Inflation and CBs 5: Capitalism Without Failure is Like Religion Without Sin

Capitalism without failure is like religion without sin. The statement is from a CATO scholar, Gerald P. O'Driscoll Jr., in his paper, "Treasury's Thieves". Perhaps people should keep that in mind before they conclude that the current financial turmoil in the US, which is spreading to financial markets abroad, marks the beginning of the "end of capitalism".

The current financial "meltdown" should happen. If the meltdown does not happen today, then it should happen tomorrow, or next week, or next year. And it should continue, if only to weed out the irresponsible corporate leaders and the cheaters.

What should not happen is a government bail-out of collapsing and imploding big banks and firms. In this case, the proposed US government bailout for the financial sector to the tune of $700 billion -- not counting the projected budget deficit of more than $480 billion by the end of 2008 of the federal government alone (many states, cities and counties have their own sets of budget deficits).

So why is government bailout not justifiable? Three important reasons.

One, make those responsible for a corporate collapse be accountable for their mistakes. Hence, they should pay the price for their irresponsibility and misbehavior. Those who should sink must sink. And taxpayers' money should not be used to bail out irresponsible corporate guys.

Two, governments by themselves have no money on their own to bail out failed enterprises except for what governments confiscate from the income and savings of the hardworking citizens in the form of various taxes, charges regulatory fees and fines, or by printing money endlessly through their central banks, which can push inflation upwards endlessly, and thereby rob again the responsible citizens of the real value of their income, savings and investments.

And three, the US Fed's and other central banks' (like the Europe CB) large-scale bailout pool and consequent monetary policies will be distortionary. In cases like this, producers and manufacturers are forced to watch the behavior of the Fed or any central bank on whether it will raise or lower or keep existing interest rates, or protect the currency from further depreciation or appreciation, rather than watch the behavior of consumers (if their preferences and buying pattern are changing or not) or the behavior of competing producers from other countries (if they are producing better quality goods and services or selling at lower prices or a combination of both).

High inflation is caused mainly by lower supply relative to demand. So to address high inflation, expand supply relative to the size of demand. But central bank bureaucrats think they can solve the world's price problem by centralizing monetary tools in their hands, and squeeze money supply by tightening credits and raising interest rates -- which in the process choke many entrepreneurs and producers, both big and small.

The term "socialism for the rich" (under a longer phrase, "profits are privatized but losses are socialized") is wrong. The proposed multi-billion dollar bailout can be aptly called "socialism for the irresponsible" because only irresponsible and envious people would love socialism. Under socialism, the lazy and the envious will still eat, will still have allowances, and will be entitled to free "quality" education, health care, housing, etc. because social equality is non-negotiable.

For the socialists or trying-hard socialists, personal and corporate responsibility or irresponsibility do not count much. What matters to them is more "government responsibility" . So, corporate irresponsibility of officials of those big firms don't count much, those firms are "too big to fail", they should not sink, and their officials need not go to prison.

Some people ask, "Who are the irresponsible? Who defines 'irresponsibility' and who should penalize them?" There can be a BIG political battle on the definition of "irresponsible" because among the most irresponsible institutions involved in the current financial "meltdown" is the BIG US government itself.

It is easy to spot an irresponsible guy or institution: they live beyond their means, consistently. They spend much bigger than their income or revenue, consistently. Or worse, they spend and ask for more subsidies even if they have no income, nor have any plan to work and have regular income. A person who in his late 20s or 30s still depends his parents' allowance is irresponsible. A bank that lends to many people, who it perfectly knows have no jobs or no stable jobs and income, is irresponsible. A government on budget deficit, for one, two, five decades or more, is irresponsible.

So, how should they be penalized? The penalties for cases like failed companies are already in the books of any country's legal system. Bank or corporate officials who lose their stockholders' money should go to prison, or the cemetery perhaps -- in the case of those unlucky to be caught by really mad and impoverished investors.

After the US government announced the huge bailout fund that it seeks from the US Congress, the US stock markets were battered once more, the US dollar was knocked down further, and even world oil prices were up once more.

Why? It's the distrust on the US government, distrust on any fiscal "stimulus" by a bailout scheme because of the big taxes and fees that will be confiscated from the pockets and monthly salaries of US citizens in the coming months and years.

A friend shared that the proposed Treasury bailout plan has this provision:

Sec. 8. Review. Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

Dictators hate for their work and decision to be reviewed and questioned. "Non-reviewable" clause by any court or any agency speaks of the absence of accountability and transparency, absence of personal and official responsibility, for any mistakes in the future. If they are not dictators, then they should be fully transparent and fully accountable for their actions and policy decisions. If they do not want to be accountable for any future mistake, then they should not initiate such bailout move in the first place.

The pattern and the dangers are there: individual responsibility is meaningless under a socialist or trying-hard socialist framework. Everything is "government responsibility" . The primacy of the collective over the individual, always. And in their books, to have order in the collective, each individual -- except the administrators and governors of the collective -- must surrender a big portion of their income, their savings and their personal liberty, to the collective. Then there will be order in society, harmony and equality. Perhaps equality in misery.

Again, corporate failures and bankruptcies, as well as expansion and becoming big, are part of the game under a capitalist set-up. Market failures almost always result in market solutions, unlike government failures that almost always result in more bureaucracies and offices to find out how much have been wasted and stolen already.

Here at home, if Metrobank or BDO or BPI would "collapse" someday for whatever reason, taxpayers should not support any bailout by the government, whether through the the central bank (BSP) or congressional appropriation. Let any big but misbehaving ship sink if it must -- that's fair game, and this alone will put enough pressure and discipline on existing banks, corporations and enterprises not to act irresponsibly. Government has little or no role on private contracts between stockholders or owners and corporate officials, except with its usual role of a parasite -- collecting high and dozens of different taxes when one or two taxes will suffice.

* See also: Inflation and CBs 4: Subsidies and Money Printing, August 17, 2008

Inflation and CBs 3: "Bank of Last Resort"

I am not in favor of a central bank like the Fed, bailing out certain banks because they're "too big to fail". The Fed provided a credit line of around $30 B to Bear Stearns, which was bought by JP Morgan for only $2/share when less than a month ago it was trading at $90/share.

Then I read that had the Fed not acted so, other bigger banks like Lehman Brothers would be next to possibly free fall. And possibly threaten others like UBS, City and Morgan Stanley. Could this be true? I feel that the above-mentioned banks were too gigantic to be dragged down.

I hope that the next banking reform there will be that the Fed will just concentrate on setting monetary policy, no “bank of last resort” function, no bank supervision and bail-out function?

The private banks themselves should put up their own “bank of last resort”, use their own money that will be used to put up and maintain such bank. When that bank decides to bail out one or a few banks, it’s the bankers’ money that will be on the line, not the public’s. This will hopefully remove any “moral hazard” problem in banking.

On another note, a number of economic analysts are discussing how to stop inflation, and how central banks (CBs) or federal reserves can help to attain this goal. CB’s tight interest rates and other contractionary monetary policies over the long term, cannot reign in inflation. If interest rates are high to “warn” people not to spend too much, then entrepreneurs who have to borrow to start a new business or expand an existing one will have difficulty, the high cost of capital they will pass on to consumers, which can set inflationary pressure itself.

Central banks are among the remnants of central planning thinking of socialist school of thought. Central bankers maybe a “necessary evil” at the moment but nonetheless, they are unproductive bureaucrats who can better help the economy fight huge inflation spikes by becoming entrepreneurs who produce more goods and services, the best way to fight huge price spikes.

* See also: Inflation and CBs 2: Panama has no Central Bank, February 20, 2008

Inflation and CBs 1: Central Banks Can Be Anti-Globalists

When the price of certain goods and services is rising, the old but realiable law of supply and demand has an explanation. This means either or both of two things happen:
a) Fast growth in demand relative to their supply due to increase in consumers' income, change in their tastes and preferences, other reasons; and/or
b) Shrank or decreased supply (both local and global supply) relative to stable or increased demand due to natural disasters that wiped out harvests, big fires/terrorist attacks that destroyed the production plants, and other reasons.

These temporary "market failures" also create market solutions. A rise in the price of certain goods and services would invite entrepreneurs and businessmen to go and supply those commodities to cash in potentially high profits, even temporarily.

Now comes central banks (Federal Reserve, Bangko Sentral, etc.) and their inflation-targeting policies and philosophies. When a central bank rushes in to "control inflationary pressure" in the economy, it has lots of tools in its wings that it can manipulate: reduce money supply by raising overnight rates of commercial banks, raise their required reserves (RRs), among others. When this happens, this also squeezes short-term credits to entrepreneurs who would have otherwise put up new firms, or expand existing companies' operations, to supply certain goods and services that experience supply gap or reduction, whether temporarily or permanently.

It is possible to have hyper-inflation (very high rise in prices) in some commodities and deflation (reduction in prices) in other commodities, all happening at the same time. For instance, a hyper-inflation in school supplies (say the 2 largest manufacturing plants and suppliers were gutted by fire) and a deflation in burgers, pizza and softdrinks (say Coke, Pepsi, McDonald, Burger King, Jollibee, dozen other companies engaged in a sudden and fierce price war). In this case, there is no need for national government or central bank interventions to stabilize prices.

Recently, the Bank for International Settlements (BIS), also known as central bankers' bank (not the IMF), cautioned central banks around the world to prepare to raise interest rates due to (i) rising global inflationary pressure, and (ii) vulnerability to "bang" in market turbulence. Let's take these one by one.

The main drivers of global inflationary pressure are (a) high and volatile oil prices, and (b) still insufficient trade liberalization across countries. There aren't much the world can do on (a) partly because some poor countries have experienced fast economic growth (think of China and India alone) and their people are buying vehicles and boats and appliances left and right. Oil refineries are also not catching up fast enough (no thanks to hurricanes Katrina and others) to supply big demand. There are other reasons for the high world oil prices.

On (b), many countries, or more appropriately, politicians and trade negotiators of those countries, would only blame their counterparts in other countries, that is why they are closing off a big portion of their economies from foreign imports of certain commodities. That is, they are depriving their citizens of more options. These imported commodities (which are just surplus production in the exporting countries, are cheaply produced there) could have reduced inflation, even result in temporary deflation, for the sectors/commodities of the importing countries if only they allowed those goods to enter. Again, no need for national governments and central banks to come and intervene.

Central banks, the BIS and US Fed particularly, think they must make borrowers poorer by raising their cost of borrowing; by making the cost of money for business expansion that should help boost supply that should fight inflationary pressure, more expensive. After all, they are waging a holy war against global inflationary pressures.