I’ve never understood why people who have little faith in the workings of the market assume that government can magically do things better.

It’s bizarre when you think about it. It’s as if businessmen are irrationally driven by greed and the desire for power and prestige, but those in government are extremely wise and only concerned with the common good. Since when did we get such an exalted view of politicians?

First let’s get something straight: believing in the superiority of markets to government direction of the economy doesn’t mean that you have to have a blind faith that markets work perfectly or even well all of the time. Instead, those of us who place our faith in markets are guided by the belief that over the long haul a market-driven economy will perform much better than one where the heavy hand of government guides the outcomes.

Contrary to what many seem to believe, the current financial mess is a great example of why so much faith in the government is misplaced. That’s not to say that all the players in the market have covered themselves in glory, but only that so far the interventions by government have caused a great deal of damage during this time of turmoil.

Whatever the cause of the credit crunch—and I believe that any fair analysis would show that both government and irresponsible players in the marketplace share the blame for the troubles we are in—we can easily see that much of what government has done over the past few months has made things worse, not better.

Take the bailouts. We have heard much about how government intervention was critical to prevent a credit market meltdown—and we will never know what might have happened had things been left to their natural course—but what we haven’t seen yet is much in the way of positive results from the Trillion or so dollars that are getting pumped into the economy.

So what has all the government activity intervening in the markets done for us? So far the record has been appalling. Stocks have slumped farther and faster since government interventions began in earnest, credit market conditions worsened, and investor and consumer confidence dropped like a rock. You can pretty much date the time the credit crunch became a crisis to the week that Lehman Brothers was allowed to fail but AIG was bailed out: it became abundantly clear that government had no idea what it was doing or why.

So far the government interventions we have seen have been ill-thought-out, ill-timed, and have sent contradictory signals to the market. Far from smoothing things over and reassuring consumers and the market, Washingtonpolicymakers have created even more confusion and uncertainty than existed before they got involved. Markets responded as they always do when things are uncertain: private investors pulled back and consumers stopped spending, ensuring a serious recession. So while it’s possible that the right set of government interventions might have prevented or ameliorated this crisis, the wrong ones so far have done real damage.

The biggest mistake that people make when they assume that government can engineer better economic outcomes than markets can is to link the power of government—which is enormous—with the assumption that sufficient wisdom accompanies such power.

In reality power and wisdom are rarely tightly linked, and the greater the power the less likely it is that anybody or any institution could have the wisdom and the knowledge to use it properly. One of the great advantages of free markets is that power and knowledge are generally dispersed widely, usually limiting the damage that any individual or set of mistakes can make on the system as a whole. In fact, it’s when market players get too big and too powerful that things go seriously awry.

Ironically, the reason government officials felt obliged to intervene in the current market mess was the likely bankruptcy of financial institutions that were “too big to fail”—in other words, their failure imperiled the financial system as a whole. The same principle of course applies to government itself. Mistakes made by government ripple through the economy and can imperil the entire economic system (think of the mistakes that led to the Great Depression, which was worsened greatly by bad decisions in government).

In an ideal world the right policies at the right times might help stabilize markets when they are gripped by panics or manias. But government officials are as imperfect and as likely to make mistakes as any market actors, and as likely to have personal axes to grind—with the additional problem that their power is potentially absolute.

The problem with investing too much power in the hands of government can be boiled down to this: no person or institution is wise enough, or can be trusted with the kind of power available to government unleashed by constraints.

###

^{This commentary was originally published at Townhall.com. Comments welcome there.}

By now everybody has heard of Joe the plumber. It was Joe that Barack Obama told that it was government’s job to “spread the wealth around”—Joe’s wealth—in order to build the economy from the bottom up.

Joe was worried because Obama’s plans to increase taxes on the “wealthy”—him—in order to give “tax breaks” (really just government checks) to people who make less than he does. Obama argues that doing this will somehow help create wealth from the “bottom up” instead of the “top down.”

The only problem is that economies don’t really work that way. Job creation and the real sources of wealth generation have never and will never come from government taking money from some people in order to give it to others.

Think about it: most people’s income in America comes from having a job. A few of us run businesses large or small and, and even fewer of us are the truly “wealthy” who don’t have to worry about money at all.

But for most of us, our daily bread comes from having a job. And Barack Obama’s tax plan is a direct assault on the job creation on which our well-being depends. Because, like it or not, no check from the government can possibly replace the paychecks on which we rely. And in general the healthier the business we work for is, the healthier our paycheck is likely to be.

Obama’s “Robin Hood Economics” is based entirely upon the idea that taking money from job creators and giving it away to preferred groups will somehow “spread the wealth around.” That’s simply bad economics. In reality, taking money away from the small- and medium-sized businesses that Obama counts among the “wealthy” will hobble the engine of job creation and ultimately hurt our own income.

It might be nice to get that government check in the mail, but the price we will pay is fewer jobs, slower economic growth, and less investment and innovation in the economy. That’s what you’ll get by raising taxes on the so-called “wealthy.”

Obama’s plan boils down to one thing: the path to a better economy is through wealth redistribution. But by focusing on propping up people’s income he is putting the cart before the horse. Before you can have income to redistribute you need to have wealth created in the first place. By attacking wealth creation Obama is just setting up the American worker for winding up worse off than before.

Obama hopes that we’ll notice the nice check we get in the mail, but fail to notice that over time job and wealth creation have slowed in our economy, making us all less well off.

Wealth redistribution schemes are a scam. By taking from the “rich” and giving to the “poor” the people in power get to appear to be the good guys, even as they hurt you. Handing out checks is a good way to get credit for making people better off. But it doesn’t take a genius to see that long-term prosperity can never be built on a foundation of wealth redistribution simply because it requires taking the money from wealth creation.

Less wealth creation means less wealth in the long run. You wind up with an economy with fewer jobs, fewer choices for workers, and even more dependence upon government for everybody.

Believe it or not, one of the most striking facts about theU.S.economy over the past 25 years has been the relative stability it has enjoyed—until all hell broke loose the last few months.

That may be difficult to believe today, given the severity of the strains on the financial system and the reigning panic in Washington and Wall Street. But until recently economists stood in wonder at the relative stability and prosperity of the American economy over the past couple of decades.  

Ever since Fed Chairman Paul Volker wrung inflation out of the economy in the late 70’s and early 80’s, the United States and much of the Western world has enjoyed what most economists consider a golden age. Fed Chairman Ben Bernanke and other economists dubbed this age “The Great Moderation.”

What made this period unique was the combination of robust economic growth, tame inflation, short and mild recessions, and low unemployment. Periods of economic growth and decline during these 25 years were smoother and less disruptive than at any time in history, and the crises the economy faced were easier to contain and did less serious damage than in the past.

During this time crisis after crisis hit the economy: the Savings and Loan Crisis, the “Asian Flu,” the Russian default on their debt, the bursting of the dot com bubble and even the September 11^th attacks. Each of these was damaging, but none of them tipped our economy into a 1982 or 1973 style recession, and certainly no threat of a crisis as severe as the Great Depression. In fact, the USeconomy pretty much hummed along despite these crises. At no period in history had an economy been able to sustain such serial shocks without serious consequences such as soaring unemployment and declines in GDP.

It was this stability in the economy that earned former Federal Reserve Chairman Alan Greenspan the title “Maestro”—reflecting the common belief that after nearly a century the Federal Reserve had finally mastered the art of managing the economy’s ups and downs.

These days there is little talk of the great moderation, except perhaps to wonder what happened to it. A sense of crisis, perhaps panic, rules the day. The stock market has recently experienced declines comparable to the recession of 1937, and each government attempt to stem the bleeding seems to inspire more panic. Economists seem to agree that a painful recession will hit America’s economy, and are arguing more about how long and severe it will be rather than whether it will come.

What can explain such a sudden reversal of both our fortunes and of economic opinion?

Perhaps one answer is the “great moderation” itself.

History has shown that the price of economic stability is usually economic stagnation. The price for economic growth is allowing for “creative destruction” which breeds a certain level of instability. Stability and predictability are the enemies of dynamism, and countries which seek them ultimately pay with slower economic growth. Until recently it seemed impossible to have both a dynamic economy with strong growth and a stable economy with relative predictability and security.

During the “great moderation” it seemed that we could have our cake and eat it too—dynamic economic growth and relative stability and predictability in the economy. It seemed that the Federal Reserve had found the magic formula for sustaining economic growth while avoiding serious dislocations in the economy. 

But now it seems that the very success of these policies imposed an unseen cost—the creation of a new kind of moral hazard. The very success of the Fed invited investors to assume that economy could bear almost any shock and keep right on humming, as it had during the financial crises that hit during this 25 year period. The apparent success of the Fed in moderating economic swings seemed to mean reduced risk for investors. The apparent reduction in risk in turn fed an appetite for what in earlier times seemed to be high-risk investments.

Risk, it appeared, had begun to disappear from the financial system. Everybody believed that the Fed knew how to keep the economy humming and ensure that crises could be turned into mere hiccups. Even a crisis as severe as the dot com bubble in which $5 Trillion of wealth evaporated only triggered only a mild recession.

Viewed in this light, the seemingly successful policies of the past few decades helped set us up for the severity of the crisis we face today. The excessive risk-taking of the past decade was spurred on by the success of the Fed in moderating the costs to the economy of prior crises. The Fed’s earlier successes have led us to the current morass.

Unsurprisingly there turns out to be no magic bullet for eliminating the business cycle. Even a period of successful Fed management of the economy has its own potential dangers, the fruits of which we are seeing today. We can only hope that the tools the Federal Reserve and Treasury have at their disposal are up to the task of keeping our economy afloat as it works through the effects of the excessive risk-taking of the past quarter century.

### 

 David Strom is President of the Minnesota Free Market Institute

^{This commentary was originallly published at Townhall.com. Comments welcome there.}

Are we facing the worst financial crisis since the Great Depression? If so, why?

The simple answer is “probably.” And we are facing that crisis in no small measure due to the actions that are taking place in Washington D.C. and not in the financial centers of New York.

The credit crisis of today has been brewing for a long time; more than a year ago you could read about the “credit crunch” hitting markets and businesses and of you need to go back years to find the root causes for the housing bubble.

But the problems of even a year ago did not have to become the crisis of today. Wall Street has weathered serious problems in the past without massive government intervention and without causing journalists and politicians to begin reminiscing about the 1930’s. What turned this particular problem into a financial disaster were the remarkably maladroit actions of policymakers in Washington D.C.

First, let’s acknowledge that imbalances in the market are at the root of the current troubles. There is no doubt that a housing and lending bubble formed, and that the popping of that bubble has helped lead us to where we are today. Others have shown how lending rules set by politicians and monetary policies set by the Fed helped distorted the market for housing, but even without those prods this or another asset bubble could easily have formed. Markets are not infallible.

The popping of bubbles are invariably painful, and it is no surprise that policymakers jumped in to avert as much of that pain as possible. In doing so they unwittingly helped transform the credit crunch into the current credit crisis.

Ironically, Washington’s initial attempts to stem the bleeding transformed the painful but necessary correction into today’s market rout. As in 1929 and the early 1930’s, it was government intervention into the workings of the market that turned a serious problem into a crisis.

In the 1930’s the government helped create the Great Depression by making a number of blunders that helped destroy the underlying financial system. In particular the Federal Reserve stood by as bank failures led to a massive contraction of the money supply, drying up credit and leading to massive deflation that destroyed the American economy. This time around nobody can accuse the Fed of being stingy with money.

So what did Washington do this time that was so damaging?

From early this year the Fed and Treasury seem to have been following what I would call a “reverse Goldilocks” strategy, doing both too much and too little and getting the policy just wrong.

It’s hard to date when exactly the financial crunch transformed into a full-fledged crisis, but a convenient starting point would be the bailout of Fannie Mae and Freddie Mac. It was at that point that it became abundantly clear that any chance of simply muddling through the credit crunch was not going to be possible. If the companies holding nearly 70% of America’s mortgages were on the verge of bankruptcy then just about any company might follow.

The Lehman Brothers bankruptcy followed closely the demise of Fannie and Freddie, and the AIG bailout came just a day after the government let Lehman fail.

Two things were made abundantly clear by this pattern of events: first, in the judgment of the Fed and Treasury our financial system was on the brink of collapse; and second, they had no plan for how to deal with the impending disaster. They were shooting from the hip, and that’s not a great way to aim.

It was signals sent by Washington that destroyed the underlying confidence that is the bedrock of any financial system. Investors, rationally viewing Washington’s actions, quickly rushed to the sidelines in order to wait and see what the government was going to do in order to clean up the mess.

Obviously it was going to do something—the bailout of Fannie, Freddie, and AIG all signaled that some action was imminent. The bankruptcy of Lehman ensured that nobody could guess what that something might be. The failure of Lehman was intended to signal that whatever was done, it would be limited.  It’s pretty hard to make rational decisions when you have no idea what tomorrow’s market conditions might be.

If Washington was going to act—and it was telling everyone it would—is it too much to ask that it have a plan before doing so? The unpredictable nature of Washington’s words and actions helped create the crisis atmosphere that is hurting our economy today.

Washington has done nothing to calm the rattled nerves of investors since. In fact, it has made things much worse. Almost every single action and statement coming from Washington has added to both the uncertainty and anxiety that investors are feeling right now. What was a problem last year is a crisis today.

By pushing the panic button when they had no plan to deal with the crisis, the “wise men” in Washington have made things unimaginably worse than if they had done nothing at all. It may or may not in fact be the case that there was no palatable path out of this mess without massive government intervention—a proposition that splits respectable economists, even free market ones—but it is certainly clear that having the most senior economic and political officials in Washington screaming that the sky is falling has been a sure path to creating, not tamping down, a sense of crisis.

Unfortunately the die is almost certainly cast. Now that the crisis is upon us it is almost impossible to conceive of a path out without massive government intervention. The whole world is waiting to see what Washington does, and until it acts in some decisive fashion markets will be in turmoil.

Washington now needs to buttress the confidence in our financial system that it has helped undermine. We can only hope that the policies they choose prove a lot more successful than the ones chosen in the 1930s