Regulatory Illusion
By Thomas E. Brewton
Today's clamor for more regulation of financial institutions to
prevent another subprime mortgage meltdown is an exercise in self-
deception.
Congress, led by Representative Barney Frank, is planning to overhaul
regulation of the financial community, and Treasury Secretary Paulson
has already proposed a broad program for that purpose.
No doubt, much of what is proposed is needed. But it should be
obvious from repeated experience over the decades that regulations
alone will not prevent periodic economic booms and busts.
Only by dealing with the root cause will we moderate economic
cycles. And that root cause is the ineluctable human tendency to
over-expand bank credit when the money supply is artificially enlarged.
Today's proposed subprime mortgage regulations may prevent tomorrow's
repetition of that phenomenon, but they will have no restraining
impact upon whatever the next speculative bubble may be. Sarbanes-
Oxley regulation was instituted after the dot.com bubble-burst and
the corporate collapse of Enron, but it had no restraining effect
upon the speculative housing bubble, of which subprime lending is
merely a symptom, not a cause. Before that, we had the speculative
explosion of commercial real estate over-building that ended with the
collapse of the savings and loan institutions in the 1980s.
Beginning with our nation's first financial panic in 1819, similar
boom-and-bust patterns appear every five to ten years, except in
extraordinary circumstances such as wartime.
In one respect, Karl Marx's economic analysis was on the mark.
Before the advent of commercial banks, there were no economic
recessions or financial panics. In a basically agrarian economy,
good and bad crop years increased or reduced incomes, but there were
no mass collapses of businesses.
The coming of industrialization in the late 18th century brought
about the beginnings of modern banking, and with it the periodic over-
expansion of credit that led to periodic over-investment in long-
term, fixed productive assets. As bank credit expanded, businessmen
responded by investing in more productive capacity than available
real savings could support.
In every such cycle, the end point must be retrenchment: failure of
some business ventures, liquidation of inventories at fire-sale
prices, layoffs of excess workers, and strenuous efforts to reduce
other costs until businesses can again produce at a profit.
The one and only really effective thing government can do is to
maintain restraint upon expansion of the money supply, which is the
fuel that banks use to build the fires of speculative over-
expansion. Bankers, being human, will always seek ways to invest
money when it is injected into the economy by the central bank.
Businessmen, being human, will always find new ways to employ readily
available bank credit.
The process is self-reinforcing, as early business expansion proves
to be wildly profitable. As it continues, however, the effect of
over-expansion of the money supply is evidenced increasingly in
general price inflation and depreciation of the currency.
That is the stage of the Federal Reserve-created bubble we are
experiencing today. In those circumstances, when the Federal Reserve
continues to expand the money supply in order to lower interest
rates, as it is doing today, all the wrong signals are given to
businesses and consumers.
Carried forward too long, the end point is the massive inflation,
double-digit short-term interest rates, high unemployment, and low
economic production that was dubbed stagflation in the 1970s.
Thomas E. Brewton is a staff writer for the New Media Alliance, Inc.
The New Media Alliance is a non-profit (501c3) national coalition of
writers, journalists and grass-roots media outlets.
His weblog is THE VIEW FROM 1776
http://www.thomasbrewton.com/
Email comments to viewfrom1776@thomasbrewton.com
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