Monday, January 5, 2009

What is now our guidepost?

Markets have failed us.

Economics has failed us.

Our regulatory system has failed us.

Those that staffed that system have failed us.

No other economy held up better so there is no real model to choose from to replace ours... So what do we believe in? What will guide our way?

Creative destruction meets destructive destruction?
Joseph Schumpeter spoke of capitalism as full of waves of 'creative destruction'. And as surely and the computer and software became king the typewriter's future was set along with that for 'White-out" and correction tape. No one would suggets government should go in an bail them out. Or the makers of buggy whips...

Yet we see the goverment is bailing out banks and the Fed is lending more broadly. What is going on?

Daydream believers...
The system we believed in is in shambles. In trying to save it, we have violated just about every rule it purports to stand for. Yet, we are still capitalists and the Fed/Treasury was looking for a way that markets could find the solution (reverse auctions) even as markets pitched us into a deep morass of trouble.

Markets lose the functionality
Markets are suppsoed to get prices right. But oil rose to $70/bbl, surged to nearly $150/bbl then fell back sharply. So what service did this market provide to help investors sort out alternative energy issues? None. Markets have failed as the gatekeepers for getting pricing right and helping to direct investor traffic. Markets have sent many an investor scurrying in the wrong direction. Some volatily is to be expected. But look at house prices. They are not supposed to be so volatile but look at what they have done. Look at how badly they have led the consumer. Look at the eveil they have brought for banks. How are we to look at that?

Like the rest of you I expect us to put these failings behind us and to look ahead. But there is a good lesson here for using judgement and for regulators to show some gumption in doing their job.

What market failure means
No matter how much economists want to revere markets there is no denying that markets have failed in such an extreme way it will be hard to argue that there is not a a substantial role for regulators to interfere- to show judgement.

Dealing with a stacked deck
It is also hard to know when markets are by themselves going back to do the job they for a while did so well. There will be no public announcement. No email will be sent to your in-box. But markets have failed us us in so many ways that it is hard to know when to start trusting them again. So between now and then what will guide policy? How much stock will investors and the Fed place in the behavior of markets? That remains an intersting question. Unilt then we will be guided by the judgements of our main institutions, substantially the policies of our central bank.