In 1977, New York was a bankrupt, crime-ridden hole. And when the city asked the federal government for a bailout, the Ford administration demurred.
“Ford to NYC: Drop Dead,” was how The Daily News put it.
How times have changed. Now, everyone gets bailed out. Too bad. Because, getting bailed out is usually the worst thing that can happen to you.
Economics has been called the “dismal science.” But the epithet is pure flattery. Economics is not science at all. It is more like marriage counseling or homeopathy; if it works at all, it is probably just an accident. The field has more mountebanks than the hedge fund industry. It attracts more imposters than an Elvis convention. And it harbors more dangerous delusions than a national political convention. In fact, there are so many economists on the loose that if they were all laid end to end… it would probably be a good thing.
Economists don’t even have a sense of humor… or much curiosity. The Bank of England, the Exchequer, and the U.S. Federal Reserve have all recently made the most absurd announcements; but nobody laughed or asked questions.
On both sides of the Atlantic, investors, speculators, and consumers are getting worried. Lured by economic policies, they’ve borrowed too much, spent too much, and taken too many risks. So, up to the microphones step the world’s leading economists – Ben Bernanke, Mervyn King and Alistair Darling with a solution to a problem that they, more than anyone else, created. In the popular mind, they brought succor… money, that is… to those who needed it; they offered to turn the liquidity crunch into the heady wine of another boom. They offered to bail out everyone.
But how? Of course, they have a theory. Lord Keynes let it fly many years ago: Give the people a little extra money, he said, and it will “turn stones into bread.” How is this miracle performed? Where does the money come from? No one even asks. To his credit, Keynes had the good sense to suggest that government might want to run surpluses in good years so they’d have some money to let out in bad ones. This saving grace has long been forgotten, of course. Now, the money itself arises immaculately; people don’t even bother to wonder about the hanky panky that conceived it.
Nor is there much interest in the details. Ben Bernanke gave the United States a half point rate cut last week. Prices are important information… and no price is more important than the price of money. In the event, the Fed’s Open Market Committee opted for a half-point cut. How did they know that a Fed funds rate of 4.75% was just what the market needs? Why not 4.5%?
According to Keynes’ theory, consumers sometimes need encouragement. Otherwise, they might fall into bad habits, such as saving too much. Then, lower demand would produce lower prices, inciting consumers to spend even less. Pretty soon, the whole economy would collapse into a “liquidity trap,” said the dead economist, where people saved money, businesses had to close their doors, unemployment increased… and everyone got poorer.
Even if it were so, as a theoretical matter, so what? Are people saving too much now? Do we really need to encourage consumers to spend? You might as well encourage a thief to rob a bank!
Fortunately, recessions are fairly rare. Most of the time, things go in the right direction. Good decisions appear to outnumber bad ones. Growth seems to be the rule. Recessions are the exception. But even though boom beats bust, say, as 5 beats 1, there is still that occasional backwards slide. To err is human. And errors need to be corrected.
Last week, China signaled that it wanted to control inflation in the worst way possible. Then, it announced: Henceforth essential prices will be set by party officials, rather than the marketplace. In effect, China is bailing out its economy in the worst possible way. Price controls are used by desperate governments from time to time. From Emperor Diocletian to Richard Nixon to Robert Mugabe, politicians have succumbed to temptation; rather than listen to the market, they decided to do the talking. In every instance, the results were the same – the economy was twisted in a painful and grotesque way. Typically, prices were held down to artificially low levels, in order to appease political groups. Supplies disappeared – blackmarkets, hoarding, market disruptions… one absurdity followed another.
Price controls don’t work – as the Soviet Union discovered – because they mislead people. Producers over-produce… or produce too much of the wrong thing and too little of the right thing. Consumers over-consume; investors put their money into the wrong places… at the wrong time.
We remember visiting the Soviet Union in the mid-’80s. We were on a Soviet commercial airplane from Moscow to Minsk, a distance of several hundred miles. Next to us there was a young woman with a toilet seat in her lap.
When we tried to fasten our seat belt we noticed that it didn’t work.
“Don’t worry about that,” she said. “They never work.” Then, lifting hers in the air… “Look, mine’s not even attached to anything.”
Later, we asked:
“Why are you carrying a toilet seat?”
“Oh… there aren’t any toilet seats in Minsk. So, I went to Moscow to buy one. You know, all the airline prices are controlled. So, the flight only cost me about $10. And the toilet seat only cost about $1.50. You just have to find one!”
What happened in the Soviet Union was that one mistake was piled on another – over a 70-year period. “We pretend to work; they pretend to pay us,” is how the public saw it. But the Evil Empire got no bailout. Instead, the whole thing collapsed in a heap.
Now, everyone knows that prices set freely, by willing buyers and sellers, are better than prices set by bureaucrats – even economists know it. Market prices provide better information. But economists continue to control the most important price of all – the price of money. Like price meddlers everywhere and always, they cause humans to err even more than they would without help. When America’s economic apparatchiks set the price of money too low, for example, people borrow too much; they spend too much; they take too many risks – often with other people’s money.
Economists are also hallucinating if they think everything else will stay put while their easy credit bailout does its magic. On the day the Fed cut short-term rates, long-term rates rose almost an equal and opposite amount. Lenders guessed that looser credit conditions would lead to inflation. The housing market, the one they were trying to rescue from itself, depends more on the long rates rather than short ones. So, the typical subprime borrower got no relief. About 2.5 million subprime borrowers in America will have their mortgage rates reset to around 10% anyway.
What economists giveth, the markets taketh away – and then some. After the Fed’s rate cut announcement went down, the dollar went down too. Over the years, U.S. financial authorities have done such a splendid job of encouraging consumers to spend, the poor householder has no money left. Total credit in the United States rose from 150% of GDP in 1971, when the dollar was cut loose from gold, to about 340% of GDP today. Overspending and over-borrowing – presided over by overconfident economists – have turned the whole country into a subprime mess. People have more debt than ever… while their dollar-based assets and earnings go down. Over the last five years alone, the subprime nation has seen its currency marked down about 20% against its major trading partners. This year, alone, Americans will buy about $2.5 trillion worth of goods from overseas. If the dollar were still worth what it was in 2002, they’d get 20% more for their money – an amount about equal to the total of all the mortgages to be reset over the next 18 months.
As the dollar goes down, living becomes more expensive. Healthcare insurance… food (wheat recently hit an all-time high)… gasoline… housing – all are still near record highs. Except for housing, they are becoming even more expensive almost every day.
When a currency goes down, those who count their wealth and their earnings in it get poorer. Americans have lost about $10 trillion in wealth over the last five years – just from the fall of the dollar. Their houses, stocks, savings, and wages are all worth a lot less than they used to be. It is as if two out of three of all the companies listed on Wall Street had gone broke.
Note to central bankers and economists: Drop dead.
Markets and Money