Mistakes are always being made. In a properly functioning economy, these errors are made…and corrected. People go broke. People make bad investments. Projects are cancelled…discarded…and rejected.
But in the last quarter century, interest rates were generally falling. It was a very forgiving economy. Bad investments were still made. But the cost of being wrong went down. You could pay more for a house than you should have paid…but no problem; you could refinance at lower interest! And then, the price would go up – problem solved. Or, you could overpay for a stock. Again, falling interest rates were generally pushing up stock prices – you almost couldn’t lose.
Then, in the five years from the summer of ’02 to the summer of ’07, mistakes practically vanished. People might have wanted to go broke – but the credit industry wouldn’t let them. Central banks and the lenders kept showing up with more money! You could buy a house…or a Structured Investment Vehicle; no matter how dumb you were, you’d be rescued by easy money and rising asset prices. You might even look like a genius.
Looking at the economy itself, as the flood of money gushed in…mistakes disappeared beneath the surface. Typically, in the United States, there was about one quarter of correction – with negative growth – to every four or five quarters of expansion. But more recently, the ratio of correction to growth fell to only one quarter out of every 19. Are we approaching the perfection of the human race, with fewer errors than ever before…or are there a lot more mistakes in need of correction?
We will not leave you on the edge of your seats. An unanswered question is like an unconsummated marriage; you have the burden of it without the satisfaction. So here it is:
Instead of fewer mistakes in the last six years, investors made more of them.
It is not from success that we learn, but from failure. So, we are grateful to the Soviet Union. It showed what you could do with central planning and price controls. At first, prominent economists in the West believed the numbers coming from Moscow. Then, they noticed that the figures were a little fishy. Finally, with the Soviet economy on the brink of collapse, they realized they had been bamboozled. The Soviets had managed to create a value-subtracting economy. They took raw materials from the ground…added labor, organization, skills and capital…and transformed them into finished products – which were worth less than the raw materials themselves! The harder they worked, the poorer they got.
They weren’t the first to prove that price controls don’t work. Every time they are tried – by everyone from Emperor Diocletian to Richard Nixon to Robert Mugabe – the result is disaster. Why? Because controlled prices are liars. They will tell you whatever you want to hear; they mislead investors, businessmen and consumers.
Once, almost three decades ago, we were on a plane from Moscow to Minsk, in White Russia. Seated next to us was a young woman with a toilet seat on her lap.
“What are you doing with the toilet seat,” we wondered.
“Oh…I couldn’t find one in Minsk. So, I went to Moscow to get one.”
Further investigation showed that price controls had caused toilet seats to disappear from the market in Minsk…while they had reduced the price of an airline ticket to about $10. The young woman did the reasonable thing, under the circumstances. So did the Soviet economy; it self-destructed a few years later.
Western economists love to tell tales like this. It makes them feel superior. But few notice that their own central banks control the most important price of all – the price of credit. Nor do they notice that an artificially-low price of credit caused an entire generation of Americans – and Englishmen, too – to make errors. They borrowed too much and spent too much. So great were these errors that their entire economies started walking backward – destroying wealth for the average person, subtracting value from Americans’ houses…wages…and other assets.
Yes, it’s true. The average person in America is poorer now than he was five years ago…and maybe even poorer than he was 30 years ago. As we have pointed out many times in Markets and Money, he has more debt…higher expenses (prices of food and fuel have soared)…but he had more or less the same real income.
How is it possible for a booming economy to make people poorer? Well, that is what mistakes are all about. Setting the price of credit too low, the feds caused a whole generation of Americans to misjudge how rich they were. They did what people do when they think they are richer than they really are – they over-spent. Over-borrowed. Over-leveraged themselves. Made bad investments. In short, they over-did it.
And even if they saw they weren’t actually richer…they believed the promises of modern ‘zoo capitalism.’ Since the Reagan/Thatcher revolutions, people have come to believe in a new kind of capitalism – in which the dangerous beasts were all behind bars. It was Capitalism Without Fear…growth without recession…boom without bust…creation without destruction. It was capitalism presided over by central bankers – with the power to set the price of money wherever they want. Deficits didn’t matter, people believed; Dick Cheney said so. It was capitalism without mistakes, where no matter how stupid you were…no matter how high you reached…no matter how many bad investments you made…or whatever dopey thing you jumped into…you landed in honey.
It was almost too marvelous.
Markets and Money