Capitalism in Jeopardy? 16 comments
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While testifying before the House Oversight Committee last week, Alan Greenspan said,
The economic crisis has revealed a flaw in the model that I perceived as the critical functioning structure that defines how the world works… Those of us who have looked to the self-interest of lending institutions to protect shareholder’s equity, myself especially, are in a state of shock and disbelief.
The recent crisis did reveal very clearly about one aspect of how the world works. There are in essence two economies: the real economy, where real goods and services are produced and consumed, and the financial economy, where assets are swapped for investment or speculative purposes. These two economies interact and affect each other, but each requires a unique regulatory framework to support. While government intervention in the real economy is almost always bad, government intervention in the financial economy is almost always necessary. For this reason, I fully agree that we need more regulation in the financial economy, as long as we are careful not to let it spill over to the real economy.
I believe this dichotomy needs some explaining.
While the invisible hand of laissez-faire does a pretty good job at keeping things in check in the real economy, it fails when applied to the financial economy. The free market relies on the mechanism of orderly discovery of equilibrium prices. In the speculative financial markets, this mechanism, although it still exists to a certain extent, fails too often and for too long.
When there are not enough shoes being produced in a real free market, for example, shoe prices go up, and the market adjusts by selling more shoes, causing shoe prices to come back down, and vice versa. Self-correcting forces keep the free market of goods from drifting too far away from the equilibrium (i.e. just enough shoemakers selling just enough shoes at just the right price). These forces of benign price discovery fail too often in the financial markets because there are other forces, self-feeding and much more powerful, that overwhelm them.
While the real economy anchors on physical goods and services, the financial economy anchors on confidence of its participants. In this confidence game, markets degenerate too easily into a self-perpetuating cycle, more so when they involve speculative assets, and especially when they are affected by the expansion/contraction of credit.
Examples of self-perpetuating cycles are everywhere in the financial world. Bubbles are caused by people buying assets that rose in price, causing the asset prices to rise even further. The richer you are, the easier it is for you to borrow money, which you can invest with and make even more money. The reverse is also true: Lower asset prices beget more selling, contracting credit begets tightening of lending standards. The abundance of these runaway processes is the crucial difference between the financial and the real markets - lower shoe prices does not get more people into the shoe-selling business!
This is not a new idea. The lack of a stable equilibrium in the financial markets has previously been described in George Soros’s The Theory of Reflexivity. Even the late economist John Maynard Keynes knew that the “animal spirit” of market participants is unpredictable, and the government will often need to step in to prevent the economy from swinging, destructively, to the either extremes of boom and bust. The animal spirit is exceptionally acute in the financial world.
But let’s not give up on capitalism yet. Recent hiccup notwithstanding, the trend towards freer and more global markets has coincided with improvements in our overall standard of living, albeit in a choppy fashion, over the long period of history. Capitalism is not dead, it just needs some tweaking. Lending standards need to be regulated, bank deposits need to be fully insured, and money supply needs to be controlled with care. But the responsible regulators and policymakers must be astute in noticing the crucial distinction between these creatures of the financial markets and those of the real goods and services.
This credit crisis has emboldened certain observers into declaring “capitalism doesn’t work”. We already hear about politicians all over the world taking advantage of this opportunity to enact regulations over many areas of the economy. There is now significant risk that governments of many nations are on the trajectory towards a more socialistic/protectionistic stance, destroying the climate of globalization and capitalistic experimentation that has served us so well throughout history.
It is not my intention to trivialize the recent credit crisis. The crash in the Dow Jones Industrial Average, for example, has effectively erased 10 years of gains. But let’s not allow this stumble to undo our centuries of progress. Yes, the pendulum swung too far to the side of deregulation, of unchecked capitalism, and we are suffering for it; but still, more important now than ever, we need to use all our power to prevent the pendulum from overshooting to the opposite side, because the consequences will be much direr.
Disclosure: none
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This article has 16 comments:
The 12 appointed (not elected) governers manipulate economic activity in their war against the business cycle in an effort to impose their social and economic ideals on the 300 million people that make up the free market place.
Why anyone believes that the wisdom of 12 Federal Reserve governers is superior to the collective concsious of 300 million market participants is sheepish.
These people and thier ability to counterfeit money and loan it to us at rates below what the free markets would otherwise charge has proven dangerous.
Yes, their abilty to bring about credit expansion creates an intial boom and perceived prosperity, but the facade ultimately gives way to the reality of inflation, misallocation of capital, and deflationary bust.
The Federal Reserve's survival is insured by the useful idiots that are Republicans and Democrats as they point the finger at each other during each economic crises. Patisanship spares the Federal Reserve and thus it survives another day to play with our economy.
Indeed, our elected leaders meddle and reak havok on our markets. But the extent by which they can inact their policies is limited only by the willingness of the Federal Reserve to finance it with its printing presses. WIthout the Federal Reserve, FNMA and Freddie Mac never could have become what it did.
Statement of the problem is correct, inferred cause of the problem is not.
The Bubbles are caused by excessive creation of debt based money by the central bank. The freshly created 'excess' money is what allows the initial market participants to bid up the prices at the start of the bubble. More dollars chasing a fixed amount of goods = higher prices.
Remove the capability to 'control' the money supply and bubbles will be greatly diminished since the ability to borrow will be curtailed from the much higher interest rates required to borrow a fixed amount of money when many people are 'bidding' to borrow it.
A fixed money supply will go a long way toward limiting bubble formation, but it is politically unthinkable as the gub'mint's license to steal via the printing press would disappear.
Not quite, but your heart is in the right place.
A slight increase would move the earth closer to the sun making Al Gore happy for the resulting global warming.
A slight decrease would move us further away and give us global cooling.
There would be limits in either direction where impacting the sun or leaving orbit would result, but they would be significant changes.
I'm sure moonbat can figure out the required numbers. He's an engineer. a = v^2/R. The distance to the sun would change inversely to the change in gravity. Gravity up 10%, earth moves 10% closer to sun and vice-versa.
Smarty,
I are an X-engineer. The world has more than enough engineers but too few people who have some inkling of liberty and its relationship to prosperity and morality.
Plus, no math requirement!
The Fed plays a game of Russian Roullete with our economy. The game is called "PICK THE RIGHT INTEREST RATE." The game is a needless game.
If they pick the wrong rate (a rate other than what the competive forces of free markets would otherwise set) the result is economic adjustment, the degree dependant on how wrong the choice of rate and how long that wrong choice remains in effect.
If they pick the right rate (the rate the competive forces of free markets would otherwise set) economic activity will continue along the same path it would have continued had rates been set by the competitive forces of free markets.
Given the right rate is the rate set by the competive forces of 300 million free market participants, why do we need 12 people trying to figure out the right rate.
We have seen what happens when they are wrong.
Just as the monetarist replaced the keynsians, the Austrian school of economic thought must replace the monetarist. Such a school of thought will strip politicians and elites of their tools to manage our lives.
What mutant powers do YOU possess?
a) Natural rhyme-ability.
b) Super-speed typing.
c) Natural Fiat detection ability.
d) Huh?
X-cellent taste in people. So good in fact, that I often go hungry.
Sounds like a personnel problem, to me.
Oh, yeah, and really bad puns.
The limitless promotion of self concern as the foundation of capitalism is what will cause it to fail, as absolute brotherhood is the only thing that could ever perpetuate a right and successful human society, one that is the polar opposite of the selfish, uncaring one we have today.
Disclaimer: The above may actually turn out to be less tongue in cheek than it first appears to be.
For example, most of the technical innovations that led to the computer revolution that started in the early seventies were a result of the race with Russia to put a man on the moon, and came from government spending on the Space Program.
Most of the drug discoveries of the last fifty years have come from government controlled state universities (and private universities) and not Big Pharma.
The Internet came from the Arpanet project which was started by the Defense Department.
The list goes on.
To cite only one example of a failure of laissez-faire (in my opinion,) why do people choose Microsoft over Apple and both of them over Linux when reason tells us that Linux is superior to Apple, and Apple is superior to Microsoft?
It is because the market does not always work and people are often more influenced by advertising, greed, conformity and habit than reason.
This is not an argument for embracing central planned socialism and doing away with free enterprise, it's just an argument for thinking things through more carefully.
To Assume Benevolence Is Foolish.