Economics

The kindness of geniuses

by

I once saw an advertisement for a book that would apparently reveal the secret of making a profit in the foreign exchange markets. I did not buy it. Someone who knew such a secret could use it to make billions for himself. He would not sell his secret, and thereby render it worthless (currency trading is a zero-sum game), for £9.99.

You should be sceptical of those who claim to be giving away something very valuable, including their extraordinary knowledge or skills. Yet that is precisely what our political leaders are now asking us to believe of financial regulators.

The big new idea in banking regulation is that regulators should force banks to hold more capital when their lending is causing the price of assets (such as houses) to get too high: that is, to reach levels from which they must crash. The Obama administration now has a similar idea concerning commodities, such as oil. They want regulators to intervene in commodity markets to counteract speculation that they believe is making prices too high or too low.

Let us not argue about whether it makes sense to say that a price can be too high when people are willing to pay it, nor whether any human, even computer-assisted, could possibly know that it is. Suppose that some people really do know such things. Why would they work for the government on a salary of less than £50 million?

Knowing that the market has over-priced oil, for example, is extraordinarily valuable. You could take a massive short position and make a killing when the price falls from the heights it wrongly occupies. Or, if you knew that house prices are too low, you could buy shares in real estate investment trusts and soon be rolling in money. For someone who knows whether tradable assets are over- or under-valued, massive wealth is assured.

Perhaps I underestimate the benevolence of those blessed with such amazing skills, but it is hard to believe that they would forgo great wealth for the sake of working in a government department. My guess is that the people who will end up occupying the envisaged regulatory roles will be ordinary human beings. They will know no more about the proper value of things than any other well informed market participant, such as an investment banker guided by his economic research team.

Intelligent, informed people disagree about the value of things. Market prices reflect the balance of disagreement between those willing to put their money where their mouths are. If you think a panel of government employees with no “skin in the game” can do a better job … well, I wonder if you would like to buy this sensational new book …

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Jamie Whyte
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3 replies on “The kindness of geniuses”
  1. says: Steven Baker

    Well said.

    Additional background via FT.com / UK / Politics & policy – Call for more intervention on energy:

    An “interventionist” approach by the government will be needed if security of energy supply is to be guaranteed, a report commissioned by the prime minister will conclude on Wednesday.

    Malcolm Wicks, the former energy minister appointed by Gordon Brown as his special representative for international energy issues, will say that “the time for market innocence is over” and that the government needs to do more to safeguard electricity and gas supplies.

    …

    “The era of heavy reliance on companies, competition and liberalisation must be re-assessed,” he said. “We must still rely on companies for exploration, delivery and supply but the state must become more active: interventionist, where necessary.”

    Consider, for example, this from Mises in Economic Freedom and Interventionism:

    The Middle Way

    Many politicians and authors believe that they could avoid the necessity of choosing between capitalism (laissez faire) and socialism (communism, planning). They recommend a third solution which, as they say, is as far from capitalism as it is from socialism. In imperial Germany this third system was called Sozialpolitik; in the United States it is known as the New Deal. Economists prefer the term used by the French, interventionism. The idea is that private ownership of the means of production should not be entirely abolished; but the government should “improve” and correct the operation of the market by interfering with the operations of the capitalists and entrepreneurs by means of orders and prohibitions, taxes, and subsidies.

    But interventionism cannot work as a permanent system of society’s economic organization. The various measures recommended must necessarily bring about results which, from the point of view of their own advocates and the governments resorting to them, are more unsatisfactory than the previous state of affairs which they were designed to alter. If the government neither acquiesces in this outcome nor derives from it the conclusion that it is advisable to abstain from all such measures, it is forced to supplement its first steps by more and more interference until it has abolished private control of the means of production entirely and thus established socialism. The conduct of economic affairs, i.e. the determination of the purposes for which the factors of production should be employed, can ultimately be directed either by buying and abstention from buying on the part of consumers, or by government decrees. There is no middle way. Control is indivisible.

    It is interventionism that produces all those evils for which a misguided public opinion indicts laissez-faire capitalism. As has been pointed out above, the endeavors to lower the rate of interest by means of credit expansion generate the recurrence of depression. Attempts to raise wage rates above the height they would attain in an unhampered market result in prolonged mass unemployment. “Soak-the-rich” taxation results in capital consumption. The joint outcome of all interventionist measures is general impoverishment. It is a misnomer to call the interventionist state the welfare state. What it ultimately achieves is not improving but lowering the common man’s welfare, his standard of living. The unprecedented economic development of the United States and the high standard of living of its population were achievements of the free enterprise system.

    We need a better way.

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