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Changing Markets: Robert Reich has a Plan: Rebuild Trust
By: James Jeff McLaren
Major Topic: Economics
Minor Topic: Psychology

Robert Reich has written and article which is full of faulty analyses and non-solutions posing as solutions. “Bailouts, subsidies and government insurance won't help Wall Street because the Street's fundamental problem isn't lack of capital. It's lack of trust.” Well, lack of trust may be a problem but it is not 'the Street's fundamental problem'. He goes on to give an example of a lack of trust issue but the example is of a lack of knowledge. People were recklessly trading things about which they knew nothing. He seems to lament the fact that as this crisis continues people are exercising a little more prudence. It seems that people had too much trust when they should not have been so trusting. Yet his solution, which he claims will build trust, will not build trust nor will it solve the true underline problem. The results of increased regulations will be to create the appearance of trustworthiness which will evaporate at a later crisis. The real fundamental problem is with the system of fractional reserves and the creation of fiat money. This system is based on a belief that the money supply should be government controlled in order to better build the economy and control prices. This system has many advantages and some draw backs. The principle draw back is the inevitability of market crises. Regulations will not stop crises from developing. Why then would intelligent men like Robert Reich promote such useless remedies? There appears to be an unsavory answer: a childish quest to effect any kind of change that may increase their personal power or prestige.

         Psychological analysis

         Children often run and “tell on” one of their peers. They experience something that makes them want to affect a situation. When they find they are powerless on their own they seek to bring in a third party which they can control in some way. Perhaps one child hears another use trash words and remembers being admonished by an authority figure to not use such words. Perhaps the child witnesses an incidence of bullying and remembers a punishment that was dealt out in the past. In either case the child senses that an authority figure may be able to be brought in to affect the situation. If successful the child will feel a strong sense of power: they affected a situation by harnessing an authority figure in a way that produced results far in excess of what they could do on their own. The successful deployment of an authority figure to intervene brings an immense sense of accomplishment and personal power which can be addictive. Depending on each case, the adult who hears the complaint should have one of two possible responses: First to laugh it off when the point at issue is frivolous, not an injustice or is designed to punish unjustly. Second to go and fix the injustice when a legitimate concern is raised. A failure to enlist the authority's power will result in further reflection on the nature of what motivates the authority or depression and disillusionment. As a parent, one hopes that children learn to distinguish justified cases from unjustified cases.

         This discernment is a life long process for this game is not only played by children in a school yards. It is played at all ages throughout life. The most public form of the game is played out in court cases where a judge is the authority figure who judges complaints as having merit worthy of state intervention or as having no merit worthy of state intervention. The winners in such positions feel the same sense of power that the child in the playground felt in successfully mustering the teacher to fix some wrong.

         At the highest most consequential level in which the game is played, the authority is the U.S. Congress and/or president. Together these two offices can have a greater effect on the lives of people everywhere than any other body (although another body may act with more force the potential force that the U.S. Government can call up exceeds all others). For someone to yoke them to their will is likely the most powerful form of personal power that any policy maker will ever experience. This often takes the form of a “call to action.” Someone express an idea that they think will affect a given problem. Then calls on the government to take action.

         We all have or should have the right to express ourselves but when the expression calls for action on the part of a powerful authority we should seriously consider whether the proposed action is meritorious or unmeritorious; effective or ineffective.

         If the agent calling for change is making unmeritorious suggestion – similar to child trying to inappropriately involve an authority figure – then we should at least ignore such calls for change or more appropriately expose their true nature.

         If, on the other hand, there is a break with basic justice and the action meritorious then we should look deeper and determine whether a course of action will be effective or ineffective at restoring justice. There are tests for determining the justice of an event. The simplest principle of justice is that people ought to get what they deserve. In the article's illustrated example of the hedge fund manager who did not know what assets he had purchased for his fund, I see an example of a fool who probably deserves to have junk in his fund's assets. If he fails he probably deserved to fail.

         There are clearly some foolish parties who deserve what they get from the current credit crisis but there are some who did not get what they deserved from this credit crisis.

         For those cases, Robert Reich's analysis and proposed solution are hard to accept. His analysis seems to be off and his solution is not designed to fix his identified problem.

         He claims that the fundamental problem is a lack of trust. This, he claims, is why people are not lending. I submit to you that too much trust was the reason they were lending too much for risky and imprudent ventures. More trust now would continue the bubble. Someone somewhere woke up and started acting a little more prudently resulting in everyone re-evaluating their assets. This prudence is something that should always be in fashion.

         He further claims that “Financial markets trade in promises – that assets have a certain value,...” This is unbelievable, anyone who looks at a live stock market chart or a live NASDAQ level II screen can see the the values of all kinds of assets change by the second. He continues, “...that the numbers on a balance sheet are accurate,...” Naturally we believe they are accurate at the time of printing for the specified time. But no one believes they are accurate for all time. If they turn out to be inaccurate we call that fraud and we have police to arrest the fraudsters. “...that a loan carries a limited risk.” How limited the risk depends on the fine print and a whole host of external factors that cannot always be identified or quantified. Risk cannot be eliminated entirely – I do not imagine there is anyone who believe in a completely risk free investment.

         The only one of these that is even plausibly as a reason for the current credit crunch is the second one: fraud. There has been some evidence alleging fraud but fraud does not seem to be rampant enough on its own to cause this crisis. A more likely reason is stupidity. Where does this alleged stupidity come from that can cause the whole system to act foolishly? I will answer that in the next section.

         First though, Robert Reich uses his three reasons to call for building more trust. “And the best way to rebuild trust is through regulations that require financial players to stand behind their promises and tell the truth along with strict oversight to make sure they do.” Any institution that engages in fraud is punishable by law. If they do not keep their promises they are sued or have fallen into bankruptcy. How do you “make sure” they tell the truth when they are ignorant? It sounds from the example of the hedge fund manager that he told the truth when he said he did not know what assets were in his fund.

         Evidently Robert Reich believes we need more regulations and oversight. Now it becomes necessary to determine whether his suggestions will solve the “problem of trust” or the more accurate problem of stupidity.

         No one likes being told they cannot do something that they enjoy or have found profitable. This seems to be universally true for all humans. Anyone who has been around children knows that they will express their displeasure in countless ways. But more to my point, they will also test the limits of parental enforcement. They will find cunning ways to avoid breaking the letter of the law while breaking the spirit of the law. The adult version of this game focuses the creative energies of many people into finding ways to legally get around the new regulations. The regulations themselves only give the appearance of trustworthiness which will evaporate at the next crisis. This has been a reoccurring pattern: every crisis has led to more regulations yet these new regulations do not keep the next crisis from coming. Concerning regulations on knowledge: it seems that we cannot regulate knowledge. People forget things people play dumb and sometimes people pretend that they are smarter than they really are.

         The fundamental problem is that crises are part of the trade off to have a fast growing economy. Demand side economic theory encourages and justifies policies and institutions designed to develop the economy through government intervention by making sure that anyone who needs money to start or grow a venture will have it and by making sure that aggregate demand remains high during economic down turns (that is everyone should have access to funds to purchase the goods and services made by business). An unlimited supply of money (or more precisely credit) is needed to do this. The requirements are a fiat money system with a lender of last resort that can create money (if needed) and a system of fractional reserve banking. The benefits have been immense. Economic growth has been much faster and more prolonged. The detriments that the system causes are periodic financial crises, inflation and a certain injustice in the adjustment of interest rates and in who is allowed access to the unlimited credit reserves.

         Periodic financial crises arise because there is still a business cycle. Demand side economic policy has not eliminated the cycle it has amplified it. With one (or a derivative) interest rate for all firms being set by the central bank, all firms whether they are well run or poorly run are treated equally. This diminishes the benefits of prudent actions and applies a downward pressure towards fiscal irresponsibility. This makes a loss of confidence a general phenomenon rather than a localized phenomenon.

         When there is a crisis of confidence the central bank must provide liquidity to the system (that is insure that the financial players are solvent enough to meet their liabilities). But it must be careful. Increasing the money supply by a greater amount than the increase in goods and services will make consumers bid up the price of everything – otherwise known as inflation. The system works by creating demand which comes from increasing the money supply – this is the source of the constant inflation in our system. In a crisis, in theory the central bank could bail anyone and everyone out. But this would aggravate inflation and lead to the moral hazard of complete and total reckless behavior by firms. Therefore it must let some fail and die. In other words crises have to hurt some in order to prevent more hurt later to more people.

         It is usually considered unjust to treat unequals equally. In this sense one central interest rate is unjust. A well run and highly stable bank should be of less risk than a poorly run and unstable bank, yet they are both treated to the same interest rate by the central bank. What is the benefit of prudent judgment for banks? In theory there is little reason to be prudent. In practice the government seems to bail out the worst offenders (the offenders that are “too big to fail” that is those who were the most reckless) as an example Lehman Brothers was allowed to fail but AIG was not.

         Robert Reich's solution is not really a solution to his identified problem nor is it a solution to the real problem. Why then do so many intelligent people call for this kind of action?

         I suspect it is another childish game played at the highest adult level. Games of boasting and bragging are common among children as we mature the game becomes more subtle and hopefully more worthy. Where children are apt to say, “My father/house/toy is better than your father/house/toy because ...” and then make up any excuse to justify this rationalization, adults often do the same. A more mature version should not be based on fantasy, wishful thinking or unsubstantiated opinion, rather it should be based on the facts of reality.

         Robert Reich is calling for something that is, unfortunately, quite likely to happen. If it does he will have contributed to manufacturing the consent of the public for a new regulatory framework. This IS something to brag about. Sadly it is the wrong thing to brag about. For Robert Reich it may even return him to the inside circle of the power elite. However like a child who is not concerned with facts, the truth, or reality, Robert Reich seems to care less about an effective and meritorious solution than one that can increase his personal power and prestige.

Added on: 2010-05-29 06:36:18
By: James Jeff McLaren
© 2008 - 2018, James Jeff McLaren