As always, the current government’s knee-jerk reaction to the financial crisis, as any good Keynesian-infused cocktail of wanna-be economists would have it, is to propose more regulation.
The ruling powers are pushing for financial regulators to once again tighten the screws on financial institutions, the same institutions they keep throwing freshly-minted money at when the rubber hits the road. But a helicopter-parenting approach to economics eventually blows back on both the child and the parents.
Any market, be it the market for ideas, the vegetable market or the financial market, has a natural self-regulatory mechanism, and does not require nor benefit from external regulation.
This is easy to understand if we apply the idea of natural selection to a market environment. Self-regulation works very simply – bad propositions fail and destroy any resources that were allocated to them, while good propositions attract more resources and benefit both involved parties by multiplying the “invested” resources and/or leading to wealth (happiness, business growth, life quality, technology, money, assets, progress, etc.)
Mis-allocated resource is lost, well-allocated resource multiplies. People that lose resource will turn elsewhere to find propositions that will reward their resources, while people that multiply correctly allocated resources or gain wealth stay with the working proposition. Good propositions receive more resource, and bad ones less. Thereby, the “good” is encouraged and the “bad” fades away.
Good ideas are good because they work in reality, i.e. they align with the core economic values of humanity – growth, prosperity, happiness, progress.
For example, good ideas, including good patents, or political or sociological tenets, lead to good products, services, communities and prosperous nations – bad ones don’t, and thus will naturally phase out, if left to regulate freely. A government coming in and saying an idea, patent, political or sociological rulebook ‘should’ work and be enforced is the moral equivalent of the communist tenets that were practiced in the Soviet Union, prescribing what people should think and do, or else. The natural result of such a society is sooner or later always the junkyard, as history shows.
Good vegetable farmers know what they are doing, and their products reflect that in their quality. As a result, they will sell more, people will be more happy and healthy with their food, and the farmer gets more money so he can expand his business and live better. A win-win. Bad vegetable farmers sell rotten, crooked, unhealthy or outright poisonous vegetables – once people see this, they stop buying, depriving that farmer of money and thus chance to poison the world more.
Good banks manage money well, bad banks do the opposite. Mis-allocated capital is lost, well-allocated capital multiplies in a win-win. Regulating bad banks misses the point of prosperity completely – that bad banks can by definition not contribute to a prosperous society, and only take away from it via mis-allocation/destruction of resources/capital.
In a free market, good ideas, good vegetable farmers or financial vessels are allowed to thrive, while bad ones are naturally weeded out (or need to learn how to grow good vegetables). It’s a natural mechanism that rewards that which works (i.e. from a philosophical perspective is “good”) and discourages/destroys that which does not work (i.e. is “bad”).
Now, imagine if someone came in and bailed out the poisoning farmers. More bad or unhealthy product would move, and people would suffer. And of course, this bail-out would have to be paid with someones money, which inevitably ends up being a redistribution from the proceeds of the “good” actors (always stemming from taxation or creating artificial credit).
When governments and central banks interfere and save bad banks from market death, it rewards bad actors/behavior/skill-sets and disenfranchises good ones. When money is taken from the producers and handed to the non-producers, when serious mistakes aren’t penalized and even supported, or the money supply is diluted, the producers start wondering why they bother working to high standards in the first place.
The problem is, in the end, even the system that applies external regulation (e.g. the state bailing out bad financial players, or the state printing money endlessly) forms a functional unit in yet another invisible wider-horizon market – the market for monetary systems. And even here, self-regulation applies, as bad monetary systems fade out of existence over decades or centuries. This is the path the Eurodollar zone is heading down at the current time.
As much as limited social factors are mounted to fine-tune a darwinistic mechanism in markets that revolve around humans, a laissez-faire policy resulting in free markets as envisioned a long time before the introduction of central banks & government bailouts is the only way that financial markets can self-regulate.
When governments bail out bad actors, they do this either with everybody’s money (taxes, insurance funds from bank fees, etc.) or by printing money, again hurting everybody. When bad financial actors area allowed to fail, only the bad or unskilled actors suffer, while the rest does not.
Ironically, what most people don’t know is that the hardship that financial markets occasionally put on the ‘normal citizen’ in form of financial crises, the ever-growing wealth gap between asset-owners (the “haves”) and prudent savers (the “have-nots” in today’s world of price inflation), inflation itself, or boom-and-bust cycles, is always caused by government interference – it does not happen in spite of it. Such phenomena are not natural, but artificial results of interference.
Capitalism has gotten a bad rep, because it is often mistaken for a version of capitalism that is regulated by partisan interests and “helicopter parenting” by the government. Genuine capitalism is an unregulated, unbridled self-regulating environment that dispenses with the bad/unable and rewards the good/able, leading to an upwards spiral of ability and prosperity. It’s “improve/grow or lose relevance”. Unfortunately, most of the Western world has all but forgotten the power of free markets.
Natural selection is cruel, but it has worked for billions of years in any sphere of inorganic or organic endeavor. How much experience do we have with government interference of free markets? A few instances in history, a couple of decades in modern times, and the system is starting to crumble already.
For clarification, I’m not suggesting a lack of legislation here, but a lack of regulation. There is no and there can be no better regulator of a market than that same market itself, because in the end a market is nothing but a collection of free individuals freely dealing with each other to their own benefit. External regulation of a market equals imposing external wishes and expectations of what regulators think that market participants should do or should want, which stands in stark contrast to what these individuals actually do and want to do. Governments do not know better than the individual what is good for the individual.
As Milton Friedman stated – “When government – in pursuit of good intentions – tries to rearrange the economy, legislate morality, or help special interests, the cost come in inefficiency, lack of motivation, and loss of freedom. Government should be a referee, not an active player.”
Therefore, we should dispense with the idea of Big Brother watching and saving us, but rather go back to relying on Adam Smith’s invisible hand.
