The Out-Lawyer's Blog

BAIL OUT 2.0 ?

FOLK WISDOM

AND COMMON SENSE ECONOMICS

I’ll never forget walking in almost complete darkness in a New Zealand cave next to a cataract of falling water – the only barrier was a tiny, symbolic railing that would never pass OSHA or ADA standards in the states.   The cheerful Kiwi guide said, “Be careful mates, we can’t pick you up if you fall in.  And careless people don’t get to file lawsuits here.” 

We were very, very careful….

As the USA lurches towards a massive transfer of money – truly staggering sums from public, tax supported funds to private finance – we can only hope that adult supervision prevails.  It doesn’t appear to be coming from POTUS or the democratic leadership at the moment.  

At this writing, it seems that Senator McCain has lined up most of the quavering, cranky republicans, getting them to hold fast long enough to wring out some bailout concessions that might mitigate the scale and severity of this money transfer, and reduce, however minimally, the risk of an intolerable drain on the public treasury. 

As I wrote in my last post, most of us are strongly predisposed not to send good money after bad… at least when we have a moment of sober reflection.  In this crisis atmosphere, sober reflection is measured by a single night’s fitful rest between frantic negotiating sessions.

As this parody of posturing - punctuated by occasional flashes of common sense – unfolds, it is well to remember the basic economic rules that never fail to operate. Their iron grip on any monetary exchange dynamic is why economics has been called the “dismal science”.  The hard messages of economic laws continue to disappoint the naïve, the unrealistic and the unprepared.

Here are three rules of money creation everyone should know:

(1) Money is a commodity.

(2) Like any other commodity, the value of money is governed by supply and demand.

(3) Ever since the gold standard was abandoned, money is measured only by what it will buy in the general marketplace, which is a function how much money is set loose in the economy chasing how many goods and services whose sellers are willing to take it in an  exchange.

If that picture suggests a circular measure of value, you are on the right page.  The fed can create money out of thin air, but its actual value is always determined by larger, utterly impersonal forces.  The desirability of owning American money is a function of its utility in a huge circle of purchases and sales the very center of which are those specifically American goods and services (including our overvalued real estate) that people, business and countries are willing and able to buy at a given price.  The fed can pump money into the economic system virtually at will, but it cannot create the goods and services on which its desirability and utility depend, nor create demand for them.

Here are three rules of public policy that everyone should know:

(1) All innovative development involves the risk of failure; without some risk taking, economies and civilizations stagnate and decline.

(2) Risk takers are driven by the hope of reward and are willing to accept the cost of failure; and paradoxically this remains true even when failure is several times more likely than success.

(3) When policy makers take away the rewards of those whose innovations were achieved at risk (by heavily or differentially taxing them), or significantly mitigate the costs of those whose innovations failed (by subsidizing them), there are always negative consequences; innovation dries up, the economy begins to stagnate and decline.

Nothing I’ve just said applies to the economic predators who attempt to game the economic system to grab short term profits without having developed any useful or valuable innovations, except more clever forms of theft.  No system is more open to predatory gaming than one that is infected with politically manipulated subsidies.  The prospect of punishment tends to deter greed only to a point.  Better still – scrub the process of all the greed opportunities, taking care not to confuse the rewards to legitimate risk takers as predatory.  To the contrary, risk taking innovation, writ large, is a form of natural altruism kept alive by the prospect of an occasional legitimate jackpot.

BOTTOM LINE

There is a very strong case for letting the lending institutions involved in the current crisis to actually fail and for injecting the money necessary to restore the damaged credit system on an as needed basis to an entirely new set of lenders who are forewarned by the collapse of the bad lenders: Be prudent - we will not pick you up if you fall.

JBG