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Friday, April 3, 2009

The G(rasping)-20

We expected little of sense to come out of the G-20 summit, and it met our expectations with flying colors.

When you don’t understand how the economy got into a mess, you are not likely to understand how it can get out. Politicians either can’t or won’t graps the key fact: “the free market” did not cause our problems. How do we know this? It’s logic: the nonexistent cannot be the cause of anything. I’d like someone to show me this free market that brought on all the current turmoil. Please. The banking industry gets most of the blame, but banking has been part of a formal government-sponsored cartel since 1914 and is regulated, as well as privileged, by multiple layers of authorities, among them the Federal Reserve, the Federal Deposit Insurance Corporation, and the Comptroller of the Currency. An international agreement among the major central bankers, the Basel Accord, controls capital requirements and related matters. (Before 1914 a patchwork of regulations existed.) And let’s not forget the regulators in the states. With perhaps a local or exception or two, there has never been an unregulated banking industry in America (or most anywhere else).

This only scratches the surface of the corporate state’s stewardship of the economy. But politicians, who wield power and spend coercively acquired money for a living, have no incentive to see this. How could they? That’s not how the game of politics is played. They have no reason to see things in a way that would counsel against their exercising authority.

So, with complete predictability, the Gang of 20 promised to spend over a trillion dollars they don’t have to “stimulate” the world economy, to help struggling countries through the IMF (its record is so good at that), and other noble purposes. The G-20 also endorsed worldwide inflation by central banks and promised—I love this one—to “take action against” tax havens.

“The era of banking secrecy is over,” said the communiqué, as though that were a good thing. “We stand ready to deploy sanctions to protect our public finances and financial systems.”

The Obama administration led us to believe it was standing firm against a world regulatory authority, which was pushed by French President Sarkozy. But you be the judge. Here’s what the communiqué says:

“We each agree to ensure our domestic regulatory systems are strong. But we also agree to establish the much greater consistency and systematic cooperation between countries, and the framework of internationally agreed high standards, that a global financial system requires…. In particular we agree: … to establish a new Financial Stability Board (FSB) with a strengthened mandate, as a successor to the Financial Stability Forum (FSF), including all G20 countries, FSF members, Spain, and the European Commission…; to reshape our regulatory systems so that our authorities are able to identify and take account of macro-prudential risks; to extend regulation and oversight to all systemically important financial institutions, instruments and markets. This will include, for the first time, systemically important hedge funds; to endorse and implement the FSF’s tough new principles on pay and compensation and to support sustainable compensation schemes and the corporate social responsibility of all firms….”

And more—as if the regulators could have the requisite knowledge to manage economic affairs. This is a regulatory cartel, and to the extent it squelches competition among jurisdictions, it will produce all the evils of a coercive monopoly. That of course is the point. There is to be no safe haven where people can protect their wealth from the grasping politicians.

Economies Aren’t Run

The presumptuous and undistinguished assembly in London—why are they regarded by the media as wise men and women of accomplishment?—aspire to run the world economy, and they know that out-and-out nationalization is not necessary to that end. Of course, they disclaim any such objective. The current White House occupant, Barack Obama, said in his post-conference news conference that he believes in the free market—he did say that!—but that government must set rules to keep it from running “off the rails.”

Well, of course, an economy is not a locomotive and there are no rails. It’s people engaging in exchanges. “Society is purely and solely a continual series of exchanges,” said the eighteenth-century French liberal economist Destutt de Tracy. So Obama’s idea translates into politicians regulating our peaceful, consensual conduct in order to bring about or to avoid certain outcomes. The current economic turmoil has politicians convinced that they must limit risk taken by financial firms. This, pardon me, is a bad joke. It is none other than government itself that has systematically socialized risk in the financial industry and therefore encouraged individuals and firms to undertake greater risks than they would have taken otherwise. The irony is that the more the politicians strive for a risk-free society, the greater the danger to us all. That’s moral hazard, the largest manufacturer of which is the state.

If banks, hedge funds, and other sorts of operations (including government-sponsored enterprises) assume the Federal Reserve or the Treasury will bail them out in a crisis, they will be less risk-averse than they would have been without that guarantee. If depositors see an FDIC sticker on every bank they encounter, they won’t be too particular about which one they entrust with their money. Safety will not be a competitive factor because deposit insurance makes them all appear equal. The bankers know this.

Full Market Discipline

If politicians were really interested in reducing reckless financial activity with the potential for external harm, they would want to see the full force of market discipline at work. The full force. But remember the point about political incentives. Letting market forces discipline banks, insurance companies, automakers, and other firms would leave politicians and bureaucrats little to do. Market discipline—the threat of loss and bankruptcy—is the product of laissez faire, and, loosely translated, that means: “Politicians, keep your cotton-picking hands off peaceful voluntary exchange.”

We face a serious challenge. On the one hand, people who understand markets realize that government regulation—which includes the corporate safety net—was the essential cause of the economic failure. Any seeming irrationality by bankers and financial managers must be grasped in the context of well-understood government guarantees, including the implied promise by the Federal Reserve—the Great Counterfeiter—to buy toxic assets and provide fiat liquidity in a crunch. This was the indispensable underpinning of the government housing policy that encouraged the making and securitizing of dubious mortgage loans (prime and subprime) and the underwriting of those who invested in them.

On the other hand, people who don’t understand markets or who dislike markets can always blame them for any problem that arises. After all, government regulators, no how much power they have, can’t be everywhere watching everything, can they? So as I’ve written elsewhere, “No matter how much the government controls the economic system, any problem will be blamed on whatever small zone of freedom that remains.” (I modestly acknowledge that Laurence Vance has dubbed this, Richman’s Law. I have no objection.) And the “solution” will be—of course—more regulation. Just ask Obama and Treasury Secretary Timothy Geithner. Don’t think of regulation as being imposed. Think of it as the modest price for government privileges and protection.

So the market’s opponents can rely on demagogic sound bites and pervasive economic ignorance, while the market’s defenders must ask people to think. Sad to say, this puts the freedom philosophy at a disadvantage. And so we press on.

  • Sheldon Richman is the former editor of The Freeman and a contributor to The Concise Encyclopedia of Economics. He is the author of Separating School and State: How to Liberate America's Families and thousands of articles.