult and potentially dangerous (for reasons we noted above). Thus, if credit money is not forth coming (i.e. the banks stick to the Austrian claims that loans must equal savings) then the rise in interest rates required will generate a slump. If it is forthcoming, then the danger of over-investment becomes increasingly likely. All in all, the business cycle is part of capitalism and not caused by "external" factors like the existence of government.

As Reekie notes, to Austrians "ignorance of the future is endemic" [Op. Cit., p. 117] but you would be forgiven for thinking that this is not the case when it comes to investment. An individual firm cannot know whether its investment project will generate the stream of returns necessary to meet the stream of payment commitments undertaken to finance the project. And neither can the banks who fund those projects. Even if a bank does not get tempted into providing credit money in excess of savings, it cannot predict whether other banks will do the same or whether the projects it funds will be successful. Firms, looking for credit, may turn to more flexible competitors (who practice reserve banking to some degree) and the inflexible bank may see its market share and profits decrease. After all, commercial banks "typically establish relations with customers to reduce the uncertainty involved in making loans. Once a bank has entered into a relationship with a customer, it has strong incentives to meet the demands of that customer." [Wray, Op. Cit., p. 85]

There are example of fully privatised banks. For example, in the United States "which was without a central bank after 1837" "the major banks in New York were in a bind between their roles as profit seekers, which made them contributors to the instability of credit, and as possessors of country deposits against whose instability they had to guard." [Kindleberger, Op. Cit., p. 85]

In Scotland, the banks were unregulated between 1772 and 1845 but "the leading commercial banks accumulated the notes of lessor ones, as the Second Bank of the United States did contemporaneously in [the USA], ready to convert them to specie if they thought they were getting out of line. They served, that is, as an informal controller of the money supply. For the rest, as so often, historical evidence runs against strong theory, as demonstrated by the country banks in England from 1745 to 1835, wildcat banking in Michigan in the 1830s, and the latest experience with bank deregulation in Latin America." [Op. Cit., p. 82] And we should note there were a few banking "wars" during the period of deregulation in Scotland which forced a few of the smaller banks to fail as the bigger ones refused their money and that there was a major bank failure in the Ayr Bank.

Kendleberger argues that central banking "arose to impose control on the instability of credit" and did not cause the instability which right-libertarians maintain it does. And as we note in section F.10.3, the USA suffered massive economic instability during its period without central banking. Thus, if credit money is the cause of the business cycle, it is likely that a "pure" capitalism will still suffer from it just as much as "actually existing" capitalism (either due to high interest rates or over-investment).

In general, as the failed Monetarist experiments of the 1980s prove, trying to control the money supply is impossible. The demand for money is dependent on the needs of the economy and any attempt to control it will fail (and cause a deep depression, usually via high interest rates). The business cycle, therefore, is an endogenous phenomenon caused by the normal functioning of the capitalist economic system. Austrian and right-libertarian claims that "slump flows boom, but for a totally unnecessary reason: government inspired mal-investment" [Reekie, Op. Cit., p. 74] are simply wrong. Over-investment does occur, but it is not "inspired" by the government. It is "inspired" by the banks need to make profits from loans and from businesses need for investment funds which the banks accommodate. In other words, by the nature of the capitalist system.

F.10.2 How does the labour market effect capitalism?

But under full employment this changes. As we argued in section B.4.4 and section C.7, in such a situation it is the bosses who have to start compromising. And they do not like it. As Schor notes, America "has never experienced a sustained period of full employment. The closest we have gotten is the late 1960s, when the overall unemployment rate was under 4 percent for four years. But that experience does more to prove the point than any other example. The trauma caused to business by those years of a tight labour market was considerable. Since then, there has been a powerful consensus that the nation cannot withstand such a low rate of unemployment." [Op. Cit., pp. 75-76]

So, in other words, full employment is not good for the capitalist system due to the power full employment provides workers. Thus unemployment is a necessary requirement for a successful capitalist economy and not some kind of aberration in an otherwise healthy system. Thus "anarcho"-capitalist claims that "pure" capitalism will soon result in permanent full employment are false. Any moves towards full employment will result in a slump as capitalists see their profits squeezed from below by either collective class struggle or by individual mobility in the labour market.

This was recognised by Individualist Anarchists like Benjamin Tucker, who argued that mutual banking would "give an unheard of impetus to business, and consequently create an unprecedented demand for labour, -- a demand which would always be in excess of the supply, directly contrary of the present condition of the labour market." [The Anarchist Reader, pp. 149-150] In other words, full employment would end capitalist exploitation, drive non-labour income to zero and ensure the worker the full value of her labour -- in other words, end capitalism. Thus, for most (if not all) anarchists the exploitation of labour is only possible when unemployment exists and the supply of labour exceeds the demand for it. Any move towards unemployment will result in a profits squeeze and either the end of capitalism or an economic slump.

Indeed, as we argued in the last section, the extended periods of (approximately) full employment until the 1960s had the advantage that any profit squeeze could (in the short run anyway) be passed onto working class people in the shape of inflation. As prices rise, labour is made cheaper and profits margins supported. This option is restricted under a "pure" capitalism (for reasons we discussed in the last section) and so "pure" capitalism will be affected by full employment faster than "impure" capitalism.

As an economy approaches full employment, "hiring new workers suddenly becomes much more difficult. They are harder to find, cost more, and are less experiences. Such shortages are extremely costly for a firm." [Schor, Op. Cit., p. 75] This encourages a firm to pass on these rises to society in the form of price rises, so creating inflation. Workers, in turn, try to maintain their standard of living. "Every general increase in labour costs in recent years," note J. Brecher and J. Costello in the late 1970s, "has followed, rather than preceded, an increase in consumer prices. Wage increases have been the result of workers' efforts to catch up after their incomes have already been eroded by inflation. Nor could it easily be otherwise. All a businessman has to do to raise a price . . . [is to] make an announcement. . . Wage rates . . . are primarily determined by contracts" and so cannot be easily adjusted in the short term. [Common Sense for Bad Times, p, 120]

These full employment pressures will still exist with "pure" capitalism (and due to the nature of the banking system will not have the safety value of inflation). This means that periodic profit squeezes will occur, due to the nature of a tight labour market and the increased power of workers this generates. This in turn means that a "pure" capitalism will be subject to periods of unemployment (as we argued in section C.9) and so still have a business cycle. This is usually acknowledged by right-libertarians in passing, although they seem to think that this is purely a "short-term" problem (it seems a strange "short-term" problem that continually occurs).

But such an analysis is denied by right-libertarians. For them government action, combined with the habit of many labour unions to obtain higher than market wage rates for their members, creates and exacerbates mass unemployment. This flows from the deductive logic of much capitalist economics. The basic assumption of capitalism is that markets clear. So if unemployment exists then it can only be because the price of labour (wages) is too high (Austrian Economist W. Duncan Reekie argues that unemployment will "disappear provided real wages are not artificially high" [Markets, Entrepreneurs and Liberty, p. 72]).

Thus the assumption provokes the conclusion -- unemployment is caused by an unclearing market as markets always clear. And the cause for this is either the state or unions. But what if the labour market cannot clear without seriously damaging the power and profits of capitalists? What if unemployment is required to maximise profits by weakening labours' bargaining position on the market and so maximising the capitalists power? In that case unemployment is caused by capitalism, not by forces external to it.

However, let us assume that the right-libertarian theory is correct. Let us assume that unemployment is all the fault of the selfish unions and that a job-seeker "who does not want to wait will always get a job in the unhampered market economy." [von Mises, Human Action, p. 595]

Would crushing the unions reduce unemployment? Let us assume that the unions have been crushed and government has been abolished (or, at the very least, become a minimum state). The aim of the capitalist class is to maximise their profits and to do this they invest in labour saving machinery and otherwise attempt to increase productivity. But increasing productivity means that the prices of goods fall and falling prices mean increasing real wages. It is high real wages that, according to right-libertarians, that cause unemployment. So as a reward for increasing productivity, workers will have to have their money wages cut in order to stop unemployment occurring! For this reason some employers might refrain from cutting wages in order to avoid damage to morale - potentially an important concern.

Moreover, wage contracts involve time -- a contract will usually agree a certain wage for a certain period. This builds in rigidity into the market, wages cannot be adjusted as quickly as other commodity prices. Of course, it could be argued that reducing the period of the contract and/or allowing the wage to be adjusted could overcome this problem. However, if we reduce the period of the contract then workers are at a suffer disadvantage as they will not know if they have a job tomorrow and so they will not be able to easily plan their future (an evil situation for anyone to be in). Moreover, even without formal contracts, wage renegotiation can be expensive. After all, it takes time to bargain (and time is money under capitalism) and wage cutting can involve the risk of the loss of mutual good will between employer and employee. And would you give your boss the power to "adjust" your wages as he/she thought was necessary? To do so would imply an altruistic trust in others not to abuse their power.

Thus a "pure" capitalism would be constantly seeing employment increase and decrease as productivity levels change. There exist important reasons why the labour market need not clear which revolve around the avoidance/delaying of wage cuts by the actions of capitalists themselves. Thus, given a choice between cutting wages for all workers and laying off some workers without cutting the wages of the remaining employees, it is unsurprising that capitalists usually go for the later. After all, the sack is an important disciplining device and firing workers can make the remaining employees more inclined to work harder and be more obedient.

And, of course, many employers are not inclined to hire over-qualified workers. This is because, once the economy picks up again, their worker has a tendency to move elsewhere and so it can cost them time and money finding a replacement and training them. This means that involuntary unemployment can easily occur, so reducing tendencies towards full employment even more. In addition, one of the assumptions of the standard marginalist economic model is one of decreasing returns to scale. This means that as employment increases, costs rise and so prices also rise (and so real wages fall). But in reality many industries have increasing returns to scale, which means that as production increases unit costs fall, prices fall and so real wages rise. Thus in such an economy unemployment would increase simply because of the nature of the production process!

Moreover, as we argued in-depth in section C.9, a cut in money wages is not a neutral act. A cut in money wages means a reduction in demand for certain industries, which may have to reduce the wages of its employees (or fire them) to make ends meet. This could produce a accumulative effect and actually increase unemployment rather than reduce it.

In addition, there are no "self-correcting" forces at work in the labour market which will quickly bring employment back to full levels. This is for a few reasons. Firstly, the supply of labour cannot be reduced by cutting back production as in other markets. All we can do is move to other areas and hope to find work there. Secondly, the supply of labour can sometimes adjust to wage decreases in the wrong direction. Low wages might drive workers to offer a greater amount of labour (i.e. longer hours) to make up for any short fall (or to keep their job). This is usually termed the "efficiency wage" effect. Similarly, another family member may seek employment in order to maintain a given standard of living. Falling wages may cause the number of workers seeking employment to increase, causing a full further fall in wages and so on (and this is ignoring the effects of lowering wages on demand discussed in section C.9).

The paradox of piece work is an important example of this effect. As Schor argues, "piece-rate workers were caught in a viscous downward spiral of poverty and overwork. . . When rates were low, they found themselves compelled to make up in extra output what they were losing on each piece. But the extra output produced glutted the market and drove rates down further." [Juliet C. Schor, The Overworked American, p, 58]

Thus, in the face of reducing wages, the labour market may see an accumulative move away from (rather than towards) full employment, The right-libertarian argument is that unemployment is caused by real wages being too high which in turn flows from the assumption that markets clear. If there is unemployment, then the price of the commodity labour is too high -- otherwise supply and demand would meet and the market clear. But if, as we argued above, unemployment is essential to discipline workers then the labour market cannot clear except for short periods. If the labour market clears, profits are squeezed. Thus the claim that unemployment is caused by "too high" real wages is false (and as we argue in section C.9, cutting these wages will result in deepening any slump and making recovery longer to come about).

In other words, the assumption that the labour market must clear is false, as is any assumption that reducing wages will tend to push the economy quickly back to full employment. The nature of wage labour and the "commodity" being sold (i.e. human labour/time/liberty) ensure that it can never be the same as others. This has important implications for economic theory and the claims of right-libertarians, implications that they fail to see due to their vision of labour as a commodity like any other.

The question arises, of course, of whether, during periods of full employment, workers could not take advantage of their market power and gain increased workers' control, create co-operatives and so reform away capitalism. This was the argument of the Mutualist and Individualist anarchists and it does have its merits. However, it is clear (see section J.5.12) that bosses hate to have their authority reduced and so combat workers' control whenever they can. The logic is simple, if workers increase their control within the workplace the manager and bosses may soon be out of a job and (more importantly) they may start to control the allocation of profits. Any increase in working class militancy may provoke capitalists to stop/reduce investment and credit and so create the economic environment (i.e. increasing unemployment) necessary to undercut working class power.

In other words, a period of full unemployment is not sufficient to reform capitalism away. Full employment (nevermind any struggle over workers' control) will reduce profits and if profits are reduced then firms find it hard to repay debts, fund investment and provide profits for shareholders. This profits squeeze would be enough to force capitalism into a slump and any attempts at gaining workers' self-management in periods of high employment will help push it over the edge (after all, workers' control without control over the allocation of any surplus is distinctly phoney). Moreover, even if we ignore the effects of full employment may not last due to problems associated with over-investment (see section C.7.2), credit and interest rate problems (see section F.10.1) and realisation/aggregate demand disjoints. Full employment adds to the problems associated with the capitalist business cycle and so, if class struggle and workers power did not exist or cost problem, capitalism would still not be stable.

If equilibrium is a myth, then so is full employment. It seems somewhat ironic that "anarcho"-capitalists and other right-libertarians maintain that there will be equilibrium (full employment) in the one market within capitalism it can never actually exist in! This is usually quietly acknowledged by most right-libertarians, who mention in passing that some "temporary" unemployment will exist in their system -- but "temporary" unemployment is not full employment. Of course, you could maintain that all unemployment is "voluntary" and get round the problem by denying it, but that will not get us very far.

So it is all fine and well saying that "libertarian" capitalism would be based upon the maxim "From each as they choose, to each as they are chosen." [Robert Nozick, Anarchy, State, and Utopia, p. 160] But if the labour market is such that workers have little option about what they "choose" to give and fear that they will not be chosen, then they are at a disadvantage when compared to their bosses and so "consent" to being treated as a resource from the capitalist can make a profit from. And so this will result in any "free" contract on the labour market favouring one party at the expense of the other -- as can be seen from "actually existing capitalism".

Thus any "free exchange" on the labour market will usually not reflect the true desires of working people (and who will make all the "adjusting" and end up wanting what they get). Only when the economy is approaching full employment will the labour market start to reflect the true desires of working people and their wage start to approach its full product. And when this happens, profits are squeezed and capitalism goes into slump and the resulting unemployment disciplines the working class and restores profit margins. Thus full employment will be the exception rather than the rule within capitalism (and that is a conclusion which the historical record indicates).

In other words, in a normally working capitalist economy any labour contracts will not create relationships based upon freedom due to the inequalities in power between workers and capitalists. Instead, any contracts will be based upon domination, not freedom. Which prompts the question, how is libertarian capitalism libertarian if it erodes the liberty of a large class of people?

F.10.3 Was laissez-faire capitalism stable?

Yes, we are well aware that 19th century USA was far from laissez-faire -- there was a state, protectionism, government economic activity and so on -- but as this example has been often used by right-Libertarians' themselves (for example, Ayn Rand) we think that we can gain a lot from looking at this imperfect approximation of "pure" capitalism (and as we argued in section F.8, it is the "quasi" aspects of the system that counted in industrialisation, not the laissez-faire ones).

So, was 19th century America stable? No, it most definitely was not.

Firstly, throughout that century there were a continual economic booms and slumps. The last third of the 19th century (often considered as a heyday of private enterprise) was a period of profound instability and anxiety. Between 1867 and 1900 there were 8 complete business cycles. Over these 396 months, the economy expanded during 199 months and contracted during 197. Hardly a sign of great stability (since the end of world war II, only about a fifth of the time has spent in periods of recession or depression, by way of comparison). Overall, the economy went into a slump, panic or crisis in 1807, 1817, 1828, 1834, 1837, 1854, 1857, 1873, 1882, and 1893 (in addition, 1903 and 1907 were also crisis years).

Part of this instability came from the eras banking system. "Lack of a central banking system," writes Richard Du Boff, "until the Federal Reserve act of 1913 made financial panics worse and business cycle swings more severe" [Accumulation and Power, p. 177] It was in response to this instability that the Federal Reserve system was created; and as Doug Henwood notes "the campaign for a more rational system of money and credit was not a movement of Wall Street vs. industry or regional finance, but a broad movement of elite bankers and the managers of the new corporations as well as academics and business journalists. The emergence of the Fed was the culmination of attempts to define a standard of value that began in the 1890s with the emergence of the modern professionally managed corporation owned not by its managers but dispersed public shareholders." [Wall Street, p. 93] Indeed, the Bank of England was often forced to act as lender of last resort to the US, which had no central bank.

In the decentralised banking system of the 19th century, during panics thousands of banks would hoard resources, so starving the system for liquidity precisely at the moment it was most badly needed. The creation of trusts was one way in which capitalists tried to manage the system's instabilities (at the expense of consumers) and the corporation was a response to the outlawing of trusts. "By internalising lots of the competitive system's gaps -- by bring more transactions within the same institutional walls -- corporations greatly stabilised the economy." [Henwood, Op. Cit., p. 94]

All during the hey-day of laissez faire we also find popular protests against the money system used, namely specie (in particular gold), which was considered as a hindrance to economic activity and expansion (as well as being a tool for the rich). The Individualist Anarchists, for example, considered the money monopoly (which included the use of specie as money) as the means by which capitalists ensured that "the labourers . . . [are] kept in the condition of wage labourers," and reduced "to the conditions of servants; and subject to all such extortions as their employers . . . may choose to practice upon them", indeed they became the "mere tools and machines in the hands of their employers". With the end of this monopoly, "[t]he amount of money, capable of being furnished . . . [would assure that all would] be under no necessity to act as a servant, or sell his or her labour to others." [Lysander Spooner, A Letter to Grover Cleveland, p. 47, p. 39, p. 50, p. 41] In other words, a specie based system (as desired by many "anarcho"-capitalists) was considered a key way of maintaining wage labour and exploitation.

Interestingly, since the end of the era of the Gold Standard (and so commodity money) popular debate, protest and concern about money has disappeared. The debate and protest was in response to the effects of commodity money on the economy -- with many people correctly viewing the seriously restrictive monetary regime of the time responsible for economic problems and crisis as well as increasing inequalities. Instead radicals across the political spectrum urged a more flexible regime, one that did not cause wage slavery and crisis by reducing the amount of money in circulation when it could be used to expand production and reduce the impact of slumps. Needless to say, the Federal Reserve system in the USA was far from the institution these populists wanted (after all, it is run by and for the elite interests who desired its creation).

That the laissez-faire system was so volatile and panic-ridden suggests that "anarcho"-capitalist dreams of privatising everything, including banking, and everything will be fine are very optimistic at best (and, ironically, it was members of the capitalist class who lead the movement towards state-managed capitalism in the name of "sound money").