The default belief  of our economic history of the last 100 years has been an acceptance of the dynamic growth of capitalism punctuated by excesses of market greed that have to be corrected by the singular wisdom of government regulation.

On closer examination many of those moments of market greed and excess look more like incompetent government meddling caused the problem.

During the Depression of 1929 we saw 10,000 banks collapse in the United States. Yet during that same period the number of bank failures in Canada were zero.  Was Canada spared the depression that engulfed the United States? No, but Canada was spared a regulation that prevented banks from crossing state lines.

Bending to pressure to protect local banks from encountering big business center banks, they got relief and protection from the Federal government in the restriction of interstate competition.  But that also severely limited their flexibility in dealing with a crisis, a limit that did not exist in Canada where risks were spread over larger areas and underutilized assets could be easily relocated.

Yet to respond to the bank failures that the government largely caused they created the FDIC (Federal Deposit Insurance Corporation).  FDR opposed the FDIC because he saw it would create a sanction for reckless behavior and penalize prudently run banks.  FDR capitulated in a compromise and the FDIC began by insuring deposits for $2500 in 1934. It was raised to $5,000 in 1935, $10,000 in 1950 (Truman), $15,000 in 1966 (Johnson), $20,000 in 1968 (LBJ again), $40,000 in 1974 (Nixon), and then $100,000 under Jimmy Carter in 1980.  Bush raised it to $250,000 before he left office, but it is due to revert back to $100,000 in 2013.

Ten years after Carter raised the limit we experienced the Savings and Loans meltdown, caused by the excessive risk taking in that industry. The government again intervened and created the Resolution Trust Corporation (RTC) to dispose of failed thrift institutions taken over by regulators after January 1, 1989 in an orderly manner.

The FDIC created the moral hazard FDR feared. It privatized the profits and socialized the risks.  This behavior was repeated, but on steroids, with the implicit assumption of risk by Fannie Mae and Freddie Mac.

Housing was deemed a federal priority, and helping the poorer people get into housing has been a priority since Fannie Mae was created again by FDR in 1938.  But housing prices were highest and least affordable in select areas where local ordinances had restricted supply and raised prices far more than in areas were market forces prevailed.

Tax policies such as mortgage interest deductions and preferred capital gains treatment increased the demand for housing. The Community Reinvestment Act, passed under Carter but exploited under Clinton and Bush, pressured banks to make mortgage loans to less and less qualified buyers. Fannie Mae guaranteed loans, clearing the ratings agencies which had a government protected franchise; to give higher ratings than these mortgage backed securities could have conceivably obtained on the merits of their assets. This widened the market for these securities and caused even more money to be driven into the housing market from all over the world creating the bubble that had to burst.

To compound the damage the government required a mark to market rule for valuing these mortgage loans at the worst possible time; when no market existed.  The market to market rule causes valuations to go to extremes, high and low.  This caused capital to dry up and regulations required banks to rebuild capital reserves instead of making loans. Then at a time when information was critical to valuing these securities, the government suspended short selling, a critical source of such information.

During the recent financial disaster, Canada did not exhibit near the real estate collapse we did in the United States.  In Canada they had far less exposure to sub prime loans, large down payments were still required while we all but eliminated down payments for the poorest home buyers in the name of ‘compassionate conservatism’, and mortgage borrowers in Canada were still held personally liable for their loans. Canada had tougher and more prudent lending standards, but they avoided the fiasco foisted on us by well intentioned but misguided moral supremacists on the government payroll.

The government in the U.S. inflated this bubble as eagerly as any on Wall Street, but our government “had a much bigger pump”.

Seventy five years ago we could have looked to our northern neighbor and learned better behavior instead of demonizing capitalism. Today we can learn the same lesson, but again we seek to demonize the private sector for conditions created by incompetent government regulation. Wall Street clearly has its demons to account for, but its greed was enabled and often encouraged by incompetent regulations and policy that has a long history.

As we crave more government oversight we should ask who will oversee the government that has demonstrated such spectacular failure.

‘Sound currency’ is like ‘ world peace.’  We all agree we want it, especially when we do not have it.  Yet either we can never agree how to get it, or we are never willing to make the sacrifice it requires.

Economic history is a struggle to tap our virtues. Political history is a struggle to restrain our vices. When we confuse their roles we are in deep trouble.

Markets can tolerate, even thrive on risk; but they cannot tolerate chaos.  There must be consistent and stable rules.

Trying to manage conflicting regulations is like dating a schizophrenic bisexual- you are never quite sure what you are supposed to do.

History does repeat itself but we are usually oblivious because it never repeats in the same way.

In the wake of the elections  of November 3, 2008 we noted the dramatic swing of the independent voter.  Who are these voters and why do they refuse to ally themselves with one of the two major parties?  I confess up front that this is my sense and perception and I do not propose to support this with any legitimate research.

The independent is fiscally conservative and socially tolerant. This would make them libertarian but they are not dogmatically so.  They do realize that there is a place in foreign affairs for the military whereas the more dogmatic of the libertarian would categorically condemn foreign military adventures.

The social tolerance explains their willingness to support a black man with a distinctly ethnic name.  They are tolerant of ethnic diversity and I guess they are probably about evenly split on the subjects of gay marriage and abortion rights.

The independent is a realist.  He realizes that there is a continuum of socialistic government policy and individual liberty and is only likely to become mobilized when he sees a move to an extreme, which he probably now sees. When 48% of the population received more in benefits that they pay in taxes it is extreme in any reasonable view. The independent recognizes that there is evil in the world and that there is a time when violence must be employed.

The independent is civil.  The demonization of one party by the other, the name calling, and the negative campaigning alienates the independent. In a display of uncivil discourse they hear only the emotion and not the message.

The independent is rational.  He does not blindly follow a party line if it does not make sense. He is skeptical of radical change, but willing to question policies that no longer work. He understands that taking money from one person and giving it to another does not create wealth. In fact it is more likely to destroy it. He understands that the economic laws that govern his household are not dramatically different than the economic laws that govern our nation. Wealth must be earned, and debt must be repaid- one way or another.

The independent understands the role of government and its limits. He understands that life is imperfect, often unfair, and frequently uncertain.   He understands that government policies that seek to solve all our problems and counter the laws of nature often end in tyranny.

The independent is not necessarily the same as a populist.  The independent is more likely to compromise than the populist, less likely to have a single issue litmus test, and less likely to campaign actively, put a bumper sticker on their car or attend a ‘Tea Party.’

The independent is less tied to a principled philosophy and thus is more likely to be swayed by appearances and charisma. By not being attached to a party he is more likely to change if his candidate disappoints.  This explains the voter swing in VA and NJ.

The independent is more likely to change priorities in crisis.  After 9/11 they became hawks. After the financial meltdown they became economics Keynesians. After the bailouts and nationalizations they became fiscal conservatives.

The independents are honest and expect the representatives to be honest as well.  Transparency and bipartisan efforts were promised by this administration and they are not keeping their promise. They are intolerant of the corruption that is plaguing the party in power. They are even more intolerant that the party leaders tolerate the blatant corruption of a Charles Rangel or Chris Dodd.

The Republican populists that challenged the party leaders in NY district 23 are probably correct that the Republicans cannot win by being a lighter version of Democrats. But they also cannot win by ignoring the wishes and motivation of the independents. The alliance between the independents and populists in matters of sound economics and limited government will not necessarily include a mandate on social issues the independents oppose.

The radical policies of the current administration have energized the Republican base more than the attractiveness of any specific candidate to represent them.  Centrist Democrats in the White House or in Congress may have rendered a figure like Sarah Palin irrelevant.  Combined with the flexibility (or fickleness) of the independents the Right has quickly regained a footing many recently thought was unrecoverable.

The work of noted economist John Maynard Keynes is used to justify a bigger government role in the economy.  After the recent (or more accurately current) crisis it is understandable that many would return to this economist.  Yet most who do not read economics know very little about him and his economic philosophy in his most noted work, “The General Theory of Employment, Interest, and Money.”  It is not a surprise that his economic theory developed during the popularity of socialism.

Keynes considered savings a very bad policy for an economy. He considered the Calvinist doctrine of savings a distortion of common sense. Keynes advocated an interest rate of 0% to be achieved by the government controlling the money to be made available for capital investment. To Keynes the world was mired in poverty because the rich controlled the capital and always charged too much interest.  The zero interest he advocated is a reversion to the early church’s ban on charging interest that characterized the Dark ages.

He advocated confiscatory taxes to take money from the rich because they would save it,  and give to the poorer so they would spend it. Spending was his sole economic driver. Private capital could not be trusted to do good for society.

His present focused economic view was the engine for the socialist redistribution he and so many advocated.  By driving interest to zero and making capital freely available there would be no unemployment.

The flaws in his thinking are so enormous that it stuns me how many believe it makes sense. For example, how do you explain the record high unemployment we now have with the record low interest rates now available? With zero interest how do we prioritize one investment opportunity from another?

The antithesis to Keynes is Ludwig von Mises who published “The Theory of Money and Credit” in 1912.  In “The Man Who predicted the Depression” Mark Sitznagel noted,

“Government-imposed expansion of bank credit distorts our “time preferences,” or our desire for saving versus consumption. Government-imposed interest rates artificially below rates demanded by savers leads to increased borrowing and capital investment beyond what savers will provide. This causes temporarily higher employment, wages and consumption.

“Ordinarily, any random spikes in credit would be quickly absorbed by the system-the pricing errors corrected, the half-baked investments liquidated, like a supple tree yielding to the wind and then returning. But when the government holds rates artificially low in order to feed ever higher capital investment in otherwise unsound, unsustainable businesses, it creates the conditions for a crash. Everyone looks smart for a while, but eventually the whole monstrosity collapses under its own weight through a credit contraction or, worse, a banking collapse.”

“…Ludwig was very nearly alone in warning of the collapse to come from this credit expansion. In mid-1929, he stubbornly turned down a lucrative job offer from the Viennese bank Kreditanstalt, much to the annoyance of his fiancée, proclaiming “A great crash is coming, and I don’t want my name in any way connected with it.”

“overleveraged banks (including Kreditanstalt) collapsed, businesses collapsed, employment collapsed. Following Mises’s logic, was this a failure of capitalism, or a failure of hubris?”

Keynes predicted in 1927 “We will not have any more crashes in our time. I find the markets very interesting, and the prices low. So where should a crisis come from?”

Unlike Keynes von Mises’s theories stand up to observation and common sense, yet our government economists prefer the ideas of Keynes.

I am constantly amazed at how sitting political leaders and naive citizens think that the government can create jobs. If the government could create jobs why would we ever tolerate any unemployment?  Either the leaders are economically ignorant or liars.

If you only read one economics book I recommend ‘Economic in One Lesson’ by Henry Hazlitt. Hazlitt was not an economist, but a reporter and he wrote this book in 1946.  This passage explains why the government is incapable of creating jobs without sacrificing at least the same number of jobs from the private sector.

This is what is immediately seen. But if we have trained ourselves to look beyond immediate to secondary consequences, and beyond those who are directly benefited by a government project to others who are indirectly affected, a different picture presents itself. It is true that a particular group of bridgeworkers may receive more employment that otherwise. But the bridge has to be paid for out of taxes. For every dollar that is spent on the bridge a dollar will be taken away from taxpayers. If the bridge cost $10 million the taxpayers will lose $10 million. They will have that much taken away from them which they would otherwise have spent on the things they needed most.

Therefore, for every public job created by the bridge project a private job has been destroyed somewhere else. We can see the men employed on the bridge. We can watch them at work. The employment argument of the government spenders becomes vivid, and probably for most people convincing. But there are other things that we do not see, because, alas, they have never been permitted to come into existence. They are the jobs destroyed by the $10 million taken away from the taxpayers. All that has happened, at best, is that there has been a diversion of jobs because of that project. More bridge builders; few automobile workers, television technicians, clothing workers, farmers.

This sounds so logical and obvious that I fail to understand why anyone would swallow the government promises to create jobs.