Discussion with a friend

[partofme]

I have a friend that considers himself a libertarian much like I did myself several years ago. I sent him a message wondering what his take is on the situation and the bailout and it follows.

I was just wonder what your take is on the bailout and the financial crisis in general. I read this article which takes a very harsh stance against libertarianism.

http://www.slate.com/id/2202489/

On the other hand I'm read The Economist probably more than any other source that tends to be a bit more pragmatic but still more libertarian leaning as well as more in depth and thoughtful than most and they are actually for the bailout yet warn strongly against a trend towards socialistic ideas in general. Their view is that capitalism is still the best creator of wealth we have found yet but that to be realistic without any bailout and sensible regulation it just doesn't work.

Personally I tend to see most that claim themselves to be libertarians as going a little to far in not seeing the faults that capitalism does have and being pragmatic enough to recognize to realize it does need regulation and a set form of government rules to work in but that care must be taken to make those rules as lenient as possible in order to not step over the line. In other words perhaps some have gone too far with deregulation and privatization in some areas but overall we need to keep an eye out for overcorrection as well which is entirely possible especially if we have a larger democratic majority and a democrat in the white house as well which is highly likely. I hope this makes sense because I have had a little too much to drink. Thoughts?

In response he gave the following reply.

I dont really think this meltdown is indicative of a failure of market capitalism, nor too little regulation. Furthermore, I think libertarians and other free-marketer's opposition to most regulatory policies as they are executed is misunderstood to be opposition to regulation in general.

To explain, I like to compare the economy to the traffic system:

I don't think we should be completely without traffic laws. Certainly there is a role for government in passing speed limits, erecting traffic lights and stop signs, and arresting drunk drivers, etc. If the government completely separated itself from transportation, I think the streets would be chaos.
But this doesn't mean that I think the government should attempt to centrally coordinate the transportation of every individual driver. Traffic is far too complex for this.
So what level of involvement should the government have in regulating traffic? First we have to consider what we hope to gain from government involvement. In the case of traffic, I think we we want safety and efficiency. We want to be able to get where we need to go as quickly as possible without feeling that our lives are in danger.
Secondly, I think we have to consider that safety and efficiency are often opposing values. We could certainly make the streets safer if we lowered the speed limit to 5mph and put a cop at every intersection manually directing the traffic. But this would be very costly. It would take an extremely long time for people to commute to work or to engage in other economic activity. It would take longer to ship goods, and make it more costly which would drive up the costs of most everything. The army of cops required for directing traffic and enforcing the draconian speed limits would have to be paid their salaries.
On the other, we lifted the speed limit to 150mph, we could certainly get where we needed to go faster and more efficiently, but it would be costly in terms of loss of human life, damage to personal property, etc.
The goal of government in this case then is to find some kind of balance between safety and efficiency, and I think our society has pretty much settled on the idea that we should have a few basic rules for driving and a moderate level of enforcement.
It's strange how a catastrophic traffic accident doesn't alter our general outlook on traffic regulation the way a financial crash changes our outlook on economic regulation. A 20 car collision at a busy intersection may stimulate dialog on the possibility of lowering a speed limit on THAT street, or erecting a traffic light at THAT intersection, but it definitely wouldnt be interpreted as a need for increased government control of transportation everywhere across the board.

The current financial meltdown is, I think, a result of the government running huge deficits, creating what economists call the "crowding out effect" in which the goverment eats up the supply of loanable funds in the economy pushes out productive private investment, combined with the fed keeping interest rates artificially low which muted the market's signals that the credit crunch was imminent.

I think the anti-capitalism rhetoric and the calls for increased regulation are just the opportunistic rabble of those that were already anti-market and pro-regulation and are using the circumstances to beef up their agendas.

While I think the situation may call for regulating certain aspects of the system differently, I dont think it calls for "more" regulation. I think most policy that calls for more regulation can be easily deflated if you substitute the word "regulation" with "bureaucracy" which is basically what it amounts to.

As far as the bailout goes, I was against it. There was a petition that circulated among 50 of the top economists in the country, signed by each, that said that the package was both expensive and counterproductive. I tend to listen to economists when it comes to matters of the economy.
Plus, think about the fact that Japan has been in a 10-15 year recession that resulted from this exact type of policy: Trying to avert financial crises by propping up failed financial institutions.

And then I offered this question.

That was a really well thought out answer. The only thing I'm not sure about is the final part in that most things I have read on the situation in Japan suggest that they put off doing almost anything for a very long time which is why it dragged on so long and eventually they did end up propping up those institutions after the point in which is would have been effective. I can't really say which I think is correct because I don't know much about it beyond those sources which mainly comes from very mainstream publications. Do you think that the bailout will make no difference at all, make things worse, or just isn't worth the negative consequences it may lead to? .

I was wondering what your takes our on the response he gave. He is somebody I respect very much and I definitely think that we need better regulation if not more but his reasoning in regards to Japan seems to go against the views of most economic analysis I have heard on the subject.

[Michael]

Interesting exchange.

First of all, I'd say that the 'traffic analogy' is a very good analogy to use in generally explaining the nature and purpose of government regulations.

However, I don't like the way it is used to support this 'straw-man' argument...
It's strange how a catastrophic traffic accident doesn't alter our general outlook on traffic regulation the way a financial crash changes our outlook on economic regulation. A 20 car collision at a busy intersection may stimulate dialog on the possibility of lowering a speed limit on THAT street, or erecting a traffic light at THAT intersection, but it definitely wouldnt be interpreted as a need for increased government control of transportation everywhere across the board.

To maintain the integrity of the traffic analogy, a 20 car collision at a busy intersection (ludicriously rare that is - 20 car collisions usually only occur on high-speed freeways), is merely the equivilent of 20 homeowners going bankrupt on their mortgages to one small local bank. In both cases, in comparison with the overall size of the traffic or banking networks, these are small potatos.

The reality of the 'credit crisis', in terms of this traffic analogy, is the equivilent of the whole of the US Interstate Highway system shutting down.

In other words, 20 car collisions or 20 bankrupt homeowners are neither sufficient to justfiy major government action or wholesale re-working of the regulations. Having the whole US Interstate Highway system cease to function is a closer comparison on this analogy as that is exactly what has happened in the banking sector - the whole of the 'inter-bank' trading network has virtually ceased to function.

If one uses the proper analogy, your friend's argument on this point evaporates. The problem is indeed, quite severe - far beyond any 20-car smash-up. We'd need many millions cars and transport trucks to be effected for a similar scale to the banking crisis.

Secondly, I'd address this little bit of ideological masturbation...

The current financial meltdown is, I think, a result of the government running huge deficits, creating what economists call the "crowding out effect" in which the goverment eats up the supply of loanable funds in the economy pushes out productive private investment, combined with the fed keeping interest rates artificially low which muted the market's signals that the credit crunch was imminent.

This is stated/asserted as a simple article of faith in order to justify an ideological opinion. The facts of the matter don't actually support this interpretation.

Prior to this year, Japan, Italy and Greece are/were the most heavily indebted nations in the western world - all with public debts above well 100% of GDP (170% for Japan). Belgium and Germany come next. If government debt (demand for credit) was so dangerous to the proper operation of financial-credit markets, then we should expect these particular countries to have the most horrific banking problems (rather than the USA leading the pack). Though Belgium has had to assist in the Fortis bailout/nationalization. Indeed, Japan with the highest ratio of public debt in the western world, actually is in pretty good shape on the banking/financial system going right now.

And Iceland and Ireland, two countries that have been amongst the hardest hit by the banking crisis show comparatively low levels of public debt (far lower than the USA). Britain also has been hit very hard and they have public debt levels less than France, Austria, Finland and Sweden (all who are suffering comparably less from the credit crisis).

I might also add that overall public debt levels (expressed as a percentage of GDP) is comparably less than it was 20-30 years ago. Why is the crisis happening now and not then?

Ergo, government debt ought to be rationally rejected as a 'suspect' in the murder of the financial sector. The facts of the matter just don't support that interpretation.

That being said, asserting that public debt is the ultimate evil is a common component of 'US Libertarian' style ideology. The assertion is pure ideology and thus is usually held independent of factual support.

Thirdly, with respect to your friend's comments about the particular US bailout package ($700 billion Bush-Paulson plan), I think he is again playing a bit of a game here, though he may be unaware of how this plan has been radically changed since it was initially proposed.

That is to say, the initial plan was indeed a boondoogle of the worst kind and no self-respecting economist supported it. However, it has been substantially altered in Congress at the time of its passage to permit the US Treasury to engage in exactly the same steps that the British Exchequer has taken - a policy approach that has been generally applauded by most economists.

The so-called 'British-Brown' plan has quickly become the most generally accepted 'consensus' position for how to address the present problem with public monies. This is now what the US Treasury is actually doing (or planning to do) with a substantial portion of the $700 billion bailout funding package (though I'm sure they will still find a way to funnel a few billions back to their friends and supporters - as that is the American Government way and always has been - 'to the winner goes the spoils').

In other words, many/most economists NOW do support the present US Treasury spending of the $700 billion - because of these changes and always with the caveat of following the 'British-Brown' plan of approach (particularly on the issue of bank recapitalization).

The original Bush-Paulson plan called for buying $700 billion in ugly assets off US banker's books. The British-Brown plan calls for spending a comparatively similar amount of money on equity in British banks.

The reason is all about capital-equity ratios. Investing $700 billion in bank capital (buying bank shares) equals $7 trillion in money that can be loaned out by the bank. Alternatively, buying $700 billion in ugly bank assets just adds $700 billion to the pot of money that the bank can theoretically lend out. The difference is an order of magnitude. $7 trillion vs $700 billion. Economists absolutely favor the capital-equity approach over buying distressed assets.

Bottom line is that there really is a big problem out there and it really does need public money to 'fix' the problem to prevent a major economic collapse (of the 1930's magnitude, which was roughly a 25% drop in US GDP).

Something needs to be done and thankfully, the US Treasury has been coming around to the British position on the issue and that is very, very good news. I will go along with The Economist on this issue.

[partofme]

Interesting exchange.

First of all, I'd say that the 'traffic analogy' is a very good analogy to use in generally explaining the nature and purpose of government regulations.

However, I don't like the way it is used to support this 'straw-man' argument...


To maintain the integrity of the traffic analogy, a 20 car collision at a busy intersection (ludicriously rare that is - 20 car collisions usually only occur on high-speed freeways), is merely the equivilent of 20 homeowners going bankrupt on their mortgages to one small local bank. In both cases, in comparison with the overall size of the traffic or banking networks, these are small potatos.

The reality of the 'credit crisis', in terms of this traffic analogy, is the equivilent of the whole of the US Interstate Highway system shutting down.

In other words, 20 car collisions or 20 bankrupt homeowners are neither sufficient to justfiy major government action or wholesale re-working of the regulations. Having the whole US Interstate Highway system cease to function is a closer comparison on this analogy as that is exactly what has happened in the banking sector - the whole of the 'inter-bank' trading network has virtually ceased to function.

If one uses the proper analogy, your friend's argument on this point evaporates. The problem is indeed, quite severe - far beyond any 20-car smash-up. We'd need many millions cars and transport trucks to be effected for a similar scale to the banking crisis.

Secondly, I'd address this little bit of ideological masturbation...



This is stated/asserted as a simple article of faith in order to justify an ideological opinion. The facts of the matter don't actually support this interpretation.

Prior to this year, Japan, Italy and Greece are/were the most heavily indebted nations in the western world - all with public debts above well 100% of GDP (170% for Japan). Belgium and Germany come next. If government debt (demand for credit) was so dangerous to the proper operation of financial-credit markets, then we should expect these particular countries to have the most horrific banking problems (rather than the USA leading the pack). Though Belgium has had to assist in the Fortis bailout/nationalization. Indeed, Japan with the highest ratio of public debt in the western world, actually is in pretty good shape on the banking/financial system going right now.

And Iceland and Ireland, two countries that have been amongst the hardest hit by the banking crisis show comparatively low levels of public debt (far lower than the USA). Britain also has been hit very hard and they have public debt levels less than France, Austria, Finland and Sweden (all who are suffering comparably less from the credit crisis).

I might also add that overall public debt levels (expressed as a percentage of GDP) is comparably less than it was 20-30 years ago. Why is the crisis happening now and not then?

Ergo, government debt ought to be rationally rejected as a 'suspect' in the murder of the financial sector. The facts of the matter just don't support that interpretation.

That being said, asserting that public debt is the ultimate evil is a common component of 'US Libertarian' style ideology. The assertion is pure ideology and thus is usually held independent of factual support.

Thirdly, with respect to your friend's comments about the particular US bailout package ($700 billion Bush-Paulson plan), I think he is again playing a bit of a game here, though he may be unaware of how this plan has been radically changed since it was initially proposed.

That is to say, the initial plan was indeed a boondoogle of the worst kind and no self-respecting economist supported it. However, it has been substantially altered in Congress at the time of its passage to permit the US Treasury to engage in exactly the same steps that the British Exchequer has taken - a policy approach that has been generally applauded by most economists.

The so-called 'British-Brown' plan has quickly become the most generally accepted 'consensus' position for how to address the present problem with public monies. This is now what the US Treasury is actually doing (or planning to do) with a substantial portion of the $700 billion bailout funding package (though I'm sure they will still find a way to funnel a few billions back to their friends and supporters - as that is the American Government way and always has been - 'to the winner goes the spoils').

In other words, many/most economists NOW do support the present US Treasury spending of the $700 billion - because of these changes and always with the caveat of following the 'British-Brown' plan of approach (particularly on the issue of bank recapitalization).

The original Bush-Paulson plan called for buying $700 billion in ugly assets off US banker's books. The British-Brown plan calls for spending a comparatively similar amount of money on equity in British banks.

The reason is all about capital-equity ratios. Investing $700 billion in bank capital (buying bank shares) equals $7 trillion in money that can be loaned out by the bank. Alternatively, buying $700 billion in ugly bank assets just adds $700 billion to the pot of money that the bank can theoretically lend out. The difference is an order of magnitude. $7 trillion vs $700 billion. Economists absolutely favor the capital-equity approach over buying distressed assets.

Bottom line is that there really is a big problem out there and it really does need public money to 'fix' the problem to prevent a major economic collapse (of the 1930's magnitude, which was roughly a 25% drop in US GDP).

Something needs to be done and thankfully, the US Treasury has been coming around to the British position on the issue and that is very, very good news. I will go along with The Economist on this issue.

Impressive post. :eek:

Too bad he isn't a member here. I would love to see his reaction to your post. He is very confident in his stances. I have invited him but he never joined.

What do you think about his example about Japan? It seems to contradict everything I have seen on the subject.

[Michael]

As for Japan, that's an important situation to look back on - since they experienced a local version of this same problem with the popping of their property bubble in 1989. At the time, Japanese banks topped the world's charts (3 out of top 5 largest banks were Japanese in the late 1980's).

The Japanese were very slow to do anything, and they did dozens of different things, always too little, too late and never anything that would offend the politically entrenched powers that had contributed/enabled/profited from the bubble. Thus, it dragged on and on and on for more than a decade, flittering with recession and deflation. They've finally recovered over the course of the last five years, but I think that has only been through natural attrition and natural economic growth. The Japanese finance officials deserve probably no praise at all for anything - not even the slow recovery.

It was like Japan just bunkered down and waited out the storm - and eventually lucked out with a recovery after a dozen years of stumbling in the dark. In the process they spent/wasted the equivilent of about 25-30% of GDP and doubled their national debt. Whatever one does here, don't look to the Japanese experience for guidance. The Japanese 'economy' is a world unto itself - ruled (I think) by old feudal warlord families.

[partofme]

As for Japan, that's an important situation to look back on - since they experienced a local version of this same problem with the popping of their property bubble in 1989. At the time, Japanese banks topped the world's charts (3 out of top 5 largest banks were Japanese in the late 1980's).

The Japanese were very slow to do anything, and they did dozens of different things, always too little, too late and never anything that would offend the politically entrenched powers that had contributed/enabled/profited from the bubble. Thus, it dragged on and on and on for more than a decade, flittering with recession and deflation. They've finally recovered over the course of the last five years, but I think that has only been through natural attrition and natural economic growth. The Japanese finance officials deserve probably no praise at all for anything - not even the slow recovery.

It was like Japan just bunkered down and waited out the storm - and eventually lucked out with a recovery after a dozen years of stumbling in the dark. In the process they spent/wasted the equivilent of about 25-30% of GDP and doubled their national debt. Whatever one does here, don't look to the Japanese experience for guidance. The Japanese 'economy' is a world unto itself - ruled (I think) by old feudal warlord families.

That was my argument. He tried to claim that things went bad and the crisis there went on for over a decade because of the intervention rather than because of the original problem.

[Michael]

That was my argument. He tried to claim that things went bad and the crisis there went on for over a decade because of the intervention rather than because of the original problem.

Gosh no. I don't think the Japanese actually solved their problem - they just weathered the worst effects and waited for things to slowly come back eventually.

The Japanese are rather well structured to repeat the problem. The connections and cozy relationships between government finance, banks and private industry are as opaque as they have ever been. :rolleyes:

[partofme]

Gosh no. I don't think the Japanese actually solved their problem - they just weathered the worst effects and waited for things to slowly come back eventually.

The Japanese are rather well structured to repeat the problem. :rolleyes:

And that seems to be what he advocates that we should do.

[Michael]

Here's some support for my assertion that US economists are generally in favor of the 'equity-capital' approach recently announced by the US Treasury. The source of the link itself is important for making the point here. ;)

Source: WSJ (http://blogs.wsj.com/economics/2008/10/14/a-thumbs-up-from-the-ivory-tower/)

[partofme]

Here's some support for my assertion that US economists are generally in favor of the 'equity-capital' approach recently announced by the US Treasury. The source of the link itself is important for making the point here. ;)

Source: WSJ (http://blogs.wsj.com/economics/2008/10/14/a-thumbs-up-from-the-ivory-tower/)

Thanks. :)

I'm not going to steal your arguments but it was helpful to see your take on it.