“We inflate our paper currency, we repair commerce with unlimited credit, and are presently visited with unlimited bankruptcy.”
— Ralph Waldo Emerson, The Young American, 1844
Whether with respect to America’s foreign policy or its economic policies, more and more conservatives find themselves agreeing with liberals that many of George W. Bush’s policies are wrongheaded and dangerous. This agreement was illustrated most dramatically last week in the U.S. House of Representatives when the left wing of the Democratic Party coalesced with the right wing of the Republican Party to defeat the Bush Administration’s bailout of Wall Street.
Conservatives and liberals alike were repulsed by the President’s effort to panic Congress and the American public into ceding him unprecedented power and tax dollars to reward Wall Street’s high rollers for their bad decisions. Conservatives were particularly appalled by the complete abandonment of prudence, common sense and free-market principles in the President’s proposal. Liberals found the idea of forcing the little guy on Main Street to bail out fat-cat bankers on Wall Street a total violation of everything for which the Democratic Party professes to stand.
The left/right coalition of opposition did not understand the true nature of the problem, however, and therefore could not effectively counter the hysterical assertion of the Administration and the Washington Establishment after the bailout’s defeat that “doing nothing is not an option.” Nor could Members in opposition conceive of a truly effective workout plan to substitute for the Establishment’s bailout proposal, offering instead bailout-lite alternatives in the form of loans and guarantees. Thus, by proclaiming that bailing out Wall Street was necessary to prevent economic devastation on Main Street, the Administration and the congressional leadership were able to peel away enough votes from the opposition coalition to pass a plan the Members did not like and did not believe would work.
Although there remains serious disagreement about what policies are necessary to solve the immediate banking crisis, there has emerged, ironically, an ill-conceived bipartisan consensus both about the causes of the financial crisis and the remedial policies that should be enacted to prevent its recurrence. This new consensus blames the financial crisis on lax government regulation and markets gone wild.
For example, during the first presidential debate, Senator John McCain said it was “regulatory agencies that weren’t doing their job that has brought on this crisis.” Governor Sarah Palin followed up in the vice presidential debate by blaming the crisis on predator lenders on Main Street, greed and corruption on Wall Street, and lax oversight out of Washington. Both McCain and Palin promised to punish greed and corruption with more oversight and regulation.
This new-found Washington consensus, while in perfect sync with traditional liberal views, illustrates the extent to which conservatives have lost their economic bearings. Markets do not spontaneously go wild, and there is no evidence that the human vices have become any more prevalent today than they were in the past to account for the crisis. There certainly was no lack of government regulation on the books.
THE REASON THE OPPOSITION COALITION fizzled out and the source of the muddle-headed Washington consensus stem from a failure to comprehend the true source of the problem — the debauching of the currency and the resulting boom/bust cycle of inflationary credit expansion followed by financial panic, which is inevitable under a central-bank-managed fiat currency. John Maynard Keynes said it best in 1920: “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”
There is no doubt with the price of gold soaring from $265 an ounce in January 2000 to $920 in August 2008, the Fed has debauched the dollar. A debauched currency corrupts everything it touches, short-circuiting price signals, aggravating the worst traits of human economic behavior — greed, gambling, dishonesty — and clouding the judgment of average people and the most astute businessmen. Although Alan Greenspan used to talk a lot about “taking away the punch bowl,” America during the first decade of the 21st century under his tenure as Fed chairman has been living on one long spring break, guzzling from a spiked currency-punch bowl.
If the currency is sound, markets work properly and are robust. They provide continuous negative feedback, which combines with an intricate system of market rewards and penalties to adjust automatically, which provides for “self-control” of human vices as a result. Properly functioning markets act as a flywheel on the economy, restraining greed by dampening profits, which in turn dampens risky and dishonest behavior and channels capital to its best and highest use. Beyond a basic amount of monitoring to ensure free information flow and to minimize fraud and corruption, markets truly are self-regulating if prices are left free to transmit information efficiently.
When a surfeit of money saturates society, however, these negative feedback mechanisms short circuit; price signals go haywire; information is distorted; capital is misallocated; people make bad judgments and engage in crazy, risky behavior based on bad information. Positive feedback replaces negative feedback, which results invariably in a financial implosion. If government tries to keep the binge going with more hair-of-the-dog liquidity, it only prolongs and exacerbates the agony. If government tries to correct the problem with price controls to fix asset prices above market-clearing levels, it further distorts economic signals and sends the economy into a tailspin.
IN THE ABSENCE of sound money, there is no other choice but to restrain people’s behavior and transmit information through stringent bureaucratic rules and regulations. Yet, regulations cannot substitute for the discipline that comes with functioning markets, and in fact the more stringent the regulations are, the more they diminish economic activity and distort business decisions. There arises a hue and cry to “deregulate” to prevent sending the economy into a decline. When deregulation of financial markets combines with debauchery of the currency, the stage is set for what we are experiencing now.
Rules, regulations, and laws are a part of the normal civilized order but to work they must be gentle, select, simple, understandable, consensual, and they don’t need excessive enforcement because they support the automatic order, not substitute for it. They are the rails on which civilization runs, not the locomotive that drives it. When the automatic order breaks down, it looks to people as if the gentle, targeted, lightly enforced regulations/laws are to blame. An uninformed consensus arises that this mess never would have happened if the regulators and policemen had been on the job, which misplaces the blame by mistaking a symptom for the root cause.
The single most important thing Congress can do now is eliminate the Fed’s discretion to debauch the currency by requiring it to conduct monetary policy subject to a simple rule that would maintain the value of the dollar, which will prevent markets from slipping the traces and running into a ditch. Congress should enact a law setting the dollar-price of gold statutorily somewhere in the range of $800 to $900 an ounce. The law also should provide that the Fed must conduct open-market operations (i.e., buy and sell federal securities in the open market) so as to maintain the dollar price of gold within a narrow statutory band about the statutory price of gold. Markets will enforce the law and automatically maintain a sound dollar if the law provides further that the U.S. Department of the Treasury must upon demand redeem dollars for gold and gold for dollars at the statutory price of gold.
Making the dollar as good as gold once again would hit the reset button on the American economy and launch it forward toward stability and prosperity.