Monday, December 22, 2008

Rule of Law vs. Regime Uncertainty

(Roberts' article is a bit dated on the specifics, but quite relevant on principle.)

Paulson's Faulty Imagination

By Russ Roberts

(This article appeared on on 11/14/08)

Secretary Paulson might be the only person in America who worries that consumers haven't borrowed enough money. He says the consumer credit market has "ground to a halt." He wants to get it going again — maybe if we all just buy enough cars and use our credit cards, the economy will come back to life.

Paulson is also upset that banks aren't doing enough. He's given them all this money and they're sitting on it.

He doesn't seem to realize that these two phenomena are really one and the same.
He can inject all the money he wants into the consumer credit market and it isn't going to make us want to buy cars or use our credit cards.

We did enough of that for a while. More than enough. Too much. And right now, before we spend, spend, spend, we're going to wait and see if we keep our jobs.

But we're also going to wait and see what the government's going to do next. Nobody knows, and that evidently includes the secretary of the treasury.

When no one knows how the rules of the game are going to change — and they seem to change from week to week — who wants to take a risk? Who wants to borrow money? Who wants to invest? Business and consumers are hunkering down, waiting for the storm of change to pass.

The problem isn't liquidity.

It's uncertainty.

Paulson doesn't realize that his erratic attempts at creating liquidity are creating the uncertainty that makes liquidity meaningless.

And his erratic moves elsewhere just add to the uncertainty. A few days ago, he announced that he was "exploring strategies" to use the TARP (the Troubled Asset Relief Program) for "foreclosure mitigation." Then came the news that, no, the FDIC would have to go it alone in helping mortgage workouts. No TARP for them.

I guess he's done exploring. At least until tomorrow.

As the TARP spreads, the cost will keep rising. Remember the talk about how the government might even profit from its $700 billion "investment?" (Insert hollow laugh here.)

I'd feel better if the money spent so far was helping. But there's no evidence that it is achieving what Paulson intends.

And who's going to pay for all of this? Those who lived within their means, who went with the smaller house, who waited a few more years to get that new car, who took a part-time job rather than borrowing even more money to pay for college. Suckers. You missed out on the thrills and now you're going to be paying the bills. The prudent will be paying for the imprudent for a long time.

The great economist F.A. Hayek wrote that "the curious task of economics is to demonstrate to men how little they really know about what they imagine they can design."

With each improvisation, Secretary Paulson is proving how little he knows about what he imagines he can design.

Russell Roberts is professor of economics at George Mason University and a research fellow at Stanford's Hoover Institution. His latest book is The Price of Everything: A Parable of Possibility and Prosperity.

Another interesting article on this topic is one by Robert Higgs, "Regime Uncertainty: Why the Great Depression Lasted so Long and Why Prosperity Returned after the War." In this article, Higgs analyzes the economic effects of the New Deal and WWII on real standard of living. He clearly demonstrates economy did not recover (and prosperity did not return) until after the end of WWII. A key aspect the harmful effects of Hoover and FDR were the anti-business government policies and rhetoric which inhibited the resumption of private investment and delayed eventual recovery. Higgs also shows how arguments which credit WWII with ending the Great Depression are based on fatally flawed data. I read this article in an updated form published in Higgs' book Depression, War and Cold War, but the essentials of theory and data are in the pdf linked above.

Understanding the true effects of the New Deal policies is essential to formulating the best approach for the situation we face today. Many of the details between now and then are quite different, but the underlying principles of what leads to prosperity, and what are the effects government intervention, remain the same. As we hear more and more of the New New Deal, we better be sure we correctly understand the Old New Deal. For that, I recommend the works of Higgs, Freidman, Rothbard and Best.

On my desk sit library copies of The Great Crash of 1929 by John Kenneth Galbraith and The Return of Depression Economics by Paul Krugman which I hope I can get to before I run out of renewals. Anyone care to suggest other sources of opposing views?

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