Wednesday, April 27, 2011

David Stockman is Right On Crony Capitalism and the Fed

David Stockman seems to just get better and better in his analysis of our current economic institutions. In a little over four minutes, he does an excellent job describing the shortcomings of our current economic system that stem from our faulty economic policies developed over decades.

He so gets the distinction between a free market and the crony capitalism rampant today.  He understands that the economic crisis is not a failure of the market, but that the market was not allowed to function because the "rules of the game" were changed.

One of the things that makes the free market work as an institution of social coordination is that it is a profit and loss system. It is the risk of loss that encourages entrepreneurs to invest only in supplying goods people demand. If they do not, but rather produce goods that they cannot sell at a price high enough to cover their costs, they reap losses. It is good that they do so, because this provides a very quick and real incentive not to waste scarce factors of production. If they persist in reaping losses, they eventually will run out of capital and will have to cease functioning as an entrepreneur. They will not be able to waste resources forever.

When the state intervenes, however, in such a way so that entrepreneurs think that certain investments cannot lose, because the government will cover any losses, this creates a tremendous moral hazard.  Entrepreneurs are encouraged  to invest in the more risky, but protected investments.

He is also extremely perceptive in understanding the Federal Reserve to be "the great enabler." The Fed bankrolls it all.

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