OK, this just sucked me in. It's intriguing as hell. And it's beautiful.
Hat tip: Diana
As some of us have continued to say, it will continue to get worse until fundamentals are addressed. Money was given to banks, but balance sheets were not restructured. As such it is only a temporary delay in financial troubles. As long as financial markets are stopped up, demand freezes, and the longer that persists the more impact it has on actual demand. A general slow down ensues, and real firms, the worst run, and most at risk, begin to falter. Voila, autos slump; retailers are next.
The financial bail-out has failed. Primarily this is indicated by the precipitous drop in selected financial stocks after they were infused with cash. Bank of America, Citigroup, and Goldman Sachs are off more than 50%. There was no need to hide which banks were in trouble, since the bailout wouldn't work, we were bound to find out by watching their stocks.
Some suggest that this is not yet as bad as The Great Depression, pointing at the jobless rate as a key indicator. However, we must remember that in the Depression our economy was much more self-providing than it is now. Most of our manufacturing has been moved off shore to places like China. If you look at what's happening to factories, and unemployment there, it is not pretty.
Our government continues to throw money at the problem, and attempt to improve things by stimulating consumers to buy. However, this is attempting to change the cause by stimulating the effect. It is doomed to failure. What does the Federal Government risk through this policy? It already is close to lowering interest rates as much as it possibly can (to 0% effectively). But that is absolutely the wrong thing to do. Lower rates are what got us into this problem, and it only encourages poor investing. Capital has already been destroyed. What we need is higher rates to spur conservative investing and capital preservation, but this does not fit with the stimulatory policy of the monetarist Fed. While sound policy guarantees a protracted recession, doing the opposite is now almost sure to guarantee a depression. The Fed has thrown so much money at this, that it now threatens the viability of the dollar as a currency of standard. If dollar confidence erodes enough, expect massive dollar flight and a significant decline in dollar values, making the problem even worse. We're in a deflationary period now, but that is due to real demand destruction. If the Fed continues its stimulatory policy, expect the deflation cycle to turn to rapid inflation.
We also do not need industry bail-outs. This phenomenon is nothing more than poorly run company "pigs" to an ever widening trough. The other half of the US auto industry is fine. Why do we continue to reward failure? Every bail-out, the financial one included, has done nothing but reward those who have failed to manage their companies well, and punished those who have succeeded. While some advocates of a bail-out continue to think that it can be structured in such a way as to force Detroit to restructure, Megan McCardle points out that things have become so cynical back in Washington, the those who support the auto bailout there now nakedly see it for what it is, a cash grab, "Hail Mary" play. Yet, they advocate it anyway. My God, what have we become!
Citi begs for help, and Wells Fargo has "help" forced upon it. A free market would work in reverse. Wells would gobble up Citi, but as long as the govt is in play, Citi resists, holding out for a hand-out. When strong banks suggest that they will use bail-out funds to make acquisitions, the one rational, helpful action in this crisis, tax payers howl.
This crisis could have been avoided. If the government had only stayed out when the banking sector worsened, and let the natural course of bankruptcy restructure sick balance sheets.
There are letters being penned to my congressmen, and I'm planning a few LTE's as well. Now more than ever, there is only one thing to advocate, lasseiz faire!
Readers tell me of breaking stories, new perspectives, and counterarguments to prevailing assumptions. And this is what blogging, in turn, does to reporting. The traditional method involves a journalist searching for key sources, nurturing them, and sequestering them from his rivals. A blogger splashes gamely into a subject and dares the sources to come to him.
Not all of it is mere information. Much of it is also opinion and scholarship, a knowledge base that exceeds the research department of any newspaper. A good blog is your own private Wikipedia. Indeed, the most pleasant surprise of blogging has been the number of people working in law or government or academia or rearing kids at home who have real literary talent and real knowledge, and who had no outlet—until now.
To use an obvious analogy, jazz entered our civilization much later than composed, formal music. But it hasn’t replaced it; and no jazz musician would ever claim that it could. Jazz merely demands a different way of playing and listening, just as blogging requires a different mode of writing and reading. Jazz and blogging are intimate, improvisational, and individual—but also inherently collective. And the audience talks over both.
The reason they talk while listening, and comment or link while reading, is that they understand that this is a kind of music that needs to be engaged rather than merely absorbed. To listen to jazz as one would listen to an aria is to miss the point. Reading at a monitor, at a desk, or on an iPhone provokes a querulous, impatient, distracted attitude, a demand for instant, usable information, that is simply not conducive to opening a novel or a favorite magazine on the couch. Reading on paper evokes a more relaxed and meditative response. The message dictates the medium. And each medium has its place—as long as one is not mistaken for the other.
Anna Schwartz co-authored "A Monetary History of the United States" with Milton Friedman. While the monetarists have their own issues, she gave an interview to the Wall Street Journal this week on the financial crisis, "Bernanke is Fighting the Last War, and it is superb. She made five key points that echoed themes I've been discussing in the past weeks.
First, the current Federal policies are not addressing the fundamental cause of the confidence problem. That cause is distressed balance sheets which can only be fixed by write down and recapitalization.
This is not due to a lack of money available to lend, Ms. Schwartz says, but to a lack of faith in the ability of borrowers to repay their debts. "The Fed," she argues, "has gone about as if the problem is a shortage of liquidity. That is not the basic problem. The basic problem for the markets is that [uncertainty] that the balance sheets of financial firms are credible."
So even though the Fed has flooded the credit markets with cash, spreads haven't budged because banks don't know who is still solvent and who is not. This uncertainty, says Ms. Schwartz, is "the basic problem in the credit market. Lending freezes up when lenders are uncertain that would-be borrowers have the resources to repay them. So to assume that the whole problem is inadequate liquidity bypasses the real issue."
Second, bank failures are not the end of the world, and in fact are part of the restructuring process that is needed.
In fact, by keeping otherwise insolvent banks afloat, the Federal Reserve and the Treasury have actually prolonged the crisis. "They should not be recapitalizing firms that should be shut down."
Rather, "firms that made wrong decisions should fail," she says bluntly. "You shouldn't rescue them. And once that's established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich." The trouble is, "that's not the way the world has been going in recent years."
Third, the idea of "systemic risk" as a Doomsday scenario is bogus, and only propagates the "too big to fail" mindset.
Instead, we've been hearing for most of the past year about "systemic risk" -- the notion that allowing one firm to fail will cause a cascade that will take down otherwise healthy companies in its wake.
Ms. Schwartz doesn't buy it. "It's very easy when you're a market participant," she notes with a smile, "to claim that you shouldn't shut down a firm that's in really bad straits because everybody else who has lent to it will be injured. Well, if they lent to a firm that they knew was pretty rocky, that's their responsibility. And if they have to be denied repayment of their loans, well, they wished it on themselves. The [government] doesn't have to save them, just as it didn't save the stockholders and the employees of Bear Stearns. Why should they be worried about the creditors? Creditors are no more worthy of being rescued than ordinary people, who are really innocent of what's been going on."
Fourth, regardless of market forces that reacted during the buildup, one of the underlying causes was loose money policy at the FED. Anna, as a monetarist obviously focuses on this as a primary cause, but I can forgive that. I like this development, not so much for it's errors, but because of the fundamental idea that seemingly unexplainable phenomena are explainable. That mysterious "booms" are not so mysterious.
How did we get into this mess in the first place? As in the 1920s, the current "disturbance" started with a "mania." But manias always have a cause. "If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset.
"The particular asset varied from one boom to another. But the basic underlying propagator was too-easy monetary policy and too-low interest rates that induced ordinary people to say, well, it's so cheap to acquire whatever is the object of desire in an asset boom, and go ahead and acquire that object. And then of course if monetary policy tightens, the boom collapses."
And finally, on Alan Greenspan's role in the mess,
The house-price boom began with the very low interest rates in the early years of this decade under former Fed Chairman Alan Greenspan.
"Now, Alan Greenspan has issued an epilogue to his memoir, 'Time of Turbulence,' and it's about what's going on in the credit market," Ms. Schwartz says. "And he says, 'Well, it's true that monetary policy was expansive. But there was nothing that a central bank could do in those circumstances. The market would have been very much displeased, if the Fed had tightened and crushed the boom. They would have felt that it wasn't just the boom in the assets that was being terminated.'" In other words, Mr. Greenspan "absolves himself. There was no way you could really terminate the boom because you'd be doing collateral damage to areas of the economy that you don't really want to damage."
I have an entire post on the revisionist perspective that Alan Greenspan has himself put to his decisions and actions. However, every time I sit to write it, I get too infuriated to finish it. This particular account made my blood boil as it shows in his own thinking the pragmatist and sell-out he has become. And in the end in doing so he's become capitalism's worst detractor.
Thanks Anna for saying what had to be said!
The last debate starts in an hour or so. I can't do it, really. I'll be ill if I try. After watching the last several weeks of an incredible resurgence of statism from government intervention in the economy, it really doesn't matter what the candidates say.
I was tempted for a while to vote McCain, just because the economic crisis is so bad, and will potentially be so devastating if mishandled. My hope was that there was some semblance of basic economics somewhere in his camp. However, after reading about what Franklin Roosevelt promised regarding monetary policy and what he actually did after being elected (which you can find in this publication: The Great Myths of the Great Depression) it's clear to me that a vote for a pragmatist who says he's for the free market, and consistently bashes it in word and deed is no vote at all. The Republicans are slaves to religion and a pragmatist like McCain will go wherever his handlers lead him. And a Democratic Legislative / Executive combination can only do no good. There is no choice this year. I'm sitting this one out. I'll use the time to pen a few letters to my congressman, and maybe some Letters to the Editor.
Today I read of the heavy handed tactics used by Treasury on our nine largest banks. I read of force used to take ownership rights in banks in exchange for capital. Forced used on both good banks and bad banks alike, and capital thrust upon good banks that didn't need or want it. You should read some of the account here. It is chilling.
The only difference between Hank Paulson and Hugo Chavez is that Paulson "feels badly" about what he's done. Our American statism takes the unique form of a seemingly concerned, reluctant paternalism. Here, instead of the stern dictator, we have the "reluctant father." Never mind that both have to punish their misbehaving children, in exactly the same fashion.
But I digress. On to the topic at hand.
Megan McCardle almost had me snookered last week, but not this week. She's concerned about something in the market called "systemic risk," and thinks that this is cause for some form of government regulation in the financial markets. For those of you who don't know finance, systemic risk is risk that an entire system is subject to. It is said to be the risk that you cannot eliminate through diversification. This concept however has become the basis for a line of thought which has a parallel in the environmental movement, namely The Doomsday Scenario. Last week this scenario was posited for the commercial paper and money markets.
The idea is that these systemic risks threaten the very existence of the financial markets, and because the markets move so fast it is possible that once they near a certain point, it will be impossible to stop the financial system from imploding. Therefore one needs to regulate the markets in such a way that they are kept away from these systemic "cliffs." While markets do move quickly, and can get themselves into trouble, I think it is fallacious to then posit that the outcome is catastrophic, and that it can be mitigated by government action.
I'm not suggesting that such risk doesn't exist, but I am seriously questioning that idea that one can mitigate it by regulation. Forgetting for a second that governments themselves are subject to systemic risks, that their meddling can in and of itself be a systemic risk through unintended consequences (as is the case in this crisis), and that systemic risks are in part unmitigatable because the are unforseeable (making one wonder how one a priori regulates against them). The argument that caught me off guard was her thought on why governments are uniquely qualified to do the damage control when a crisis hits.
In her discussion on the crisis with Yves Smith of Naked Capitalism (whose blog I have come to rely on for its up to the minute detailed information on this crisis, and who is "gobsmacked" at the Paulson bailout. For her take on why the bailout won't work see her BloggingHeads with McCardle - 18:00. It's quite good.) Megan posits (bold mine),
One of the core issues here, I think what the government is really good at in doing this kind of regulation is first of all it's great at transparency and it's really good at coordination. And so some of the things that people are suggesting, like Luigi Zengales is saying 'look just force people to do an equity transfer' and the reason you want the government to do this is that anyone who does it by themselves sends a bad signal to the market, but if you force everyone to recapitalize at once, then there's no signaling of [balance sheet problems].... But the government is really good at that stuff, when you have a collective action problem in the financial markets which you often do. (passage starts at 38:30, the whole discussion of systemic risk starts at 28:00)
My first response to this was "hmm, ok, yes government can generate broad, unified action." It is of course telling that she uses the word "force" since that is the mechanism by which government accomplishes "unified" action. And it is true that this crisis needs a unified action. I spent a day noodling on that problem, until one of my favorite capitalists, J.P. Morgan, gave me the answer. Back to my post of last week, Morgan's answer to the crisis of 1907 was to bring all bankers together, turn out balance sheets, and restructure them with capital infusions and write-downs.
In a sense the action required here is the same, a unified action, involving all the main banks, restructuring through write-downs and capital infusions. A free market could do this on it's own. Treasury might be able to do it, but it inherently requires nationalization. So why isn't the free market acting? Why is government supposedly better at such action? Because if bank heads do this today, it goes by the term collusion, and it is patently illegal. But it should not be! Government is better at it because it has made the act of doing it illegal for all but itself. Also, for the CEO who has managed his bank poorly, the free market option means he will lose his firm. Such a person, acting pragmatically, would rather hold out for a government bail-out, even if he risks bankruptcy. Implied government action creates that moral hazard that prevents these free-market-led negotiations!
A "collective action" problem is better handled by the free market, but today such action is illegal. It should not be. The truth is that instead of Henry Paulson forcing good banks to accept nationalization, it is the good banks who should be presiding over the recapitalization of their more poorly-run brethren.
I realized this today. In a follow up to my post on "Why Paulson's Money is No Good" describing why government money can't replace private capital, I forgot one key item, and it's a really good one.
Broad open-ended "emergency" legislation such as the $700b bailout is implemented and interpreted by men. A key feature of the rule of law, and the principle behind the idea the idea of a "government of laws, not men" is that the caliber of people to objectively interpret and benevolently administer law varies. And one feature of a pragmatic approach to public service is that credible men make us think that a government of men is alright. Greenspan, in many times running the FED as if he were a private banker, lulled us into thinking that the FED as legal entity isn't so bad.
Enter Hank Paulson. He's credible as an ex-Wall Street CEO, right? I have many conservative friends who, on that basis alone, are willing to at least entertain the idea that the bail-out money can't be spent that poorly. But civil servants change. New ones come. Sometimes the one we entrust a particular policy to is not the one who actually carries it out, and as a result, they carry it out poorly.
Hank Paulson isn't going to be the one administering this bail-out. In all likelihood, it will be the person selected as Treasury Secretary under President Obama [sic]. Do you know who that is? I certainly don't. Are you willing to trust that person to make good judgements about how to effectively spend this money? I shudder at the thought.
The Bail-out bill continues it's steady march to realization. While the mainstream media and a lot of intelligent people I know continue to advocate for the bail-out, the narrative of the proper causes of the bailout is making it into the mainstream. I don't think it's a majority voice yet, but it is a mainstream voice. Radio commentators like Glenn Beck, Dennis Miller, and even morning radio entertainer Mancow (this morning he identified Fannie/Freddy, the CRA, and government intervention as the key causes of the mess) are openly advocating and identifying root causes properly. Senator DeMint and popular economic commentators are starting to advocate strongly against the bail-out.
The problem however, judging from those I've talked to is that the analysis of the cause and effect seem to be superfluous to the thinking of what to do going forward. I have a whole post brewing on why this is, but I think that we who advocate on the principles of free markets, also have to begin to articulate the concrete free market options, and question the wisdom of the prevailing thinking. That is why I changed my tone on the last letter to my Congressman. I don't think it's necessary that you have a knowledge of economics take this tack. You can also focus on experts in the media who are advocating options, and pointing out problems with the bail-out option.
I have a post brewing on some of what I perceive as the faults in this line of thinking. One aspect is that while many people consider the intended consequences of any advocated action, it is many times the unintended actions that actually can do the damage. Many examples abound, and here are two regarding the crisis.
From a Wall Street Journal Article "Free AIG", it appears as though, in retrospect, the nationalization of AIG a few weeks ago, may not have been a good idea (bold mine).
We don't know if AIG debt deserves a downgrade, but the ratings drama tells us something about the original deal. In fact, the further we get from the New York Fed's takeover of AIG, the worse this transaction appears for both taxpayers and shareholders. In the wake of Lehman's bankruptcy filing, an intervention might have appeared necessary. Now this alleged rescue is even drawing skeptical looks from state insurance regulators, triggering a surreal press release on Monday.
The New York Fed's release had no news, only an assurance that its credit facility was actually intended to help AIG: "This program is designed to stabilize AIG with sufficient liquidity, and to enable AIG to make appropriate dispositions of certain assets over time." (Read full press release here.) Why does the Fed need to convince people that it's helping a company it is lending $85 billion to? Perhaps because shareholders didn't vote for this federal help and might reject it if they could.
There's also downside for taxpayers, because the bizarre structure of this deal encourages the company to put them on the hook for all $85 billion. AIG would have to pay 10.5% this year on the full $85 billion, even if the company didn't borrow a nickel. Taking the money only increases the rate to about 14%. Naturally, the company has already borrowed more than half of the available taxpayer funds.
Once accepted, the onerous terms of this facility force AIG to immediately commence asset sales. Taxpayers might celebrate that the Fed is driving such a hard bargain when owners of a business come to Washington for help, but again, the owners never did. We have found no evidence to suggest that the AIG board, the Treasury or the New York Fed consulted the firm's largest shareholders before striking this deal.
Some shareholders are wondering if a Chapter 11 filing wouldn't have been a better deal. Clearly the word "bankruptcy" in news stories about an insurer can be toxic. Customers begin to flee and state regulators might seek to put even the healthy insurance subsidiaries in conservatorship. But with the company preparing to sell off pieces to satisfy Fed loans, AIG is not exactly in a growth phase now. Shareholders have occasionally prospered when a holding company with a liquidity problem but otherwise healthy business has reorganized under Chapter 11.
Only weeks after the deal, it's unclear that it had any effect that a Chapter 11 filing wouldn't have had. Here's a great example of a free market option that simply wasn't taken, that could have been, and may have been better for the company in the long run.
And on another note, the common belief among many smart but pragmatic advocates of the bail-out today deals with the belief that the short term credit market (commercial paper, and money markets) is too big to fail. This market is used to fund ongoing operations (payroll, accounts receivables, etc) at many companies, and so many CEO's are worried about how to finance these operations, and whether they can raise capital. This is one key aspect addressed Treasury's "sorta" plan. However, some technically knowledgeable people are now considering whether the act of the FED raising $700B in capital by selling Treasury notes won't harm these short term markets rather than help them, simply by sucking cash from them, because of investors seeking safer investments than the currently shaky markets are offering. Think about that. It starts to make everyday common sense. If the problem is one of liquidity (cash flow), where is Treasury going to get the $700B? By sucking it out of the markets that are already illiquid! An unintended consequence. See discussion here, and here.
It is the unintended consequences that will hurt us here, and given that it is highly unclear that government action will improve things and it is very possible that it will make things worse.
These types of arguments are directed at the question "What do we do next?" and they are concrete. I believe that this is what we can start to point out. In essence we argue for more time and consideration, for a rational consideration of the options. Argue it on common sense grounds. Argue to give more time for the voices which are starting to hear raised. Yes, argue in principles, but we also need to make those principles understood by chewing them and giving very easily inducible, concretized arguments that they support. "Capitalism by Induction" if you will.
This letter went to my Representative today (or at least it will as soon as his website isn't so jammed.) I took a little more pragmatic approach in my positioning, only because of where I'm seeing the argument leading among honest individuals these days. More on that in another post. There is still time. Please write your congressman.
As the House now considers a 2nd “Bail out” provision, I again urge you to vote NO on any such provision.
This crisis was caused by extended government intervention in the financial markets, over the course of many years. It is very difficult to see how our government’s ability to understand the unintended consequences of its actions is going to improve by an increasing level of panic, shortened time of execution and far too little consideration of alternatives. It is said that “we cannot afford to stand by and do nothing,” but I would say that when government stands up to “do something” in the economic markets, there is hardly assurance that the cure will not be worse than the illness.
I know that CEO Andrew Liveris of Dow Chemical has come out for the bail-out on the basis that the short term credit market cannot afford to fail. His voice surely makes an impression on you. Yet, even now, many are beginning to worry that in an effort to save the short term credit market, the raising of such large sums of money via Treasury’s issuance of T-bills will in fact make the liquidity crisis worse by pulling money from those markets. It is the unintended consequences of hastily-taken policy moves like this one which will ultimately undo our financial system. (please see: http://www.nakedcapitalism.com/2008/10/more-discussion-of-why-bailout-bill.html )
The Great Depression of the 1930’s was not caused primarily by the stock market crash of ’29, but by a series of actions by government including excessive tarrifs, taxes, and social programs enacted in the subsequent years, which ultimately deepened what could have been a short recession. Congress at that time, was trying to help as well.
Please take this time to think hard that in passing this bill, your vote to “do something” may have unintended consequences that may very well make things worse.
Let the “something” we choose to do be to allow the free markets to work out this crisis, to lower capital gains and income taxes to fuel liquidity and spur growth, and to clear bureaucratic hurdles to allowing speedy recapitalizations of these distressed companies.
Vote NO on any “stimulus” package.
Welcome to the October 2, 2008 edition of Objectivist round up. This week we're focusing specifically on the Financial Crisis from an Objectivist perspective. This is a crucial point in our nation's history, and one which illustrates the value of good ideas, and the failure of bad ones. Your voice is necessary in this time of high anxiety. Hopefully, the Objectivists here help make things a little bit clearer. This issue is quite full so let's get right to the substance.
Also, the Ayn Rand Center for Individual Rights has set up a web site dealing specifically with the Financial Crisis and offering insight and analysis on this crisis and capitalism in general. That site is located here.
Ari Armstrong presents Capitalism In Two Minutes posted at FreeColorado.com, saying, "While I've posted several other links to good articles against the bailout, I thought this short, pithy piece served as a decent summary of the virtues of capitalism -- and the evils of economic controls."
Edward Cline presents America vs. Congress et al. posted at The Rule of Reason, saying, "There was nothing in the original Constitution that gave the government the power to "improve" the economy, except, implicitly, to let it alone."
Noah Stahl presents Blank-and-effect – The economics of pragmatism posted at The Undercurrent, saying, "Stahl examines the current administration's "flexible” approach to the financial crisis, about which President Bush said, “There will be ample opportunity to discuss the origins of this problems[sic]. Now is the time to solve it.” Why do Bush and Paulson think they can solve the problem with no understanding of how it came about?"
C. August presents RIP Bailout... Now What? posted at Titanic Deck Chairs, saying, "The House voted down the bailout. A sigh of relief was followed by dire predictions for what it would do next week. Now it seems that the Senate may beat them to it."
Nicholas Provenzo presents The Financial Panic and the Only Proper Answer to It posted at The Rule of Reason, saying, "We are told that the ruthless self-interest of Wall Street (rather than the "compassionate" gift-giving of the Congress) is the cause of the current financial crisis. Unfortunately, the truth is a little more complex. Perhaps we should examine this truth, that is, before we blithely allow our political leaders to add nearly a trillion dollars to the public debt and give new powers to those who helped bring the disaster along in the first place."
Eric Clayton presents To Defeat the Growth of Government it's Time to Win the War of Ideas posted at Atlantis.
Burgess Laughlin presents What can historians study? posted at Making Progress, saying, "This is an ode to the enormous variety of objects--wide and narrow, great and small, abstract and concrete, exalted and mundane--that historians (and their readers) can study."
Peter Cresswell presents Is the phenomenenal disconnected from the noumenal ... ?posted at Not PC, saying, "A little humour for Objectivists this week ... by all appearance the world's most destructive philosopher is alive and well and in business down in Fiji!"
John Drake presents China for a day posted at Try Reason!, saying, "Thomas Friedman, famed author of the book "The World is Flat", is out peddling his latest book "Hot, Flat, and Crowded". In it, he reveals to the world his disdain for individual rights. In my post, I discuss his speech for the Washtenaw Economic Club, delivered at Eastern Michigan University, and how his vision for tomorrow is fundamental wrong."
Ryan Puzycki presents A Stroke of Good Luck posted at The Undercurrent, saying, "Instead of nervously worrying about the declining health of North Korean leader Kim Jong-Il, the U.S. should view it as an opportunity to reevaluate our appeasement of his despotic regime."
The Editors at The Undercurrent presents The Environmentalist Attack on Outdoorsmanship posted at The Undercurrent, saying, "This essay examines the corruption of the conservationist movement, which once sought to conserve nature for human pleasure - not from human beings, as current environmentalists do."
Kristina Saraka presents Protesting Prices posted at The Undercurrent, saying, "Kristina looks at the phenomena of protesting in order to bring about lower or higher prices, and examines what bad premises such protests are based on."
Adam Reed presents Religion is the Marxism of the 21st Century posted at Born to Identify, saying, "The last economic crisis of comparable magnitude led to the Great Depression and the Age of Dictators. What can we learn from the history of ideas about the corresponding risks and threat levels from this one?"
That concludes this edition. Submit your blog article to the next edition of objectivist round up using our carnival submission form. Past posts and future hosts can be found on our blog carnival index page.
Money frees you from doing things you dislike. Since I dislike doing nearly everything, money is handy.
- Groucho Marx
As Diana points out, free-market economists and businessmen are starting to articulate the proper principles, causes and needed actions in this crisis. I fear however, that the prevailing philosophy in Washington will not respond to these voices and we will see a nominally similar bail-out pass through Congress. Coupled with a probable Obama presidency and a Democratic Congress, and the tax increases and "relief" measures sure to pass, I also fear a looming full-scale Depression. If capital should flee American shores as a result, we will see a severe loss of value as the Dollar slides and is no longer the bulwark of stability in a storm. Capital has options today. It's not like the Crash of '29.
Many of my Objectivist friends are blogging and articulating the proper philosophical principles by which to evaluate the crisis including The Rule of Reason, Galileo Blogs, Applying Philosophy, and the Ayn Rand Center for Individual Rights.
In today's post I thought I'd attempt to discuss what the current crisis consists of, what a proper solution would accomplish, and why bail-out money cannot accomplish the same thing.
Most of the free-market solutions I'm seeing posted all involve the same sorts of actions: orderly liquidations, and/or recapitalizations, and some sort of write-down/containment of the distressed instruments (mortgage-backed securities and credit default swaps) to restore liquidity. But what the heck does that mean?
The primary issue here is one of confidence, and hence liquidity. A lack of liquidity is jargon for the inability of money to flow (hence the "liquid" reference) to where it needs to. Note that this does not mean that there isn't money out there ready to flow, but that it simply is frozen. Why? Well, the primary reason is that some banks are holding assets or liabilities that are changing in value at a rapid pace, and in some cases this is threatening to overwhelm a banks ability to pay its obligations. These banks can no longer loan out money. Banks to whom they owe money see that they may not get paid and as a result have stopped lending funds to conserve cash. Healthy banks that might loan them money do not wish to do so because it's unclear what their assets are worth and whether they can pay back the loans. Some banks are sick, some banks are really sick, and since the value of their potential liabilities are changing, it's difficult to decipher which banks could go under and which will survive. So money stops flowing. Uncertainty is high. Confidence is low.
Note, when a bank is close to going under, this does not mean that the healthy assets of a bank somehow vanish. What it means is that under the current capital structure, the bank has more liabilities than assets and has run out of cash, and can no longer raise cash to meet it's obligations.
The key is with the sick banks. In order to restore confidence to the system and hence liquidity, these banks have to be restructured or recapitalized. This can involve the purchase of a stake in the company, outright purchase and assumption of the obligations, and write downs of the asset value. It almost always means that some parties, most notably the owners or stockholders must take a loss. Sometimes certain of the banks obligations are defaulted upon, and even creditors may lose a portion of their assets. Usually the capital infusions result in new controlling interests and the management team is replaced. The new cash, coupled with the loss taken by the various interests, and the change in value of various assets or obligations restores the balance sheet of the company to health. At this point, the bank has the assets to be able to begin loaning again, and confidence in it's balance sheet and it's new management mean that other banks will loan to it. The banks that were owed have taken some loss and may or may not need recapitalization of their own, but eventually, they too can begin loaning again.
There is an orderly due process by which this occurs in the free market, up to and including the use of receivership/bankruptcy to liquidate assets. This process preserves the existing priorities of owners of the company, and it has been shown to work. In a phenomenal article in Monday's Wall Street Journal, "Calling J.P. Morgan" the mechanism by which Morgan recapitalized banks in the crisis of 1907 is wonderfully detailed.
In the fall of 1907, it took J.P. Morgan just eight weeks to resolve a credit crisis similar to ours. Several years of buoyant growth and too much risk-taking in poorly understood investments led to needs for capital that could not be met. Morgan, then 70, locked the nation's top bankers into the ornate library at his home for late-night confession sessions. He asked them to lay bare their balance sheets, keeping himself alert with endless Havana cigars.
The bankers reviewed one another's assets and liabilities. Morgan then decided which financial institutions had to go and which would live, getting commitments from the survivors and from the U.S. Treasury for infusions of capital. This Panic of 1907 had rattled the New York Stock Exchange and the markets for gold and municipal bonds, ruined several banks and trust companies, and nearly bankrupted New York City. Share prices fell by half. But once Morgan was done knocking banking heads together, markets swiftly recovered.
Ever heard of the Panic of 1907? There's a reason. "Markets swiftly recovered." The faster that this can happen today, the faster that we will recover. Yes, government intervention in our economy for the last 10 years means that a large amount of assets are far overpriced and these assets must be revalued, and losses will occur. It will mean that bankers that were foolish enough to overvalue these assets will lose their companies. However, these distressed assets are limited to two sectors of the economy (sub-prime mortgages, and credit default swaps) and in the case of sub-prime the underlying assets (homes) still have value, as do the remainder of assets in all the other sectors. The devaluation of the overvalued assets will mean a recession, but the quicker banks are restored to health, the quicker capital begins flowing and the economy revives.
The question is, aren't capital infusions from the government to recapitalize companies just as good? Here are some key differences to think about, and they are differences that are so fundamental that I counter that even an attempt by Hank Paulson to "look" like a free market will still fail. In a free market:
1. Capital is not used to prop up unhealthy balance sheets. Assets that are truly overvalued are written down quickly. Losses are taken quickly. Propping up bad decisions by pretending that they weren't bad only compounds the problem. Govt money most assuredly will mix it's aims, seeking to rescue those who do not deserve it, either out of altruism or the "too big to fail" doctrine. Government will buy assets before private investors would (since they claim that no one is stepping in, when really no one rationally would step in, at that price) and so guarantee the taxpayers a loss.
2. The people doing the recapitalization have proved themselves adept at managing these operations. In effect, the successful are taking over the unsuccessful. With a regulator making decision, who know if he is capable or not.
3. The people doing the recapitalization have a strong incentive to value assets properly - they put their own money on the line. Transparency of target balance sheets is demanded or no deal. I considered some sort of system where Paulson was required to put every last cent of his personal fortune against his restructuring decisions in direct proportion as a motivator. That certainly incentivizes him, but because of #2 it does nothing to assure that he's capable of making the proper decisions, only that he's motivated.
4. Prior management teams are almost always disposed of. The key here is less that we get rid of the old CEO's but that their replacements are proven to be capable. I don't worry for an instant that Paulson could depose a CEO, but I strongly doubt his decisions on a replacement.
5. The rule of law and sanctity of contract are preserved. In the seizure of WaMu, Treasury seized the company and by fiat destroyed all contractual priorities set forth in the capital structure. This act alone has exacerbated the liquidity problem because now any potential lender to a distressed bank risks losing his entire investment regardless of pre-negotiated terms, to arbitrary exercise of force. Henry Paulson's money comes paired with the potential for wholesale rights violations.
The use of government to attempt this function necessitates rights violations, spends money indiscriminately, and preserves the structures which created the panic at taxpayers expense. The proposed bail-out illustrates perfectly the concept of chasing bad money with good. Voluntary action by the free market instead "cleans house". It cannot be otherwise, no matter how well-intentioned the government.
What can the government do? Primarily, get out of the way, and preserve the rule of law. It needs to definitively state that it will not meddle in the function of the market. By implying that it will do so, government actually impedes the free market from functioning as it should since distressed bank management are hoping to preserve their operations through government action, rather than lose their banks in recapitalizations. It should reduce taxes; capital gains, corporate income, and personal income. In so doing it will encourage the influx of capital and stimulate liquidity and healthy economic functioning. It should clear bureaucratic barriers to bankruptcy and receivership so that these mechanisms can function as quickly as possible. In essence, government should proceed to leave the economy, not meddle in it.
There is one answer to this crisis: laissez-faire!
a. What could possibly go wrong?
b. It's different this time.
c. You just don't get it.
1. Set up a Mechanism to Launder Risky Home Mortgage Debt. Create an agency whose sole purpose is to "offer liquidity to the secondary mortgage market." The agency will guarantee home loans for a small "insurance" fee, or it will buy them and repackage them as "mortgage-backed securities" also guaranteed to pay, regardless of default. Set low standards for the types of loans that will quality, and make sure your fees are low so lots of people will sign up for your insurance. Sell these new low risk securities into the financial markets. Viola! You make risky debt look good, and sell it to "suckers" thereby providing liquidity to the mortgage market. Oh, it's true that some of them won't fall for it, but all we need a few, the dumber ones, and the ones who know what's going on, but who are hoping to find a sucker of their own to pass the buck to. Oh, almost forgot. Make sure you set up this agency as a "private" company. Imply that you'll save it if it gets into trouble, but don't promise it explicitly. Give it a nifty, folksy name like Freddie Mac or Fannie Mae.They'll love that.
2. Force banks to offer Risky Debt. What? Not enough people are helping you issue risky debt? Well, that's easy. Just pass a law that forces banks to lend to high-risk prospects. Tell them you won't let them do things like merge with other banks unless they can prove they are issuing risky debt the way you want them too. Make sure the law states that they specifically shouldn't look at things like applicants' income, or current assets when making decisions about them. If it doesn't work so well at first we can just revise it, so our money laundering agency gets into the act too. Oh, name again. We certainly don't want something like the "Let's Issue More Risky Debt Act", so we need something that will tug at their heartstrings. Got it! the "Community Reinvestment Act"! They'll love that.
3. Hold interest rates down so anyone can afford Risky Debt. OK it's starting to work, but still not enough risky debt to clobber the economy. We need more time! A delaying tactic. Wait! We control interest rates right? Shoot let's just keep interest rates low for a while. We know low interest rates stimulate potential new risky debt holders to go ahead and get that house they can't afford. Do that for a couple of years and we'll have risky debt all over the place! Oh, once again, we don't want anyone to know. Let's wait until we have some sort of minor crisis and say we're doing it to help "stimulate" the economy. How about that "Dot com bubble" we just had? Oh, and we need some cover again. Let's get some free-market guy to advocate it. Some pragmatist who's advocated some pretty strong free-market principles but who'll sell them out at a hat drop, and whine about it afterward that he didn't know. What? Robert Stadler isn't available? How about that Greenspan guy? Yeah, they love him.
4. Make it a moral, noble action to take out Risky Debt. Proclaim that every citizen should indulge the noble dream of home ownership. That buying a home is good for the economy; that it's the government's duty to help you afford your new home purchase, and it's your duty to help out the economy. Use the full power of the largest public relations machine in the free world, the U.S. Government, to trumpet the notion. This is the key, of course. Now when Joe Citizen shows up at his local bank and wonders why his banker doesn't ask him about his income, he won't second guess it because he knows that what he's doing is good for the economy. When Joe Banker sells of his mortgage to Freddie, and wonders how it is that Freddie can afford to guarantee what he suspects is a risky debt, he won't think to ask, because it's the government's duty to see that everyone has a home. Oh, I just get warm and fuzzy thinking about it.
5. Wait. That's it. Just let the machinery work. After a few years, Risky Debt will be everywhere. Some people will be worried, but our PR will have worked on most. Even if they're worried, they'll think about how noble and selfless they're being and all that worry will just evaporate in a cloud of happy thoughts.
6. Blame the Free Market. The implosion will happen. What sets it off will be immaterial because the mechanism, the time bomb, will have long been in place. Everyone will be powerless to help it. We will be too, but think of the mileage we'll get by blaming the free market! We'll get to nationalize things, and give out tons of money. We'll call those Wall Streeters "greedy" bastards, call for their heads, take away their companies. Everyone will come to us for help, and we'll tell them we will, even though we can't really. We'll ask for broader powers. Say that we need to be left alone to handle things the way we see fit. And they'll give them to us, of course. Because they won't know any better.
Now I certainly don't want to imply some sort of conspiracy on the part of government here, but the cause and effect I've outlined is real. It is the cause of this financial mess we're in. And it has nothing to do with the free market. But after all the finger pointing at the greed of the businessman I've heard spewed in the last few days, this version pales in its sinister quality, and the actual actions line up better with the facts on the ground. Free-market intellectuals know this and they are saying so, Bank CEO's, the ones who weren't duped by this trickery, know this and they are saying so.
There is one action on this list however that was taken, consciously and consistently. #4 - making it a noble, moral action. You cannot go anywhere today and not hear the resounding chorus. Man is too selfish and greedy; it is his duty to help those less fortunate; we are our brothers' keepers; it is right for government to force this to happen; people rise to their highest when they pursue a "cause greater than self-interest". It doesn't matter if all the other actions above are mistakes. #4 is not, and from #4 all the others necessarily follow. #4 is known as altruism, and it has only one known antidote, rational self-interest as a moral code, and a politics based upon individual rights.
From his recent The Objective Standard article "The Resurgence of Big Government", ARI Executive Director Yaron Brook states it better than I can:
If selfishness and the profit motive are immoral, then no wonder they are blamed for any and all economic crises. Nor is it any wonder that the government—which we are assured is not self-interested—is posited as the solution to such greed-induced crises. Politicians and bureaucrats, we are told, are working not for their own benefit, but for the “common good” or “public interest.” Thus, economic disasters cannot be their fault; the blame must lie on the shoulders of greedy businessmen.
Because Americans accept the notion that self-interest is morally wrong, they have come to equate businessmen with crooks, on the grounds that both pursue self-interested goals. The argument goes, in effect, like this: Left to his own devices, free from the watchful eye of our public servants in Washington, a businessman will try to make a buck by raiding the cookie jar rather than by producing and selling cookies.
Americans must come to understand that appeals to the “common good” and the “public interest” are not moral claims but licenses to evil. Because the American public is just a number of separate individuals, whenever some group trumpets action in the name of the “public interest”—say, a new prescription drug benefit or Social Security scheme—it is declaring that the wishes of some individuals trump the rights and interests of other individuals. But everyone has a moral right to pursue his own happiness, free from coercive interference by others. If it is to have a legitimate meaning, the “public interest” can mean only this: The rights of each and every individual are equally protected by the government.
If Americans want to turn permanently toward a genuinely free market—and thus toward peak prosperity—they will have to reconsider their moral convictions. They will have to discover a new morality, one based on the requirements of human life and backed by detailed arguments and demonstrable facts. This is what Ayn Rand offers in her body of writings. She is the only champion of capitalism who would and could defend capitalism on moral grounds, as indicated by the radical titles of her books Capitalism: The Unknown Ideal andThe Virtue of Selfishness. Those who want to fight the trend toward statism—those who want to effect a real and lasting turn toward capitalism—would do well to study her thought.
The people who know what's going on are saying so. I'm saying so. It's time for you to do the same.
The following letter went to my congressmen at the end of last week. Should another "bailout" plan be proposed which, while smaller in total dollar figure, differ little in principle then subsequent follow-up letters will be sent.
I urge you if you have not done so yet, to do the same!
As Congress considers a bail-out provision totaling over $700B and which could run higher, please reconsider any decision to vote for this sort of proposal in any way.
What the country needs now is not the govt granting broad reaching, unchecked powers to the Department of Treasury so that it can spend taxpayers money to buy up bad paper and greater than market prices. Such a measure will not save the economy but plunge it further into crisis. It will not punish those executives who made poor decisions while saving those who were smart. It will treat all equally.
What the country needs now is for the govt to provide an orderly mechanism to allow banks to liquidate assets as needed to solve their liquidity problems. That mechanism exists under the rule of law already. It is known as Chapter 11 restructuring. The free market, a truly free market must be allowed to work to clean up the mess, which ultimately has government intervention in both monetary policy and the mortgage industry at the heart of its cause.
Today John Allison, CEO of BB&T, one of the largest commercial banks in the country articulated the principles by which government should behave in a letter to all of Congress. I agree wholeheartedly with his assessment and urge you not to vote for any sort of bail-out plan.
I have generally voted for you and the Republican party party in the past; however, your vote for such a plan now will irrevocably change my future vote. This action will be akin to the disastrous aftermath of the 1929 crash whereby government attempts to solve the financial problems they created only made them worse and caused a protracted Depression. The Democrats were no friend of capitalism in that time, and should this measure pass with Republican approval, then I will have to conclude on principle that the Republican party is no longer a friend of capitalism either.
Kudos to Rule of Reason's Nick Provenzo today for standing up to nationally-syndicated talk show host Laura Ingraham. His recent piece analyzing Sarah Palin's choice to give birth to a baby she knew had Down Syndrome and the broader implications that the glorification of her choice implies for abortion rights was picked up by pro-life media in a big way, culminating in his invitation to appear on Laura Ingraham's show. Misrepresented time and again, he published a follow-up piece as well.
Ingraham, a fervent religionist, is staunchly pro-life. While she deals with most of her "friendly" guests in a respectable manner, those who have views contrary to hers can be subjected to anything from berating to a downright railroad job, and Nick was no exception. His talking points for the show, and his response after the interview are here and here respectively.
Nick stuck to his guns, did not allow himself to be misrepresented, and eventually forced Ingraham to direct and blatant ad hominem. My respect goes out to Nick. Facing tough audiences like this is a tough job, and he handled himself well.
"It is the government's duty to intervene. Now we have a very good example that it is acceptable." -- former Chinese government advisor
What is this government official referring to? Could it be the Russian invasion of Georgia? The latest move by Venezuelan strong-man Hugo Chavez to nationalize more of his country's industry? Not at all. The official refers to Treasury Secretary Paulsen's decision last week to effectively nationalize the U.S. mortgage industry.
As fellow blogger, Gallileo articulated last week, this nationalization was simply making a long standing situation explicit. However, this very public act serves as a demonstration of how far away from the free market the US has actually strayed, and how badly we undercut our efforts to influence other nations' policies.
From a Wall Street Journal article, "U.S. Plan serves as Template For China to Bolster Its Markets"
Still, over the past 30 years, China has studied the U.S. economic model and cherry-picked elements to introduce little by little. It has adopted U.S.-style financial principles to build a market-based system for trading stock. It has invited U.S. financiers to help, with cash and advice, transform its banks into consumer-focused firms with mortgages and private lending. America-focused economic courses are popular at Chinese universities.
U.S. officials have often called on China to cease heavy-handed interventions and occasionally lectured Beijing on financial issues such as how it manages its currency. With the U.S. having to increase its own market intervention, foreign calls for liberalization are likely to be received more cynically in Beijing.
"I think the Chinese regulators will learn the wrong lesson from this," says Liu Jing, professor of accounting and finance at the Cheung Kong Graduate School of Business in Beijing. "Both systems have problems. The problem in China is too much government control, not too little. And they will end up thinking that they should control even more."
The Federal bail-outs, nationalizations and liquidity injections over this crisis are some of the largest interventions in the financial sector since the Great Depression. They are an example of statism, and statist moves. But as this example points out, the US is seen by others as trumpeting the free-market, as an example of how to run free markets, and it is the name of the free market that will be sullied instead of the true cause here, statism.
As Yaron Brook effectively points out in his recent Forbe's op-ed, "The Government Did It," the blame for this financial crisis is to be laid squarely at the doorstep of big government and statist policies. This not an example of the free market mismanagement, but of statism, using an altruist philosophy, run amok.
Again, the The Wall Street Journal article,
Overall, however, the U.S. housing crisis has raised questions about the wisdom of adopting too much American-style capitalism that aren't likely to dissipate soon. The U.S. mortgage crisis is "sobering" for Chinese, who are used to believing "that American financial markets are the best regulated and best managed," says Mr. Zhou [Zhou Dunren, deputy director of the Pudong Institute for the U.S. Economy].
What other nations get wrong when they see this example is that this is a case of American-style statism, not capitalism. True American-style capitalism takes one form, lasseiz-faire, and it would do America some good to once again start practicing it.
I am pleased to inform you that you have been accepted into the Objectivist Academic Center. After carefully reviewing your application for admission, we are confident that you will thoroughly enjoy and benefit from our unique undergraduate-level educational program for the study of Objectivism.
Classes will begin in October 2008. Congratulations, and I look forward to meeting you soon.
Dean, Objectivist Academic Center
Ayn Rand Institute
Thanks to Myrhaf for pointing to a fantastic article, "Does McCain Understand Markets?" by John Stossel discussing my favorite topic, the free market, or at least why a supposedly pro-free market candidate seem to put down the free markets constantly, and the "dreaded" speculator. I love Stossel, calm, cool, collected - just parsing McCain's words and showing him for what he is, as great a collectivist as socialist Obama.
Obama wants us to sacrifice for the poor and disenfranchised. McCain wants us to sacrifice for something "greater than ourselves" - I assume that means the state. Both think personal success, and independent, self-interested action is morally suspect.
By the way, the economic disaster that is US energy policy is terribly on my mind in the past weeks. I work for the company mentioned in my previous post, and my life over the last several weeks has been divereted into crisis mode of, you guessed it, raising prices. I have several different issues with the whole fiasco, but I'm too damn busy raising prices to get decent posts out! :)
SO instead I'll point you to other posts that I think address some of the same issues. Galileo over at Galileo Blogs has a great post on the most infuriating aspect of Congress' "non-action" actions toward this whole situation: the creation of the speculative scapegoat.
I've had this post brewing in me (is that what they do, exactly, brew?) since I got home from Spain.
In my previous post on monetary policy, Fire Sale, I highlighted indicators of the effects of the Fed's disasterous monetary policy as reflected in the most recent run up in the price of oil (or should I say decline in the value of the dollar). In that post I predicted what the future indicators were that this cycle was playing out as an indicator of Fed's causing of inflation, namely that the initial profit surge seen in the economy due to export volume would have to cease and be followed by subsequent rise in the prices of products.
Once again, it seems, my blogging life has intersected with my professional life, as on 5/28, CEO of my company Andrew Liveris, announced a broad price increase on Dow's products of up to 20% due to rising raw material costs, namely crude oil, and energy. Dow is a perfect barometer of the effects of monetary policy as it's primary feedstock, oil is denominated in dollars and will see the effect of inflation of the dollar. Several petrochemical companies have followed suit with similar announcements. This is the first step of the inflationary effect and it took about a quarter or two to manifest itself in the first step on its journey toward the consumer. Give it another two to three quarters to manifest itself broadly in the economy. Recognize that prices are going up in a depressed economy which means demand destruction, and stagnation soon follow.
And our illustrious Fed? What was it doing at the same time? As a June 5th Wall Street Journal Editorial, "The Buck Stops Where?" pointed out, after several years of rising commodity prices, and falling dollar valuations, relative to major currencies that aren't pegged to the dollar, it seems the Fed and Chairman Ben Bernanke has now expressed concern over possible inflation.
This week current Fed Chairman Ben Bernanke waved the white flag over Mr. Volcker's point by declaring his own public concern "that the dollar remains a strong and stable currency." Apologies accepted, provisionally.
The tragedy is that this is big news. The Fed has monopoly power over dollar creation, and concern for its value ought to go without saying. Yet so great has been the Fed's dollar abdication in recent years, and especially since last summer, that Mr. Bernanke's words have come as a great global relief. As the dollar has strengthened in welcome response, the price of gold and oil has fallen in each of the last two days.
The question now is whether the Fed will follow up its new words with action. "We are attentive to the implications of changes in the value of the dollar for inflation and inflation expectations," Mr. Bernanke said on Tuesday, a sign that the Fed may be waking up to the inflation threat. But the Fed chief also signaled that he isn't about to tighten monetary policy any time soon because current "policy seems well positioned to promote moderate growth and price stability over time."
Price stability where? Not in the U.S., where every economic report shows rising price pressure...
The Bernanke Fed has also been oblivious to the fact that it runs a global dollar bloc. Central banks in dozens of countries peg or otherwise link their own currencies to the world's reserve currency, which is the dollar. They do so for the sake of exchange-rate stability, which helps with trade and investment flows. They essentially subcontract their monetary policy to the U.S. central bank.
The Fed's dollar indifference has sent an inflation shock through those dollar-linked economies. This week alone, we've read about price riots in Vietnam; inflation hitting 10.1% in Kuwait; Abu Dhabi contemplating price or wage controls; South Korean and Indonesian central bankers considering rate hikes; and the Chinese letting the yuan rise ever higher to curb inflationary pressures imported from the U.S.
Many of these countries are now delinking from the greenback. Meanwhile, the dollar plunge has translated into a net transfer of trillions in wealth from the U.S. to the rest of the world. The result has been the largest decline in America's global economic influence since the 1970s.
If the editorial language strikes anyone as incredulous, it's no surprise. While oil prices dropped on this news, they were soon back up. I'm not sure why they would have dropped in the first place since Bernanke's stance to not tighten monetary policy belies its complete misunderstanding of the situation. In a June 18 follow-up "FED Mood Titls Away from Rate Increase" it's clear that this inflationary pressure does not worry the FED as much as it might think.
As the editorial points out, the FED has complete control over inflation of the dollar. If there's inflation out there, it is due to inappropriate monetary actions by the FED. Notice how in most of the FED's language it treats inflation as some causeless effect out in the world. As such the FED's action to curb inflation are never viewed as self-correction, but rather as attempts to keep the unruly market in check.
The misguided policy is that the FED wishes to believe that it's stimulatory actions (keeping interest rates low) will "stabilize" the housing market before it has to deal with inflation. But let's go back to our lead story and price increases. It takes time for prices to trickle through to the consumer. When it does its destabilizing effects will overwhelm any stimulus the FED thinks it's injecting in the short term. Inflation has already been unleashed, and is a torpedo headed for the housing market. Since the FED is the only agent that can act to head it off, keeping a "steady as she goes" monetary policy is a recipe for disaster! If the housing market is bad now, it won't be helped when the cost of materials that go into new starts and renovations skyrockets, as it is sure to do.
And today we have an even larger signal of this effect as in no less than 3 weeks after it's first announcement, Dow has again announced broad pricing increase of up to an additional 25% on it's products. Including these increases and the ones most chemical companies have been making over the last 12 months that's more than doubling of prices!
The FED will not make substantive moves (whole digit percentage points move upward in interest rates) until the furor over inflation reaches a deafening roar. It will not do so because it believes it is helping the situation instead of the primary cause of it. It misunderstands its own cause and effect and the consequences will be disastrous. It doesn't see that it has launched the inflation torpedo now working its way through to consumer product prices. Leading indicators of this? Look at airlines and chemicals. Airlines are highly dependant on oil, and are a direct pass through of oil costs to the consumer. Chemicals are only one step removed from oil, and manufacture products that are ubiquitous in almost all downstream markets. Both these industries are reeling with price increases and reduced demand.
The FED will make time-delayed reactionary moves. Free markets on the other hand act in an anticipatory manner moving ahead of the impact based upon actual cause and effect. This in fact is the best empirical case to be made for privatization of monetary policy. Businessmen cannot afford to wait until a crisis exists to act. They must anticipate it. As long as the FED is oblivious to its own shenanigans, it cannot act in this fashion.
The cure is known, and can be enacted now, but it is not popular. It's essentially a tightening of the money supply, as was effected by the Reagan FED to head off stagflation of the late 70's, and it rests primarily in the hands of our money regulators. If the free market were running monetary policy it would already be in effect. Of course one could argue that we never would have gotten into this mess in the first place.