How Capitalism Will Save Us (70 page)

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hortly after taking office, President Obama responded rapidly to the financial crisis. He unveiled his massive stimulus package, calling on Congress to “act boldly and act now” to pass it immediately.
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Even those who didn’t agree with his breathtaking spending were impressed by his swift response. His decisive performance no doubt helped contribute to his initial high approval ratings.

When a crisis hits, most people are taught that the correct response is to “do something” to “fix” the problem. That impulse is ingrained in our collective psyche as a “can-do” nation. When something bad happens,
we’re supposed to come to the rescue with all the expertise at our disposal, doing what we know how to do best. For politicians, “doing what they do best” means making laws and spending lots of money. Not only politicians but also the public seem to want leaders who will act. So you can’t entirely blame people when they assert that the response to a crisis in the economy is to intervene and “do something” to change the situation. To do otherwise is considered by many to be downright un-American.

In the 1930s, Friedrich von Hayek was asked what should be done about the Great Depression. Hayek famously said, “Do nothing. The economy will recover on its own.”
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Author and economist Mark Skousen writes that this was not what people wanted to hear. “When the economy didn’t recover for years, Hayek and the Austrians lost the war of ideas to Keynes.”
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What Hayek probably meant was that government should not impose artificial constraints on the market and instead allow it to work. That doesn’t mean “doing nothing.” Mark Skousen believes that Hayek might have won his debate with Keynes if instead of recommending that we “do nothing,” he’d presented his ideas for what they most likely were: a plan to stimulate the economy by lowering taxes, eliminating draconian regulations, and creating an environment of sufficient certainty that businesses could invest, grow, and recover.

Hayek’s words may not have been well chosen. But his ideas are constantly borne out in the Real World. Despite the chest beating of freemarket critics over even normal business cycles, most recessions don’t last very long and are self-limiting. Prior to the financial crisis, the average recession lasted an average of eleven months.

Again, remember the story of the pencil. The market’s “invisible hand” responds spontaneously to meet the needs of people. When there is an imbalance in demand or supply, the market automatically works to restore equilibrium—without any bureaucratic diktat or government stimulus. That includes correcting the conditions that cause a recession. If too many people are out of work, for instance, prices drop. Lower prices and, eventually, pent-up demand spur people to start buying again. Entrepreneurs, including people who may have been laid off in the downturn, take advantage of cheaper prices and available manpower and start new businesses. The economy begins to recover.

Unfortunately, in the Real World, government efforts to “do something” and “fix” a down economy often end up creating additional imbalances and barriers that inhibit these forces. They make things immediately worse—or set the stage for a future market upheaval. People understood this in the early part of our history. As Robert Higgs, an economist at the Independent Institute, a respected market-based policy think tank, wrote recently,

The Smoot-Hawley Tariff was far from the only government move responsible for the Depression. Economist and historian Amity Shlaes compellingly recounts in her landmark book
The Forgotten Man: A New History of the Great Depression
that a succession of interventions caused and prolonged the historic slump. She recently wrote in
Forbes
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FDR took office in 1933 in the pit of the Depression. He immediately instituted a bevy of measures intended to boost the economy and create
jobs—including public-works programs, wage and price controls, and enormous tax increases. Not only did they drain the economy of capital, they created an uncertain, hostile climate that crippled private-sector businesses and job creation.

Shlaes writes that this uncertain climate caused the United States to rebound more slowly than France, Britain, and Canada. When it finally took place, our recovery was less than robust. American unemployment was higher than in those other countries. Before the Depression an American worker earned 30 percent more than his British counterpart. However, by the beginning of World War II, U.S. workers had lost their wage superiority.

Robert Higgs has noted that the “regime uncertainty” created by policy activism is “what Keynesians usually fail to grasp.”
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Whatever the intentions of such policies, in the Real World, “activism itself works against economic prosperity by creating … a pervasive uncertainty about the very nature of the impending economic order, especially about how the government will treat private property rights in the future.”
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Higgs points out that similar economy-inhibiting regime uncertainty is being created today by “the government’s frenetic series of bailouts, capital infusions, emergency loans, takeovers, stimulus packages, and other extraordinary measures crammed into a period of less than a year.”
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F
or starters, we should avoid repeating the mistakes that got us into this crisis. The Federal Reserve and the U.S. government must have a firm policy, codified into law, that assures a stable dollar. The way to do this is a link to gold. Gold’s effectiveness in creating a healthy economy is borne out by history: George Washington and our first Treasury secretary, Alexander Hamilton, wisely recognized that a monetary policy based on a gold standard constituted the bedrock of a strong economy. Their prescience and insight helped give birth to America’s economic miracle.

Along with going to a gold standard, we should fully privatize Fannie Mae and Freddie Mac. These monster government affiliates should be broken up into several parts and their ties to government severed. Breaking up Freddie and Fannie into smaller private mortgage entities would eliminate the market distortions created by these two giants; it would open the field to new companies that would not have to fear having to compete against the U.S. government. The smaller entities could perform Fannie and Freddie’s role: raising private capital to buy mortgages from banks and mortgage bankers, then packaging and reselling them to pension funds and other investors. If one of these smaller companies got into trouble, the impact on the market wouldn’t be as great.

Breaking up Fannie and Freddie and instituting monetary reforms would eliminate two key sources of today’s problems—the excess money and the monopolistic, government-backed mortgage companies that artificially stimulated the housing markets. What about low-income people? Mortgages would be available for those who have the income to service them and who have saved up for a proper down payment. However, market sanity would be restored. Federal government agencies such as the
Department of Housing and Urban Development and the Federal Housing Authority would no longer pressure banks to make dicey mortgages. There would be an end to politicians encouraging no-down-payment mortgages, as occurred in the administrations of Bill Clinton and George W. Bush. Subprime mortgages can work if proper lending standards are adhered to.

On the regulatory front, greater transparency in the derivatives market would have helped avoid the catastrophic growth of credit-default swaps (CDSs). In and of themselves, CDSs play a needed role in the market as a form of bond insurance. The idea of a bondholder purchasing insurance against a default is eminently sensible and desirable. However, inadequate transparency encouraged excessive risk taking among CDS providers. They were able to get away with having insufficient collateral or reserves to protect themselves from defaults.