Recently I spent a bit of time reading about economic theory. While I find the actions of government and the Federal Reserve fairly predictable, I still wanted to see the logic behind their choices, to contemplate the underpinnings for blatantly misguided policy. Accordingly, I endeavored to catch up on some books that were collecting dust on my book shelf. Here's what I gleamed...
The architect of today's bad policy is John Maynard Keynes (although one could argue that there is a hint of mercantilism present as well). His 1936 treatise, The General Theory of Employment, Interest and Money, is the playbook we've seen implemented on a global scale. And while there are plenty who subscribe to his theories like religion, I think he misses the boat, particularly on the importance of price discovery. When bad decisions are made, there should be consequences, not do-overs.
In his writings, Keynes argues a few major points: interest rates are always too high when left to their own devices; money printing should be used to manipulate those rates down (ideally to zero); such new money created by the government is real savings; the goal should be to maintain the quasi-boom permanently; and, the part I'll focus on most, it is the intervention of government that lead us out of crisis times -- all told, the argument for a "free lunch". My goal is not to write a lengthy rebuttal, but to highlight in quick terms why these beliefs are utterly destined to fail.
Through the tech and housing bubbles, interest rates were kept too low for too long -- the pricing mechanism was not allowed to work. With low interest rates, investment was made based on the notion that savings existed (i.e., what low interest rates should normally indicate), and businesses and assets that were not necessarily driven by actual consumer preference were priced up (you can make the case that regulators were asleep at the wheel, but that's not the original sin in my opinion). Nevertheless, at least initially, the government generates the desired result, as many take part in the speculative ride, driving prices even higher. The trigger that ultimately will cause it all to implode cannot necessarily be identified or timed in advance, except to say that we know a boom premised on malinvestment, where the proper analysis of incentives and pricing are missing, is destined to end in a bust. It's happened twice within a decade.
In the aftermath of both, the goal has been to re-inflate asset prices, following the prescription laid out by Keynes. He believed that the downward trajectory, the slump, would simply feed on itself and lead to a permanently depressed state. The answer was to get the money presses going to lower interest rates and encourage spending over savings. And when individuals weren't ready to spend, government should fill that void. Not surprisingly, then, you saw TARP and stimulus and QE1 and QE2 and jobs programs and...well, you get the point.
But, guess what, it turns out the cause of the boom doesn't solve the bust -- unemployment has gone up, not down (and the always intellectually honest Keynesians are conveniently saying the extent of spending and money printing simply wasn't large enough up front). Sure, the stock market rallied, but there is a difference between paper assets getting bid up and actual productivity that leads to growth. Add to that we saw inflation in commodities -- there's nothing better for a family on a budget. All told, it is enough to confirm that the Keynes position falls flat (note: there are plenty of folks out there who have written about the problems with Keynesian positions point-by-point, I prefer to deal with the most obvious issue). If it isn't clear, government doesn't function with any constraints. Some might argue that that reality is, in fact, why it is best positioned to save us all. But, implicitly, it means they have no great concern for profit and loss, which means their choices are not going to be as precise and efficient. Be honest, these are the same folks who already created a bubble in late 90s, only to deal with it by creating another bubble right afterwards. So, why are they going to get it right this time?
The key point is that government interference only exacerbates the problems. If the market is allowed to function, there is pain, but there is also genuine healing as stronger hands are able to emerge. Government tries to pick winners and does a bad job -- their analysis is flawed and incomplete.
So, having already gone on longer than I intended, I will end by noting that there is plenty more to be said and that my exposition only touched the surface. The logical conclusion, however, is that the foundation of the government approach is terribly dangerous.
