Leave Markets Alone

Government intervention and increased regulation of the banking industry will only worsen the economic crisis

As the cacophony of calls grows for a new, highly-regulated form of capitalism which encompasses much greater state intervention, Vaclav Klaus, president of the Czech Republic and current holder of the European Union presidency, provides a refreshing antidote. “Our historical experience gives us a clear instruction,” he wrote recently. “We always need more markets and less government intervention. We also know that government failure is more costly than market failure.” More than 40 years of living under communist rule gives Klaus first-hand knowledge of what overbearing government can do to society. Yet with the markets accused of plunging us into possibly the worst global recession since the 1930s, a backlash is under way against the previous orthodoxy of economic liberalisation.

Once taxpayers’ money is applied to bailing out the financial system on the monumental scale now being seen, a crushing increase in regulatory control and state interference becomes almost inevitable. It’s the politicians’ quid pro quo for coming to the rescue.

Such a regulatory crackdown is both unnecessary and wrong-headed. Certainly, without a degree of regulation, markets tend towards chaos, corruption, abuse and monopoly. Without standards and policing, they self-destruct. Capitalism works because markets and governments have learned to regulate themselves. Yet the idea that the present crisis is down to decades of Thatcherite-style deregulation of the capital markets is largely a myth. No sector of the economy is more subject to intrusive regulation than banking. Indeed, the quantity of box-ticking has grown exponentially over the past ten years and little good it did.

Regulatory reform is always about fighting the last war. Right now you could abandon all banking regulation, and banks would behave themselves for generations to come, such has been the searing experience of the last two years.

Markets are prone to bubbles. They happen not because of an absence of regulation, but because as the good times roll, investors, bankers, consumers and, yes, regulators too, forget the lessons of the last bust and come to believe that innovation has made things different this time, or even that the cycle has been abolished.

The root cause of the current crisis was big, macro-economic trends compounded by mistakes in the operation of monetary policy. The vast capital surpluses generated by Asia and the oil-exporting nations of the Middle East flooded the world with cheap money, leading to a breakdown in traditional standards of risk assessment as too much money chased scarce investment opportunities. The “Greenspan put”, whereby whenever the system showed signs of correcting, the Federal Reserve would come riding over the hill by cutting interest rates and swamping the system with liquidity, further exaggerated the crisis. There’s an old saying that you can’t have both guns and butter. The Americans tried to have both – a costly war in Iraq and a consumer boom of unprecedented proportions.

Most attempts to manipulate markets for the supposed common good are doomed to failure. I fear we are about to see another costly lesson in the old truism: there’s no mess so bad that government intervention doesn’t make even worse.

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