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Monday, December 6, 2010

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:

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.


  1. Long live free markets! They may have to go underground, but they will never die. I'd argue that our current policy makers are no better than the previous policy makers. They are still trying to artificially manipulate the economy to achieve a desired outcome, thereby creating the next series of bubbles. But we are Keynesians now, except, of course, for those of us who live in Grouchland where the coins of the realm are still made of silver and gold, there is no federal reserve, free trade abounds with all other countries, and interest rates and capital float freely according to market conditions.

  2. I've read an interesting news article somewhere that mentioned that one of the reasons why the current morass is dragging on is because more and more, people are seeing things in a more Austrian light. They are refusing to start up the business cycle again by being "fooled" by the low interest rates, as they know where that path is going to lead again. I wonder how long this can remain true, but it's interesting...

  3. Once a Keynesian, always a Keynesian, it seems. To answer your question, I think that certain people are incapable of slicing through the cognitive dissonance and learning from all this. I had a discussion recently with a good friend whose politics skew leftish, and the subject of Japan in the 90's came up. One stimulus after another, without much to show for it, at least in my opinion. My friend had quite another view point, that the Japanese finance ministers "just didn't do enough". It didn't work, so let's do it again, except this time, do it *harder*!!

    This type of groan-inducing sentiments used to hurt my head hurt. A little less now, since we're all Keynesians :-)

    @ Kevin/IIW --- I agree that actors in the free market may be more Austrian, but the policy makers remain as thick-headedly statist as ever. It's in their best interests, after all.