The Common Courtesy
It is common courtesy to blame the market economy for every economic “downturn” or shall we call it “depression” as a more accurate description of this economic phenomenon. The free market in the current almost two years long Economic depression in Lebanon (Started by late 2019), preceded by a couple of years of economic stagnation (2017–2018), was not spared from such accusations. According to almost all economic schools of thought, the Business Cycle (Boom & Bust) is caused by the lack of government and must be regulated by government intervention. The most notable school to adopt such view, which is followed widely by the global economy and almost all big nation states, is the Keynesian School. The Keynesian Business Cycle suggests that during a boom we will have inflation caused by excessive spending by the public, thus it shall be fixed by an increase in taxation. While during a recession we will have deflation caused by lack of spending by the public, thus the cure is for the government to increase spending, through debt and deficit. Moreover, the idea that market economies breed the business cycle is Marxian in origin. According to Karl Marx, business cycles did not exist before the industrial revolution, there was no consistent boom and busts back then, depressions only happened because of a certain war or deliberate impoverishment by kings and queens who use violence to seize people’s resources. Hence, the Marxian conclusion, which is arguably naïve, suggests that the Business Cycle is an inherent feature of the capitalist market economy. The depression phase will not cease to exist and will only get worse unless the people revolt and seek a change of system.
In defence of the Market Economy
In his book “America’s Great Depression” the great Austrian Economist Murray Rothbard did not attempt to refute Marx’s conclusion regarding the market economy breeding business cycles, rather he made the case that booms & busts go unnoticed in a purely free market. He did so by comparing the 1921 unnoticed market correction and 1929’s Great Depression, which was caused by endless intervention to prolong the boom and stimulate the economy. The more the boom got prolonged using the so called “Keynesian tools” by modern economists, which is just another word for money printing and coercion, the more severe the bust ought to be.
The first and foremost dismissed argument to refute accusations against the free market being the exacerbator of the business cycle is that free markets play according to the rules of supply and demand. When you have such rules in place, the market can always find equilibrium of prices of production and consumption goods. This is the general economic theory. Moreover, market economies rely on the entrepreneur to perform business calculation and prediction. The entrepreneur who does a good job at predicting the market and serving the economy properly is rewarded with profit. The entrepreneur who is unable to properly predict the market will be punished with non-profitability and if they persist on missing the bullseye, they will eventually get weeded out of the market and replaced by another entrepreneur who is capable of serving and producing better. Thus, one can conclude that in a market economy, errors (malinvestments) can happen, but will only happen at the levels of the individual entrepreneur and such errors are actually healthy for the market as the participants seek development (better services & products). They are also an opportunity for the said participants to enter the industry through the doors of innovation and efficiency/efficacy (Better calculation).
If malinvestments materialize only on the individual level and are replaced by better economically calculated investments, then how come we see a cluster of malinvestments that take shape during the boom phase and lead to the bust phase? This is simply due to the government intervention in the market as it wrecks all the signals an entrepreneur relies on to perform economic calculation.
Monetary Expansion
The first government tool of intervention that leads to the disruption of market signals that serve as a guide for entrepreneurs to perform calculation, is monetary expansion. When the money supply in the economy is based on a specific predetermined rate of inflation (or elastic rate), entrepreneurs can price their goods and services accordingly and account for potential gains and losses. When a sudden and unaccounted for shift in the monetary policy takes place, which leads to higher rates of inflation, pricing models get disrupted and realized gains or losses become over or under stated in the accounting books of the entrepreneur. Moreover, the Cantillon effect takes its toll as the first receivers of the newly created money gain an edge over their competitors in the market and might eventually throw them out of the industry in which they operate. Hence when all entrepreneurs in the market are left to face this unexpected event caused by the market interventionist, a big chunk of them might face disturbance which will lead to a grand scale of malinvestment, or a “cluster of errors”.
Interest Rate Manipulation
The second tool used by the government to mediate with the market economy is manipulating interest rates. Interest rates must be purely set based on the time preference of the economic individuals in the market. When the overall time preference of the participants is low, people tend to save more, but as the interest rates go up to attract those savers, they will eventually drop, which could mean a signal for entrepreneurs that there is excess money saved by the market. From such signal they can conclude that investments become a possibility and more affordable in the light of the market reaching lower levels than usual interest rates. On the other hand, In an interventionist economy this is not the case. Interest rates are manipulated for the main purpose to perform a dogmatic alteration over people’s choices in the market. Whenever the market reaches a stage of stagnation during a deflationary period, the central bank lowers interest rates to push the market to invest and consume more but save less. When interest rates are low, entrepreneurs seek out loans thinking that there is excess of money in the economy saved by the public, but in reality, this money was created out of thin air in order to achieve the said low interest rates. This newly created money is supposedly paid back in the future through taxation, other means of resource confiscation (including war) or even more debt if that was still a possibility. When this event takes place, and as the most important economic calculation signal no longer serves as a signal, a big number of those entrepreneurs will engage in malinvestments and thus we will have yet another cluster of errors. The depression phase is the time when the said errors are getting liquidated in the market.
Another instance of cluster of errors is when the interventionists do the opposite. When they artificially increase interest rates. Governments also increase interest rates by issuing high interest rates government bonds to the “public”. When buying the said bonds, lending institutions like banks, increase their assets on the balance sheet, on that account they are capable of increasing liabilities by attracting deposits through increased interest rates. Why is this type of interest rate fake? Because government is not a real producer of goods and services in the market. When government takes on loans from the public, they usually spend it as redistribution of wealth and not creation of it. Eventually unproductive governments will either default on the debt or resort to the printing press to pay it back. Through this interventionist tool, the government is altering people’s decisions and pushing them towards the illusion of saving. Moreover, the cluster of “errors” gets reduced to the one and only error, which is the government defaulting.
Business Cycle, Lebanon
So far, we established how a central authority who has a monopoly over money issuance can use some sneaky tools to plan the economy and lead it to the Business cycle. The exacerbated Business cycle is not an inherent feature of capitalism as Marx likes to portray, it is not the product of Laissez-Faire as John Maynard Keynes struggled to explain. Business cycle is a problem of cluster of errors that could only be remotely possible under a planned economy, and this is exactly what the Lebanese economy has been operating on for the last 30 years.
Back in March 2020, Lebanon announced default on their $1.2 Billion of Eurobonds, but this is not even considered the biggest chunk of debt taken up and consumed by the government. The only reason this default happened is because the central bank is not a producer of foreign currency ($), the rest of the Lebanese debt is local and denominated in LBP. Lebanese commercial banks would buy high interest rate bonds from the central bank, who in turn would give this free money to the government to spend the way it sees fits at the rate of LBP1515/USD, an artificially pegged rate, with a fractional legal reserve. Commercial banks saw the government as a hefty customer, who had a pretty good record of 30 years to pay back their dues, so getting into this deal allowed them to set highly competitive interest rates on deposits and attract the supposedly “savers” who saw no purpose in investing their money in any place other than something like a 15% deposit at a commercial bank in a country that has a high credit rating at the Standard & Poor and Moody’s agencies, and in supposedly well off highly professional banks that enjoyed luxurious offices in skyscrapers in downtown Beirut.
As this deal kept going for years, the boom phase of the business cycle lasted with it. The government was getting into debt, paying back on a timely manner, depositors were paid their interest, and banks enjoyed being the arbitrageur. The government was using this money in failed projects and redistribution to the commonwealth, like public electricity monopoly, subsidies of housing, few development projects here and there, more than 300,000 mostly unproductive public employees etc. This is precisely why this was all one big malinvestment, one error that needed to be finally liquidated in a brutal bust phase. Unfortunately, the interventionists are not letting this natural cycle take its toll.
As we are currently in this economic recession, one would argue that the bust phase is happening. It might as well be, but it is being greatly slowed down by the market manipulators yet again! Instead of enduring liquidation, the malinvestors, aka Government, banks, and depositors, are getting the can kicked for them. Instead of defaulting, the central bank is printing money and paying government debt back and Banks are in turn using that money to pay back depositors. What are the consequences of such actions? The LBP/USD rate went up from 1515 in late 2019 to 12,000 as these lines are being written.
Time to Bust.
It is very odd how the main malinvestments of the artificial boom are the only errors which did not get liquidated amid this economic crisis, instead the burden fell on other factors of the economy. Government assets are still intact, not one single Government balance sheet item has been sold. All public employees kept their jobs; however, they were indirectly affected as they saw their printed salaries went drastically down in value. All banks are still operating at almost full capacity, we saw a few branch closures here and there, but nothing significant enough that can match the size of the actual malinvestments that took place. Depositors were not defaulted against and they did not even endure some kind of a haircut on deposits, instead they received an indirect haircut as their deposits were Lirafied (Paid in printed lira) and thus lost value amid the increase in the LBP/USD rate.
What should have actually been done is the opposite of what’s currently happening. The gullibility of the economic individuals in the market during the prolonged boom phase of artificial interest rates ceased to exist. The biggest channel of money creation and distribution <Depositor -> Bank -> Government> is no longer feasible for any serious market participant. Yet this channel is still operating coercively at the account of everyone else in the economy.
The decision makers, this bunch of academics who put little care to the natural forces of the economy “The economy is not even real bro”, think they can run away from reality, the full effects of the bust will take place whether we like it or not and the more we postpone it the more exacerbated it will be. The Lebanese economy does not require any more Keynesian tools of inflation & taxation and it definitely does not require a “revolt by the proletariat against the bourgeoisie”. It certainly does not require burdening everyone else in the market or the future generations with someone else’s life of consumption and debt. it simply needs common sense back, it needs reinforcement on entrepreneurs taking on individual risks (NOT COLLECTIVE) through private initiatives. But first, it is time to BUST! Only then we can start healing the Lebanese economy.
