Friday, January 18, 2008

Capitalism's Scourge

Reading the Wall Street Journal's lead story today, I can't help but think back and wonder just how this mess could happen in a world that has supposedly "seen the light" about free markets and capitalism since the 1980s.

The article describes the difficulties soon to be revealed by some very large insurance companies, who are required by their contracts to pay up during this financial turmoil but who are unable to come up with the cash as promised. The potential amounts involved are so large as to cause tremors of fear to ripple throughout the stock markets of the world. This is only the latest of many death knolls for the recent booms in our boom/bust/stagflation economy.

[Thanks to for this picture]

Many people, from wise old economic owls and international financial geniuses, to permabears and silly gadflies like me, saw these events coming. (See this post for links to past warnings from all sectors.) I as a staunch capitalist can't help but ponder, how is it that brilliant corporate minds could allow their companies to get us into this? It's really mind boggling.

My easy answer is twofold (admittedly not scientific).

The Mixed Economy

Surprise, surprise, the US does not have a capitalist economy. Over the last couple of centuries, companies have realized that the best way to survive next to a growing public sector is to work hand in hand with city hall rather than trying to fight it, because of the mutual short-term privileges this affords both parties. You rub my back, I'll rub yours.

The naive believe that large corporations prefer free markets, but this is not always true. Some--and some of the most successful--have found it is much easier to achieve their goal of monetary success (profit is not an improper goal) by using all the tools at their disposal including the politicians, rather than "wasting their time" manifesting on behalf of a political ideal such as a more pure capitalism, especially when that ideal is rejected by a majority of voters.

It's the old "if you can't beat 'em join 'em" syndrome.

Example: In order to stem bank failures experienced during the 1800s, and to give themselves the allure of protectors of the poor, the US state and federal government politicians began toying with the idea of requiring banks to obtain special charters in order to deal in certain transactions. The banks resisted at first, but quickly understood that by acquiescing to this requirement they would be able to limit the playing field around them.

The new requirements would throw rocks and hurdles at the big banks' competitors, thereby obtaining for the larger, more robust survivors special status and monopoly-like privilege with protection from the state. (This is not always the panacea it appears, to wit some of the railroad "robber" barons of a hundred years ago who disappeared just as quickly as they appeared.)

This phenomenon of mutual vice has taken hold over the years behind the public's back and in the name of "public welfare," and today our biggest financial houses have become so intertwined with government, so huge, that they are now what economists refer to as "too big to fail." In other words, any threat to their collective survival means instability for the whole economy, if not even for the entire world.

I continue my conjecture by stating that such power, influence and monetary gain (you've heard about the salaries of the big CEOs, including their bonuses, stock options and severance packages) attract not only very able people, but also a few less than honorable people who don't mind compromising their capitalist ideals, and/or some with limited longer-term foresight who--to give them the benefit of the doubt--have not been excessively thorough in their analysis of the risks they are asking the nation to incur and insure through too-big-too-fail government bail-outs and FDIC and other compensation.

Fiat Money

The second part of my answer deals with the "fiat" (unstandardized) nature of money in today's world economies. See this post and others for an explanation. In sum, the wave of excess credit issued by the central banks of the world caused much mischief in financial markets and is a major factor in our mess.

Both of these elements come from the public's irrational behavior--or let's call it emotional behavior, so as to avoid a t'is-t'aint-style academic economic debate. We approve of capitalism, but we also approve and vote for quick fixes for "me." Does it feel good to have the government act as protective daddy and approve of banks through charters, even if it is counterproductive? Most will answer yes. The counter-productivity doesn't show itself until too late, and in obscure, misleading ways.

Does it feel good to have insurance on our CDs and checking accounts through the (insufficiently funded) government FDIC program? Of course. Do we want to punish the big finance houses even if it means we ourselves might suffer? That would be masochistic.

Walking the straight and narrow is difficult for all parties to the capitalist game, and the result is a mixed economy that causes more trouble than it cures.

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