Popcorn vs Domino theory of Financial Crisis

“Although there are legitimate concerns about contagion, the fundamental problem facing Europe is one of governments becoming too big to be supported by the economy … Both in Europe and the U.S., structural weakness stems from government excess and slow economic growth. More important than stemming contagion is reversing the policies that created the problem in the first place.”

Great quote from full op/ed copied below:  "The Euro Crisis: Doubting the 'Domino' Effect"

My Two Cents:  … One insidious manifestation of Big Government not explicitly recognized by the author of the WSJ op/ed ( Ed Lazear) is easy money facilitated by the Fed.   You can’t get to Big Government without a central bank willing and able to fund massive public debt accumulation by printing massive amounts of un-backed government fiat money.  The ECB pretends to be a vigilant protector of sound money – and on a relative basis it may in fact pursue a more sound monetary policy than the Fed.   but central banks were originally invented to do the bidding of politicians (who needed a captive purchaser of public debt issued to pay for welfare and/or war fare projects which otherwise would be unaffordable via direct taxation).   

so there is no such thing as a “sound money” central bank.   this is clearly the case with the ECB as evidenced by the massive debt accumulation in the EZ.  Central banks = Big Debt = Big government.  The political left and right in the US are equally guilty of using the Federal Reserve to fund special interest group support.   The establishment of the Fed is a perfect example when bipartisan support for a policy or public institution is NOT healthy!!!

We don’t want bipartisan support if it means equal support for policies that each party uses to buy off their respective special interest groups!! 

That is exactly the situation we have now with the Fed.  

The left uses the central bank to fund the social welfare complex,  the right uses the central bank to fund the military industrial complex and both the left and the right support the entitlement complex.    IT is no coincidence that social security reform is called the third rail of US politics.  Neither party is willing to talk straight about unaffordable entitlements funded by debt!!!! 

OCTOBER 31, 2011

The Euro Crisis: Doubting the 'Domino' Effect

Preventing a Greek default will not reverse the lackluster growth that has plagued the other vulnerable countries for many years now.

By EDWARD P. LAZEAR

It seems everyone is worried that problems in Europe will derail our fragile recovery. For this reason, markets breathed a sigh of relief when the Europeans came up with a plan to provide yet another reprieve to Greece. The main worry, now somewhat eased, was that a Greek default would spread to countries like Italy, Spain and Portugal.

Although there are legitimate concerns about contagion, the fundamental problem facing Europe is one of governments becoming too big to be supported by the economy. Unless Europe solves its fundamental problems with meaningful structural reform, a temporary debt restructuring, no matter how clever, will fail to right the ship. Closer to home, the same issues that threaten Europe may soon become immediate concerns to Americans.

To understand why, consider two theories of economic destruction, which can be labeled the domino theory and the popcorn theory. Everyone knows the domino theory; it is the analogy that is commonly used to denote contagion. If one domino falls, it will topple the others, and conversely, if the first domino remains upright, the others will not fall. It is this logic that underlies most bailout strategies.

The popcorn theory emphasizes a different mechanism. When popcorn is made (the old fashioned way), oil and corn kernels are placed in the bottom of a pan, heat is applied and the kernels pop. Were the first kernel to pop removed from the pan, there would be no noticeable difference. The other kernels would pop anyway because of the heat. The fundamental structural cause is the heat, not the fact that one kernel popped, triggering others to follow.

Many who believe that bailouts will solve Europe's problems cite the Sept. 15, 2008 bankruptcy of Lehman Brothers as evidence of what allowing one domino to fall can do to an economy. This is a misreading of the historical record. Our financial crisis was mostly a popcorn phenomenon. At the risk of sounding defensive (I was in the government at the time), I believe that Lehman's downfall was more a result of the factors that weakened our economic structure than the cause of the crisis.

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Consider the events of 2007-08 that either preceded or had nothing to do with Lehman. World liquidity showed major signs of tightening by early August 2007. The recession began in December 2007. Bear Stearns failed and was rescued in early 2008. The auction-rate securities markets failed in the first half of 2008, monoline insurers encountered major difficulties during the spring, and, if not for some creative behind-the-scenes work, the student-loan market would have failed by that summer. The Dow Jones Industrial Average had lost about 3000 points from its peak by September 2008.

The week before Lehman failed, Fannie Mae and Freddie Mac, both on the edge of bankruptcy, were placed into conservatorship. On the weekend that the Lehman deal fell through, Merrill Lynch, also on the brink, was saved by Bank of America. By that weekend AIG was already showing signs of likely failure, as were Washington Mutual and Wachovia. Although GM and Chrysler crashed post-Lehman and were kept alive by a government loan, their troubles resulted from the decline in auto sales, coupled with noncompetitive costs. The sum of these events was more than enough to be called a financial crisis and to worsen the recession that was already under way.

Lehman's demise may well have been an exacerbating factor in the financial crisis and perhaps things might not have been as bad had Lehman not failed. Most directly, the Reserve Primary Fund, a money-market mutual fund that held $785 million in Lehman-issued securities, couldn't meet investor requests for redemptions at par value. That likely triggered a run on money markets. Other markets may also have been affected by Lehman's demise. One does not have to deny the role of contagion to believe that Lehman was not the domino that toppled the others.

But our financial crisis was caused by factors that affected the entire system, just as all corn kernels pop when they are warmed by the same flame. This lesson is important because interpreting our crisis as primarily a contagion event leads to the wrong strategies for dealing with potential disasters. After Lehman, Europeans seem to be so taken with worries of contagion that they are failing to emphasize remedies that actually have a chance of making things better. In their case, and in ours, the solution is primarily a reduction in the bloated size of government expenditures that come about by making promises that cannot be kept.

Especially in Italy and Portugal, as in Greece, the government has grown more rapidly than the economy, which has meant unsustainable government borrowing. Preventing a Greek default will not reverse the lackluster growth that has plagued the other vulnerable countries for many years now. As for the U.S., our economy will be stronger if Europe's health improves, but we must address our own underlying structural problems that are associated with a doubling of our 2008 debt levels by next year. No bailout of another economy will restore our fiscal health or that of Europe.

The cases of Estonia and Turkey attest to the effectiveness of structural change. After a significant economic contraction in 2001, Turkey embarked on a new path of rapid fiscal consolidation. By the end of 2002, growth was 6% and by 2004, 9%. Rather than slowing the economy further, government tightening was associated with strong and almost immediate growth. More recently, Estonia, which experienced almost a 20% contraction by the end of 2009, instituted fiscal reforms. Among them was a 10% reduction in government operating expenses and a flattening of the pension growth trajectory. In 2010, the year following the reforms, growth had already turned positive, to around 3%, and it is forecast to be above 6% for 2011.

These two examples, and that of our own financial crisis, suggest that fundamental problems need to be addressed early and forcefully. Both in Europe and the U.S., structural weakness stems from government excess and slow economic growth. More important than stemming contagion is reversing the policies that created the problem in the first place.

Mr. Lazear, chairman of the President's Council of Economic Advisers from 2006-09, is a professor at Stanford's Graduate School of Business and a Hoover Institution fellow.

For liberals, income inequality is the new global warming

my radar goes up whenever the mainstream media (read: progressives and/or liberals) begin to argue that some topic is so settled already it is politically incorrect to debate anymore.  global warming has that status.    James Pethokoukis argues that liberals are trying to turn income inequality into a similar kind of taboo topic in an article i've copied at bottom of this blog post titled:

For liberals, income inequality is the new global warming

 

I am not going to say there is no such thing as global warming or that there isn't evidence of rising income inequality in the US.  The debate about whether or not there is global warming obscures the much more important question: can we do anything about these problems?

I can say with the same certainty I have when i assume a ball will fall to the ground if i drop it from a building that liberal/progressive top-down government imposed solutions to either global warming or income inequality will only make things worse such that either the problem is solved by killing the economy -- such that rich and poor are made equally poor, or the problem is not solved and the solution still adversely impacts the economy while leaving the most at-risk households worse off than before the well intended intervention.

There is not such thing as market failures that require government intervention.  So called market failures are natural (albeit negative) unintended consequences of a system of free exchange, private property rights and division of labor.  Income inequality is natural to any market system because markets require division of labor which leads to income inequality.  equality can only be achieved by making everyone equally poor and destitute, such as we see in North Korea today.

When income inequality becomes stretched beyond what would be its natural distribution in a free market economy, the cause of this exaggerated inequality can be assumed with certainty to be some government intervention in the economy that was implemented with all good intentions but that resulted in negative unintended consequences, including facilitating income compression in poor households and wealth accumulation in already wealthy households.  the rich get richer and the poor get poorer not because of any flaw in free markets, but because of well intended government policies that ineluctably lead to negative unintended consequences.

central banking and fiat money is a perfect example:  easy money creates asset bubbles that benefit the rich and price inflation that hurts the poor disproportionally.  the rich get richer and the poor get poorer!!!  and then liberals blame the evil market.  division of labor must lead to income inequality, but it doesn't lead to the sort of exagerrated income inequality we see in modern economies organized around fiat money central banking systems. 

global warming can be understood through a similar analytical lens.  carbon dioxide emissions are a natural feature of the modern economy. (and CO2 emissions are a natural feature of human existence!!!  why do we think of CO2 emissions as artificial when we humans emit CO2!!???)

and who is to decide what is the optimal level of CO2 emissions in a society or economy at any given level of economic development??  are we supposed to believe that we can model the earth climate and economy and calculate what total CO2 emissions should be, and then implement a global policy that delivers the required target results???

It is impossible for humans to model the global economy let alone the earth climate, let alone implement policies that engineer outcomes in either!!!  we have seen what happens when man tries to engineer outcomes in the economy.

remember it was only after the Fed was established in 1913 (ostensibly to eliminate business cycles which were assumed to hurt poor households worst) did we get the largest economic boom and bust cycle in the history of the world!!!  so much for curing business cycles.

should we assume that experts can manage the economy AND the earths climate simultaneously???

Just because we see a problem in society does not mean we can fix it or that we have a moral obligation to fix it.  IF the economy was an artificial construct of humans designed and planned by humans, THEN maybe we would have a moral obligation to fix what we actively created. 

HOWEVER, we have no such moral obligation because the economy is a spontaneously organized complex system of exchange.  it is not artificially man-made like a computer or a car. 

the old proverb "the road to hell is paved with good intentions" is consistent with what we now know about the law of unintended consequences when humans attempt to intervene in natural complex systems. (including and especially with well intended public policy).

why don't we listen to the intuitive logic of proverbs and instead listen to the expert testimony of so called modern science?? 

The conclusion that man must be at fault for global warming and therefore that he has a moral obligation to fix global warming is based on the erroneous assumption that man is responsible for designing and artificially creating the human economy in the first place.

no one designed the economy.  the economy is NOT a man-made artificial construct.  man has designed component parts of the economy like cars and computers.  and there are small islands of central planning and design in the economy, such as we see with corporations and urban planning. 

but no one designed the larger pattern of interaction and exchange that characterizes the larger (invisible) "thing" we call "the economy" or "the market." 

liberals and conservatives fight over whether global warming or income inequality is real while Rome burns.  it doesn't matter if global warming is real.  even if it is real, we cannot do anything about it via direct policy intervention.

the only way to fix global warming is to let the market find its own optimal level of CO2.  that means REDUCING government interventions (like central banking) and other assorted distortions such as subsidies, taxes and regulations.  the road to sustainable growth does NOT entail doubling down on the very failed policies that have caused exaggerated distortions of natural (albeit negative) features of the market with new policies that will only sow new distortions and problems.  the only way to do reduce income inequality or to fix a global warming "problem" (if there is one)  is to identify and REMOVE the well intended government policies aimed at fixing so called "market failures" such as business cycles and income inequality. 

YES, the market is imperfect but it is still the best we can do.  WE do live in the best of all possible worlds if only we would let it emerge without screwing everything up with well intended central planning and public policy interventions.

the fundamental cause of global warming is too much growth fueled by easy money created by central banks.  no central bank = no global warming.  it is that simple.   the human economy is not "artificial" in the sense that it is man made.  there are artificial components that make up what we consider to be the economy.  like i mentioned already we see artificial products everywhere: roads, cars, computers, houses, phones, etc etc.  But just because the components of the human economy are artificial DOES NOT MEAN by definition that the economy itself is artificial.

this is a key point!!!  the economy is a natural system of exchange, just like the amazon rain forest.  

Exchange is the key natural feature of the economy that gives it form and function.  man made artificial components do not define the modern economy.  what defines the economy is exchange and division of labor.  without exchange there is no economy.  

if we let the market work, it will develop in the best way considering the physical constraints imposed by the real world.  will it be perfect?? no.  there will always be natural disasters in the economy same as in the earth system.  We should not try to fix natural disasters (such as hurricanes or earthquakes)???  i read in scientific american that some climatologists are arguing we can reduce the force of hurricanes by injecting aerisols into emergent hurricanes.  This is pure insanity!! what hubris to assume that we humans can micro manage the earth's weather patterns without causing some negative unintended consequence somewhere else in the system.  we cannot fix hurricanes or earthquakes any more than we can fix so called market failures, which are really just negative unintended consequences of a naturally robust and dyanammic system that requires a dynamic process of creative destruction to deliver productivity gains over time. 

can we monitor natural disasters and limit their impact on human society in the natural economy and in the earth system???  yes!!  yes! yes?  but, lets not be so naive as to believe we can fix the natural disasters directly and not adversely impact the larger earth system. 

there are no free lunches.  you don't get to have the positive unintended consequences delivered by the market (e.g. productivity gains, new technology, improving standard of living) if you try to eliminate the negative unintended consequences (such as CO2 emissions, income inequality, pollution, business cycles, etc, etc).  

we CAN make a difference in the world on a micro level.  person to person we can help people in need.  but we cannot engineer and design macro or social pattern outcomes into the economy.   natural systems must be allowed to emerge and to create their own future without intervention.  

another way to say this idea is that humans are like gods in some ways.  humans are creative like no other species on earth.  creativity is the purview of the gods or God.  but just because we can be creative in a certain limited domain on earth doesn't mean we can be creative and god-like in all domains on earth. 

in the domain of natural spontaneously forming systems, like the earth's biosphere or modern economy, we cannot be like Gods.  natural spontaneously forming complex systems have a future that is radically unpredictable.  if we try to enforce certain macro outcomes in a natural system we are begging unintended consequences that can boomarang and result in outcomes completely contrary to our intentions (especially good intentions).  

natural systems are defined by both creation and destruction.  you don't get to have one without the other.  you don't get productivity gains and rising standard of living without the underlying dynamics that lead to income inequality and pollution. 

there are no free lunches in "life" because life occurs within the natural laws that govern the behavior of spontaneously organizing natural complex systems! 

in spontaneously organizing complex systems, there is no order without disorder.  there is no success without failure.  you don't get the good without the bad.   

government promises to eliminate the bad and to maintain the good aspects of society are free lunch promises that can't possibly work in the real world.  the real world behaves according to laws of nature that define the behavior of natural complex systems -- and that do not allow for free lunches!

that is one of the great ironies of the progressive world view:  progressives accuse radical free market types as impractical dreamers.  progressives claim they live in the real world and try to fix real problems.  if liberals understood the rules of natural systems like the economy, they would understand how foolish it is to claim to be able to fix (negative unintended) natural features of a natural complex system like the human economy.  it is true that free market types are out to lunch when/if they claim that all social and macro economic problems can be solved as long as we turn the problem over to the free market.   

the notion that markets solve all problems is as silly as the notion that humans can intervene with enlightened public policy aimed at fixing (or ameliorating) natural market features such as income inequality.  Markets are inherently unfair, imperfect, volatile, dynamic, unpredictable and beyond human control or modelling or prediction.  

the so called "market failures" that are really just natural flaws and negative unintended consequences of free exchange are exactly the features that interact with human ingenuity and hard work and risk taking -- and lead spontaneously and unpredictably in an organic process of creative destruction that ultimately leads to the invisible (but REAL) thing that we call "the economy."      

well, ok, here is Pethokoukis' awesome article after all ....  well worth reading...

For liberals, income inequality is the new global warming

By James Pethokoukis

October 27, 2011, 11:57 am

Liberals think there are lots of ideas that intelligent Americans just aren’t supposed to challenge.

If they do, they’ll be labeled “deniers,” intentionally raising a nasty comparison to Holocaust rejectionists. It’s politics at its absolute lowest.

Among the unchallengeable dogmata: the Obama stimulus created millions of jobs, Obamacare will save trillions of dollars, Dodd-Frank prevents future bank bailouts, and policy uncertainty isn’t an issue hampering the recovery. And, of course, global warming poses an existential threat to civilization and humanity. Make that an “undeniable” threat.

You can now add “income inequality” to the list, thanks to New York magazine’s Jonathan Chait. In a column headlined “The Ideological Fantasies of Inequality Deniers,” Chait writes: “Rising income inequality, like climate change, is an ideologically inconvenient issue for conservatives. … The underlying facts, like the facts of climate change, are stark. Over the last few decades, income growth for most Americans has slowed to a crawl, while income for the very rich has exploded.”

In a way, Chait is correct that income inequality really resembled global warming. Both are issues that, to the extent they are even problems, could be be fixed though faster economic growth. And both serve as handy excuses for the Left to raise taxes and expand government.

The reality about “exploding income inequality” and wage stagnation is far different than what Chait, the Obama White House, and Elizabeth Warren (D-Occupy Wall Street) contend. One example: Brand new research from the University of Chicago’s Bruce Meyer and Notre Dame’s James Sullivan finds “median income and consumption both rose by more than 50 percent in real terms between 1980 and 2009. … Our results provide strong evidence that the well-being of the middle class and the poor has improved considerably over the past thirty years.”

Those results aren’t above challenge. But there certainly seems to be legitimate counter-arguments and evidence to the “exploding income inequality” meme. Indeed, differing household demographics and differing inflation measures between incomes levels means the “rise in American inequality has been exaggerated both in magnitude and timing,” according to Northwestern University’s Robert Gordon. That and other studies undercut a new CBO analysis showing massive income gains for the “1 percent” at the expense of everyone else. But maybe Gordon is a denier, too; another guy on the Koch-RNC payroll. Except Gordon is an Obama supporter.

America needs an informed debate on how the American middle class can prosper in the future the way it has in the past—even if it is ideologically inconvenient for Chait and other liberals.

intentions don't matter: individual freedom is moral, big government is not

Robert Sirico speaks with great wisdom in the WSJ op/ed published in today’s paper titled:  “The Vatican's Monetary Wisdom: More than 'greed,' fiat money and central-bank policies caused the financial crisis.”  I've copied the full op/ed below the following editorial comments; it is well worth reading.

I am familiar with Sirico because I have gotten to know him through his writings related to his role as president of the Acton Institute, which is one of the handful of think tanks whose mission and work I trust and support.   

This is from the Acton Institute home page:

“The Mission of the Acton Institute is to promote a free and virtuous society characterized by individual liberty and sustained by religious principles.”

The religious component is a very interesting (as well as a relatively unique) aspect of the Acton Institute mission statement's commitment to promoting a free and virtuous society characterized by individual liberty.   Other think tanks promote individual liberty and freedom but without an explicit religious orientation.  Some of my favorites include FEE (Foundation for Economic Education -- which is by far the best!!!!), CATO Institute, Mises Institute, Ayn Rand Institute, etc.  

There is a long history in the Christian tradition of support for socialism, statism and for government solutions to social problems.  The idea that we should help our fellow man has historically been used (erroneously) by various religions to justify government directed welfare systems.  It is one thing to help a man directly, human individual to human individual.   yes, i agree such charitable behavior is morally and ethically justified by Christian tradition.  But, when the process of local human to human compassion is transformed into a process whereby individuals are replaced or intermediated by a central government, then what happens is compassion turns into greed and corruption both for the providers (big government) and for the receivers (welfare recipients and so called underprivileged).

The Acton Institute is a rare institution promoting the ideals of individual liberty and limited government via the explicit use of Christian religious doctrine.   

The Acton Institute full name is "The Acton Institute for the Study of Religion and Liberty".  It is named after the great English historian, Lord John Acton (1834-1902) who is best known for his famous remark: “Power tends to corrupt, and absolute power corrupts absolutely.”  Inspired by his work on the relation between liberty and morality, the Acton Institute seeks to articulate a vision of society that is both free and virtuous, the end of which is human flourishing.

To clarify this relationship, the Institute holds seminars and publishes various books, monographs, periodicals, and articles.

It seems counter intuitive that Christian doctrine would argue that benevolent big government is immoral. 

The assumption underlying this important idea is that IF big government is brought in to solve social problems what is required is that the government must sacrifice the individual liberties of one group for the benefit of some other group.    For example, when government “levels the playing field” (which sounds moral and ethical and good) what it does is really evil because leveling the playing field requires coercive policies aimed at picking winners and losers in society.  What happens when government levels the playing field is that it turns society into an unethical battle of might makes right.   

Liberals say the market is an unethical battle between haves and have nots and thus they argue that government has to make things more fair.  This is nonsense.   Free exchange is by definition moral.

Both sides win.  Government intervention requires brute force to accomplish its goals. 

Of course, the know it all do gooders claim that their well intended ends always justify their tyrannical means.  And very often these tyrannical means are well hidden behind a Democratic process.   Our founding fathers understood that direct Democracy was an extremely flawed form of government because direct Democracy risks turning into a tyranny of the majority.  Adolf Hitler was voted into office by Democratic process after all!!!

Liberals use what appears superficially to be moral Democratic rhetoric to justify what is really tyranny and force.  If liberals can't get their way via direct vote, they justify government fiat to get their way by arguing that if people weren't so selfish they would see the fundamental morality of government policy aimed at improving society by reducing income inequality, reducing poverty, leveling the playing field, creating jobs, etc etc etc. 

Liberals argue that if only we weren’t all so selfish and we willingly went along with the ethical and moral way of life, then we would all be willing to hand over more of our hard earned incomes to the government for the greater good.

This is nonsense.  Government promises to deliver free-lunch outcomes to society are in all practical fact impossible to implement in the real world!!!  There is no such thing as a government provided free lunch.  If the government provides an economic good, e.g. public education or health care, the result will inevitably be a lower quality product at a higher price than a comparable good or service offered by in a competitive market.

I find it ironic that liberals decry private monopolies (because they claim these evil brutes will take advantage of market dominance in order to fleece customers) yet they believe that goverment monopolies are inherently ethical, moral and aimed at promoting public good. 

This is absolutely upside down logic.  Firstly, government monopolies protected by government fiat have zero incentive to carry out the public good.  Meantime, there is no obvious example in the history of the modern world where a private monopoly successfully took advantage (for any sustained period) whereby it caused a loss of public welfare by reducing supply and hiking prices above the market rate.  if a market player tries to screw the public there a thousands of entrpreneurs who are ready to supply an alternative product or service. 

when the government has a monopoly however on a service like public education or fiat money, then it is very possible, if not inevitable that the service ends up being of inferior quality or of higher price than comparable service provided by the market.  In markets, private firms that screw customers go out of business.  in the case of monopolies operated by the public sector, such as education or postal services, the service can run perennial deficits and yet it is bailed out by tax payer funding.

 

When the government is put in charge of leveling the playing field what happens is that the individuals in charge of actually carrying out this (supposedly) noble charge in the real world are ineluctably corrupted by their activities.  AS Lord Acton observed:  "power tends to corrupt and absolute power corrupts absolutely." 

the very process of picking winners and losers in society (required in government efforts to level the so called playing field in society) opens up even the most righteous individual to the temptation of graft, corruption, money skimming, vice, etc. etc. etc.

The free market is by definition moral.  I understand this is a heavy concept and contrary to what seems to be common sense.  But, the world doesn’t work according to the simple cause and effect logic we were taught in kindergarten.

The world works according to the logic of spontaneous order and unintended consequences.

That means we cannot use government to solve social problems directly because as soon as we use government in an attempt to accomplish noble goals, the implementation of this government plan is compromised (corrupted in the language of Lord Action) by "power." 

Having said all of that, I am not arguing that the market is perfect.  There will always be greed and bad behavior and people getting cheated.  Basic laws emerging out of a common law tradition are necessary in addressing behavior that adversely impacts another individuals right to enjoy their own personal freedom.  IT is not the case that free markets means "anything goes." 

Free markets operate according to the fundamental principle of mutual restraint.  If i do something that impinges on your right to personal liberty, I am doing wrong.  Government ought to be limitted to ensuring individual freedoms are mutually respected and guaranteed.

Too often nowadays, however, government usurps individual freedoms for some greater good.  The result is the very "might makes right" society that modern progressives and liberals claim they want to get rid of with government intervention.

The truth is that government intervention aimed at fixing markets or guaranteeing outcomes leads to an ends justify the means mentality which is amoral.   I don't believe it is possible to inject moral behavior into society using the brute force of government fiat.

When the government tries to fix market failures, it enters into a self reinforcing slippery slope (to hell) whereby government intervention has negative unintended consequences which begs new governemtn interventions which have negative unintended consequences and so on, until we end up on Fredrich Hayeks "road to serfdom."   Hayeks "road to serfdom" echoes the logic of the old proverb:   "The road to hell is paved with good intentions.  This proverb reflects how the world actually works, not how we wish the world worked.  Good intentions cannot deliver positive macro results because man cannot engineer market or social outcomes without also sowing the seeds of negative unintended consequences (worse than the original "problem"). 

The best way to ensure a virtuous society is to ensure the sanctity of private property rights and mutual freedom of exchange.  There is no way to judge objectively that an exchange is “Unfair.”  An exchange occurs when each party believes he/she will be make better.  The world works according to subjective assessments whereby people enter into exchanges to improve their welfare.  it may be the case that an exchange is a bad trade.  but then it is a learning experience.  if the exchange was entered into freely, then it is an ethical exchange.   

There is no way to objectively assess trades and ensure they are “fair” in any objective sense.

Liberals accuse free-market types as impractical dreamers whereas the liberals claim themselves to be the hard headed practical ones trying to solve real problems in the real world.  What liberals don’t understand is that their real world solutions to social problems are IN FACT complete FANTASY assuming that free lunches are possible in the real world.  In the real world, the government cannot deliver free lunch win/win solutions to society.  The only win/win solutions for society come when individuals come together freely in society to exchange goods and services with each other and in the process engage in a never ending division of labor -- which leads to productivity and welfare gains for individuals and society as a whole.  Division of labor requires that incomes be divided unequally!!!!

the only way to ensure income equality is to prevent division of labor, which by definition is a sure way to impoverish society.  Is less income inequality better than more income inequality?  it is impossible to make this statement for two reasons.  number one, there is a natural rate of inequality in society that emerges from the process of division of labor.  It is hard to know what this natural rate of income inequality is supposed to be.

if we see a situation where income inequality is very exagerrated like for example in Brazil or even in the US today, we may be tempted to say -- we must reduce income inequality.  But, we cannot reduce income inequality directly without injecting negative unintended consequences into society that are worse than the income inequality problem we have identified.  What we can assume is that an exagerrated income inequality distribution in society is NOT the result of flaws in the market.  The market leads to income inequality, but it does not lead to the sort of dysfunctional income inequality we see in Brazil.  the source of dysfunctional income inequality MUST be a result of some government regulation or intervention or market distortion or subsidty that facilitates rent seeking opporunties and government supported wealth accumulation of some kind!!!  The only way to reduce income inequality is to reduce government intervention in the economy, not to increase it, which will only make problems worse.  the perfect example of this is high marginal tax rates.  The Laffer curve shows there are diminishing returns beyond some marginal tax rate on income.  if govt raises marginal rates too high, rich people move or have enormous incentive to avoid taxes.  the result is predictably counter productive. 

Liberals like to call free market types “dreamers” because they say that supporters of freemarkets erroneously assume that free markets can solve any social problem.  This may be true of some free market advocates, but not of the ones who understand the nature of free markets. 

it is true that markets can’t solve social problems.  Markets are inherently “flawed” just like every natural system is flawed.  Just like the earth system has natural disasters, markets have their own version of natural disasters:  inequality, pollution, business cycles, near monopoly, etc.  These are natural features of markets, they are not market failures per se. 

However, it is also true that IF we try to fix so called market failures with coordinated, centralized government solution, the outcome will inevitably be worse than the problem designed to solve in the first place.  Again central banking is a perfect example of the law of unintended consequences.  When government interventions inevitably fail (as they must) the market is trotted out as the convenient whipping boy / scape goat. 

Yes markets are imperfect, but if you try to fix them, they will become sick and potentially even dysfunctional.  I believe "we" must accept market imperfections by developing faith in a few basic principles such as individual liberty and freedom of exchange.  This is where religious may be helpful as a partner in promoting individual freedom.  Faith is a religious concept that applies to markets.

  Ultimately an understanding of and support for free markets requires a deep faith that society is beyond the control of man and that while a society based on individual freedom is not perfect, it is the best we can do.

That doesn’t mean you have to believe in God to believe in markets.  But i do think it helps.  Liberals claim they don't need to believe in god or religion because they have science. 

Modern Science is a false God -- at least the kind of science that claims man can play God on earth in terms of engineering macro social (or environmental) outcomes.  indivuals who claim they don't need God or gods or religion because they have science are engaging in what the Greeks called hubris. 

in fact, the latest break through ideas in thermodynamics "proves" that there are natural systems that man will never be able to model or understand or design or engineer or predict or actively improve!!!!

What an irony.  Science PROVES that man cannot use science to fix or engineer or improve society via objective criteria.
you don't have to believe in God or religion to have faith in markets.  but to believe in God may help one understand the concept of a faith in something above and beyond human control.

free markets are beyond human control and understanding.  that is a fact based in hard science!!

ironic but true.  the best we can do is put faith in human dignity, personal freedom, limited government, free exchange and the sanctity of private property -- and struggle the good struggle as good and bad play out in a future for society as a whole that is radically unpredictable. 

There are natural laws (including the 4th law of thermodynamics) that prove free markets will lead ineluctably to social order IF we establish basic principles of interaction in society including respect for private property and sanctity of individual freedom.  This social order that naturally emerges from simple moral rules will NOT BE PERFECT.  Spontaneous order doesn’t suggest perfect order!!!  There will always be a dynamic interchange between order and disorder related to “creative destruction” process that the famous economist Joseph Schumpeter described in the 1800’s as the underlying process of the market.  This creative destruction process is a NATURAL process that leads to market and social order.  If the disorder aspect of creative destruction is attempted to be eliminated by well intended government intervention what happens is that too much order results which leads to total destruction.  There is a trade off in life that requires a deep faith. 

Faith is required in understanding that episodic and unpredictable disorder and destruction is a necessary and natural part of “life.”  If we try to fix what we identify (erroneously) as market failures, then we short circuit the organic natural processes that lead to sustainable order.  Sustainable order is ugly.  It is imperfect.  It has obvious flaws, such as inequality and pollution and mini booms and busts. 

If we try to engineer what we believe objectively will be a more perfect order including less income inequality for example (via modern economic policy tools), the result may be temporary benefits and increased order in the short term, but in med to long term, there will will inevitably be less order and a worse outcome for what are identified as the groups in society government policy is ostensibly designed to help.   We have seen this happen when the benevolent social welfare state creates dependence dynamics which effectively imprisons generations of so called disadvantaged individuals and families into a permanent welfare culture.    Star Parker (one of my favorite activists for individual freedom) accurately calls the welfare state:  “Uncles Sam’s Plantation.”

Government transfers wealth and it carries out what appear to be economic activities such as building roads, etc.  But these activities are ultimately  uneconomic because they are decided by policy makers outside of market signals.  Whatever the government does in a well meaning attempt to improve the economy or improve upon some market failure is destined to result in a worse overall result for society.  Why is our infrastructure crumbling??  Liberals would argue we need to spend more public funds on infrastructure.  I would argue the infrastructure is crumbling because we put the govt in charge. 

Society will always be poorer net net when the government takes over some economic activity, no matter whether this is provision of education, infrastructure, health care, postal service, central banking, etc. etc. etc.   It is total myth that public education fueled the rise of US economic supremacy.  US greatness occurred despite public education and despite Eisenhower’s highway system, not because of these well intended big government boondoggles.    I can say boondoggles with the benefit of hindsight since we have seen the total failure of govt to sustain quality education and infrastructure after claiming early victory and success.

Central banking is the most insidious and evil of benevolent government’s interventions in the market.  Remember the Fed was established to eradicate business cycles, but it was only after the Fed was established that we had the biggest boom and biggest bust in the history of the world economy, thanks to the Fed flooding the US and world economy with “easy money.”  Sound familiar???  

Sirico hits the nail on the head with this op/ed.  Highly recommended.

OCTOBER 27, 2011

The Vatican's Monetary Wisdom

More than 'greed,' fiat money and central-bank policies caused the financial crisis.

By ROBERT A. SIRICO

On Monday, the Vatican released an 18-page document titled "Toward Reforming the International Financial and Monetary Systems in the Context of a Global Public Authority." Since then, it has been celebrated by advocates of bigger government the world over.

What's ignored is that the document—released to stimulate debate, not offer official doctrine—embraces a sound economic theory concerning the cause of the world financial crisis: the breakdown of the postwar Bretton Woods monetary system and the unleashing of fiat currencies and central-bank printing presses.

Let's look at a representative passage, while keeping in mind several important markers: 1971 was the year that the Nixon administration killed the gold standard, and along with it Bretton Woods and hard currencies; in the early 1980s, financial deregulation in many countries removed the last major barriers to virtually unlimited amounts of credit; and the 1990s was the decade when the drive to suppress interest rates became the common policy of central banks around the world.

Since the 1990s, we have seen that money and credit instruments worldwide have grown more rapidly than revenue, even adjusting for current prices. From this came the formation of pockets of excessive liquidity and speculative bubbles which later turned into a series of solvency and confidence crises that have spread and followed one another over the years.

A first crisis took place in the 1970s until the early 1980s and was related to the sudden sharp rises in oil prices. Subsequently, there was a series of crises in the developing world, for example, the first crisis in Mexico in the 1980s and those in Brazil, Russia and Korea, and then again in Mexico in the 1990s as well as in Thailand and Argentina.

The speculative bubble in real estate and the recent financial crisis have the very same origin in the excessive amount of money and the plethora of financial instruments globally.

Under the gold standard, there was a check on the whim of financial masters. The Vatican seems to understand this.

This is sophisticated economic analysis. People are occupying Wall Street, blaming capitalism, speculation and greed, but rare is the analysis that traces all these problems back to the structural change in money that was brought about in the early 1970s.

We went from a hard-money regime, in which there were restrictions on the power of central banks and financial institutions to create money and credit, to one where money became purely paper. There were no restrictions remaining on the power of governments to finance unlimited debt. Banks could create credit seemingly without limit. Central banks became the real power in the world economy.

None of this was true under a gold standard. That system limits the expansion of credit by an indelible physical fact. There was a limit, a check, a rule that went beyond the whim of financial masters and politicians. The Vatican seems to understand this.

But discerning the disease and finding the cure are very different undertakings, and here the document falls short. It imagines a new world central bank and political authority that will rule without "any partial vision or particular good" but rather seek "the common good." Its decisions should "be made in the interest of all, not only to the advantage of some groups, whether they are formed by private lobbies or national governments."

Somehow, with an intelligence never before discovered in government bureaucracies, these proposed global authorities would create "socio-economic, political and legal conditions essential for the existence of markets that are efficient and efficacious."

Contrary to what is being said, this document presumes the existence and continuation of "free and stable markets." The problem is that the Vatican imagines that a "world central bank" and a "global public authority" can do this with more competence than national governments that have a checkered history in this regard.

It was centralization that caused this mess in the first place. Central banks created paper money, easy and limitless credit, and the moral hazard that accompanies them. Why should we believe that more centralization is the solution when experience suggests precisely the opposite?

Many people who favor free markets worry about the implications of the Vatican document. And there is no question that it will be used around the world to stir up political mischief. It will also be used to convince the Catholic faithful that big-government solutions are morally justified. But let's not forget that there are really two parts to the document: the diagnosis and the prescription. We should embrace the former and eschew the latter.

Fr. Sirico is president of the Acton Institute in Grand Rapids, Mich.

Moderates, Extremists, and Liberty

I love this article I coped below by Gary Galles, prof of economics at Pepperdine Univ.  The first reason i love the article is that it highlights the ideas of one of my favorite thinkers in the history of ideas, i.e. Frederic Bastiat, a Frenchman who lived in first part of 20th century.   

The second reason i like Galles' article, is that it speaks to the central theme of this very blog, which is that the "real" extremists are the interventionists on the right and the left, not the supporters of individual freedom in the true moral and founding "center" of America.

Consider this quote from the last paragraph of Professor Galles article (if you don't have time for whole article copied below).  The quote is as relevant today as it was in the first half of 19th century.  amazing.  the more things change the more they stay the same....:

"Frederic Bastiat recognized that, in his era, politically popular "moderation" resulted in expanding government coercion, while extremism, which was continually attacked, meant commitment to defending liberty."

Moderates, Extremists, and Liberty

Mises Daily: Thursday, September 22, 2011 by Gary Galles

As I have observed the mainstream media (MSM, to the cognoscenti) over the past few decades, I have noted a growing infatuation with the words moderate and extremist. Those words, paired together in a particular way, have become far more common.

In California, where I live, every time the legislature has trouble passing a budget, pundits blame it on a decline in the number of moderate members, whose seats are now held by extremists. Of course, what is really involved is that Democrats, who have long dominated the legislature, have found it harder to buy off enough Republican votes to impose their budget priorities, which invariably involve increasing the burden on some to give more to others. When opposition-party members who are only moderately attached to the principle of self-ownership (moderates) are replaced with those more firmly attached to it (extremists), at least with regard to taxes, the price of buying the necessary swing votes can rise dramatically. Democrats cannot impose their agenda as easily and gridlock becomes more common.

The MSM treatment of the tea party during the debt-ceiling impasse followed much the same line. In the wake of a historic expansion of federal power and spending, where 40 percent of every dollar had to be borrowed, pundits called for moderates, because they would compromise toward President Obama's demand for higher taxes, rather than the current extremists, who wanted to undo some of the new and improved profligacy in government outlays.

In both of these examples, and many others (such as the MSM treatment of Rep. Ron Paul throughout his political career), the moderation called for is always moderation in defense of some aspect of liberty (self-ownership), so that further inroads can be imposed, with those firmest in their defense tarred as unreasonable extremists.

However, I recently discovered that this tendency is of longer standing than I had been aware of. In an "electoral manifesto" published in November 1830, Frederic Bastiat offered a dead-on discussion of the same problem in France. Since he expresses himself with his characteristic clarity, wit, and irony, I think it is worth recalling:

To the electors of the Department of the Landes:
[I]t is above all the moderation which plays a role in this army of sophisms.
Everyone wants moderates at any price; we fear extremists above all … since the center is definitely between the right and the left, we conclude that this is where moderation lies.

$24 $14

Were those who each year voted for more taxes than the nation could bear moderates? What about those who never found the contributions to be sufficiently heavy, emoluments sufficiently huge, and sinecures sufficiently numerous … the betrayal of the confidence of their constituents.…
And are those who want to prevent the return of such excesses extremists? I mean those who want to inject a dose of moderation into spending; those who want to moderate the action of the people in power … those who do not want the nation to be exploited by one party rather than another.…
[T]he government … tends strongly to … expand indefinitely its sphere of action. Left to itself, it soon exceeds the limits which circumscribe its mission. It increases beyond all reason … It no longer administers, it exploits.… It no longer protects, it oppresses.
This would be the way all governments operate … if the people did not place obstacles in the way of governmental encroachments.
[L]iberty should not be bargained over … it is an asset so precious that no price is too high for it.…
[P]rodigality and liberty … are incompatible.
But where can there be liberty when the government, in order to sustain enormous expenditures and forced to levy huge fiscal contributions, must resort to the most offensive and burdensome taxation … to invade the sphere of private industry, to narrow incessantly the circle of individual activity, to make itself merchant, manufacturer, postman and teacher.… Are we free if the government … subjects all its activities to the goal of enlarging its cohort of employees, hampers all businesses, constrains all faculties, interferes with all commercial exchanges in order to restrain some people, hinder others, and hold almost all of them to ransom?

           Can we expect order from a regime that places millions of enticements to greed all around the country … increasingly spreading the mania for governing and a zeal for domination.

Do we want then to free government from the plotters who pursue it in order to share out the spoils, from factions who undermine it in order to capture it, and from the tyrants who strengthen it in order to control it? Do we want to achieve order, freedom and public peace?
Do we want the government to take more of an interest in us than we take in ourselves? Are we expecting it to restrain itself it we strengthen it and become less active if we send it reinforcements? Do we hope that the spoils it can take from us will be refused.… Should we expect a supernatural nobility of spirit or a chimerical impartiality in those who govern us, while for our part we are incapable of defending … our dearest interests!
Electors, be careful. We will not be able to retrieve the opportunity if we let it slip … we should not shut our eyes to the evidence … if there has been no material improvement, have we at least then been given any reason for hope? No.

[L]iberty … are we going to destroy its work with our votes?

Frederic Bastiat recognized that, in his era, politically popular "moderation" resulted in expanding government coercion, while extremism, which was continually attacked, meant commitment to defending liberty.

Unfortunately, little seems to have changed when it comes to political punditry, beyond the explosion of media in which to misrepresent that crucial issue. But fortunately, if we recognize with Bastiat what is really at stake — a liberty too precious to be bargained over — such misleading rhetoric cannot fool us into becoming accomplices in destroying liberty with our political choices.

Gary M. Galles is a professor of economics at Pepperdine University. Send him mail. See Gary Galles's article archives.

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Frederic Bastiat

Bastiat is among my most favorite writers in the entire history of economic thought.

His small book, The Law, is essential reading for anyone who wants to make sense of the world.

You can find THe Law at the following web link address:

http://bastiat.org/en/the_law.html

born 1801, died 1850.

http://en.wikipedia.org/wiki/Fr%C3%A9d%C3%A9ric_Bastiat

Following are a few highlights of what Bastiat says (in my intepretation/words) in The Law:

Democracy and voting only matters when the government gets in the game of choosing winners and losers in society via (well intended) regluations, taxes and interventions of all sorts.

If the government limited its role to protecting individual private property rights equally under the law, then we wouldn't need to worry about who gets suffrage. 

however, when the government decides social and/or economic outcomes (as it does in modern society), then suffrage becomes hugely important because suffrage is a way for special interest groups to maximize their ability to extract rent seeking opportunities (free lunches and handouts and subsidies, etc.) from society via the ballot box. 

Once one special groups gets suffrage, then it is only a matter of time before other groups attempt to gain rent seeking opportunities through suffrage and so on.  in this way the principle of democracy becomes bastardized by special interest groups all vying for access to the vote (so they can vote themselves special preferences).   

IF we put our faith in government to solve social problems, we create a receptive environment for the spontaneous development of money politics.  Money politics follows government intervention like day follows night.    

Big business does not favor "free markets."'  Big business favors money politics and government intervention because big business will always win in the game of money politics.  If you want to help the little guy, do not do it with direct government intervention.  Protect the interests of the little guy by limiting government to ensruing the equal treatment of all under the law.

There are trade offs in life.  Life is not fair.   The government can only provide free lunches to some at the expense of others; government cannot provide free lunches to society no matter how good the intentions.

Bottom line:  well intended government interventions are self defeating.  Don't believe politicians "selling" free lunches.  you will pay one way or the other for government provided goodies.

Here are a couple of related quotes from other great thinkers that remind me of Bastiat

“Those willing to give up liberty for safety deserve neither.”  Ben Franklin

"Power corrupts and absolute power corrupts absolutely."  Lord Action

 Primum non nocere (which means "First, do no harm").  part of Hippocratic Oath ... p
oliticians should follow the same precept.   

 see wikipedia entry for basic biographical sketch.