European Debt Crisis: Stop Pretending It's Capitalism's Fault


Einstein once said that insanity is doing the same thing over and over again and expecting different results. On Monday, the new meeting of the European Union's economic leadership,or so-called Troika, honored the great physicist and approved another round of financial aid for Greece, which raises the question: Why should there be any different outcome this time?

The growing narrative in Brussels suggests that the financial stress we have to endure today is nothing other than the inevitable consequence of massive deregulation. According to this line of argument, the free-market revolution fueled by the economic union allowed financial excess and encouraged irresponsible credit expansion across all member states, resulting in several unsustainable booms and bubbles.

All around Europe the political class is dancing to the same beat. The old discourse against unregulated markets and institutions has been sold in a very coherent and attractive way, making it quite appealing to the lay taxpayer. Therefore, stealing from their pockets is naively accepted as a necessary “solidarity” action, or else aliens will come and destroy the entire economic union.

Nothing could be farther from the truth. Any serious inquiry into the nature and causes of the sovereign-debt crisis will provide a very rich source of market interventions and soaring regulatory planning.

Be that as it may, the concrete proposal put forward by our good old Keynesian Nobel laureate is to step in and add even more sugar: “Aggressive monetary and fiscal intervention in the core,” inflating our sovereign debts away. The objective? Saving irresponsible member states who decided to scratch the backs of their fat crony friends in the private sector. The most harmful and regressive consequence of this interventionist Keynesian paradigm has been the rolling back of financial freedom throughout the union.

So allow me to share a dose of common sense into the pie. First of all, a fractional-reserve banking system where bailouts are implicitly guaranteed has allowed several institutions to privatize the profits and socialize the losses. Humankind has never witnessed any greater Ponzi scheme and moral hazard working together in one big melting pot. This deadly combination is clearly not the byproduct of unregulated markets.

The euro zone crisis cannot be understood as the consequence of free markets since, by definition, losses in a free-market system must always be accounted for. What we have in Europe instead is a socialist market system where the establishment draws upon “forced-solidarity” from the poor taxpayers to bailout financial friends in Spain, Portugal, Ireland, Cyprus, and even Germany. Socializing the losses is not free-market capitalism — it is a clear-cut all-around socialist scheme.

Second, a full-reserve banking system based on sound money will never trigger such rapid credit expansion as the one we witnessed all across EU member states. Why? This system would require banks to keep the full amount of depositors’ funds in cash. It goes without saying why such system would completely eradicate the financial risks associated with bank runs (something that has become quite common on the continent nowadays).

If we draw upon Mises’ praxeology, a full-reserve banking system should function as a natural “constraint” or framework for human action. Therefore, with such a sound banking system there is no need for more regulations and interventions from Brussels and the ECB.

In The Mystery of Banking, Austrian economist Murray Rothbard asserted that fractional-reserve banking is fraudulent and inflationary. In Money, Bank Credit and Economic Cycles Professor Huerta de Soto makes a very compelling case to describe why and how a fractional-reserve banking system mirrors a Ponzi scheme. If we dig deeper into the EU structure greasing the wheels for monetary (and fiscal) expansion, we will uncover a much larger-scale pattern which suggests that the euro zone crisis should rather be dissected as a Madoff-style scheme.



What I’m trying to say is that a full-reserve banking system should never be confused with more regulations, but rather be understood as part of an organic bottom-up process mirroring the tradition of the common law. In other words, if properly contrasted against a fractional-reserve human design, full-reserve banking should be dissected as the basic rules for a fair game and the baseline structure for a prosperous society based on responsible human action.

To conclude, a full-reserve banking system is not a move towards more regulation because banks would be free to do as they please, provided that they back any credit expansion with capital reserves. Full-reserve banking is a complete new paradigm that Brussels could really use to its advantage. 

Let us hope that the ongoing sovereign-debt crisis becomes the turning point in history that will allow some political elites to return to a system of sound money, where nobody is too big to fail and where everyone is free and responsible for their actions.