Money is the barometer of society’s virtue.  When you see that trading is done, not by consent, but by compulsion- when you see that in order to produce, you need to obtain permission from men who produce nothing- when you see that men get richer from graft and by pull than by work, and your laws don’t protect you against them, but protect them against you- when you see corruption being rewarded and honesty becoming a self sacrifice- you may know that your society is doomed.  Money is so noble a medium that it does not compete with guns and it does not make terms with brutality.  It will not permit a country to survive as half-property, half-loot.

Whenever destroyers appear among men, they start by destroying money, for money is men’s protection and the base of a moral existence.  Destroyers seize gold and leave to its owners a counterfeit pile of paper.  This kills all objective standards and delivers men into the arbitrary power of an arbitrary setter of values.  Paper is a mortgage on wealth that does not exist, backed by a gun aimed at those who are expected to produce it.

From Atlas Shrugged by Ayn Rand.  This passage is from a long monologue from Franciso d’Anconia in response to a character who contended that money is the root of all evil.

HKO comment:

Capitalism is the function of economic self interest. Regulation and restriction of free enterprise substitutes political self interest for economic self interest. Individual liberty usually suffers as a result.  Note for example how many of the special interest groups who pushed for the Obama health insurance plan now seek and receive exemptions from the same government who is forcing it on everyone else.  Wealth is being less generated by competition in the market place and more generated by success in obtaining political power.

“Too big to fail” is as antithetical to capitalism and economic growth as sugary high fat diet is to good health.

Some free market supporters prefer the phrase “free enterprise” to capitalism, because of the bad name capitalism has developed.  It was a derogatory name used by Karl Marx.  He could be right. The open-mindedness of classical liberalism has certainly been redefined by the distinctly close-mindedness of modern political liberalism.

But whatever term you prefer the modern perception of capitalism is being distorted by recent events.  Crony capitalism is a system where select groups are able to game the political system for advantage rather than compete in the market place. Crony capitalism is to capitalism what national socialism (Nazism)  is to socialism.

There are two critical assumptions to capitalism. The first is that individuals are more capable of making effective choices for themselves than would be made by others. True capitalism is incompatible with a society that has no respect for individual liberty. Big government solutions with bureaucratic micromanagement of consumer choices, whether for health care or automobiles, is antithetical to effective capitalism.

The second essential assumption of capitalism is the preference of allocating capital based on productivity or merit rather than force, political power or class.  Failure is essential to freeing up capital from unproductive use and transferring it to productive use. Our bankruptcy system which allows a rapid discharge of debts is a part of the reallocation of capital that makes capitalism work so well. Our legal system understands the importance of failure to a growth economy.

But few countries and cultures are willing or able to accept the pain of failure that is essential to the good health of a capitalist economy.  The acceptance of the doctrine of “too big to fail” is a blatant rejection of this essential element.  Those that are deemed too important to be subjected to the discipline of the market place, will have an advantage and be able to game the political system that protects them.

It is no secret that America’s tremendous economic growth was fueled by these two essential elements of capitalism. Financial bubbles, a civil war and a history of global conflicts proved to be only minor setbacks.  The current administration’s assault on these two elements, however, can prove more damaging than many of these historical crisis we have endured.

Just as an unhealthy diet is very satisfying now, but potentially deadly later; our unwillingness to accept the pain of business failure today seems to only make the next crisis worse.  Our inability to accept short term pain leads only to greater long term pain.

Ever since Michael Douglas’s character Gordon Gekko in the movie Wall Street declared “Greed is Good” capitalism has been cast in a sinister role that it has yet to overcome.

The movie speech was rumored to be taken from a speech given by Ivan Boesky at a college address. Boesky was indicted for insider trader, served time in jail and paid millions in fines.

Capitalism is not about greed; it is about economic self interest, and this is far more than a semantic distinction. When you take a job paying $10 an hour over the job paying only $8 an hour you are displaying economic self interest, not greed. And when you decide to take the job paying $8 an hour over the job paying $10 an hour because you like the conditions or the work at the lower paying job enough to sacrifice the higher pay you are also acting in your own economic self interest. Economics is about far more than money.

When you decide to take a steady job in a traditional workplace rather than make much more money in drugs and prostitution you are also acting in your economic self interest. It is when your economic self interest disconnects from moral and ethical considerations that it becomes greed.

The ultimate power is the power over your own destiny and environment, but power is most often considered in the control over others. Whereas economic self interest in about control over your own destiny, political self interest is about controlling others.

Capitalism is about people acting in each other’s own self interest and the society benefiting as a result. This works because achieving your self interest requires serving others.

Advanced economic theory also realized that self interest and sharing is not mutually exclusive. In “A Beautiful Mind” John Nash had a Eureka moment courting ladies at the beer hall with his college buddies. He realized that Adam Smith was wrong, or at least incomplete. He developed a theory of equilibrium in competitive game theory. Basically this meant that he realized that your best outcome was not to grab as much as you can for yourself, but that your chance of success was enhanced by assuring at least some success for your competitors. Not only are consumers’ well being enhanced by competition, but the outcome for the competitors themselves is improved.

In order to profit you have to provide a product or service some one else values. Bill Gates, Michael Dell, and Stephen Jobs are very, very wealthy because everyone values Microsoft Windows and Office, iPhones, Macs, and laptops.

Few people complain about the wealth of these techno entrepreneurs because they all provide value we understand. The same can be said of Warren Buffet.

Yet we are outraged at the fortunes made in the financial industry where record amounts of value have been destroyed while CEOs made millions in bonuses. We do not understand derivatives, collateralized debt obligations, and financial models: Apparently neither did the CEO’s and boards of the companies selling these products.

The Wall Street mess was the product of “crony capitalism” which is to capitalism what National Socialism (Nazism) is to socialism. Crony Capitalism is a perversion of the principles of capitalism that includes the freedom “for every man to make himself” to use the phrase of Abraham Lincoln. “Crony capitalism” has its roots in the mercantilist tradition of Alexander Hamilton. During our early years Hamilton saw a need for financial interests and the government to work “closely”. He favored a central bank and such “public private partnerships.”

Hamilton was strongly opposed by Jefferson who favored decentralization and saw the favoritism fostered by mercantilism and the influence such financiers could have over our government as a threat to liberty.

Fannie Mae for example was given special treatment and access to low interest funds available to no other financial institution, and exempted from both SEC and FDIC regulation, Fannie Mae lobbied Congress and plied their special regulators with large campaign contributions. Senator Chris Dodd, head of the Senate Banking Committee and then Senator Barak Obama were the two largest recipients.

But the real damage was not compromising two high profile Senators. Fannie Mae was given special privileges in order to carry out the political will of Congress to make housing affordable for people who shouldn’t buy homes. They created the hunting grounds for the unscrupulous.

Bonuses and bailout funds for Fannie Mae did not elicit near the outrage of AIG and the Wall Street banks. The public still thinks it was the ‘Gordon Gekko’ greed of Wall Street rather than the political greed of K Street.

We still blame the economic self interest instead of the political self interest. Articles decry the old capitalism and herald the new era of state capitalism. The last time we heralded state capitalism was in Italy in the 1920’s and 30’s.

Crony capitalism was not limited to Fannie Mac and Freddie Mac. There has been a revolving door between Wall Street and Washington for decades. As long as the complicated instruments served the political greed, political leaders were willing to ignore prudent financial principles and assume that the overpaid magicians knew what they were doing.

The financial scandals of the 1980’s, the S&L collapse under George H Bush, the collapse of Long Term Capital in 1998, The collapse of the high tech bubble should have been a warning that high salaries and bonuses are not synonymous with competence.

But the solution is not to promote more crony capitalism, also called state capitalism or my favorite term used in the book “Nudge” (Richard Thaler and Cass Sunstein) , ‘Libertarian Paternalism’  (my vote for oxymoron of the year).

By now we should have learned that when business gets in bed with the government, somebody gets screwed.

There is a certain dynamism and egalitarianism built into modern industrial society. For “Industrial society is the only society ever to live by and rely on sustained and perpetual growth, on an expected and continuous improvement,” (Ernest) Gellner writes. Indeed its very legitimacy depends on its provision of economic growth:”Its favored mode of social control is … buying off social aggression with material enhancement; its greatest weakness is its inability to survive any temporary reduction of the social bribery fund, and to weather the loss of legitimacy which befalls it if the cornucopia becomes temporarily jammed and the flow falters.”

From Capitalism and the Jews by Jerry Z. Muller

The president ran on clear ideals of a fairer and more just society,  ultimately meaning redistribution of income. He saw the gaps between the rich and the poor widening.  He has been demonized by his opposition for being socialist, communist , corporatists, and fascist. Such pejoratives cloud the issues even if in elements of policy they may be true.

The gap between rich and poor is subject to clarification. If you measure the difference between the top 20% and the bottom 20% as a group the disparity is widening, but this ignores both the social mobility happening between the groups and  the cultural changes that affect the result.  Few in the bottom group remain there,  most of them rise into the middle class.  And  many in the top groups drop into lower groups as businesses fail and the values of financial assets drop. Bernie Madoff has done more to equalize income than the intentional policies that attempt to flatten income distribution.

The rise of capitalism upset the social order of European aristocracy because it achieved redistribution in a radically new way.  Capital was deployed based on merit, productivity, and innovation rather than power and status. Capitalism proved to be the most just, unbiased, efficient, and productive form of redistribution ever attempted.

The free flow of capital helped Samuel Mayer, born in poverty, create the movie industry; Scottish born Andrew Carnegie create the steel industry; and Russian born Sergie Brin create Google.  Each of these and thousands of others like them created millions of jobs and benefits because capital was allowed to seek its productive use.

But capitalism is brutal when you are on the losing end of the reallocation of capital. Just as the aristocrats of Europe tried to fight this “creative destruction”, we have a new aristocracy that seeks political power to help keep them from losing their economic power.

We hear that social justice is necessary to preserve our capitalist system.  Even George Bush commented during the crisis “We must destroy free market capitalism to save it.”  FDR uttered similar comments after the Great Depression.

Under some examination the free market did not fall of the cliff,  it was driven off, less by reckless deregulation than by specific regulations that precipitated and aggravated the crisis. Markets, like human nature, are driven to excesses, but they are also driven to correction.  Government intervention is often like a weak chemotherapy  that is used even though it is ineffective because it causes less discomfort.

In our effort to redistribute in the name of social justice rather than productivity, we risk serious damage to the machine that creates the wealth to distribute. It is a fine balance to extract enough to bribe the less productive to let the more productive enjoy the fruits of their success, without burdening them with such costs that they can no longer produce. The more radical and drastic the change the more likely this destructive outcome is to be.

The wealthy are driven by more than money. They measure risk as hazard plus outrage. They can quickly cease production if their capital is treated poorly.  The can move capital to different industries and to different countries. As the other developing countries are developing their own consumer base this becomes an easier option.

High taxes and more misguided regulation on capital will make the income discrepancies larger and eliminate the social mobility that neuters  these differences.  Reducing the allocation of capital to its most productive, though occasionally painful, use also reduces the creation of capital and the economic growth that raises everyone’s living standards, even if it doesn’t do it equally.

We would all be much better off with a growing economy even with its occasional bubbles than with a stagnant economy with a ‘fairer’ distribution decided by political power.

Do not confuse capitalism with the crony capitalism of Wall Street and the corporatist bailout of Washington.  Crony capitalism is to capitalism what national socialism is to socialism.

We cannot have success without failure, not just in the philosophical sense but in the real sense that without failure capital cannot be reallocated to more productive use. Exchanging the productive re-allocation of capitalism for political based redistribution will only make us all poorer.