Why Isn't the Market Listening?

You've probably seen the Disney film, Fantasia, in the segment called The Sorcerer's Apprentice. Mickey Mouse is the apprentice, and he decides to use some of the sorcerer's magic while the boss is away. The experience is glorious, until he realizes that he can't control it any more and he finds himself drowning in a self-created flood.


[Thanks to Wikipedia.org for the illustration by S. Barth.]

Jean-Claude Trichet, the European Central Bank president, must see the market as a kind of sorcerer who is on his way home to save the day. As the Financial Times tells us (here and here), Mr. Trichet has called on financial markets to "help policymakers rebuild the levels of confidence in the banking system required to kick-start economic growth around the world." He "gave a stark warning to financial markets yesterday to stop putting pressure on banks to hold more capital."

But the market is not the sorcerer. It is the water--neither good nor bad, just flowing, or flooding, or drying up, doing what water does.

Trichet's jawboning reveals that politicians and their appointees, the quasi-government officials, are not part of the solution; they're part of the problem. They are Mickey.

It should be no surprise, then, that Mickey decided in 1913 to take over the powers of the sorcerer by turning a market-suggested financial-market-system convenience--the Federal Reserve clearing house set-up--into a powerful and politically expedient government-like macromanager of our money supply. Nor should it be a surprise when he ends up destroying our economy in the process. (See my article on the Fed, Page 1, Page 2, and Page 3 for more.) He's got the broom now, and things are getting out of hand. Mickey can call on every power he possesses, the water will never heed him.

We shouldn't be disappointed when ordinary humans fail at sorcery. It's not really their fault. Our government agents are themselves part of a bigger "market," in a sense. When we go to the polls and vote for more government intervention in our life, we are expressing our political "market" preference for government sorcery.

In our current crisis, here's an example that shows the pickle their in. This article in the FT says:

"Amid the recrimination and hand-wringing over the causes and consequences of the financial crisis, bankers and policymakers at the World Economic Forum in Davos have identified a new threat to global prosperity: the rise of financial protectionism. The huge state-backed bank bail-outs in Europe and the US, while necessary to prevent a collapse of confidence in the financial system, have forced banks to withdraw from overseas markets in order to concentrate their limited resources at home. ... The sharp reversal of capital flows appears at least partly due to political pressure on banks, especially those that have received large doses of state support, to sacrifice international operations in favour of maintaining lending to domestic consumers and companies. For governments attempting to explain their decision to commit hundreds of billions of taxpayers' money, this is an understandable response."

Likewise, when our factory workers start to hurt, the government becomes protectionist on that front as well. In 1930, Roosevelt's Congress, in response to public pressure to "do something," forced the market to "buy American" by passing the Smoot-Hawley Tariff Act. This Tariff turned out to be one of the main reasons the country didn't recover from the Great Depression until a decade later.

Here's more evidence of the public's growing protectionist spirit in the form of restrictions on purchases of steel with the stimulus package. (At press time, Obama seems to be rethinking this, but he will have to disappoint his base to do anything about it.)

Another example of forthcoming problems for the Sorcerer's Apprentice: The stimulus package won't work the way it's intended. You can't force banks to lend by throwing money at them, because as one banker put it, paraphrased by the Financial Times, "it is difficult to make loans to companies and individuals as most new lending would be loss-making and end up burdening their balance sheets with further writedowns." (FT Article.)

You can't buck the market. Nor can you force home buyers to buy when they know darn well prices will go down even more. Furthermore, when the government borrows money to spend on its own projects, it takes it away from the very people it is trying to help: capital-starved small businesses.

If we step back for a better perspective, clearly we are confronted with a culturo-political phenomenon: People have turned to government to cure a problem of government's own making. That's like asking Apprentice Mickey to solve the water problem.

There is one natural market phenomenon that will get Mickey back onto dry land in the longer run. It is a return to some form of a gold standard. This standard evolved in the marketplaces of the world over the centuries, and it would exist today if government agents had not decided to force their citizens to abandon it by declaring paper money to be our only legitimate legal tender.