Friday, March 14, 2008
Fluxions
First, an announcement: Eternity Road has acquired a new co-conspirator: the lovely, talented, and extremely well shod Fetiche Nouvelle. Fetiche has blogged sporadically at High Heels and Fetish Adventures for about two years, but has "gotten a little lonely over there." Recently she persuaded your Curmudgeon -- well, yes, that Fran person concurred -- that her particular gifts and subject matter preferences would bring a welcome dollop of variety to this stodgy old dump.
Fetiche's posts will appear here as the Spirit moves her. But that's true of all of us, isn't it?
Among the least worthy "crises" of our time is the so-called "sub-prime mortgage meltdown." Granted that a substantial number of persons now find themselves unable to afford the mortgages they contracted during the easy-credit years of the late Nineties and early Zeroes. Granted that a substantial percentage of that group will be foreclosed out of the homes they occupy. On the strength of these stipulations, approximately fifty-one governments have trumpeted the necessity of swiftly contriving rescue measures for those "endangered" "homeowners." Virtually all of the measures contemplated will impose severe costs on the lending industry and create powerful incentives that will pervert borrowers' judgment for decades to come.
Why are they doing it? In a presidential election year, you have to ask? Your Curmudgeon is never surprised when a prominent politician cooks up a new "crisis" in a year divisible by four. The Pandering Steeplechase never actually ends, but the jockeys go to their crops most ardently in a quadrennial year. If they don't have a ready-made rationale, they'll synthesize one out of whatever's available.
But your Curmudgeon is more interested in the processes they thwart: the fluxions that cleanse our economy of bad decisions and dead tissue, if permitted to operate.
Among Joseph Schumpeter's better known aphorisms is his characterization of a market economy as a process of "creative destruction." The statement has been willfully misinterpreted by the enemies of capitalism many times. Such is the pervasive ignorance of market economics that few persons are capable of seeing through the slanders.
All economic concepts are premised upon scarcity: that is, the finitude of material resources and labor. (Marxian socialism, which baselessly predicts a "superabundance" of all material goods once the iron thumb of the moneyed interests has been lifted from the backs of the workers, is more of a fairy tale than a logical construct. A serious man need not confront its claims seriously.) That premise compels an economic thinker to choose from a small group of alternatives for apportioning goods to persons:
- The free market;
- Authoritarian allocation and regulation;
- Syndicalism.
The market is the method of free men, each of whom trades with the others by offering what he has for what he wants. The market compels us, collectively if not individually, to produce at least as much as we consume, for every trader wants to receive something more valuable than what he surrenders for it, and no man will trade at a loss without suffering ruin.
The authoritarian model has seen several instantiations. All of them grant a political body, whether a monarch, a committee of oligarchs, an elected government, or a bureaucracy, the privilege of assigning stewardship of resources and directing economic activity. This model's incentives are all toward the satisfaction of the political directors, for it is they and only they who determine who shall prosper and who shall dwindle.
Syndicalism is a decentralized version of the authoritarian model. A syndicate -- a group of workers in a common trade -- seizes the means of production in that trade, and operates it under quasi-democratic rule. Authority is vested in a "soviet" -- a workers' council -- which decides on matters relevant to the direction of the syndicate. In theory, every worker has the same chance of being elected to the soviet. In practice, the council swiftly becomes a self-perpetuating authoritarian oligarchy, and remains that way until the syndicate is swallowed by a larger body with greater coercive resources. Its incentive structure parallels that of an authoritarian economy.
The differences among these mechanisms are many both in principle and in practice. One of the most important ones is that in a free market, no one is guaranteed to succeed.
The possibility of failure is the least well appreciated virtue of the free market. This is not because failure is inherently a good thing, but because failures in a market economy simultaneously free poorly employed resources of labor and capital, while teaching us a lesson about what not to do. A business of whatever size that fails to operate at a profit will be liquidated; that is, its assets will be detached from the business and either transferred or transformed to other ventures. But the loss itself will be felt only by those persons who voluntarily invested their money or labor in the failed enterprise.
In other words, the market confines the costs of bad decisions to those who make them, rather than spreading them to uninvolved others, while the liquidation of failed ventures simultaneously liberates the misdirected resources for other uses.
In a world of finite resources, such fluxions of capital and labor out of bad uses and into the pool of available resources are quite as important as the profit that accrues to a well thought out, well run venture. If failure were not possible, the resources failures absorb would not be freed. Eventually there would be no available resources with which to attempt anything else, because the overwhelming majority of enterprises operate at a loss.
It's rare for laymen pondering economic systems to recognize the importance of this mechanism. We don't like to think about failure, even though it dominates our world. It troubles us to think that economic progress depends on a successful minority of enterprises rather than a sturdy majority. Indeed, it's difficult even to see one's way clear to the recognition of that fact. It suggests that economic security, however envisioned, is an inherently impossible goal, which runs contrary to American experience.
The solution to the puzzle lies in the realization that enterprises fail, but individuals recover. A business undertaking, to be successful, must have a sharply defined goal toward which its efforts are directed. An individual involved with such a business is free to redirect himself in the event that it proves unprofitable. There may be short-term discomfort involved; indeed, there often is. But in a nation composed of sound families buttressed by eleemosynary institutions dedicated to the assistance of those fallen on hard times, a free market economy will almost never lose productive citizens permanently to impoverishment.
The fluxion of resources away from failures and toward other ventures is vitally necessary for economic progress. But in an authoritarian economy or a syndicalist system, such fluxions are thwarted by the application of coercive power. Enterprises run by friends of the regime will be propped up with capital seized from others, whether through an anonymizing mechanism such as taxation and subsidy or by the outright expropriation of the disfavored businesses. Failure, then, is only meaningful if one is not among the favored of the State. As long as the State lasts, at least.
The sub-prime mortgage mess had its genesis in bad decision making by many persons. They didn't quite believe that they were getting something for nothing, but they did underestimate the chances of an unfavorable turn of events. Variable-rate loans always carry the possibility of a precipitous escalation, but one consumed by the desire of a house of his own will often yield to wishful thinking in assessing his risks.
The typical measure being proposed to forestall the wave of foreclosures attendant upon recent developments in the credit market would lock the lenders into their unwise borrowers on terms quite different from those written into their mortgage contracts. In effect, the lender will be compelled to leave his capital in the hands of the borrower at a loss, rather than liquidate the loan and put the money where it would yield a net return. To "soften the blow," -- yes, those are "sneer quotes" -- the Federal Reserve System is flooding the credit markets with freshly created money, deliberately reducing the value of every dollar in circulation to prevent the foreclosures that would otherwise occur.
The way to gauge the damage to the dollar is to watch the prices of fundamental commodities. Your Curmudgeon prefers to watch gold, long the most reliable measure of the value of a fiat currency. But in recent times, the price of crude oil has served equally well. Both indicate that the dollar has lost nearly 20% of its value in the past three months. Comparisons against the euro and the yen tell the same story.
To prevent the fluxion of capital away from unwise mortgagors, the Fed has stolen 20% of the value of every dollar in every American's checking account, savings account, IRA or 401(k).
As if that weren't bad enough, the message to those unwise mortgagors could hardly be clearer: Borrow as freely as you please; Momma Washington will prevent you from suffering from your mistakes. Is it not clear that this will perpetuate the immediate-gratification mindset so important to the creation of the mortgage mess? Can we possibly believe that credit-issuing institutions will fail to notice?
But politicians ever alert for an opportunity to posture as white knights aren't about to allow such a chance to slip away. That includes a nominally (but not truly) conservative president and a majority of his co-partisans in the Congress of the United States. Not with an election approaching that will determine hegemony over the federal government for the next four years at least.
Sad, but true: we must allow persons who make bad decisions to feel the pain that attaches to them, even if those persons are thoroughly good and decent sorts who'd never harm a fly. Their sufferings, which are likely to be mitigated by all manner of compassionate institutions, are essential to the proper guidance of the most dynamic economy the world has ever seen. The alternative has been delineated above.
But for the present at least, we have chosen another, far less perspicacious course. We've chosen to destroy the value of the dollar so that a couple of million bad loans won't be liquidated...so that a couple of million "homeowners" won't be forced to move into less desirable residences. The fluxion will be thwarted; the misallocated capital will be forced to remain where it is.
What of the new ventures that would have succeeded if that capital were made available to them? We cannot know what they might be; we can only know that the resources that will be available to them will be substantially less than if we were wise enough to allow the market's process of "creative destruction" to operate as designed.
This is the consequence of allowing politicians any say over economic or fiscal matters. If you like it, vote Democrat in November. Or Republican; in this regard, the two major parties are no longer different enough to warrant distinction.
