Posts Tagged ‘markets’

Government Isn’t Us

Wednesday, May 5th, 2010

President Obama recently spoke at the University of Michigan. In his speech, he criticised those who attack government as inherently bad. He stated that such people fail to comprehend that “in a democracy, Government is us.”

Why Obama Is Wrong – 1. Democracy?!?

At some level, democratic governments are supposed to be the collective will of the people. But let’s think about that for a second.

In the 2008 election, approximately 63 million votes for Obama were cast. That’s about a fifth of the people. You can’t claim that every policy you want is justified by the fact that a fifth of Americans voted for you, even if fewer voted for the alternative. At the very least, Obama should be saying that Government should be us.

Moreover, this is a rather disturbing example of the belief that 50%+1 should be able to set the rules for everyone. If you’re in the majority, you can get whatever you want; in the land of “we”, people have to give and take. Perhaps for students at the University of Michigan, in a town which voted 70% for Obama, the President meant “We, the majority” rather than “We, the People.”

Why Obama Is Wrong – 2. If Government Is Us, Why Does the State have Special Powers?

Is it right if I lock you up? Can I take thousands of pounds with the threat of force if you do not comply? Can I order a drone to blow you to smithereens? No. No. No.

If we agree with Mr. Obama, then it is morally OK for a large group of people to do things which would be wrong if individuals did them. Indeed, as noted above in the Democracy section, Obama would seem to believe that a sufficiently large mob becomes moral by virtue of its size alone.

There are reasons why the State has some special powers – some theorists might consider it a Social Contract whereby individuals trade some liberty for security. It remains the case, however, that Government is an entity that is supposed to work on our behalf, rather than “us”.

If Government is Not “Us”, What Is?

What can be termed “us” accurately? It would have to be the sum of everyone’s interactions with everyone else. There are two words we could use for this – Society, or the Market. The former implies non-financial interactions and the latter the opposite, but in reality, they are interchangeable. Why? If one stops looking at the Market narrowly as exchange of money and looks at it more broadly as the exchange of our wants and needs, one can include the way we choose to spend our time and amuse ourselves as well.

There is such a thing as Society. It’s not the same as Government, but it is the same as the Market.

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Posted in Politics by Joseph M Sanderson | No Comments »

The Cambridge Union is Proud of Margaret Thatcher

Friday, May 8th, 2009

Cambridge Union rightly voted in favour of the motion “This House is proud of Thatcher’s time as Prime Minister”. John Redwood, james-sharpe-in-the-chairPeter Lilley and Edward Leigh did a great job of standing up for Mrs Thatcher. Our own James Winfield Arthur Edward Sharpe III chaired the debate, resplendent in his white tie outfit. See him in action here.

Come discuss the result at PORT AND CHEESE on SATURDAY 9th MAY in the Green Room of Caius College. £6 for members else £8 .

Excerpt from John Redwood’s Blog:

“I said five things that I felt needed saying.

1. Margaret in office was always most concerned personally about people around her, supporting them in dredwood-speakingifficulties, writing notes to them at times of trouble and showing great courtesy. She would always ask what could the UK do to help whenever she heard of a tragedy anywhere in the world. She was the best boss I ever worked for.

2. She helped Ronnie Reagan win the Cold War. Surely it is good news that Eastern Europe has been liberated from the grip of communism? That was only possible because the Western alliance was resolute in the 1980s.

3. At home she introduced demcoracy to the Unions. She wanted Aurthur Scragill to ballot his members about a strike. His failure to do so split his Union, and represented a challenge to the legal authority of Parliament.

4. She allowed many more people to buy their own home, and shares in the business they worked for. She believed in empowering more people through ownership. She championed the worker and the saver against the vested interests of the establishment.redwood-replying

5. She taxed the rich more . She knew that if you set lower and more realistic rates of tax, the rich will come here, stay here, create jobs here. It worked. Mr Blair kept those rates. Mr Brown is changing them in a way which will damage both the country and his party.”

 

 

 

Coming Up:

CUCA Speaker Meetings are FREE and OPEN TO ALL

Owen Paterson (with CUIS)

Shadow Secretary of State for Northern Ireland

-11th May  – Kennedy Room of CUS at 715.

Michael Howard 

Home Secretary ’93-’97 (crime down 18%); Party Leader ’03-’05 (seats up to 198); President of CUCA

12th May – Kennedy Room of CUS at 7pmmichaelhoward

For Dinner with our speakers afterwards, please contact the Chairman (hdpb2)

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Posted in Event news, Event reviews, General, Photographs by Callum Wood | No Comments »

Creditcrunchy by Fergus McGhee

Friday, April 3rd, 2009

Creditcrunchy

A Cautionary Tale

~

Behold the Crunch of Credit!
That alliterative beast
Which skulks along Threadneedle Street
With violent caprice;
Which darkens every board room door,
And prowls about the trading floor,
Devouring Christmas bonuses;
Disturbing fiscal peace.

Beware the Crunch of Credit!
The debt that bites, the risks that catch!
Defaults of every size and sort
He’ll frumiously despatch!

Observe the Crunch of Credit
And his wicked weaponry.
The stocks have crashed, the LIBOR soars,
¡Negative equity!

Survey the Crunch of Credit:
How he slithers, how he writhes,
How he toppled with one subprime swipe
The fated Rock, the mighty Bear,
Brought low the Brothers Lehman,
Made the Scottish banks despair!

Perceive the Crunch of Credit,
And detect his subtle powers:
How he raised from rank obscurity
That mercurial Peston of ours.
Admire the bard’s concise adage
And prescience so stellar:
“The nature of bad news,” he wrote in truth,
“Infects the teller!”

And banks, in their lividity,
Sent copious liquidity
Careering through pecuniary pipelines.
Recapitalisation was on all the experts’ lips,
While the name of Keynes was whispered in the streets.
And so we took the plunge
And bailed them out, the bungling banks.
Each mortgage-backed security
We bought hold-to-maturity,
And now we must all hold on to our seats.

Eheu!
The Crunch of Credit
Hath another victim slain.
Just as we mourned the passing
Of the noble Woolworths chain
The news arrived of worse to come –
GM and Chrysler are undone!

Across that vast new continent
Exhausted cries of woe accrue;
Their answer is a distant, but distinct,
Bavarian “Juhu!”
And yet they have their problems too:
The market shrank, the Euro flew
As the glorious pound became less sound;
O what were we to do?

St Gordon took his sword in hand:
All boom and bust he’d soon disband.
Long time his manxome foe he sought –
So rested he by his brooding tree
And stood awhile in thought.

And as in dithering thought he stood,
The Credit Crunch, with eyes of flame,
Came whiffing through that tulgey wood,
And burbled as it came!

A spending spree, slashed V.A.T.
The fiscal blade went snicker-snack!
And though the sword was double-edged
It didn’t hold him back.

And at Westminster’s Palace
He arrived in prudent pomp,
And took to the despatch box
With a clunking-fisted thomp.

“Fear not,” said he (for mighty dread
Had seized their troubled minds);
“Glad tidings of great joy I bring
To you and all mankind.”

A silence grasped the chamber,
Every member was in thrall…
“For I have slain the Credit Crunch
And saved the world withal!”

And hast thou slain the Credit Crunch?
Come to my arms, my beamish boy!
O frabjous day! Callooh! Callay!
The Dow Jones shall be up today!

What forces dark could explicate
These grand felicitations?
A Faustian pact, no less,
Bought with our future generations.

It was now clear the Saint had been
Trained in the School of Madoff,
And all men of good sense agree
It’s time that he was laid off.

But Gordon is not all to blame;
Some people bear a greater shame.
The problem, if you care to see,
Was monetary policy.

Who spawned the Crunch of Credit?
That ‘twas bankers still persists.
All true, but don’t forget
The scholarly economists.

The money in supply, M4 –
as it’s known in the trade –
Approximately doubled over that
Debtors’ decade.

The learned persons thus assembled
Knew this and lamented;
And yet, instead of raising rates
Accordingly, relented.
And as night follows day
They had unwittingly consented
To preconditioning
This boom and bust unprecedented.

But how now learned friends?
What weaponry are you possessed of?
Alchemical de-squeezing
Such as “quantitative easing”?
The Crunch of Credit scoffs
And, Calibanically gleaming,
Jeers, “Who are these pretenders
With their gyring, gimbling scheming?”

And lo! so sudden from the sky
A voice was heard to prophesy,
“Hark, ye mimsy banks!
Hark ye, thou uffish Premier!
Hearken all who hear the call
Of downturns and despair!
The reckless beast cannot be maimed
With instruments of recklessness.
No victory can yet be claimed
While mired in such a fecklessness.”

And choirs celestial sang the strain
Which plumbed the very azure main:
The words of our absolving shrift,
The ancient liturgy of thrift:
“Sumptus censum ne superet!”
Repeat it, pray, lest we forget:
“Sumptus censum ne superet!”

The Hellenistic world agreed:
“????? ????” they decreed.
And in the plain vernacular,
Micawber took the lead.

Yet howsoever it may be said,
How loud, how slow, how clearly read,
Let each without exception
Brand its meaning on his head.

And then, just when
We can say Amen!
To being in the black,
We’ll go anew galumphing
To spend what we don’t lack.

~

(with grateful acknowledgements to Mr Lewis Carroll)

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Posted in Creative, General, Politics by Admin | 1 Comment »

Abolish the minimum wage

Thursday, April 2nd, 2009

There are some things which few people will thank you for saying, but still need to be said. There are some statements which will lose a politician more votes than they gain him, but still need to be said.

As Sean Gabb says in “Free Life Commentary”:

“A political leader, as opposed to a demagogue, has a duty to listen, but also to educate. This means on occasion resisting the will of the majority. It means the sort of patient explanation of truth that I last saw in the early 1980s, when several dozen Conservatives, in or out of office, went about the country telling often hostile audiences why the calls for reflation had to be resisted.”

One thing that needs to be explained is the badness of the minimum wage. Just as any price-fixing will cause a shortage or a surplus, the minimum wage causes unemployment (a surplus of labour). There are some people whose labour is simply not worth the minimum wage. With minimum wage laws, they will never get a job. To believe otherwise is to believe that government can legislate against the laws of economics. But governments can no more do that than they can legislate against the laws of physics.

Of course, if a minimum wage is brought in at £5/hour, not everyone previously earning less than £5/hour will suddenly lose their jobs. Like most political decisions, some people benefit from it, and some people lose out. But there are plenty of tasks which are simply not worth paying for at that cost. Various jobs are destroyed, and plenty of people do become unemployed. The government know this, of course, which is why there are different minimum wages in the UK for those aged 22 and above (£5.73), those aged between 18 and 21 (£4.77), and those younger than 18 (£3.53). Most under-18s are not skilled enough for their labour to be worth the adult minimum wage. Rather than see even more unemployment, the government created a tiered minimum wage. But it is not the case that the labour of everyone in any particular age band is worth the same. There are plenty of adults (currently unemployed) aged over 22 whose labour is worth less than £3.53/hour. Rather than differentiating by age, we should differentiate between each individual. But that would mean abolishing the minimum wage. This clearly demonstrates that the minimum wage was created for reasons of political popularity, despite the clear economic argument against it.

A good way to see why minimum wages are bad is to ponder why the minimum wage is currently £5.73.

In this clip from the BBC’s “Politics Show”, a woman says “I’ll vote Labour if they put the minimum wage up to £8″. Why isn’t it £8/hour? Or indeed £20/hour?

Perhaps this woman was on minimum wage. It’s hardly surprising that someone would turn to a politician for a pay rise when they couldn’t get it from their boss. However, raising the legal minimum wage to £8/hour would certainly have the unintended consequence of lowering this person’s actual wage to £0. Rather than increasing their income, they would become unemployed as a result of such a policy.

On Thursday 6th November 2008, in the annual “No Confidence” debate at the Union, Oliver Letwin was asked, “Why did you vote against the minimum wage?” It didn’t seem to have occurred to the questioner that there could be any good reason for opposing a minimum wage. Mr Letwin replied that he had been responsible for changing Conservative policy on the minimum wage “because we were wrong about it. It turned out not to price people out of jobs the way we thought it would. The reason we were sceptical about it is because we thought it would price people out of jobs… I hope, I trust, that it’s not going to rise to a level where it does that in a recession.”

Mr Letwin is wrong that the minimum wage has not priced people out of jobs. Indeed, now that we are in a recession, it is surely responsible for even more unemployment. The reason the minimum wage is not £8/hour is because that would cause more unemployment. So the choice for a politician when setting the level of the minimum wage is: How much unemployment do you want? Unemployment will never be minimised as long as minimum wage legislation remains in force.

Lowering or abolishing the minimum wage is of increased importance at the moment, because lowering wages is essential to ending recessions.

“It is common and indeed conventional knowledge that only World War II ended the Depression… What is less often acknowledged is that the New Deal as such thus failed to end to the Depression. Nor is it generally understood why the Depression did not return in 1946, after the military was demobilized and war production ended. By all rights, nothing should have been any different from 1939. But the Depression did not return. Despite demobilization and the end of war production, unemployment in 1946 was 3.9% and in 1947 3.9%…

So why didn’t the Depression return in 1946? Because wages were frozen even while the money supply was inflated with the war spending. This drove down real wages, the opposite of the consistent policy of Hoover and Roosevelt for a decade to drive up wages. In 1946, wages were low enough to clear the employment market. If employers could then hire workers at a market wage, and produce consumer goods, business could get back to normal. It did.”

However,

Dave Prentis, general secretary of Unison, will cut a special cake in the Commons to celebrate the anniversary, saying that the current £5.73 an hour rate should increase to £7.45 by October 2010.

The union also wants apprentices to be covered by the minimum wage, adding that the “development rate” for younger workers should be scrapped as it “discriminated” against young people.

As Tim Worstall puts it,

Are these people mad? A 30% pay rise in the middle of a recession? When people are shedding labour left, right and centre, you’re going to make labour more expensive?

The minimum wage is a blunt instrument. Prices are information, and setting prices (including wages) distorts the market, preventing it from solving the economic calculation problem and allocating resources efficiently. Just as we don’t set prices, we shouldn’t set wages.

The minimum wage is unfortunately popular amongst many people that it harms. If you want to redistribute wealth, which is what the minimum wage tries to do, a negative income tax would be a far more effective method.

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Posted in Politics by Hugo Hadlow | 12 Comments »

[un]Fairtrade

Tuesday, March 3rd, 2009

It’s probably a little lazy of me to just post a link. However, I feel quite strongly about Fairtrade being a BAD IDEA and failing to properly address its aims and intentions.

The Adam Smith Institute (ASI) have written a critique of Fairtrade.

Here’s the Executive Summary:

  • Fairtrade Fortnight is a marketing exercise intended to maintain the Fairtrade mark’s predominance in an increasingly competitive marketplace for ethically-branded products. The hype is necessary, because there is every reason for the shrewd consumer to make other choices.
  • Fair trade is unfair. It offers only a very small number of farmers a higher, fixed price for their goods. These higher prices come at the expense of the great majority of farmers, who — unable to qualify for Fairtrade certification — are left even worse off.
  • Most of the farmers helped by Fairtrade are in Mexico, a relatively developed country, and not in places like Ethiopia.
  • Fair trade does not aid economic development. It operates to keep the poor in their place, sustaining uncompetitive farmers on their land and holding back diversification, mechanization, and moves up the value chain. This denies future generations the chance of a better life.
  • Fair trade only helps landowners, not the agricultural labourers who suffer the severest poverty. Indeed, Fairtrade rules deny labourers the opportunity of permanent, full-time employment.
  • Four-fifths of the produce sold by Fairtrade-certified farmers ends up in non-Fairtrade goods. At the same time, it is possible that many goods sold as Fairtrade might not actually be Fairtrade at all.
  • Just 10% of the premium consumers pay for Fairtrade actually goes to the producer. Retailers pocket the rest.
  • The consumer now has a wide variety of ethical alternatives to Fairtrade, many of which represent more effective ways to fight poverty, increase the poor’s standard of living and aid economic development.
  • Fairtrade arose from the coffee crisis of the 1990s. This was not a free market failure. Governments tried to rig the market through the International Coffee Agreement and subsidized over-plantation with the encouragement of well-meaning but misguided aid agencies. The crash in prices was the inevitable result of this government intervention, but coffee prices have largely recovered since then.
  • Free trade is the most effective poverty reduction strategy the world has ever seen. If we really want to aid international development we should abolish barriers to trade in the rich world, and persuade the developing world to do the same. The evidence is clear: fair trade is unfair, but free trade makes you rich.

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Posted in General, Politics by Callum Wood | 2 Comments »

What is Capitalism for?

Monday, January 19th, 2009

by Hugh Burling

The other night I was accused of being a Socialist. In conversation I had pursued the claim that it would be a good idea to encourage ordinary people and high-street banks to make lower-risk investments, such that there would be less risk overall in the system, and that slower growth was a fair price to pay for a steadier market. I made no reference to legal compulsion at any stage. As I understand it, the high-risk investment strategies that were until recently so widespread became so partly due to the popular demand for them. That is, ordinary people wanted higher and higher returns on their savings accounts and their small-scale investments, alongside lower and lower interest charged them on their use of credit cards and borrowing. To meet these demands, win more customers and stay ahead in the finance market, banks (investment, lending and otherwise) encouraged their employees to engage in more sophisticated and risky practices. Some thing or things went wrong and the cards slipped. I beg forgiveness for my primitive understanding and exposition of our financial markets and crisis: I think my comments below will make clear why I don’t take as much interest as some in the minutiae of the operation of our collective greed.

At any rate, the conversation was reduced to the question being asked of me: “Imagining that you trusted the borrower so implicitly that the ‘risk’ of a loan could only be judged as ‘zero’, what would you consider a fair rate of return, when you leant someone your money?”

Once upon a time, the moral engines of our society condemned usury, the lending of money for the lender’s profit. The consequence was the emergence of a complex system of gifting and deviously-worded insurance deals based on bartering. I am no expert on the financial operations of the Knights Templars but I strongly suspect that even their feudal wheelings and dealings were much simpler than usury has become since it was made legal for the majority of the population. We have always had markets and capital. At least, they both seem to go back a long way (see Sean Gabb’s “Market Behaviour in the Ancient World: An Overview of the Debate” (also available as a pdf). Wanting to make a profit from helping other people is probably ‘innate’ to human economic behaviour – at least it is so common that the desire needs to be factored into considering how to motivate people to help each other.

Indeed, the beauty of Capital‘ism’ is that it reveals how a selfish motivation can benefit others. But that beauty does not stem from the selfishness of the motivation. Intellectually (rather than historically or emotionally), we support financial markets because of three truisms: (1) “many people act out of selfish motivations more readily than out of altruistic ones”, (2) “borrowing money is a very efficient way for an individual to be able to begin new enterprises and hence develop new technology, provide more services, and a variety of other things we like to have” and (3) “many incidences of borrowing and lending must occur in order to have all the things we like produced or provided”. Because so many ‘lending transactions’ – the term ‘investment’ assumes that the transaction has a selfish motivation – must be carried out, we need to take account of the selfish motivations of the aforesaid many people. Also because selfish motivations are so popular, we do not expect a majority of entrepreneurs, inventors, artists and so forth to make a living on the feudal basis of patronage (in which they suffered perpetual disadvantage). So what we do is to try and facilitate selfishly motivated lending.

The problem arises when that facilitation changes to expectation, then reliance and finally the inability to imagine that people do, sometimes, want to help other people for reasons other than financial gain, and that alternative motivations are ultimately better, if rarer. This inability leads to a twisting of the truisms. The selfish ‘many’ changes to ‘all’, and usury becomes, in the mind of the public, the only means towards growth rather than merely a very efficient one.

To end the suspense, the answer I gave to the question was “nothing”. If one could spare the money, and one sufficiently trusted the borrower to return it to one before one needed it, there would be no point in one asking for interest. Nothing would have been lost. Of course, the lender would have gained nothing either. My accuser was flabbergasted at the idea of performing a transaction without the aim of capital gain, hence his accusation.

When we advocate a free market, extol the virtues of honest trade and applaud the system which makes the best of our too-often selfish instincts, we must never forget that a compromise is all capitalism is: a compromise with our greed. It is not an ideology, it cannot provide a goal and we should not allow its mathematical doctrines to persuade us that all humans are only ever selfish, simply because we have a clever system for working with the many of us who often are. In short, capitalism is not an ism like the isms that suffix its opponent theories. It is a perpetual jury-rig, not because we once had some pristine, more efficient system or are likely to manufacture a new one, but because we’re basically not good enough to build a proper mast ourselves.

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Posted in General, Politics by Hugh Burling | 7 Comments »

Abolish the Bank of England

Friday, November 14th, 2008

I have an article in this week’s “Varsity Debate”.

The title was “Should the Bank of England have cut the interest rate? Last week, in desperate bid to protect the UK economy from a severe recession, the Bank of England announced its decision to slash interest rates to their lowest level in 50 years.”

I argue that “The decision should not be up to the Bank of England; it should be up to us”, and that the rate should be higher, not lower, because the natural rate would be higher. As Jock Bruce-Gardyne said, “There is no economic problem that cannot be solved by a stiff rise in interest rates”.

The problem with a government set interest rate is that it disconnects the ratio between investment & consumption, and people’s true time preferences. When the government sets any price, they disconnect the relationship between demand and supply. If a price is set above the market equilibrium, more people supply the good, but fewer people demand it, creating a surplus (and an illegal “black market” selling the good at the true price). If a price is set below the market equilibrium, more people demand it, but fewer people supply it, creating a shortage. The only situation when the same amount is produced as is demanded, is when the price is allowed to be set by the market. That is the only way resources can be allocated efficiently. And this applies not just to markets for food, or furniture, but to markets for currency and for credit. An interest rate is a price like any other.

A government interest rate disconnects the relationship between investors and savers. However, a low government interest rate does not create a shortage of capital, because not only does the govenment set the price, it enters the market as a lender, and it controls the currency. The low rate means that far fewer people save for the future, but investors can still borrow even more money because the government provides it instead of the savers.

Here’s the complete version:

The interest rate is the price people demand for postponing consumption. If you would give up ten apples now for eleven next year, your interest rate is 10%. A free market will naturally find an equilibrium interest rate. If you would be willing to lend at lower than the market rate, you can lend at the market rate and make a profit. If you are only willing to lend at above the natural rate, no one will borrow from you.

Why can the government lend at below the natural rate? Anyone else who lends their money at below the natural rate will have no shortage of customers looking for a bargain, and will soon have lent all their money. And anyone lending at below the natural rate of interest is making a loss, so no one does it. No one, that is, except the government. The government cannot run out of money, because it can print it. And while an ordinary lender lending at below the natural rate will not have much effect on it, the government can affect it simply because so much of the money in the economy is on loan from the government.

The current interest rate is lower than it would be in a free market. Why does the government lend at below the natural rate? Why does it want to distort the interest rate? A low interest rate encourages more spending now. It is in essence a Keynesian policy, and shares his deep contempt for savings and thrift, because a low interest rate discourages saving and planning for the long term. After all, “in the long run, we are all dead”, so why bother to plan ahead?

Just as spending by the government will cause a short-term boom, cheap lending by the government will encourage more private spending and cause a short-term boom. Most investment is funded by borrowing, and so the more money there is available, the more investments that will be made. The extra investments enabled by extra government money would not be made in a free market: they are the riskiest investments. Government intervention destroys the natural equilibrium between savers and borrowers, causing malinvestment, followed ultimately by correcting recessions when unprofitable investments are liquidated, freeing up capital for new investment.

Make no mistake: this recession is temporary. It is an inevitable correction to bad investments encouraged by government intervention. Long-term economic growth caused by technology will not stop, but the short-term economic growth caused by cheap money must stop eventually.
Further government action, including dropping the interest rate and the resulting inflation from this expansion of the money supply, might stave off recession temporarily, but it cannot stop it forever, and will make it worse. Further government action might be justified to allay the suffering caused by previous government action, though, of course, it would have been better if the economy had been allowed to grow more slowly in the first place, so it didn’t have to recede now. But shock tactics are best: abolish the Bank of England and go straight to a market interest rate. In the long run, we’ll all be better off.

Gordon Brown was recently asked if he regretted his boast, “No more boom and bust”. He replied, “I actually said, ‘No more Tory boom and bust’”. He did indeed say this, once, so he’s not lying. But, of course, he said it without the “Tory” on many occasions. The implication is that Labour boom and bust is fine. This is the kind of drivel Brown is now reduced to spouting.

Brown is often lauded for removing government interest rate from control by politicians and handing it to the Bank of England’s Monetary Policy Committee. This has certainly removed the ability of governments to slash interest rates before an election, causing a boom, with the bust only following after they have been re-elected. However, when it was made independent, the Bank of England was charged with controlling inflation. This has enabled Brown to carry on spending massively while being able to absolve himself of responsibility for inflation.

The interest rate certainly shouldn’t be controlled by politicians. But neither should it be controlled by appointed “experts”. It should be controlled by us. Then it will reflect people’s true time preferences, enabling us to allocate resources efficiently. To prevent politicians for meddling again in the future, we should abolish legal tender laws and go back to free banking, with competing currencies, so that no one will be able to get away with inflating them. In the meantime, any increase in the government rate is welcome. We need a return to a natural interest rate. We need to return to a truly free market.

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Posted in Politics by Hugo Hadlow | No Comments »

Don’t blame markets

Sunday, October 5th, 2008

I have an article in this term’s Berry.

Many people see the current financial crisis as demonstrating the failure of free markets, and the need for increased government regulation. However, as I show, we do not have anything like a free market, and that economic crises are caused by past and current government intervention. To fix things, we don’t need more government intervention, but less. We need to return to free banking. We need what we don’t have: a truly free market.

Here’s the article:

The banking crisis is not a result of market failure. It is the result of two things: the ownership structures of investment banks, and government intervention in the money market.

Most investment banks are owned by dispersed shareholders, and their shares are traded on the stock market. Management is divorced from ownership, with the result that the shareholders can exert little control over fund managers. This separation of ownership from control means that traders are free to gamble with other people’s money. In a growing economy, everyone does well on average and traders enjoy large bonuses. But if investments turn out to be bad, traders face almost no sanction. It is not their money that is lost; the most a trader loses is his job. This leads to excessive risk taking.

Three of the big five Wall Street investment banks have gone under. Yet hedge funds, which before the crisis were thought to be much riskier, have not been hit nearly as hard. This shows that the problem is not with markets, but with the structure of investment banks.

Hedge funds are privately owned, often as partnerships. Fund managers usually invest their own money as well as others’, so they have incentives not to take huge risks. The small size of hedge funds allows managers to assess fund manager performance more closely. It also means that if bad decisions are made, they cannot have such large effects. If a hedge fund goes bust, the effect on the economy is less significant.

Big banks are therefore looking at changing their business structures. UBS is considering splitting its asset-management and investment banking businesses.

The second, bigger problem is government intervention in the lending market.

A simple example is legislation in America which discourages lenders from denying mortgage applications from fear of being accused of racism. The Community Reinvestment Act has coerced lenders into allowing riskier mortgages, ultimately leading to more repossessions when borrowers couldn’t make their repayments.

But the central banking system is a more systemic problem. Governments keep the interest rate artificially low by lending money at a lower rate than the going market rate. A small player wouldn’t have much effect, but because governments can print money, they exert a large enough influence on the market to change the interest rate. After years of inflating the money supply, most of the pounds and dollars in circulation are lent by the central banks. As well as being the cause of inflation, this allows investments in riskier activities which wouldn’t be allocated resources by a free market. It creates bubbles or inflates certain markets, such as the housing market.

The debt bubble that has been built up over the last decade or so is the real cause of the current economic crisis, and central banks are to blame. They provided the cheap money which underpinned the growth of debt. The so-called “Greenspan put” refers to twenty years of US Federal Reserve policy to cut government interest rates aggressively every time drops in market confidence threatened the long economic boom. The 1987 stock market crash; the Gulf War; the Mexican crisis; the Asian crisis; the LTCM debacle; Y2K; the internet bubble burst; 9/11; and now: every time, US rates were slashed. Often, US government interest rates were actually lower than the inflation rate: real interest rates were negative. That is really cheap money.

Investors in the UK and US increasingly believe that when things go bad, the government will inject liquidity until the problem got better. Governments do so every time, and the perception has become firmly embedded in asset pricing in the form of higher valuation, narrower credit spreads, and excess risk taking. The end result has been moral hazard in risk taking and has caused bubbles in equities, credit, real estate, and commodities.

The knowledge that the government will bail out any business distorts the market: it encourages rash decisions in the short term, and in the long term stupefies the market from adjusting to changes in demand and technology.

Ultimately, “capital injections” do not prevent credit crunches. They exacerbate business cycles and makes the crunches bigger when they inevitably do come.

Bad ownership structures are not a long term problem. As long as their shareholders are not bailed out, banks will fix themselves.

But government intervention is a long term problem. Central banks should be abolished. Government should not interfere with the market interest rate. The only way to long-term economic health is to trust the markets.

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Posted in Politics by Hugo Hadlow | No Comments »

Market Crisis and Regulation

Wednesday, October 1st, 2008

The financial sector is in crisis. Lehman Brothers has collapsed, Merrill Lynch sold, Fannie Mae and Freddie Mac nationalised, and AIG looks like it may well go the same way. In the face of such market turmoil, it is to be expected that the old doomsayers are out in force, bemoaning the folly of the free market, and wallowing in the glories of nationalisation as our collective saviour. But such joy is misplaced. The free market is still only partial, and indeed too young to be blamed for the current economic woes.

To use an analogy, imagine that person A and person B have been given a chain saw. Person A has been given an instruction book, reads it, and follows it to the letter. As such they immediately and quickly get started trimming a few bushes.

Person B, on the other hand, has not been given an instruction book. Instead he must work out how to use the chain saw for himself. Because he is an intelligent person (and can learn from the work performed by A) B quickly works out how to use the chain saw. However, because B does not have an instruction book, he is quite happy to cut everything in site, while A checks each section to ensure that he does not attempt to cut something that is too thick for the chain saw.

Very quickly, B is able to take over A, and produces, because he is not stopping and starting, produces a cleaner and more even cut. Unfortunately, B is suddenly stopped in his tracks when he tries to cut something too thick. The chain saw jams; indeed, the chain saw backfires and B loses his grip. B is shaken for a few minutes, but he quickly recovers and starts again. This time he avoids the thick branch.

Soon, A and B find a poll in the bush made of a material neither has come across before. A can find no reference to the poll in his instructions. As such, both A and B decide to try and cut it. They both fail and the chain saws backfire. Afterwards, A is given a new instruction book, listing iron poles as another thing that the chain saw cannot cut through. B is not given any regulation.

Later, A and B come across a pole made of another material neither have come across. With his new instructions, A is told not to cut through anything that he does not recognise. As such, he does not cut it. In contrast, B tries to cut the pole and finds that it is made of rubber and cuts easily. He can then continue, ending up with a clean shaven bush with only a couple of thick branches and iron poles protruding.

What this is trying to show is that a regulated market is retrospective. With deregulation, banks have been able to make investments they have never been able to try before. Some of these investments, like the metal pole, have proved to be bad. But it is only after the investment was tried that this proved to be the case. As such, the free market has also learnt the lesson.

Nevertheless, some investments, like the graphite pole, were successful. In an ever changing world where regulations are often years behind progress, such investments would not have been realised had it not been for the free market.

Undoubtedly, the current economic crisis derives from banks lending to people who cannot pay them back. The fall-out from this has meant that the liquidity upon which banks depend has contracted. But what should be emphasised is that the free market can now learn from this mistake. As such, person B will not try and cut the thick branch with the chain saw again.

A deregulated market is in its infancy, and people are still learning how to use the freedom it affords. To finish with a final analogy, a child who has been playing virtual rugby for years is finally allowed to play it for real. During his first match he breaks his leg, and mother prevents him from ever playing again. So, he returns to his virtual game. Just imagine the opportunities lost by that child had he been able to learn rugby properly, especially now that he is an overweight couch potato in front of a television screen.

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Posted in Politics by James Arthur Sharpe | No Comments »