Thursday, January 07, 2010

The Fallacy of "Stabilization"

Prices need to adjust

The Times today has an article about "some at Fed" who believe that we need to "do more for housing". This is of course a fallacy. There was a housing boom and bust, and prices need to adjust to supply and demand and not have more government-created distortions propping-up bloated housing prices as a gimme to the mortgage and real-estate industries not to mention the financial industry who trades the government-backed mortgage bonds. Even Barney Frank, he of endless support to Fannie Mae and Freddie Mac, believes that not everyone is ready to or should own a house (a politician speaking out of both sides of his mouth, no! say it ain't true!).

The point is is that government just cannot predict or control what people demand (well they can, but not in a free society). Prices adjust to allocate resources in society to those that are willing to pay for them and supply them based on this demand. When government, be it the Fed or through stimulus spending, tries to control this supply and demand it just creates waste.

The same thing happened in the bubble leading up to the Great Depression, when 'price stability' first gained its mantra. It was thought that the newly-created Fed, through manipulation of interest rates and the money supply, could control prices and thusly stabilize the economy. This is too a fallacy; prices are relative, some go up (when demand goes up) and some go down (when technological improvements are made in production). Monetary policy is just too broad a brush and stabilization does nothing but create wasteful investment and unemployment, most specifically pumping too much money (or too little) into the economy, creating bubbles or contractions where already-existing policy distortions exist.

During the 1920s there were great breakthroughs in innovation and manufactoring techniques, prices should have been going down, but the Fed kept kicking-up the money supply to keep prices higher than they should have been, all in the name of early 20th Century economist Irving Fisher's 'stabilization'. This lead to the stock market bubble, and later, crash when the Fed started tightening the money supply, again in the name of 'stabilization'.

The Times had it right yesterday when they said that the Fed missed the housing bubble this time around so why should they be given more oversight authority? What is to prevent the Fed from missing a bubble next time around? And perhaps most importantly, and which remains unasked, even if the Fed does see the next asset bubble what can they indeed do about it?

Reducing the money supply or raising interest rates effects the whole economy, distorts prices in the whole economy, and does not just effect the asset it is targeting. This of course lets alone the consideration as to whether or not the economy can be planned ahead of time and whether or not some central planner can determine ahead of time what prices for a class of assets should actually be (this of course cannot be planned or estimated to such a degree that 'fine-tuning' can take place). To loosen the broad brush of monetary policy and allow targeted discretionary bailouts which of course has been done of late, is a violation of the rule of law and gives too much power to the central planners, who of course target the bailouts to politically-connected groups at the expense of the productive class. What we are learning, then, is that it is best perhaps to end the era of central banking.

Sadly the pundits, and thusly the populace, are missing the big picture on this. Perhaps the one thing we learn from history is that we don't learn anything from history. Or perhaps to paraphrase Marx, the first time its tragedy, the second time its farce. It is time not to depend on the Fed or the profligates in Washington DC for 'stabilization'. It is time to learn from history and not repeat it.