Monday, September 22, 2008

This Isn't Capitalism, It's Corporatist Socialism: There's Nothing Free Market About It

When congressional leaders and presidential candidates Obama and McCain call for more government oversight of our struggling financial institutions, go ahead and laugh. You know you want to. The idea that the private sector would be in better shape today if only we demanded more oversight from our politicians is preposterous. Our politicians wouldn't recognize "fiscal responsibility" if it spat in their ears.

Wall Street moguls may be "greedy," as both McCain and Obama have described them, but at least there are real consequences when their greed becomes excessive. They go out of business.

Except, that is, when the government bails them out. Thus far, in addition to being on the hook for the federal government's own massive debt, taxpayers are also putting up $85 billion to back insurance giant AIG, up to $100 billion each to back Freddie Mac and Fannie Mae, and we're funding the Bear Stearns backstop. Congress is also expected to approve at least $25 billion in corporate welfare for the big three automakers. You can probably expect more handouts down the road. All of this has some analysts now questioning the U.S. government's bond rating, and worse, wondering whether the government itself may soon collapse under the weight of its own debt.

When you, Joe Citizen, spend frivolously and default on your loans, the bank takes your house. When the government spends your tax dollars frivolously, it simply cooks the books to cover its excesses. When the books are left in ashes, the government just takes more of your money, or it prints more money, leaving the money it hasn't already taken from you devalued. Over the last few weeks, we've learned that you now face the prospect of an additional indignity: When your neighbor's bank spends frivolously and defaults on its loans, the government's going take your money then, too, to keep the bank in business.

Many commenters have blamed all of this on capitalism. This isn't capitalism. It's a peculiar kind of corporatist socialism, where good risks and the resulting profits remain private, but bad risks and the resulting losses are passed on to taxpayers. There's nothing free-market about it.

Governments have been screwing over taxpayers for about as long as there have been governments and taxpayers. Capitalism, on the other hand, is a fairly recent development, and has spurred an explosion of wealth and the greatest standard of living in human history. What's happening now isn't capitalism, but capitalism is certainly taking the brunt of the blame.

Radley Balko, senior editor for Reason magazine


At 9/22/2008 5:40 PM, Blogger PeakTrader said...

Summary: The Panic of 2008

The Bush Administration and the Bernanke Fed recognize the problem. Bad debt locked-up lending to the point where banks wouldn't even lend to each other. The $700 billion injection of cash, in exchange for bad debt, will remove the reason banks are distrustful of lending. It's a brilliant policy, and supports my statements on the causes of this crisis.

The U.S. already captured the real assets and goods, in exchange for employment of export-led economies, and the U.S. government will sell those mortgage-backed securities in the future when housing prices rise again, which this policy will facilitate. This is an appropriate response to the government policies of export-led economies, and the benefits of this policy will far exceed the costs.

The U.S. government needed to act, because the freezing of liquidity was a systemic problem, more than a problem of a few firms.


Government policies of export-led economies created global imbalances. They facilitated export growth, in many ways, while creating trade barriers, for imports, which caused these economies to overproduce and underconsume. Consequently, the U.S., which has open markets, free trade, and unrestrictive capital flows, underproduced and overconsumed.

Foreigners paid Americans to purchase their goods (e.g. by selling below true costs) and paid Americans to borrow their dollars (e.g. through negative real returns). However, the U.S. government received those dollars through the sale of U.S. Treasury bonds. So, the U.S. government needs to refund those dollars to Americans. The U.S. received the assets and goods, while export-led economies received employment.

The U.S. had to clear the market of "excess" capital from huge foreign capital inflows, which coincided with huge U.S. trade deficits (to keep the balance of payments balanced). The U.S. already captured the real assets and goods. Now, the U.S. needs to absorb those worth less securities, by exchanging dollars for those securities, to compensate the domestic losers, e.g. lenders and investors.

"Financial innovation" was needed to clear the market of excess capital, and much of that capital flowed into the U.S. housing market. There was a huge transfer of real wealth from savers, mostly the rich, including foreigners, to borrowers, including lower income Americans. Inequality can be reduced more through consumption, e.g. prices and interest rates, than through production, e.g. taxes and income redistribution. Sustainable growth is optimal growth, since there's neither strain nor slack utilizing resources. So, output per capita is maximized over time. It's the difference between GWB's Great Society and LBJ's Great Society.


I'd place the blame of this crisis on the Bernanke Fed. The Greenspan/Bernanke Fed raised the Fed Funds Rate from 1% to 5 1/4%, or 25 basis points at 17 consecutive meetings, from June 2004 to June 2006, and left the Rate unchanged at 5 1/4% until September 2007.

U.S. real GDP expanded about 5% in the third quarter of 2007, and then fell quickly to roughly zero in the fourth quarter. So, although the Fed began the easing cycle when real growth was 5%, it was too little and too late.

Investment banks were leveraged up to 30:1, which made huge profits for many years. However, the downturn took place so quickly, they lost a lot of money fast. If you can borrow unlimited funds, you'll always end up at some point with gains. Unfortunately, investment banks, e.g. Lehman, were maxed out when the economy peaked. Wall Street has been cleaning its house, including ridding itself of the investment banking model.

I wouldn't blame the crisis on Greenspan. The U.S. housing boom was needed to raise actual output towards potential output, i.e. close the U.S. output gap, which raised U.S. living standards at a steeper rate, i.e. the U.S. underproduced slightly, while overconsumed by a large margin. However, over the second half of the 1990s, I blame Greenspan for allowing actual output to stay above potential output for too long, which proved to be unsustainable.


Some are predicting the U.S. economy is past its peak, some say it's fundamentally strong, while others (e.g. Kudlow and Reich) have no idea what they're talking about.

To understand where the U.S. economy is going, it's important to understand where it's been. I've shown in the 2000s, the U.S. economy generally underproduced and overconsumed, which raise living standards at a steeper rate, captured the greatest gains of trade, in the global economy, and became substantially much more efficient, producing more output with a given level of inputs.

When the S&P 500 reached an all-time high last year, U.S. real GDP growth was 5%. However, similar to the stock market, economic growth fell substantially and quickly. The U.S. never had a 10-year expansion without a recession. A mild recession took place in 2001. I suspect U.S. growth will reaccelerate in 2009.

Higher debt levels and lower saving rates will force Americans to work longer, which will add to future economic growth and postpone retirements, since Americans have proven adept at maintaining autonomous consumption. In the 2010s, after the current slowdown, there will be a period of stronger production growth and slower consumption growth, which will also correct global imbalances caused by export led economies poor policies. The U.S. will remain at its peak in the 2010s, until the last of the Baby-Boomers reach 65 in 2029, and then there will be a 10-year economic crisis, similar to the 1870s, 1930s, and 1970s.


Foreigners sold their exports too cheaply to induce U.S. demand. They invested those dollars in the U.S. and kept dollars in their central banks to keep their currencies weaker than they'd otherwise be to maintain U.S. demand for their goods.

They continued to maintain export growth by accepting smaller gains of trade (while the U.S. received larger gains of trade). Foreigners sold their goods even more cheaply, since the U.S. had diminishing marginal utility, for those goods, and foreigners paid high prices for U.S. Treasury bonds, to where they received negative returns after inflation and lower interest rates. Foreigners lost even more money through the depreciated dollar (since they received fewer and fewer units of their currencies on those returns). Foreigners should have exchanged their goods for U.S. goods. Instead, they exchanged their goods for U.S. dollars, which became increasingly worth less through depreciation, along with losing purchasing power from inflation (not buying U.S. goods years ago), receiving negative returns, etc. While export-led economies gains of trade decreased, U.S. gains of trade increased. The U.S. is using its improved terms-of-trade and commands market power to complete the process of capturing those real assets (from cheap foreign capital) and real goods (from low prices). Funding Fannie and Freddie helps correct global imbalances slowly.


Here's what Adam Smith believed about free trade:

"In Wealth of Nations Smith argues that everyone benefits from the removal of tariffs and other barriers to trade. Because of supply and demand, production will increase as demand increases. This may lead to new employment opportunities for the workforce and to collateral industries emerging in response to new demands. For example, an increase in France's wine production would also lead to an increased demand for bottles, for barrels, for cork, and an increase in shipping, thus leading to a variety of new employment opportunities. Adam Smith was convinced that the market would stimulate development, improve living conditions, reduce social strife, and create an atmosphere that was conducive to peace and human cooperation."

Also, Smith sums up China's economy well:

"Wealth of Nations represents a highly critical commentary on mercantilism, the prevailing economic system of Smith's day. Mercantilism emphasized the maximizing of exports and the minimizing of imports. In Wealth of Nations, one senses Smith's passion for what is right and his concern that mercantilism benefits the wealthy and the politically powerful while it deprives the common people of the better quality and less expensive goods that would be available if protectionism ended and free trade prevailed."

At 9/22/2008 7:23 PM, Blogger K T Cat said...

What he said.

At 9/22/2008 8:31 PM, Anonymous Anonymous said...

$700 Billion Dollar Bailout Good For Economy

WASHINGTON (AP) -- It's the largest government bailout in U.S. history and two days after it was introduced to the Americans paying for it, the proposal is still largely a mystery.

Among the unanswered questions: How will the government mop up the bad mortgage debt on banks' books, who will run the process and how much will it cost?

Key elements of the plan remain in flux as behind closed doors Democrats demand modifications that would provide more help for ordinary Americans in return for bailing out the country's financial giants.

At 9/23/2008 2:52 AM, Blogger juandos said...

Thanks for that informative comment peaktrader...

Much appreciated...

At 9/23/2008 8:06 AM, Anonymous Anonymous said...

Very thought-provoking and informative post, Peak Trader. I would like to see more of this type of lucid discourse and less of the back-and-forth political rants that seem to be growing more popular on this blog.


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