In Defense of Free Markets

March 2009

It seems like all the liberal talking heads and columnists are repeating the mantra that tax cuts and "de-regulation" are the cause of our current economic mess. The Ronald Reagan tax cuts are even mentioned as the root cause of the current collapse. (Talk about a delayed effect!) I beg to differ. Having graduated and hitting the job market during the Carter years of stagflation I have to say Reagan made a big improvement in the economy (at least for me as an engineer. Part of the improvement may have due to the big increase in military spending improving the job market for engineers.) Also, seeing how even more highly regulated financial systems in Europe are suffering similar collapse I can’t see how a change in regulations would have any meaningful impact.

In particular, the repeal of the depression era Glass-Stiegel act is often cited as contributing to the current crises. How? The act prohibited banks from investing in stocks and certain other securities. Should the banks have invested more in home mortgages like they did in the past?  Note that it was Bear-Stern and Lehman Brothers that were the first dominoes to start to fall. These were pure investment houses that did not take advantage of the repeal to go into retail banking. On the other hand JP Morgan is perhaps the most securitized bank and has been able to weather the storm pretty well.  They have even been recruited by the Feds to buy up troubled investment houses. (Unlike Citibank, they tended to stay away from securitized mortgage investments.) Of the 20 or so banks that had to be taken over so far this year, all have failed due to bad loans, not as a result of investment in securities.

The current economic state we are in is not the result of "unfettered or unregulated markets" but of specific government tax and trade policies that encouraged consumption, speculation, outsourcing and cheap imports. Federal tax policies such as a Value Added Tax (VAT) appropriately applied to imports and domestic goods could have prevented the massive loss of manufacturing jobs and encouraged savings and investment over consumption. Without the decades of massive trade deficits, there wouldn't have been all those foreign dollars available for sub-prime, no income verification loans. The mortgage interest tax deduction could have been limited in size or applied only for first time home owners to discourage house flipping and mortgage refinancing.

The markets are working the way they are supposed to. China just went through a (mainly government financed) massive build up in productive capacity (without a build up of internal demand), so of course there is a global over supply of capacity leading to a world wide down turn. The US is going through economic turmoil that will no doubt result in a relative decline in the standard of living. What do you expect when the US savings rate has bordered on zero for decades and we have gone into debt to finance non-productive items such as large screen TVs, McMansions and SUVs?

The Obama stimulus plan seems mainly to address typical liberal concerns in areas like health care, income redistribution, public education and green energy. (Why does he need to spend 100s of billions to expand health insurance coverage? Isn’t saving money the point of Universal Healthcare?) However, its net result is to only encourage more debt (this time in the public sector) and consumption. It does not address any of the root causes of the US decline. The US economy has been taking on water for years, mainly due to Wall Street influenced Republican tax and trade policies, and now Obama wants to re-arrange the deck chairs and charge full speed ahead.