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The "Old Lady" Hasn't a Clue

Mises Daily: Wednesday, April 27, 2011 by

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[An MP3 audio file of this article, narrated by Nathaniel Foote, is available for download.]

Mervyn King, Governor of the Bank of England

Recently I was fortunate enough to have an entire day to myself in London, probably my favorite city in the world. Well, I had an entire day after filling my family's tea order at Fortnum and Mason, plus buying cups, saucers, and plates approved by William and Kate as an "official" remembrance of their upcoming royal wedding. So, what would any American economist do to fill up the rest of his day except take a tour of the Bank of England, a.k.a. "The Old Lady of Threadneedle Street."

Unfortunately there is no regular tour of the bank itself, but I was directed to the bank's official museum just around the corner. After spending a delightful and informative two hours there, I believe a tour of the building itself would have been much less interesting. After all, it is just a jumble of bricks and mortar, whereas the museum is an intellectual explanation of the bank's history and its role in English and world history. And quite a history it is!

First of all, here is the good news: admission to the museum is free; there is not even a charge for the handheld recorder that one really must use for a full understanding of the bank's fascinating history and especially of how the bank sees itself. The museum is arranged so that roughly one-half consists of interesting displays of physical objects, such as building plans, old bank notes, old registers of founding members, etc., and the other half presents a history of the bank's operation and its role in English life.

Sometimes these two halves overlap. For example, behind a glass case was a mock-up of a basket of groceries from 1958. The basket included two large, round loaves of unsliced bread, a pound of bacon, a dozen eggs, a pound of butter, and a quart of milk. This basket of groceries cost slightly over twelve shillings — approximately six-tenths of a pound — in 1958. Today a pound costs approximately $1.61, so this rather large basket of wholesome English fare cost around a dollar in 1958!

I could see that we were about to get down to brass tacks, so to speak, so I examined the bank's mission. A pamphlet titled "Your Money: What the Bank Does" states that the bank's three main goals are "trust in banknotes, stable financial system, and low inflation." Needless to say, the bank has failed miserably at all three, as it admits in so many words when recounting its own history.

The bank was forced to suspend specie redemption several times throughout its long history due to its fraudulent (my word, not the bank's!) issue of paper certificates in excess of its gold holdings. Each of these suspensions was discussed very matter-of-factly, as if a meteorite had struck the bank, destroying its ability to redeem banknotes for gold.

The Bank of England Funds the Crown's Wars

WHGDtOM?

Print: $10 $8

Audio: $15

Most of these suspensions of specie redemption came during or immediately after war, illustrating the bloodthirsty link between the crown and the bank. This is a symbiotic relationship. The crown grants the bank the monopoly of money production, meaning that its stockholders and officers have the ability to reap excess seigniorage charges; this monopoly also immunizes the bank from commercial law by allowing it to suspend specie redemption without turning its assets over to its creditors.

In return, the bank monetizes the crown's debts, allowing it to confiscate more resources than its citizens would allow were the crown forced to tax them directly or borrow honestly in the credit markets. Then the citizens might question the wisdom of the crown's military adventures, requiring it to seek more pacific and, of course, less costly solutions to its international adventures.

Inflation Just Happens

The museum's explanation of inflation — i.e., higher prices — was very amusing. A recorded mini lecture and video display purported to explain this mysterious phenomenon (mysterious to The Old Lady of Threadneedle Street, anyway). I was very excited! I knew that I was going to hear either a self-critical explanation or, more likely, some hogwash.

Hogwash won, hands down! Showing videos of life a hundred or so years ago and contrasting it with videos of modern, bustling London, the audio lecture claimed that demand for modern conveniences and the rising cost of imported goods were the two main "causes" of inflation. The explicitly stated message is that if we want all the conveniences of modern life, then everything is going to cost more. There simply is nothing that the Old Lady can do about it, don't you see?

This entirely non-Austrian, yet typical, explanation ignores the fact that all prices in general cannot rise unless either the quantity of money increases or the supply of goods decreases. The videos made it clear that modern day Britons live in wonderfully more prosperous times than their ancestors, who ruled two-fifths of the surface area of the world a hundred years ago. So the paucity-of-goods explanation of inflation does not hold water.

What about the higher cost of some imported goods? After all, Britain is a trading nation, dependent upon imports for its daily bread (that's the reason why Churchill claimed that the Battle of the Atlantic was the most crucial for Britain's survival in World War II). But this is a circular argument: it begs the question of why imports cost more. In fact, whether a given staple of modern life is imported or not makes no economic difference. Political borders have no bearing on economic law.

In a sound-money economy — that is, one in which the money supply is held stable — an increase in the price of any good or service must cause a corresponding decrease in the price of some other good(s) or service(s). A nation's finances are no different from those of an individual household. Let's say that the price of some essential good such as gasoline (ahem!) goes up. Most of us would find it difficult, at least in the short term, to curtail our purchase of gasoline sufficiently to spend no more total dollars on this good than before the price rise.

Over the longer term, we may adjust by driving less (which means that the automobile is not as convenient as it was before the price rise) or we may take more drastic action, such as carpooling, walking to a bus stop, buying a more fuel-efficient car, etc. But in the short term we must curtail the purchase of something else.

That "something else" is the good or service that falls at the lowest end of our personal utility scale. For most of us that means that we may save less until we adjust our lifestyle to higher-priced gasoline. Then we may extend the date upon which we would purchase some large, expensive good, or we may forego its purchase entirely. This is Frédéric Bastiat's "unseen" cost to society. We can see more people riding the bus or walking to work, but we cannot see the vacation they did not take or the new dining-room set they can no longer afford.

But the Bank of England hasn't a clue. Higher prices are just part of modern life; if we want more "stuff" — especially foreign-made "stuff" — we just have to accept a higher price level. Don't blame the Old Lady. What can she do? Certainly you don't expect an institution that can manufacture money out of thin air to behave any differently, do you?