The Midnight Hour

I’m currently reading Alan Greenspan’s book Age of Turbulence. One idea he explores at length is the necessity of property rights in a free market economy. He rightly points out that the backbone of the American economy is a trust between buyers and sellers that buyers will pay and sellers will deliver goods or services. This trust doesn’t exist because Americans are gentlemanly, but because our government is unique in the world in its historically unwavering protection of property rights for citizen and immigrant alike. Of course, we’ve fouled this up plenty of times. However, our judicial system is still the most impartial and accessible system in the world.

Very few transactions in our economy are cash and carry exchanges between buyer and seller. Most often goods and services are purchased or provided on account or on a line of credit. If even a small percentage of these transactions resulted in default then our judicial system would be clogged with an insurmountable backlog of cases. We know that is not the case. Therefore, the overwhelming majority of transactions occur successfully and voluntarily based on knowledge that the victim would be exonerated if legal action was necessary. Without this trust our economy might grind to a screeching halt. We’re actually seeing a relevant example right now in credit markets. Lenders are no longer so sure that debtors will repay their loans, so credit has tightened.

This fundamental respect of private property has fueled the greatest economy yet seen. Other free market concepts are equally responsible. Free markets reward those who risk the capital to start a successful venture. The market does not reward unsuccessful ventures. Willing participants are another tenet of capitalism that has fueled our success. No man is forced to sell his goods or services and no man is forced to buy them. Whenever market participants are coerced into unwillingly buying or selling, which includes and is defined by buying or selling at a price not of their own choosing, the free market has ceased to exist. This is not just a matter of principle, although the ability to act free of coercion is required of any free society. Free markets most efficiently allocate resources and create wealth within a society. Any type of top-down planning–anything but willing participants agreeing upon voluntary transactions– is sure to send the market into the crapper faster than when President Bush holds a daytime press conference.

Why have I regurgitated Free Market Capitalism 101? Because we’re currently witnessing the unraveling of many foundations that have fueled our economy to greatness.

1. Market participants have eroded trust. As I mentioned above, we have suddenly and not so unpredictably determined that not everybody’s post-dated check is going to clear. Unlike the factors that follow, this has been a natural market phenomenon. Left to correct itself, the market would have done just that. Credit tightens until creditors perceive a profit opportunity in lending to valid borrowers that can probably repay but cannot currently get loans. Creditors undertake some calculated risk and extend loans to those borrowers. Their risk is rewarded more often than not, and over many millions of transaction (and admittedly an unknown amount of time) the credit market is restored. Unfortunately, that didn’t happen. The U.S. congress and our social conservative turned conservative socialist, President Bush, passed the $700 billion bailout making King Henry Paulson the most powerful man on earth. That led to the following dysfunction:

2. Risk no longer begets reward. Banks that correctly gauged their lending practices and correctly managed risk were not rewarded. The successful risk-takers not only missed out on a reward, they watched as the buffoons that mismanaged their businesses received a huge infusion of capital. The rules that propelled us to greatness no longer applied. Many a businessmen updated his Facebook status with “WTF, Hank? What do I have to screw up to get my check?” With the conventional notion of risk versus reward temporarily out the window (we can only hope it’s temporary) how did we expect markets to react? But before any of this happened we started down this slip-n-slide through the following:

3. Government coercion of “critical” industries. During the primary campaign season President-Elect Obama and soon to be Secretary of State Hillary Clinton both promised to levy “windfall profit” taxes on “Big Oil.” Somehow the Democrats decided that some companies were just too profitable, and they must be punished for their success. They argued that “obscene” profits by Exxon Mobil were partially responsible for the increase in gasoline prices, and reigning in their profits would alleviate this. Corporate greed was blamed for rising fuel prices. How is a business supposed to gauge what is “too profitable” and will result in punishment versus maximizing return to its owners, which is the natural function of a business? Once again, normal market forces cease to apply under this strategy. Today the price of gasoline near my house is $1.43/ gallon. Is corporate benevolence receiving similar accolades due to the drastic fall in prices? Of course not. This populist pandering is meant to incite anger against contrived injustice and then forgotten when the injustice can no longer be contrived.

4. Fast forward back to today and you still find normal market forces being eroded. Two automakers that cannot compete in our economy and would normally be subject to the productive and natural forces of creative destruction will likely be limped along until another crisis takes center stage for populist pandering. They will be saved in the name of being “too important to fail” when if we really thought the auto industry was important we would allow the market to naturally absorb and restructure it into a profitable venture. When the next congress convenes we may finally get our “auto czar” to centrally plan and oversee the critical functions of our auto industry. Central planning is a failure. The example of the USSR is trite, so just look to India where cellular phone service was deemed a luxury and left to the free market while energy was deemed a critical resource that must be controlled by the government. Today cellular service in India is plentiful and inexpensive, but uninterrupted electric power is a pipe dream.

Our government is changing the rules of the game. For decades they been tweaking the finer points like the play clock and instant replay, but in 2008 we’ve seen vast changes to the fundamentals. The place kicker is now the most powerful player on the field. Can’t advance the ball in four downs? No problem–have a few more. Top ranked teams are only allowed two men on the line of scrimmage. Games in the auto and banking divisions are officiated differently than in other divisions, but they all compete for the same championship title. Our government has become the BCS of our economy. It has sufficiently confused everyone to the point that direct competition doesn’t matter, and the time and political circumstances during which you lose are more important than why or how you lost.