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Did Small Government Cause Our Currnet Problems

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September 09, 2009 – Comments (23)

Funny that historian Robert Higgs would ask this question.  It gets asked here quite often...ahem.....:

Before I get to that, I wanna address some people here at CAPS.  I see gold is back up to $1000/ounce.  Very interesting.  That means that gold investors have recovered all of their loses from the recent correction.  How does that compare to the perma-bulls?  They're still cheering on rally a that puts the average investor well short of the 2007 highs.  Isn't that something?  Meanwhile, the dollar keeps taking a beating, stagflation is on its way, and the hard metals are looking good. On another note, some here may know that I'm down on most gold miners (much to TMFSInchi's dismay!)  Well, I like GRZ.  Take that for what it's worth.  Looks like the Austrian School economists were right again.  It gets boring doesn't it?

H.L. Mencken described politicians as "men who, at some time or other, have compromised with their honour, either by swallowing their convictions or by whooping for what they believe to be untrue." "Vanity remains to him," Mencken wrote, "but not pride."

David in Qatar

Did Small Government Cause Our Current Problems by Robert Higgs

As soon as I saw the headline of an August 10 article by financial columnist Peter Cohan, I knew that something was terribly wrong. It reads: "How did the politics of small government lead to big government bailouts?" This is akin to asking, How did the extinction of the elephants lead to Barack Obama's election as president? If you make a claim of the form "A caused B," but A never happened, then you are wasting your time by delving into the historical details of a bogus relationship.

Yet we continue to see one example after another of what suspicious readers may be tempted to view as the Big Lie: that deregulation or other obliging government measures caused the present economic mess. I won't go so far as to characterize this claim as a Big Lie. Although some of its purveyors, acting out of partisan motives, surely know that they are blowing smoke, others may simply suffer from economic ignorance, analytical confusion, or loss of historical memory. In any event, the public is ill-served by commentators who purport to speak with authority about our current economic troubles, yet merely peddle this worse-than-sophomoric tale.

The Cohan article in question consists of so much nonsense that a full critique of it might be enough to compose a student's senior thesis. But the part that interests me right now is the claim that

the idea of small government … helped create the ineffective regulatory agencies which allowed all kinds of questionable practices to thrive in American business, especially in the world of finance. By helping create a record debt bubble, which thrived in an era of weak regulatory oversight, small government nearly ruined the global economy last fall.

So, there you have it in plain English. To repeat: "small government nearly ruined the global economy last fall." Cohan spares us any evidence that we actually had a small government at any time during the past 25 years. I would be especially interested in such evidence, inasmuch as I have written a number of articles and books brimming with evidence that in fact the governments of this country at every level were growing in size, scope, and power during those years.

Like Cohan, those who continually blame insufficient regulation for our present plight offer little or no evidence. They rely instead on the implicit assumption that if only the regulations had been much stricter, the bankers and other business-sector malefactors never would have perpetrated their evil deeds. This faith in the regulators is touching, to be sure, but it is also extremely naïve. We now have — and long have had — miles of regulations on the books and legions of regulators at work in scores of government agencies. What specific power did they lack? And had they been given even greater powers, budgets, and staffs, what enchantment would have transformed these ostensible guardians into smart, dogged champions of the public interest, rather than the time-serving drones and co-conspirators with the regulated firms that they have always been?

Somehow, no matter how many regulations are created and how many regulators are put on the government payroll, when these rules and enforcement agents fail to prevent a disaster, many people's response is to propose that the government write more regulations and hire more regulators. If these advocates of expanded government intervention had been in New Orleans as it was being submerged under Katrina's floodwaters, they no doubt would have proposed that the Corps of Engineers dynamite the remaining levies — to prove that they favored "doing something."

"Ironically," writes Cohan, "another Republican, Ben Bernanke … decided that in the midst of a catastrophic economic collapse … the prescription for the problem was the biggest government in American history." And thank goodness, too, he opines, because owing to all of the wonderful mitigation that the Fed's unprecedented actions have produced to soften and reverse this inexplicable, out-of-blue episode of financial panic and recession, "there is a good chance that historians will look back on Bernanke as the man who saved the world."

I can't speak for all historians, but I can guarantee that no such story will be disseminated under my name. On the contrary, by taking into account how the government and the Fed created necessary conditions for the financial bubble that burst last September — as many competent analysts have already shown — notwithstanding Cohan's disregard of their findings — we quickly appreciate that Bernanke's supposed world-saving would never have been deemed necessary had he and others in high government places not done so much to place the world in jeopardy in the first place.

Never one to linger over a single piece of nonsense when another beckons, Cohan proceeds without transition to the question, "How do we keep this from happening again?" To which his amazing answer is "The most important way is to change how bankers get paid." Oh, sure, that will turn the trick. Never mind the government's countless measures from the 1930s onward to steer money into mortgage loans to borrowers with little likelihood of repaying them. Never mind the massive efforts of the government-sponsored giants Fannie Mae and Freddie Mac to create secondary markets for rotten mortgage-related IOUs galore. Never mind the Fed's pumping up of the real-estate bubble by rapidly expanding credit and holding interest rates at absurdly low levels for years on end. Never mind all of this and a great deal more. Simply change how bankers get paid, and the sun will shine on us again.

"We [by which Cohan seems to mean the government] need to change banker's pay so that they only get rewarded if their risks are profitable," he declares, "and punished if they lose money." Some readers might find this idea appealing, if they don't spend much time thinking it through. In truth, however, the government already plays too large a role: if the government and the Fed did not stand in the background, ready and willing to bail out reckless bankers, the bankers would act a great deal more prudently, as would their boards of directors when deciding how to compensate the managers. Moreover, I venture to remind our financial guru — who is described as the president of a consulting and venture-capital firm, a management teacher at Babson College and the author of eight books — that how bankers get paid lies properly within the domain of the banks' boards of directors. It's really none of my business, or his.

In contrast, how the government and the Fed act is my business because they purport to act on my behalf, and even if they didn't so purport, they still act in many ways that harm me. So I'm entitled to hold them to account for their actions. As long as the Cohans of this world continue to blame private actors and "the idea of small government" for the economic disasters that the government and the Fed produce, however, we have little chance to clarify what can — and should — be done to remedy our plight and preclude serial repetitions of such destructive actions.

Not content with having embraced several stupendously erroneous and misguided ideas, Cohan plows to an equally dim-witted conclusion by declaring that besides setting the compensation of bankers, the government should establish "an independent government agency to create financial statements for companies and money managers." Sure. Let the government keep the accounts. After all, the government has a flawless record of keeping honest accounts and scrupulously avoiding multi-trillion-dollar Ponzi schemes such as Social Security, and pie-in-the-sky promises such as Medicare, which stretches to the limits of the known financial universe.

The Department of Defense, which since 1994 has been required by law to perform an annual financial audit, has yet to perform one. Each year a DoD accounting functionary dutifully testifies before Congress that the department's accounts are in such a mess that its records cannot be audited. Is this the kind of financial-accounting proficiency we want to impose on the private sector? Cohan thinks so.

Got a problem? Just give the government even more power, and our friendly, competent rulers will take care of everything. I shudder to think that columnists may actually get paid for spouting such childish twaddle.

Robert Higgs is senior fellow in political economy for the Independent Institute and editor of The Independent Review. He is the 2007 recipient of the Gary G. Schlarbaum Prize for Lifetime Achievement in the Cause of Liberty. Send him mail. See Robert Higgs's article archives. Comment on the blog.

This essay originally appeared on Independent.org.

23 Comments – Post Your Own

#1) On September 09, 2009 at 2:59 PM, whereaminow (22.35) wrote:

Oh, pardon me. In the spirit of full disclosure I am long GRZ in real life.  (As I said before, I won't mention a stock as a buy unless I actually own it.)

David in Qatar

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#2) On September 09, 2009 at 3:11 PM, catoismymotor (32.76) wrote:

+1 Rec for the use of the word twaddle!

To risk being labeled as a *government hater* by leohaas I enjoyed this. Good job. 

 

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#3) On September 09, 2009 at 3:14 PM, goldminingXpert (29.48) wrote:

Didn't GRZ get Krystallex-ed? or am I thinking of some other unfortunate south american miner?

You can still get good miners like NXG at fair prices though most of them (like JAG) are too rich for my taste.

ABX is getting crushed today--can't believe they'd end their hedging now!!! We end our hedging a stone's throw from THE all-time high of our product. Brilliant!

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#4) On September 09, 2009 at 3:25 PM, whereaminow (22.35) wrote:

goldminingXpert,

It may not be long before all Venezuealan miners get Chavez-ed, in the spirit of open minded and loving socialism!  Until then, I like how they manage their cash, and they have a good balance sheet.  At anything under a buck, they are very undervauled.

David in Qatar 

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#5) On September 09, 2009 at 3:34 PM, brickcityman (< 20) wrote:

Could it not be said that the muddling of small-government principles coupled with not-so-small government principles is really what's caused our problems?

 

If you ask me our problems stem more from the tinkering of puppets (congress) with little grasp of the subject matter than in any wholesale adoption of a particular market philosphy.  To me selective deregulation and selective tax policy changes do more harm than good since they are often not accompanied by the sorts of counter-balances necessary to offset un-intended consequences.

 

You can carp about the innefficiencies of government beauracracies all you want but they are the collective reflection of their makers...  So long as each political party is more interested in scoring points against each other with at best a 2-4 year time horizon this is the result you'll get.

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#6) On September 09, 2009 at 3:43 PM, GNUBEE (26.92) wrote:

David, heard some excerpts from the Greenspan interview on BBC recently.

According to him the fall of the USSR caused new capital to be formed and or released (in new "free market economies") and speculatively misallocated, causing our current crisis.

Not so much tied into your blog, but found it funny that our old egg head professor thinks the emergence of new capitalist systems caused our ills. So it's not our bankers who are to blame- but the "ruskies".

 

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#7) On September 09, 2009 at 3:44 PM, leohaas (32.29) wrote:

Cato, why do you perceive being called a "government hater" a risk? I thought people like you would call it a badge of honor!

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#8) On September 09, 2009 at 3:46 PM, SkepticalOx (99.43) wrote:

I think #5 hit it on the nail. During the Bush Years, it was big government sprinkled with small-government ideas. You can't deregulate AND bailout at the same time, for example, your cut taxes AND spend more. It may possibly be better to follow big government policy in a consistent manner than a mixed salad of rules and regulation that conflict with each other and end up doing more harm.

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#9) On September 09, 2009 at 4:00 PM, whereaminow (22.35) wrote:

leohaas and SkepticalOx,

Can you address any specific part of small government ideology that caused market failure?

Blaming deregulation is like blaming Santa Claus if you don't receive a present on xmas. He doesn't exist.

The 2008 SEC Rules and Regulations is 4,000 pages long.  The Federal Reserve has regulatory responsibility over every single financial instrument created by investment bankers.

What specifically has not been regulated, or is too deregulated, that caused our current mess?

David in Qatar

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#10) On September 09, 2009 at 4:00 PM, catoismymotor (32.76) wrote:

Leohaas,

I was pretending that your negative opinion of me matters. And to set the record straight for others that might care to read this: I am not a government hater. To imply that I am is to also suggest that I am an anarchist, which simply is not the case. The rule of law is very important. I simply wish to have a less powerful federal government and to see a changes in many laws I see as harmful. I like to think this is a simple idea to understand.

Cato

The more corrupt the state, the more it legislates. – Tacitus

Timid men prefer the calm of despotism to the tempestuous sea of Liberty. – Thomas Jefferson

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#11) On September 09, 2009 at 4:15 PM, whereaminow (22.35) wrote:

A note on Robert Higgs, for those not familiar with his work.  His most important book is Crisis and Leviathan, in which he painstakingly detailed the curious habit of government to use a crisis to grow larger and more powerful, but never recede to pre-crisis levels after the crisis had passed (regardless of the government's role in creating the crisis or its ineffectiveness in solving it!) 

Does any of this sound familiar??????

David in Qatar

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#12) On September 09, 2009 at 4:28 PM, 4everlost (29.41) wrote:

Isn't it amazing that so many new regulations are an attempt to fix previous regulations?  Rec #7....

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#13) On September 09, 2009 at 4:33 PM, catoismymotor (32.76) wrote:

I have heard of the book but have never read it. Donkeys and Elephants are quite adept using scare tactics to increase their power, rob us of liberties and to increase our taxes. For either side to let a crisis go to waste is almost unheard of.

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#14) On September 09, 2009 at 5:59 PM, whereaminow (22.35) wrote:

Fellow libertarians, I just received notice that my latest book is on the way: Garet Garrett's Harangue.  I'm not sure that I've even been so excited for a book in my life.  I've posted some of his work before.  He's a forgotten journalist from a forgotten time, when liberty was held as the highest ideal by the American public, and Socialists used any deceitful tactic they could to sway public opinion (actually, that last part hasn't changed one bit.)  Friends tell me that Garrett's books blow Rand out of the water.  We'll see.

Harangue is based on the true story of North Dakota's attempt to implement a workers paradise from 1918-1921. Governor Lynn Frazier was finally recalled for incompetence in 1921 when the State Bank was found to be insolvent (sound familiar?)  Rather than spend the rest of his sociopathic life in humility, Frazier went on to serve many terms in the Senate, helping to continue the Socialist American revolution. 

It is a revolution that continues today - one not in the form of government but in the role of government

Strike the root.

David in Qatar 

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#15) On September 09, 2009 at 6:57 PM, uclayoda87 (29.24) wrote:

Meanwhile, the dollar keeps taking a beating, stagflation is on its way, and the hard metals are looking good.

Gold rising, US dollar index is falling and the unemployment rate is almost at 10%.  Looks like stagflation is already here, it was coming in 2008 when unemployment was only 6%.

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#16) On September 09, 2009 at 9:16 PM, devoish (98.37) wrote:

http://seekingalpha.com/article/71265-the-credit-bubble-deregulation-gone-wild 

I'm sorry David, I could not help myself. The link is for you, I cannot take the time now.

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#17) On September 10, 2009 at 7:18 AM, dbjella (< 20) wrote:

I always have wondered if regulation can ever be done right?  Politicians love to write regulations.  Most of these regulations are hard to uphold and left to interpretation, but they keep writing them to appease the masses.  

I am amazed how much money companies spend in compliance.  At the companies where I consult, I notice It takes longer and longer to get projects done.  As we drag in the compliance people I often hear "all we need to do is show that we are attempting to be in compliance."  You can't make it up.

David, thanks for enriching my life through your writing.  I think more by reading your posts and your links to Mises.org.

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#18) On September 10, 2009 at 11:44 AM, outoffocus (22.89) wrote:

This is just as bad as Michael Moore blaming "Capitalism" for the financial crisis.  Only someone who doesnt understand capitalism would blame capitalism for the financial crisis.

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#19) On September 10, 2009 at 11:53 AM, SkepticalOx (99.43) wrote:

whereaminow 

There's nothing inherently wrong with specific small government policies by themselves. What I had implied is that band-aiding big government with small-government policies here and there might have made things worse. The repeal of the Glass-Stegall act, the Bush tax cuts to the wealthy while spending more, etc. etc... Unless your going to completely overhaul something, simply making regulations more lax on several points won't make the situation any better.

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#20) On September 10, 2009 at 2:47 PM, whereaminow (22.35) wrote:

SkepticalOx,

I would absolutely agree that the repeal of Glass-Stegall was important.  Bush tax cuts to the wealthy, however, were smoke and mirrors.  35% vs. 39%, wow, i'm so enthused to have a republican looking out for me!!!  Give me 0% and we'll talk tax cuts.  Bush's spending was real and devastating, as is the current administrations.

But here's the thing:  If the government changes the rules for government regulated and husbanded entitites, which have a government guaranteed backing that is NOT deregulation.  

Abolishing the FDIC would be deregulation, for example.  Deregulation is the elimination of government controls.  

Bad policies are real, but deregulation is not.  It's kind of a curve ball to keep you blaming anybody but the government.

David in Qatar

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#21) On September 10, 2009 at 8:30 PM, devoish (98.37) wrote:

Deregulation;  Main Entry: de·reg·u·la·tion Pronunciation: \(ˌ)dē-ˌre-gyə-ˈlā-shən\ Function: noun Date: 1963

: the act or process of removing restrictions and regulations

de·reg·u·late \(ˌ)dē-ˈre-gyə-ˌlāt\ transitive verb

Deregulation is NOT the elimination of government controls. It is any reduction of Government controls.

At least according to Miriam Webster.

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#22) On September 11, 2009 at 1:59 PM, brickcityman (< 20) wrote:

One should avoid getting too tripped up over the need for a law to be changed in order for you the consider deregulation as real...

 

Laws are text in dusty books.  The actions of REGULATORS is what really matters.

 

And on that account I think you could safely say that many of our regulators were not regulating and many of the regulated were successful in avoiding  regulation.

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#23) On September 14, 2009 at 1:10 PM, DaretothREdux (44.04) wrote:

David,

Catching up on your blogs. This was a good one!

Dare

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