The most interesting characteristic of decision making isn't wisdom but
ignorance. Consider for a moment that any one person can only know a fraction of
what is going on around him or her, vastly more is not known than is known, and
much of what is known is false rather than true. It seems possible then by
organizing into a hierarchy for decision making rather than becoming more
efficient we are really institutionalizing ignorance. (Harvard Business Review
1958)
This observation has never been
better illustrated than by the Congressional hearings on the auto company and
AIG bailouts. Regarding AIG insurance, Congress previously approved bonus
payments, but last week we witnessed a real spectacle: Congressmen preening like
peacocks in heat to deflect criticism by feigning anger and surprise on
television at the interim CEO.
The ongoing circus confirms Nobel
laureate Friedrich Hayek's contention in "The Road to Serfdom" that government
doesn't have the ability to survey the billions of decisions made daily by
consumers and businessmen and act upon them in a timely manner. This is
something the free market does with each individual acting in accordance with
Adam Smith's "invisible hand." Leonard Read of the Foundation for Economic
Education (FEE) made the same point, frequently stating: "There is wisdom in the
free market a trillion times greater than that of any discrete group of
individuals." Including Congress, which we now know, rarely reads the bills it
passes.
So what explains lately all the
screw-ups by big business just like those that occurred during the Great
Depression and the other 21 business cycle recessions since 1900? Why do
businessmen seemingly become greedy every five to seven years on average? What
do they not know and what do they think they know that is false? Why do highly
educated businessmen and bankers who are astute and responsible for years
suddenly lack judgment during what seems to occur every seven or so years?
What accounts for the periodic
"Cluster of Errors" during peaks in the business cycles? According to economists
such as Murray Rothbard, Ludwig Von Mises and Friedrich Hayek, the cluster of
errors, booms and busts begins and ends with the Federal Reserve System whenever
government tries to "improve" upon the wisdom of the free market.
In "America's Great Depression,"
Murray Rothbard asserts: "... the monetary inflation of the 1920s inevitably set
the stage for the Depression which was aggravated by the Federal Reserve's
efforts to inflate further during the 1930s." Rothbard calculated that during
that period the money supply increased by 60 percent, far more than the increase
in national productivity. Increasing the money supply through bank credit
artificially lowers interest rates, sending false signals that make unwise
investments appear profitable.
For example: My first car
required a 20 percent down payment and balance paid over two years. A decade
later cars were offered with 10 percent down and balance to be paid over three
years, then four years and now five years, attracting less and less qualified
buyers. In 2008 you could still buy a car and finance 110 percent of the
purchase price, no money down, and use 10 percent of the loan to pay off the
balance on your trade-in.
Accordingly, dealers sold many
cars to buyers who could not afford them and that are being repossessed.
Believe it or not, you can sell a
lot more cars with no money down. Some homebuilders liked this idea so much,
they started selling homes by loaning buyers the down payments. Then banks with
excess reserves, courtesy of the Federal Reserve, agreed to artificially lower
interest rates, so-called "teaser rates." Temporarily through sub-prime loans
this stimulated more home construction to meet the artificially increased
demand. You can sell a lot more homes with lower interest rates and no money
down and for substantially higher prices, when you don't require 25 percent down
as was the case with my home 26 years ago.
Everybody loves the boom part of
the cycle. However, when the bust (panic, recession, depression) inexorably
follows people point fingers not at the cause of the problem, but at those
fooled by the government's intervention in the market.
So where does all the easy money
come from? The Federal Reserve since 1913 periodically has inflated the money
supply to stimulate the economy. Egged by the president or Congress, it
intervenes in the market through expansion of bank credit to business. When the
result is below-market interest rates and easy money, home builders, auto
manufacturers and business in general, misread demand and are fooled into
producing more products than credit-worthy buyers want or can afford. Hence:
subprime lending.
Manufacturing capacity is
expanded to meet a perceived increased demand and when surpluses become
unsalable (cars, houses, etc.) malinvestments must be liquidated. Inventories
must be discounted and workers laid-off until the market clears. Not until
prices bottom out and wages have fallen, will the market return to equilibrium.
After the market clears, greater production quickly commences with increasing
wages and employment.
If, however, unaffordable loans
are paid with bigger unaffordable loans, as is the case with the current
bailouts, this prolongs the recession and results in longer periods of high
unemployment. The greater the government intervention the longer the recession,
or more likely depression, lasts.
During stable times when
increases in the money supply do not exceed increases in productivity, workers
improve their standard of living by increasing their productivity per hour
worked with more efficient equipment and technology. This is the only way there
can be a "general" increase in the standard of living -- through savings,
capital accumulation (capitalism) and investments in technology and equipment.
The quickest way to insure greater savings and investments is through tax cuts,
particularly on capital gains. Booms and Busts begin and end with the Federal
Reserve and the management or mismanagement of the money supply.
__________________________________________________________________
Schnaubelt, president of Citizens for
Private Property Rights, has been a commercial real estate broker
for 39
years and was a San Diego City Councilman from 1977-81.
This article appeared in
the San Diego Daily Transcript on March 27, 2009
____________________________________________________________________________
Fred Schnaubelt