The business of banking has long been rather exceptional with regards to the way that it treats profits and losses. In any industry, when a company makes profits these are either retained by the company as capital or distributed to shareholders - and so it is in banking. However, in most industries when a company makes losses these must be born by the shareholders - not so in banking. Banks enjoy various government guarantees including the ability to borrow from the central bank and to use tax payer's money to insure bank deposits. When banks lose money, only a fraction of the money that they lose actually belongs to bank shareholders.

So we have the problem that, whilst the profits resulting from profitable lending serve to enrich bank shareholders and bank employees, the losses resulting from unprofitable lending serve to impoverish those who are forced to guarantee bank loans, which generally means tax payers. This fact has led some economists (such as Jeffrey Sachs) to suggest that the banks should be nationalized. Since tax payers always end up shouldering the losses when times are bad, say these economists, perhaps it would make more sense if those same tax payers at least stood to make some profits when times were good.

True regulation is the process of changing the location of certain elements in space so as to place them in positions where the regulator, the thing that has control over the location of these elements, deems them more conducive to attain a certain objective.

In economics, true regulation is the process of changing the location and shape of natural resources and of factors of production, so that their employment yields the greatest possible output of the most urgently and/or amply demanded goods, before less urgently or amply needed ones are produced.

If resources are underutilized or even unused, they are swiftly withdrawn from their current location and put to a different use by entrepreneurs who aspire to make and maximize their profit. The profit motive is the most crucial regulating factor in this process, the regulator being the entrepreneur who seeks it.

Every day we see signs of waning confidence. The politicians pontificate and the markets plunge. Talking heads rile the trading floors. People are panicking, but are unsure as to what drives the panic. Lying behind this turmoil is the fundamental flaw in our economy: our money. The antidote is gold.

Over the last few months we have seen gold rally up to $1000. Suddenly it is being heralded as the investment (if you held it since 2001, you'd really be laughing at this), and rightfully so. Even mindless stock jockeys speak to the fact that in times of uncertainty, gold is the place where people should park their cash. It is the asset of last resort. Yet if this is considered the only safe place to put our money when times are hard, then why not just make this our currency? Why do we have a paper dollar whose intrinsic worth is equivalent to that of paper and ink, or alternatively your faith in Nancy Pelosi?

Short-term unbalanced thinking has gotten us economic pain. The dangers of short-term thinking in economic matters became particularly evident to me in the late 1990s. At that time I said to colleagues that if the U.S. does not change its course, it is heading towards major economic difficulties. I made that statement after studying the trends of many economic statistics, particularly those of debt accumulation and savings rates.

The debate between demand-siders (Keynesians and one aspect of monetarists) and supply-siders (Austrians and other aspects of monetarists) is on-going. (Note that I here use the term "supply-siders" broadly, to encompass not only those persons who emphasize cuts in marginal tax-rates as a means of promoting economic growth, but those who -- regardless of their stand on taxes -- emphasize that microeconomic conditions are paramount.) The differences are not easy to resolve.

Keynesianism has three public-relations advantages over supply-side economics. First, it is instinctively appealing to business people -- indeed, to anyone who makes a living by selling goods or services (including labor). If demand for any firm's output or worker's services were higher, that firm or worker could sell more without lowering prices and would, therefore, likely be better off. When demand falls, on the other hand, either output or prices or both fall.

Growing up with five brothers, my parents had to be particularly careful that they were seen to be fair and just if all out war was not to ensue over the most trivial matters. One technique that we often used was that whoever cut the cake was the last person to be able to choose which piece of the cake they would actually receive. This ensured that the "power" to cut the cake was seen to be a responsibility rather than a privilege and that whomever this responsibility fell upon would do their utmost to make sure that the pieces of cake were all the same size. Clearly the results would have been different if the rules had been reversed and if he who wielded the knife were also given first choice as to the piece of cake he wanted. If my parents had been so foolish as to allow such a thing then the inherently selfish 10 year old cutting the cake would almost certainly cut "by accident" one or two pieces that just happened to be slightly or even vastly larger than the others - ahem, ah well, I guess I'll take that one!

It seems that 10 year old boys and girls aren't that different to 50 year old boys and girls and recent examples of cake cutting in the world's economies give us plenty of examples of special interest groups that attempt to cut a disproportionately large piece of the cake that is government funds for themselves. And even in virtually wrecked economies such as Zimbabwe you can be sure that if anyone is to go starving, government employees are always to be last on the list. When governments have the right both to cut the cake and decide the allocation of the pieces the results are as inevitable as when we hand the knife to a 10 year old boy with the same conditions.

The moral is quite simple. If we are to give someone power (for example the power to cut cake) then we should, if at all possible, remove any possible incentives for them to be able to use that power to their own advantage or in their own special interests.

This talk was given at the 2009 Jeremy Davis Mises Circle in Houston:

We are fortunate to be living in these times, for we are seeing the unfolding of events long explained and predicted by the Austrian tradition.

Maybe that sounds implausible. What is fortunate about our times? The economy is tanking, stocks have been pummeled, unemployment is rising, and Washington is pursuing the worst combination of economic policies since Hoover and FDR. Nor does the new guy in charge seem to have a clue about the limits of what government can do.

Consider what it means to live through our times in the light of economic understanding. Even in the face of calamity, there is no mystery and hence fear is reduced. You look at department stores going belly-up, and you know why. You see parking lots empty, and you know the reason. You have friends losing their jobs, and there is clarity concerning the cause. You see depositors in failing banks lose their money, and you are not surprised. Prices behave in ways that shock and surprise everyone else, but you know what's what.

Even if government spending in theory could “stimulate the economy” in a genuine, sustainable way, it would not follow that politicians and bureaucrats would know how to spend the money intelligently. The pressures to do something now and the perverse incentives facing those in charge of the money guarantee there would be more doggle than boon.