How To Fix The Economy

I like to fix things. This should be no surprise, as I am an engineer. Of course some engineers prefer to only build new things, and do not like to fix existing things, but not me. Sometimes this works against me. Whenever I encounter a problem, my first reaction is to try to figure out how to fix it. Sometimes that is not appropriate, and sometimes the problem just cannot be fixed. That is a tough thing to admit: that a problem cannot be solved. Even tougher is to spot such problems without first repeatedly failing to solve it.

What does this have to do with the economy? The economy is a problem that cannot be fixed. There is no one thing or series of things that can fix this problem. Giving money to banks has already proved to be ineffective, as has eliminating interest rates. Now some folks want to take even more drastic measures. But it is not going to work.

We like to think that we are so smart that we can understand anything, and thus solve any problem. But we are not that smart, not even close. Some things are too complex and macroeconomics are too complex. If it was possible to understand macroeconomics enough to control it, then the Soviet Union would still be running along smoothly. The Great Depression would have only lasted a few years. You get the idea.

Not convinced? Look at the causes of the Great Depression. The Fed was established the Federal Reserve Act in 1913. It really got to work after the end of World War I. Starting in 1921, The Fed used a variety of "levers" to increase the total money supply by more than 60%. The Fed made the "boom" part of the business cycle extra "boomier", but the result was an even bigger bust. Banks were incentivized to make malinvestments. When they could not cover the malinvestments that failed, a "run on banks" ensued.

Does this sound familiar? The Fed did the exact same thing in this past decade. There was no "run on banks" this time because of FDIC (more on that in a minute.) Instead there was a run on other investment instruments, and the result was equivalent : insolvent financial institutes. Only things are worse this time. Why? FDIC.

Smart people back in the 40's thought that the Depression was caused by the run on banks, not recognizing that as symptom of the sickness, not the cause. So they tried to prevent bank runs by enacting FDIC. If the government insures your deposit, then you should not freak out and pull your money out of the bank, right? Of course this creates a moral hazard because it removes some of the risk of investment. So what do we do? Regulate.

What happens? The regulation becomes dated as new types of investments are invented that are not subject to the regulation. One could argue that the reason for these new investment was to avoid paying the tax of regulation and thus give a higher return. However, the moral hazard is even worse. Even though these instruments are not insured by the government, the precedence has been set. Investment banks know that the risk will be absorbed by the government. Meanwhile the Fed once again inflates the money supply, as the government needs a big "boom" to help pay for wars, and like clockwork, we get another dramatic bust.

Do we admit that FDIC didn't work? Nope. Instead we think that the problem was that we didn't regulate those pesky new investment instruments! This is coming from a Nobel Prize winner, so it has to be The Truth, right? While the specter of government force looms as the ultimate "fix."

So am I just proposing that we roll over and do nothing? Well ideally this would be an opportunity to do things that are generally good for the economy: reduce taxes, reduce regulation, increase trade. However when most of the experts propose well-meaning solutions that would often do just the opposite, maybe the status quo is all we can hope for?

Does this mean that banks fail, businesses fail, and people lose their jobs? Yes, it does. Everyone wishes there was some magic button to push that would prevent these awful things from happening, but there is not. None of the dramatic (and unconstitutional) actions of The New Deal succeeded in fixing that mess. Maybe they prevented things from getting worse in some cases, but they also drastically prolonged The Depression and laid some of the seeds for today's problems.

Of course FDR was re-elected three times and that is all that matters to politicians. So get ready for a lot of fixes, and get ready for a long depression. Let's just hope that this economics meltdown doesn't end like the last one.

The Great Bailout

"OMG! The _____ is in trouble! What are we going to do!!!?!"

When government people say things like this, it is always a precursor to the government proposing itself as the solution to the problem. The problem is so dire, that only the government can solve it. Of course they will need more money and more power to solve the problem. Oh, and if you don't think this is all true, then you are too dumb to understand the problem or you are just un-American because you don't care about all of the Americans who could be hurt by this grave danger.

Mr. Dave Winer makes the point that the current administration has used this argument before. Only then it was Colin Powell making the case for war in Iraq. Now it is Henry Paulson doing the same thing but with regards to the banking meltdown. Dave is right on all of this. He then goes out of his mind by suggesting that Bush/Cheney should resign, Nancy Pelosi be made President, and Paulson's plan to move right ahead. The problem is not just Bush/Cheney, and Pelosi is definitely not the solution. The problem is Paulson's request for power and money. It's like saying it would have been ok to listen to Colin Powell and attack Iraq, but only if Al Gore would have been president. It didn't matter who was President, attacking Iraq was wrong in every possible way. 

Of course Ron Paul has some interesting things to say about the bailout. His opinions are largely grounded in the Austrian economic theory that the government makes business cycles more extreme (bigger booms and bigger busts) by causing malinvestments, like buying subprime mortgages for example. Like all things in Austrian economics, it is a matter of "belief" as these are statements that are purposely impossible to scientifically verify. However, it is hard to dispute that the U.S. government has encouraged high risk loands for the purpose of buying real estate, and that the very financial institutions who did this most are now the ones that are going bankrupt.

The point is that our government does not have a good track record here. Maybe it has been the main source of the problem, as Paul suggests, or maybe not, but it certainly has been part of the problem. Now it wants unprecedented (in this country at least) power and money to solve the problem that it has been at least complicit in. Given that, how can we support this idea?

Oh, but what is the alternative? I don't know, and I don't think the government knows either. Yes, there will be banks that go under. Does that mean that we'll all be out of money? No, of course not. Anyone's savings are already guaranteed by FDIC. Not to mention that even in the case of bankruptcy, creditors (that would be people that bank borrowed money from, i.e. depositors) have first priority. Nobody is going to lose their savings. 

But surely there will be other disasters, right? If so many go out of business, how will we get loans for houses, cars, or new businesses? Well perhaps not all of the banks will go out of business. Certainly there are those that have been buying up these insolvent banks. Or maybe other companies will take the opportunity to expand into the banking vacuum created by the insolvent banks. I'm not sure, but I'm not willing to let FUD from the government convince me to give the government the kind of virtually unlimited power that they are asking fo.

TextMate and the Weak Dollar

I started using TextMate as it is very popular with the Ruby on Rails crowd and I am writing a book on Rails. It is a great product, and I like using for all kinds of things now. So once my 30-day trial expired, I decided to purchase it. They use PayPal for processing payments, and they charge you in Euros. Luckily, PayPal easily handles the conversion for us Yankees. This brought a brutal reminder of just how weak the US Dollar is now:




1 U.S. Dollar = 0.68 Euros ... Ouch! Suddenly TextMate seemed like a pretty expensive text editor. I still bought it, but it really made me second-guess the most recent Federal Reserve rate cuts. That gives me one more reason to vote for Ron Paul!

Open Letter to the President and Congress

I subscribe to several progressive mailing lists. Through those sites, I get lots of "sign this petition" or "donate money" or "write a letter" solicitations. Now I am far from progressive, but that's ok. Sometimes I agree with their topic, and participate. For example, I've signed anti-war petitions and sent anti-war letters to the San Jose Mercury. Sometimes I got solicited and I have the opposite viewpoint. I respond to those too, as that's part of why I subscribe to these mailing lists.

Today I got an email soliciting me to write the President and Congress on bailing out homeowners who are being foreclosed. I'm pretty sure that I was supposed to support more aggressive bailout maneuvers, but of course I advocated just the opposite. Here's what I wrote:

The last seven years have demonstrated the inherent problems with the Federal Reserve System. An attempt to soften a recession lead to massive debt and yet another unsustainable boom. Once again we find ourselves at the beginning of an economic correction. Will we continue to make the same mistakes as in the past? Will we try to soften things again, but this time by spending billions of taxpayer dollars to bail out failed speculators and foolish home buyers? Please let the answer be no this time. Let speculators fail and let homes get foreclosed. It's the only way for the market to correct itself and reward the people who did not make bad decisions by borrowing more than they could repay. Our national debt is so huge and the dollar is so weak, don't make things worse by wasting the tax dollars of future generations on the irresponsibility of the current one.