December 23, 2008

There Is No Economic CrisisReflections on a Financial Meltdown

"Well, here's another nice mess you've gotten me into."
— Laurel to Hardy (circa 1930s)

For the past couple of months the United States has been experiencing what we are told is an economic crisis. Indeed, stock markets are down considerably and the jobless rate is rising. Financial institutions are closing and the overall economy is slowing.

The mantra of the media and many politicians pins the Wall Street meltdown on "corporate greed." We hear this mess was spawned by de-regulation of the banking industry. And there is a cry for the federal government to step in to make everything better, from fixing failing banks to bailing ailing auto manufacturers to propping up debt-ridden cities and consumers.

While the blame game is in full gear, the average citizen is left in a fog to sort through the rhetoric. What to make of it all? What is the cause of our financial woes? And what is government's role in fixing it? A little worldview analysis helps clear away the fog to reveal the underlying problem and, therefore, the proper solution.

How about Those "Greedy" Capitalists?

First of all, the underlying problem is not primarily with the "greedy" capitalists.[1] Banking executives and Wall Street speculators do what they always have done; seek to make a profit. Making a profit is the purpose for any company to be in business and there is nothing wrong with that, per se, as long as there is no fraud, theft, or coercion in their operations or transactions.

As history demonstrates, the profit motive is the only way prosperity can spread to the greatest number of people. To see this point, we simply need to recall that during the Middle Ages there were only two classes of people: the wealthy (comprised of kings and land-owners) and the poor (serfs living hand-to-mouth). Yet, today, in Western countries where free market economics has been practiced for several centuries, there are three classes of people: the wealthy and the poor, as before, but also a large and growing middle class. Further, it should be noted that today's middle class lives better than the wealthy class did just 300 years ago. This is the direct result of a free market economy.

However, there is a lot of confusion over how the economy works. According to a recent study of Americans' knowledge of economic principles, only 54% can correctly identify a basic description of the free enterprise system.[2] Therefore, if our nation is going to take the right course in these uncertain economic times, we need to refocus on the fundamentals of what makes the economy work. As my basketball coach used to say, the secret to success is perfect execution of the fundamentals. Let's be reminded of what the fundamentals are of economics before offering a solution.

Econ 101

How does the economy work? A simple example might help. Go back to when you were growing up and let's say you decide to set up a lemonade stand in front of your house. You did this, of course, to make money so you could buy something else you wanted, like a new toy! Were you being a greedy capitalist? Well, in one sense, yes, you were. You desired something you did not have. But in order to fulfill that desire, you set up a monetary exchange that benefited both you and your neighbor who bought your lemonade.

Your thirsty neighbor decided that, instead of spending his time going to the store, buying his own lemons, and squeezing them himself, he would prefer to quench his thirst by exchanging some of his money for your labor. In this exchange we have a win-win situation. Your neighbor quenches his thirst and you have a few extra coins in your pocket. No one was coerced to make the transaction and no one was defrauded by the exchange.

From this simple example we learn the essence of a free market economy. It's not based on greed. The idea that greed motivates a free market comes from the pen of radical atheist Karl Marx. Instead, free markets run on self-interest, which is not the same thing. Self-interest can be good. Self-interest is what motivates you to eat or stay healthy by exercising. These are good things.

In other words, a free market economy encompasses the golden rule: "Do unto others as you would have them do unto you." This is the biblical foundation for economics, along with the idea of private ownership of property. (These and other principles are described in more detail in Chapter 9 of David Noebel's landmark book on worldview analysis, Understanding the Times: The Collision of Today's Competing Worldviews.)

But there is a second crucial aspect of free markets. Only a free market can determine the price for a particular product or service. Going back to our example; how much should you charge for a cup of lemonade? Three factors are involved.

First, to set a price for a cup of lemonade you must determine how much it costs to produce each cup. You can easily figure that by adding together the cost of the lemons, water, sugar, paper cups, and also your investment in the pitcher and materials to build your stand. Now that you know your costs, you price each cup so you make an overall profit.

But how much above the actual costs do you charge? This is where the second factor comes into play. There is only one way to determine what to charge and it comes in two parts, like two sides of a coin. The first side is demand: do people want your product and what are they willing to pay for it. If it costs you 10 cents in raw materials to make each cup, you can try charging 25 cents. If people walk by and say, "That's too much, I'll go home and make my own lemonade," then you know the price is too high. If you lower the price to 20 cents and you find an increase in customers, then you know the price is right.

The second side to setting a price involves competition. If your friend on the next block sees you making money, she may decide to set up her own lemonade stand and charge 15 cents. In that case, your customers may decide to buy from her instead of you. Then, you will either have to lower you price or find another way to entice customers by making a superior product, for instance, by adding a maraschino cherry to each cup.

Government's Role in the Economy

What is the government's role in a free market economy? Not much, except to ensure that business transactions are conducted peacefully, freely, and without fraud or deceit. A biblical worldview acknowledges that man is basically sinful and so there is the potential to defraud, lie, or cheat to gain an advantage when exchanging with your neighbor. The legitimate role of government is to bring to justice those who break these moral laws. Beyond that, the government has no role in the economy as it relates to setting prices or determining what is made and how much of each item.

Thomas Jefferson offered a succinct way of describing the role of government in this regard. He wrote, "Were we directed from Washington when to sow, & when to reap, we should soon want bread."[3]

Jefferson's point is that the further removed government is from the local level, the greater the potential for abuse and mismanagement. Only a business owner can possibly know the best way to run his business to make a profit. Some bureaucrat or politician living miles away certainly can't know the day-to-day needs for keeping a business viable, so why should we assign them the task of "regulating" where they have no expertise? (Read the account of "I, Pencil" and you'll get a glimpse of the incredible complex web of interactions that goes into making something as common as a wooden pencil. To think that all these aspects can be regulated to produce the finished product is ludicrous.)

The job of politicians is narrowly defined in the United States Constitution and that definition does not include managing someone else's business or "spreading the wealth around" by taking from the productive workers and giving it to others.

What happens when the government steps into the economic picture? If government interferes in some way, for example by setting the price for a certain product or legislating what workers are paid, it is usually to benefit one group of people over another, and it always disrupts the dynamics of supply, demand, and pricing.

To illustrate the problem of government intervention, let's say your competitor on the next block is a friend of the mayor and offers to give the mayor a campaign contribution if he passes a zoning ordinance barring lemonade stands on your block. That knocks you out of business! So now you have to hire a lobbyist to persuade the mayor to change the ordinance. This sets in motion an escalating battle for gaining benefits for certain businesses at the expense of others. And in every case, it raises the cost of goods and services for the consumer.

The economy is best left to the decisions of the people operating in a free market. Scottish moral philosopher and pioneer in political economy Adam Smith taught us that fact in the 1700s. His book, The Wealth of Nations, detailed how a free market operated as the only basis for developing new wealth. Before the advent of free markets, the only way to increase your personal wealth was to steal something from someone else. But in a free market system people are free to specialize in doing what they do best and everyone has the opportunity to profit from their own labor as they exchange part of their labor for the work of someone else. The result is an overall increase in wealth for anyone who chooses to participate in these types of exchanges.

Intervention by the government into a free exchange of goods and services only penalizes those who are most successful and weakens the primary incentives that contribute to the free market's success. Under a government interventionist system, instead of "spreading the wealth around" the actual result ensures that everyone is equally poor. The only beneficiaries of such a ploy are the politicians who hold the reigns of power.[4]

The Makings of a Financial Meltdown: Historical Perspective

With this background, let's reassess the current financial situation here in the U.S. How did this nice mess get started? I suggest there is no financial crisis, only a political crisis. While there are a number of factors that lead us down this road, let me sketch out one avenue that set the path in this direction.

The political crisis began in 1938 with the creation of Fannie Mae as a government agency to facilitate banks' ability to make mortgages.[5] In 1968, the government converted Fannie Mae into a private shareholder-owned corporation, yet it still had strong ties with congress. In the 1970s Congress passed a law requiring banks to make loans to people who traditionally would not qualify, i.e., the poor and lower middle class. This legislation was beefed up and pushed further during the 1990s. All of these actions by congress are classic examples of interventionist policy aimed at restructuring society in some way, in this instance, to expand "affordable" housing to the "underserved."

But the manipulation didn't stop there. According to a New York Times article dated September, 1999, the Clinton administration pressured Fannie Mae to increase the percentage of mortgage loans made to low and moderate income people. The reporter insightfully commented, "In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk. . . . But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980s."[6] The ominous phrase here is "significantly more risk." And of course, "may run into trouble" was prophetic. Based on all sound economic principles, the current economic meltdown was predictable.

By 2002 it became evident that trouble indeed was brewing and by 2004 federal regulators detailed to a congressional oversight committee the many irregularities they discovered with Fannie Mae and Freddie Mac.[7] Many of our leaders in Washington refused to acknowledge any problem and instead attacked the messenger! Others called for more regulations.

But the point is there was already an incestuous relationship between these quasi-government companies and politicians. Fannie Mae and it's sister organization, Freddie Mac, were giving hundreds of millions of dollars in contributions to a number of politicians. This situation does not warrant more "regulation" or "oversight," it demands severing the unhealthy connection.

Hence, political meddling has caused "another nice mess" which is costing "we the people" over $850 billion. It will actually be much more, considering the government will probably have to print more dollars to finance this project which devalues the dollar. This means that every American will have less buying power for every dollar spent — another "tax" on the average citizen. By the way, this hits even the poorest of the poor who pay no taxes directly, but will have to bear the burden of inflation for every welfare dollar they spend, too. So much for helping the poor!

Meanwhile, politicians on both sides of the aisle congratulate themselves for "saving the economy" by passing another bailout bill and at the same time lining their campaign pockets with pork-induced payouts and favors to the tune of over $1.5 billion.

A Free Market Solution

In the current situation, our representatives should be doing what they were hired to do; run the country, not run the country's businesses. This means keeping their hands off the banking business, the automobile business, the farming business, and every other business. All businesses are none of their business.

We hear that these financial institutions are "too big" to fail and therefore must be bailed out. However, a free market solution means letting companies that are not able to offer goods and services at competitive prices go out of business, be bought by another company, or go through bankruptcy court for the purpose of reorganizing into a viable business. The free market determines winners and losers. That is just the hard reality of life.

To put this into perspective, in the early 1900s should the government have bailed out companies making buggy whips because of the advent of the automobile? How about the millions of people employed by wooden wheel manufacturers; should they have been guaranteed work because their companies were too big to fail? Or, why do we no longer drive Rambler automobiles? What did all the workers at Rambler do after the American company went defunct in 1969? (Hint: they found other jobs!)

What we are witnessing today is exactly the kind of abuse of power and mismanagement of the economy that our founders warned against. That is why they intentionally limited the scope of the federal government with a written Constitution. They envisioned the national government as the least intrusive component of our federal system, with the states and localities having the greater range of authority (the Tenth Amendment of the U.S. Constitution makes this clear).

Economic prosperity for the greatest number of people is only realized when markets are free. That freedom depends on the ability of individual consumers and companies to make their own economic decisions within the boundaries of the rule of law, meaning without fraud, theft, or coercion. What almost half of Americans and most of our current leaders have lost sight of is the principle that Adam Smith, Thomas Jefferson, and our founders clearly understood; the best economic system is left to the direction of the people, not the politicians.

Footnotes
  1. I'm not suggesting that greed has played no role in the current situation, but as will be developed further in this article, it is not the primary cause of this economic downturn.
  2. Our Fading Heritage, a 2008 study of over 2,400 Americans' knowledge of our Constitution, the basic functions of our government, the key texts of our national history, and economic principles. Interestingly, people who go to church once a week scored an overall average of 48%; while those who never go to church scored 50%.
  3. Thomas Jefferson's Autobiography, 1821, http://avalon.law.yale.edu/19th_century/jeffauto.asp, accessed 12/10/2008.
  4. For a summary of the hundreds of millions of dollars contributed to politicians just through Fannie Mae and Freddie Mac as well as hundreds of millions more siphoned off from corporate profits each year for politicians' slush funds, see Chuck Colson's Breakpoint Commentary, "Accounting for Disaster," accessed 12/15/2008.
  5. Some economists assert that Herbert Hoover's fiddling with private enterprise during the late 1920s and FDR's interventionist programs during the 1930s actually produced and prolonged the Great Depression. See Chapter 10 in Robert P. Murphy's The Politically Incorrect Guide to Capitalism (Washington, DC; Regnery Publishing, 2007).
  6. "Fannie Mae Eases Credit to Aid Mortgage Lending," by Steven A. Holmes, The New York Times, September 30, 1999, accessed 12/10/2008.
  7. To see how representatives treated the spokesman for the regulatory agency, go to this link for the C-Span video: http://www.youtube.com/watch?v=3p1Wc2NFa3w&NR=1, accessed 12/10/2008.

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