THE FAILURE OF ECONOMIC REGULATION AND THE ECONOMIC DOWNTURN (Print Version)
by Harry Valentine*
Le Québécois Libre, January 15, 2009, No 263.
Many years ago, George Stigler was one of several economists awarded the
Nobel Prize for his landmark historical research undertaken over several
decades that illustrated how economic regulation ultimately failed over
the long term. A colleague at the University of Chicago received the
same prize for having used econometric methods to prove the same result.
One likely explanation: as other pro-free market economists have
observed, most regulators actually come from the very industries and
economic sectors they are intended to regulate, and those regulated
industries ultimately "capture" the regulatory process and use it to
protect and further their own commercial interests.
For example, Professor Robert Murphy of Hillsdale College recently
undertook research into how the now notorious investment broker Bernard
Madoff was able to operate his elaborate Ponzi scheme for as long as he
did despite being under the watchful eye of the Securities and Exchange
Commission (SEC). Murphy discovered that Madoff had several relatives
and friends who worked for the SEC, and it was ultimately his sons who
turned him in. The economic turmoil caused by the unexpected meltdown of
the housing mortgage market led to the exposure of Madoff's Ponzi scheme.
He succeeded for so long not only despite SEC regulation, but ultimately
because of it.
Political Manipulation and Distorted
In the years that preceded the mortgage meltdown, the
US Federal Reserve pumped billions of dollars of new currency into money
markets with interest rates having dropped to 1%. As a means of
encouraging greater economic activity in the USA, government regulators
revised the rules of the game, and did so at a time of ultra-low
interest rates that did not reflect any actual market conditions. This
combination of below-market interest rates and revised regulation did
create new economic activity in the American housing market. It also
encouraged a massive malinvestment boom in the American housing market,
accompanied by rapidly escalating housing prices that bore no relation
to events in a market that would have been free from political
The ultra-low interest rates and revised regulations spread beyond the
housing market. They infiltrated securities markets and sent distorted
economic signals into many related markets. Entrepreneurs and businesses
base their economic decisions on signals that emerge from market
activity. One of the reliable methods by which to test for signals is to
allow prices to fluctuate and to haggle in order to discover the peak
prices the market will bear for various levels of production for
numerous products and services. The market, however, can only provide
reliable signals when it is free from political manipulation and when
interest rates accurately reflect events and developments in various
sectors of the market.
A market that is rife with political manipulation and in which interest
rates bear no relation to actual market events not only generates
grossly distorted signals; most businesses and entrepreneurs simply have
no way of discerning the accuracy of those signals. If they want to
remain in business, they have little choice but to respond to the
signals they do get, irrespective of whether those signals accurately
reflect the nature of the market or whether they are providing a
distorted caricature of what is actually happening in the real economy.
The meltdown of the American mortgage market illustrates the destructive
effects of distorted signals propagated through the markets.
That meltdown is having a ripple effect throughout the
American economy, as well as the Canadian economy. It has led to a
decline in the demand for oil and a consequent fall in world oil prices
that has in turn begun to have an impact on the economy of Alberta.
Escalating oil prices over a year ago were caused by excess printing and
circulation of new currency in the USA and distorted market signals for
the automotive sector. American monetary policies that date back to
before the escalation of oil prices created events in the American
economy that led to a demand for large private vehicles like sport
utility vehicles (SUVs).
The combination of monetary policies, natural events, and political
events caused oil prices to rise and remain high over an extended period
of time. The American automotive sector received those market signals
when sales of large vehicles dropped, leaving large stockpiles in
manufacturers' parking lots. As a result, production and employment in
Ontario's automotive sector have declined significantly. Politicians
have agreed to bailout the automotive sector with easy loans to produce
small, fuel-efficient vehicles beginning during a time of declining
world oil prices. Somehow, the market is generating signals that lead
decision makers to such a conclusion at a time of 1% interest rates.
The American government has announced that it will increase spending in
order to stimulate the economy. Leading politicians are calling for new
money and more regulation as means of "getting the economy going." The
problem is that the printing of new money and changing economic
regulations are what created the current economic debacle in the first
place. It's like trying to get a drunk sobered up and out of the gutter
by giving him more booze to drink. Restrictions will be placed on him to
regulate his behavior, to be sure, but they will simply be more
elaborate versions of the kinds of restrictions in his life that caused
him to drink to excess in the first place. Fortunately for actual drunks,
Alcoholics Anonymous and similar programs are privately run and free
from political intervention. If only the same could be said for the
economy as a whole.
Valentine is a free-marketeer living in Eastern Ontario.