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The Supremacy of Markets by Roger Martinez

    During any financial crisis, past or present, the most popular scapegoat is the Free Market.  According to the mainstream media and beltway politicians, the Free Market has failed and only massive Big Government intervention can save us.  This argument is most loudly proclaimed by the very politicians, bureaucrats, and government dependents that would benefit from government expansion.  This belief is then repeated by the mainstream media over and over until it is accepted as fact. 

    In truth, Free Market failures did not cause the current financial debacle; rather, government intrusions into the Market so distorted the economy that the current downturn was fated.  The current Market correction is not an indication of a Market Failure.  Quite the opposite, the correction is an indication that the Market is working, and further government meddling will only delay the inevitable and prolong and deepen the downturn.

What Is the Market?

    Every individual in society has specific wants and desires, hopes and dreams, fears and prejudices.  These preferences influence an individual's economic behavior, including his consumption, employment, and investing activity.  One individual may have a fondness for American made full-size SUVs with 4-wheel drive.  Another individual may prefer Japanese hybrids that get 55 mpg.  Another individual may be very present-oriented and spend all of his money as soon as he gets it.  While still another individual, may be very future-oriented and invest all of her money in 30 year T-bills.  

    One can generally predict an individual's economic behavior by analyzing that person’s demographics: age, gender, race, income, educational level, geographic location, etc.  However, it is impossible to perfectly predict such behavior because there are so many intangible and very personal variables.  For example, a man lacking in some physical characteristic is subsequently partial to expensive Italian sports cars.  Another individual, told as a child she was ugly, now has a penchant for cosmetic surgery.   Aside from personal variables, there are a large number of macro conditions that affect an individual's economic behavior.  Crises like recessions, wars, and destructive actions of nature, tend to make people more frugal.  Where as in boom times, people feel wealthier and consume more.  An individual, evaluates his macro environment makes an estimation of his current and future income, and adjusts his behavior accordingly.  These personal and macro inputs of a economic behavior are constantly changing  and subsequently, an individual's economic behavior is constantly changing.

     So what is the Market?  The Market is an aggregation of all individuals' economic behavior and all of the diverse inputs that make up these behaviors.  In short, the Market is society's wants and desires, its hopes and dreams, and even its fears and prejudices.   One can see the hopelessness of a central planner or government committee attempting to allocate goods and services in an effort to satisfy all of the fickle predilections of individuals in a society.  

The "Free" Market is the belief that individuals acting independently but simultaneously can more efficiently allocate resources.  Individuals vote with their pocketbooks and bid up or down goods and services, and suppliers adjust production of these goods and services accordingly.  The Free Market, or more specifically Free Market Capitalism, is the exchange of good and services free of government interference, regulation, and subsidy.  It is governed by the laws of supply and demand and not by central planners, faceless bureaucrats, or politicians indebted to special interests soliciting protection from a competitive economic environment.  The Free Market is designed to allocate scarce resources so as to maximize consumer satisfaction and producer efficiency, not to placate a special interest group, not to appease a powerful voting block, and certainly not to sway the results of a future election.

Laws of Economics

    Economics is often regarded as a soft science because of the difficulty in proving economic hypotheses with experimental data or mathematical models.  Nevertheless, the laws of economics are just as immutable as the laws of physics.  Think of the Market as gravity.  One can overcome gravity if energy is applied to the system.  I can pump water uphill if I constantly add gasoline to the pump, but as soon as I stop refueling, the water will return to its natural course and run downhill.  The same is true of the Market.  You can overcome market forces if you add money to the system but as soon as you stop, market forces return it to its natural course.     

    For example, in 1977, the U.S. government began forcing banks to make home loans to low income individuals who were poor credit risks (see “The Community Reinvestment Act of 1977”).   The government also created the mortgage interest tax deduction which artificially made housing cheaper.  This was followed by the Federal Reserve reducing interest rates to generational lows making housing even cheaper.

    The consumer reacted, in kind, by purchasing houses en masse.  This purchasing frenzy bid up the price of housing.  House builders reacted by ratcheting up production and 5000 square foot McMansions appeared in the exurbs of Victorville and Barstow. 

    Now prices had been bid up so high that people could no longer afford the 20% down payment.  So what did the government do?  It promptly eliminated the FHA, Freddie Mac, and Fannie Mae requirements of a down payment (more gas for the pump) and allowed borrowers to deduct their PMI payments (even more gas). 

    Once real estate reached ridiculously high levels, even the most optimistic buyers became wary and banks started tightening their lending standards.  Homeowners were unable refinance once their teaser rates reset.  Homeowners defaulted on loans they could not afford.   Foreclosed houses were added to the already swollen supply.  House prices stagnated and even began falling.  Banks, now insolvent, could no longer lend for more housing purchases or loan refinancing.  Then the federal government stepped in with the $700 billion TARP bail out plan with the intention of inducing banks to lend and consumers to borrow.  What happens when this money runs out?  You guessed it.  Prices will start falling again, and they will fall until the supply curve intersects the demand curve. 

    What can be done?  The government can keep giving away money.  They can give banks more money to make mortgage loans.  They can give homeowners money to make mortgage payments.  They can increase the mortgage interest deduction to 100%.    They can give first time home buyers subsidies to purchase homes.  This will work for awhile, but without the constant influx of money, house prices will drop until supply meets demand.

    Similarly, the Big 3 automakers require government funding to continue operations.  GM loses between $500-$1500 for every car they produce.  They also have more retirees and widows on their payroll than actual workers.  Obviously, this business model will not last long.  Now their cash reserves are drained and their creditors have stopped extending credit. 

    What can be done?  The government can "loan" the automakers money so they can continue operations.  But if nothing changes, the automakers will quickly burn through this money and will require further assistance.  Perhaps, the government will give a $1500 dollar subsidy towards the purchase of a domestically manufactured automobile to offset the increased labor input.  The idea of forcing the automakers to produce more fuel-efficient vehicles will fail because Americans don't want them.  Besides, the automakers will still be losing money on every fuel-efficient vehicle they produce.  Whatever the "solution," the taxpayer will be required to provide a continual infusion of cash.

Supremacy of the Markets

    As the economic crisis escalates, government officials panic.  In desperation, they have proposed and enacted profligate spending.  Sadly, it’s misallocation of resources.  Stimulus rebate checks will simply transfer wealth from taxpayers to non-taxpayers.  Rescuing speculative financial corporations will embolden executives and investors to continue their reckless behavior, secure in their belief that they are “too big to fail.”  Bailing out the unprofitable domestic auto industry allows the Big 3 to avoid wage and benefits reduction that could lead to profitability.  Modifying the loan terms of defaulting mortgage holders and credit card debtors will encourage continue irresponsible consumerism.  Make-work programs will transfer wealth from future taxpayers to laborers working on unnecessary projects.  These government interventions misallocate scarce resources, and misallocation of resources leads to lower economic growth and poverty.

    The Market is not good or bad, rich or poor, conservative or liberal; it just is.  You cannot reason with the Market, beg for its mercy, or bribe it with a fancy lunch at a trendy D.C. restaurant.  If you defy the Market, you do so at your own peril and be prepared to spend a lot of money.  The federal government's massive spending and bailouts will only temporarily prevent the Market from reaching equilibrium.  If government does nothing, allowing the Market to reach a steady state, it will be painful; but at least, it'll save future taxpayers trillions in principal and interest.  To do otherwise is to defy gravity. Just because they say you can fly doesn't mean you should jump off the edge of a cliff.

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