The Free Market is Dead

Sometimes we need to go back to square 1. The first day in Econ 101, after the administrative stuff is taken care of and before students start dozing off, a definition of economics is written on the board. It has to do with the allocation of scarce resources. Subsequent classes discuss different ways this is done (capitalism, socialism, control and command economies, etc.) and emphasis is put on the marvels of the free market system.

Keynes eventually comes into the picture, and the class is introduced to the conflict between his policies - at least the way they have been interpreted and applied - and the free market ideology.

I rehash all of this because of its relevance with today's conflicted macro economic policy making. I recently read an interview in which Treasury Secretary Geithner was asked what surprised him when comparing what he learned in graduate school to the real world. He said it was the practical application of Keynesian policy to the economic problems the country is now facing. In other words, he wasn't enamored with Keynesian policies in graduate school. Today he is. That the U.S. , and the world for that matter, is 100% Keynesian despite protests from the peanut gallery is beyond dispute.

This scares me because the policy makers are learning on the job - on my dime and your dime so to speak. They learned one thing and are applying another. To show how that is scary, let's take a look at a chart I found on NPR's Money Planet:

CLICK TO ENLARGE
From late 2001 to the middle of 2003, the Federal Reserve saw its mission as pushing down the federal funds rate to stave off possible deflation. It pushed rates to historically low levels. At the same time, the administration was promoting the theme of home ownership as the American dream. Mortgage brokers went wild producing esoteric mortgages and playing fast and loose with long-standing standards in order to qualify anybody and anything that was breathing.

All of this today is common knowledge, although there is still a general confusion, in the minds of many, of who exactly screwed up and who exactly is to blame.

Now let's look at the chart and think back to the definition of economics. During the 2001 to 2003 period, resources were allocated artificially - not by the market. In effect, central planners (Greenspan and Bernanke at the controls of monetary policy in conjunction with the administration) directed resources to the housing sector. Jobs were plentiful to build houses, sell houses, broker mortgages, etc. Resources were allocated to these sectors by Fed policies, not the free market. But then, in mid-2004, the central planners found they had been too aggressive and reversed course - they pushed interest rates up sharply.

After carrying out a policy that got people to buy houses they couldn't afford and then use their houses as ATMs, the Fed turned on a dime and wiped out the equity in people's houses.

Today people are scratching their heads. Why won't companies hire? Again, look at the chart. Notice that today construction is struggling. Fed policies put millions of people into housing and related industries and caused a severe over-building. The over-building was so severe that today, when money is practically free, real estate is still struggling. But this is Econ 101 stuff. Maybe 8 years ago, some of the people who saw the modern day gold-rush in mortgage banking brought about by Bernanke and his cohorts would have gone into health care or where a free market would have led them.

Here's my question: Have we learned anything from this? If you ask Greenspan, Bernanke, Geithner and much of Congress, they will respond by pointing fingers at players on the fringe. They'll point to rating agencies, securitization practices, mortgage bankers, etc. And they will continue in their central planning ways.

May the free market RIP.