February 19, 2009
The Collapse of the Capitalist Consensus
By John Tamny
“The possibility of a rapid repair of their disasters, mainly depends on whether the country has been depopulated. If its effective population have not been extirpated at the time, and are not starved afterwards; then, with the same skill and knowledge which they had before, with their land and its permanent improvements undestroyed, and the more durable buildings probably unimpaired, or only partially injured, they have nearly all the requisites for their former amount of production.”~ John Stuart Mill, Principles of Political Economy, Book I, chapter 5.
In the 2007 edition of the Forbes 400, perhaps the most notable statistic involved comparisons with the first Forbes 400, released in 1982. Of the original 400 members, only 32 remained by 2007. This isn’t to say that the departed hit the bread lines, but it was a certain example of the dynamic nature of the U.S. economy.
And just as the richest in America are a moving target, so are the top companies. For evidence of this, all one would need do is take a Fortune 500 list from 1980, and compare it to the 1990 list, 2000 and the present.
Constant change is an exciting property of capitalism whereby new entrants frequently purchase the assets of past giants, only to manage them better. In much the same way, the human capital within our borders that is surely our best asset engages in constant reinvention in order to find the best ways to work profitably, and in doing so, fulfills the consumption needs of a productive population.
So while company failure and job losses have always been an unfortunate and painful part of the process, they have also been something that Americans have mostly accepted as the price of prosperity. And far from impoverishing us permanently, our economy has regularly rebounded from its mistakes. The logical reality is that when companies fail, their assets, both physical and human, don’t disappear. Instead, they’re snapped up by the intrepid among us, often at a bargain, and productive growth resumes.
Sadly, the at times rough hand of capitalism has taken a back seat over the last eleven months to the allegedly benevolent hand of the federal government. Rather than embrace the very uncertainty that has made us wealthy by any measure, Americans have accepted a newly muscular role from Washington meant to shield us from failure. But if history is any kind of indicator, that will surely be a deadening influence over time.
The broken consensus. To a high degree the capitalist consensus held until last spring. It was then that Bear Stearns, a fairly minor bulge bracket investment bank, ran into trouble. With its share price in freefall heading into the weekend, officials at Treasury and the Federal Reserve effectively blinked, and a forced marriage ensued in which J.P. Morgan purchased Bear for next to nothing in return for the Fed taking on the fallen investment bank’s “toxic assets.”
Even though Bear Stearns wasn’t a bank in the traditional sense, government involvement was defended by some as necessary to avert a collapse of the financial system. Myriad other financial institutions had exposure (“counterparty risk”) to trades entered into by Bear, and absent the infusion of government capital, our system of credit would supposedly have cascaded downward, Depression the certain result.
In a November 21 speech for the Cato Institute, Harvard professor Jeffrey Miron eagerly stated that the idea of counterparty risk is overdone. Miron noted that the only scholarly work on the subject was written by none other than our present Fed Chairman, Ben Bernanke, back in the early ’80s. Bernanke’s fears of a domino effect with regard to banks were then, and remain pure conjecture. And assuming the domino effect is real, when we consider how whole countries have bounced back from total economic and human destruction as a result of war, it seems a reach to assume that ours would fail to bounce back from the demise of one or many banks.
More broadly, it should be pointed out that every transaction irrespective of its business purpose involves counterparty risk. When businesses go under, counterparties are left short, but one or many failures rarely have any kind of lasting economic impact.
That is so because when businesses fail, they in no way disappear. Instead, an opportunity arises for competitors to quickly snap up market share, not to mention that capital previously misused by the failed business in question is quickly redirected to those with a stated objective to deploy it more wisely. No doubt the rise of the Big Three automakers in the early part of the 20th century put a lot of carriage companies out of business, but far from harming the economy, the aforementioned rise created new, and better opportunities for capital and individuals put out of work by natural economic change.
Had Bear simply been allowed to go under, there doubtless would have been turbulent markets, but it would be hard to presume any more turbulent than they’ve been since last spring. More important, had the Fed and Treasury simply stood aside, Bear’s failure would have been a certain signal to other teetering banks to either find new capital, or quickly find a buyer.
More important, and as we've seen very clearly since last spring, government aid meant to avoid "systemic risk" creates risks far worse for the banking system. Indeed, the acceptance of government aid, rather than a bank savior, is a death sentence for the weak and healthy alike.
Those that accept government money are no longer in business for profit, and worse, their existence is a cancer on the healthy firms in the banking system who must compete with financial institutions no longer serving profit-driven shareholders. Systemic risk was the excuse for shedding free-market principles, but the far more treacherous risk of government ownership was seemingly never considered by many.
Unemployment. Another argument underpinning the newly muscular economic role of the federal government involves jobs. The saying goes that absent federal funds to prop up failing companies, job loss would be substantial, and recession a certainty.
This is certainly an intriguing thought, but then in any market economy jobs are constantly destroyed only for new ones to be created. If there’s any realistic driver of job growth, it has to do with labor supply; the more individuals looking for work, the more jobs created. And when we consider unemployment, it’s not so much the result of businesses not hiring as it has to do with the failure of individuals to supply their labor at the present market rate.
Of greater importance is that human capital is precious. Just as going-out-of-business sales at retail establishments attract all manner of buyers seeking value, layoffs, however painful they can be for the individual, create opportunities for rising businesses to hire workers that were previously too expensive. In that sense, layoffs are a rare growth opportunity for scarce human capital that suddenly becomes available at a lower rate.
But least spoken of is the likely response of those not laid off in an uncertain economic environment. When we consider that economic growth is always and everywhere the result of productive work effort, what better than a dicey job picture to scare those still employed into working much harder?
And in addition to extra work effort, an unfortunate job environment frequently makes the prodigal spender parsimonious. This is important considering that all profits result from past saving.
Looked at from an economic perspective, it’s fair to presume that one reason recessions are frequently short has to do with the fear that they engender, which makes us work harder, and save more. Our work grows the economy, and extra money saved is among other things lent to companies in need of capital in order to expand.
Stimulus. Due to the economic slowdown, there’s a misguided political consensus that the federal government must put money in peoples’ pockets so that they go out and spend. What’s shocking here is that the basic argument contradicts itself.
Governments can only spend to the extent that past economic productivity has created profits to tax. Bastiat used to say that we can’t profit from the same transaction twice, but in the bizarre world that is Washington, the basic laws of economics seemingly don’t matter.
In the real world they do, and with economic growth a function of productive work, it should be said that stimulus can only shrink the economy for the alleged beneficiary who works less thanks to the handout. And what about those taxed? If the productive see that their wealth will be handed to the indolent, don’t they have less reason to work too?
Lastly, it can’t be forgotten that government spending is a tax like anything else, and to the extent that governments spend, they are withholding capital from the laboring classes. So even if we ignore the enervating nature of handouts, it should be said that the check arriving in the mail from Uncle Sam is money that was previously withheld from the average paycheck.
A look into the future. As we try to figure out what our economy will look like in the future, there’s plenty of scope for worry. In addition to a growing deficit wrought by all manner of spending, probably the biggest challenge has to do with a business class that has forfeited a great deal of moral authority relative to the federal government.
While the U.S. economy has never in modern times been entirely free, companies could at least credibly say that federal bureaucrats should keep their distance when it comes to regulation. But thanks to the willingness of certain entities to accept funds from our minders in Washington, they’ll no longer be able to push back against the encroaching leviathan with as much vigor. Instead, thanks to the original sin that involved accepting handouts, our once vibrant commercial class will have to take the bad with the alleged good in the form of greater regulation.
That is unfortunate, because as John Stuart Mill also wrote, “The only insecurity which is altogether paralyzing to the active energies of producers, is that arising from the government, or from persons vested with its authority. Against all other depredators there is a hope of defending oneself.” Sadly, we’ve accepted the false God of government security, and with that we must now accept a certain level of paralysis that will enervate our entrepreneurial economy, and which will make us less prosperous as a result.
John Tamny is editor of RealClearMarkets, a senior economist with H.C. Wainwright Economics, and a senior economic advisor to Toreador Research and Trading (http://www.trtadvisors.com/). He can be reached at jtamny@realclearmarkets.com.
In the 2007 edition of the Forbes 400, perhaps the most notable statistic involved comparisons with the first Forbes 400, released in 1982. Of the original 400 members, only 32 remained by 2007. This isn’t to say that the departed hit the bread lines, but it was a certain example of the dynamic nature of the U.S. economy.
And just as the richest in America are a moving target, so are the top companies. For evidence of this, all one would need do is take a Fortune 500 list from 1980, and compare it to the 1990 list, 2000 and the present.
Constant change is an exciting property of capitalism whereby new entrants frequently purchase the assets of past giants, only to manage them better. In much the same way, the human capital within our borders that is surely our best asset engages in constant reinvention in order to find the best ways to work profitably, and in doing so, fulfills the consumption needs of a productive population.
So while company failure and job losses have always been an unfortunate and painful part of the process, they have also been something that Americans have mostly accepted as the price of prosperity. And far from impoverishing us permanently, our economy has regularly rebounded from its mistakes. The logical reality is that when companies fail, their assets, both physical and human, don’t disappear. Instead, they’re snapped up by the intrepid among us, often at a bargain, and productive growth resumes.
Sadly, the at times rough hand of capitalism has taken a back seat over the last eleven months to the allegedly benevolent hand of the federal government. Rather than embrace the very uncertainty that has made us wealthy by any measure, Americans have accepted a newly muscular role from Washington meant to shield us from failure. But if history is any kind of indicator, that will surely be a deadening influence over time.
The broken consensus. To a high degree the capitalist consensus held until last spring. It was then that Bear Stearns, a fairly minor bulge bracket investment bank, ran into trouble. With its share price in freefall heading into the weekend, officials at Treasury and the Federal Reserve effectively blinked, and a forced marriage ensued in which J.P. Morgan purchased Bear for next to nothing in return for the Fed taking on the fallen investment bank’s “toxic assets.”
Even though Bear Stearns wasn’t a bank in the traditional sense, government involvement was defended by some as necessary to avert a collapse of the financial system. Myriad other financial institutions had exposure (“counterparty risk”) to trades entered into by Bear, and absent the infusion of government capital, our system of credit would supposedly have cascaded downward, Depression the certain result.
In a November 21 speech for the Cato Institute, Harvard professor Jeffrey Miron eagerly stated that the idea of counterparty risk is overdone. Miron noted that the only scholarly work on the subject was written by none other than our present Fed Chairman, Ben Bernanke, back in the early ’80s. Bernanke’s fears of a domino effect with regard to banks were then, and remain pure conjecture. And assuming the domino effect is real, when we consider how whole countries have bounced back from total economic and human destruction as a result of war, it seems a reach to assume that ours would fail to bounce back from the demise of one or many banks.
More broadly, it should be pointed out that every transaction irrespective of its business purpose involves counterparty risk. When businesses go under, counterparties are left short, but one or many failures rarely have any kind of lasting economic impact.
That is so because when businesses fail, they in no way disappear. Instead, an opportunity arises for competitors to quickly snap up market share, not to mention that capital previously misused by the failed business in question is quickly redirected to those with a stated objective to deploy it more wisely. No doubt the rise of the Big Three automakers in the early part of the 20th century put a lot of carriage companies out of business, but far from harming the economy, the aforementioned rise created new, and better opportunities for capital and individuals put out of work by natural economic change.
Had Bear simply been allowed to go under, there doubtless would have been turbulent markets, but it would be hard to presume any more turbulent than they’ve been since last spring. More important, had the Fed and Treasury simply stood aside, Bear’s failure would have been a certain signal to other teetering banks to either find new capital, or quickly find a buyer.
More important, and as we've seen very clearly since last spring, government aid meant to avoid "systemic risk" creates risks far worse for the banking system. Indeed, the acceptance of government aid, rather than a bank savior, is a death sentence for the weak and healthy alike.
Those that accept government money are no longer in business for profit, and worse, their existence is a cancer on the healthy firms in the banking system who must compete with financial institutions no longer serving profit-driven shareholders. Systemic risk was the excuse for shedding free-market principles, but the far more treacherous risk of government ownership was seemingly never considered by many.
Unemployment. Another argument underpinning the newly muscular economic role of the federal government involves jobs. The saying goes that absent federal funds to prop up failing companies, job loss would be substantial, and recession a certainty.
This is certainly an intriguing thought, but then in any market economy jobs are constantly destroyed only for new ones to be created. If there’s any realistic driver of job growth, it has to do with labor supply; the more individuals looking for work, the more jobs created. And when we consider unemployment, it’s not so much the result of businesses not hiring as it has to do with the failure of individuals to supply their labor at the present market rate.
Of greater importance is that human capital is precious. Just as going-out-of-business sales at retail establishments attract all manner of buyers seeking value, layoffs, however painful they can be for the individual, create opportunities for rising businesses to hire workers that were previously too expensive. In that sense, layoffs are a rare growth opportunity for scarce human capital that suddenly becomes available at a lower rate.
But least spoken of is the likely response of those not laid off in an uncertain economic environment. When we consider that economic growth is always and everywhere the result of productive work effort, what better than a dicey job picture to scare those still employed into working much harder?
And in addition to extra work effort, an unfortunate job environment frequently makes the prodigal spender parsimonious. This is important considering that all profits result from past saving.
Looked at from an economic perspective, it’s fair to presume that one reason recessions are frequently short has to do with the fear that they engender, which makes us work harder, and save more. Our work grows the economy, and extra money saved is among other things lent to companies in need of capital in order to expand.
Stimulus. Due to the economic slowdown, there’s a misguided political consensus that the federal government must put money in peoples’ pockets so that they go out and spend. What’s shocking here is that the basic argument contradicts itself.
Governments can only spend to the extent that past economic productivity has created profits to tax. Bastiat used to say that we can’t profit from the same transaction twice, but in the bizarre world that is Washington, the basic laws of economics seemingly don’t matter.
In the real world they do, and with economic growth a function of productive work, it should be said that stimulus can only shrink the economy for the alleged beneficiary who works less thanks to the handout. And what about those taxed? If the productive see that their wealth will be handed to the indolent, don’t they have less reason to work too?
Lastly, it can’t be forgotten that government spending is a tax like anything else, and to the extent that governments spend, they are withholding capital from the laboring classes. So even if we ignore the enervating nature of handouts, it should be said that the check arriving in the mail from Uncle Sam is money that was previously withheld from the average paycheck.
A look into the future. As we try to figure out what our economy will look like in the future, there’s plenty of scope for worry. In addition to a growing deficit wrought by all manner of spending, probably the biggest challenge has to do with a business class that has forfeited a great deal of moral authority relative to the federal government.
While the U.S. economy has never in modern times been entirely free, companies could at least credibly say that federal bureaucrats should keep their distance when it comes to regulation. But thanks to the willingness of certain entities to accept funds from our minders in Washington, they’ll no longer be able to push back against the encroaching leviathan with as much vigor. Instead, thanks to the original sin that involved accepting handouts, our once vibrant commercial class will have to take the bad with the alleged good in the form of greater regulation.
That is unfortunate, because as John Stuart Mill also wrote, “The only insecurity which is altogether paralyzing to the active energies of producers, is that arising from the government, or from persons vested with its authority. Against all other depredators there is a hope of defending oneself.” Sadly, we’ve accepted the false God of government security, and with that we must now accept a certain level of paralysis that will enervate our entrepreneurial economy, and which will make us less prosperous as a result.
John Tamny is editor of RealClearMarkets, a senior economist with H.C. Wainwright Economics, and a senior economic advisor to Toreador Research and Trading (http://www.trtadvisors.com/). He can be reached at jtamny@realclearmarkets.com.