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Can We All Just Agree That Price Controls Do Not Work?

Photo by: ellievanhoutte

Laying some groundwork for a future post, I wanted to have a quick discussion about a topic that amazes me as a complete disconnect between reality and policy.  Price controls have been suggested as solutions for everything from food shortages, to black markets during sieges; but they have an amazing history of achieving the exact opposite of their intent.  In a recent example, Hugo Chavez has attempted price controls in Venezuela, with disastrous results.[1] Before I start talking about some other policy issues, I want to make sure that we all agree that price controls simply do not work.

What are Price Controls?

Price controls are when some entity, typically a government, tries to externally set the price of something.  We most often see this in the form of price ceilings where the government tries to set the maximum price producers can charge for something.  One very common example of this is rent control.  The government doesn’t want property owners “gouging” their tenants, so they set a variety of rules on what the landlord can charge. As we will see, this never has the desired effect.

Keeping It Simple

What price controls advocates never seem to accept is that changing the price of something doesn’t affect the supply of that thing.  The government can say that all Ferraris only cost $50, but that doesn’t mean everyone can have a Ferrari.  In fact, Ferrari will immediately stop producing them.  The purpose of markets is to make sure that resources get to the people who want them the most.  Keeping prices low leads to overconsumption, inefficient allocation of resources, discrimination, and disincentive to increase supply.  Let’s look at some simple examples:

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  1. BBC News – Venezuelan Shoppers Face Food Shortages []
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The Problem with Uncertainty

Photo by: whatmegsaid

When it comes to government policy it is rarely acceptable for politicians to do nothing.  Even if it’s only to give the appearance of doing something and instilling confidence, the government actually does have a role to play.   While there is certainly a case for stimulus and crisis management, too much government intervention can completely upset the whole purpose of free markets.  Even worse, the fear of government intervention can inject the same uncertainty in the market that it is supposed to help assuage.

The 2008 Crisis

In retrospect there is a lot of criticism about the TARP-the Troubled Asset Relief Program.[1] Some politicians complain that the prices paid for the equities were too high.  This criticism is somewhat problematic, since the whole purpose of the TARP was to pay more than the market was willing to pay for distressed banks.[2] Others claim that it was unnecessary, and that the market would have sorted things out itself.  These criticisms conveniently forget the abject panic that had beset the markets when the idea was put forth.  There was a tremendous amount of uncertainty as to whether the banking system was going to completely collapse and how the world would react.

With all its flaws the TARP may very well have injected some confidence into the market.  The same can be said of Obama’s sweeping stimulus.  Investors and businessmen knew that a large dose of spending was coming and had broad ideas about what it would include.  Economists may argue, but a case can be made for all these changes, particularly when they’re done quickly and in a sweeping fashion.

The Problem

The problem arises when the government becomes a first resort instead of a last resort.  When people expect the government, instead of natural forces, to correct all the ills of the market, uncertainty is sure to follow.  The government can’t do everything, so the economy becomes a guessing game of trying to determine which programs the government will implement.  Even worse it can become a hotbed of cronyism, where the supporters of those in power get bailouts and the rest watch despairingly.

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  1. Wall Street Journal - Panel Steps Up Criticism of Treasury Over TARP []
  2. The Economist – Carping about the TARP []
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Debt and Moral Hazard

Photo by: Vinay Deep

For decades now the American approach to debt has been to worry about it later.  We’ve essentially kicked the problem down the road.  While some points in our history may have suggested somewhat higher debt levels, we’ve done nothing to reduce them in more booming times.  Ultimately we’ve just turned a blind eye to a growing problem and it may be too late. 

Many people are talking about moral hazard these days, but strangely they all seem to think it’s something that applies to someone else.  Bailouts of millionaire bankers strike us as outrageous, while we personally hold an absurd amount of debt.  Somehow the country got all screwed up without any of us being at fault. 

Our politicians seem to suggest that their opponents are the ones rewarding negative behavior and that they themselves would never commit such an act.  This doesn’t hold up to much scrutiny however.  Throughout the booms of the previous decades, neither Democrat nor Republican has ever used fiscal policy to “cool down” a boom.  Nor have they used any of the booms to reduce our debt to increase our capacity to deal with the next bust.

Clinton was just beginning to talk about reducing the debt when the Internet bubble burst.  Bush managed to go through a massive housing bubble while growing the national debt by over 4 trillion dollars.[1]  Government has simply never shown any discipline in managing its budgets.  Unfortunately, this is not only true of the government.

Short Term Myopia

Americans and people in general have a tendency to look at a very short sample space and assume that the results they’re seeing are meaningful.  Ten years is a long period of time in a human life, so if something has held true for the last decade, it must be true, the thinking goes.   Unfortunately those ten years are actually quite a short time in the life of an economy.

So many times in history we’ve been told that “things have changed.”  Something has fundamentally shifted and the old rules don’t apply anymore.  For the last decade, people watched their 401(k) accounts grow by double digit figures each year and they just came to assume that this was a sustainable result.  Similarly they’ve leveraged themselves to the hilt and assumed that since they’ve been able to sustain themselves with this massive debt they’d be able to do so in the future.  Sadly, this is an untenable ponzi scheme. (more…)

  1. CBS News - Bush Administration Adds $4 Trillion To National Debt []
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Why Now May Be the Right Time for Green Stimulus

Photo by: andjohan

In the period leading up to the realization of the current economic crisis, Green was booming.  Solar cell companies were stock market darlings, and the whole sector looked like it may have the makings of the next bubble.  Unfortunately the crash has of course taken some of the bloom off that rose and investment has decreased to 2007 levels.[1]  But the crash is offset somewhat by the components of President Obama’s stimulus package that call for spending on renewable energy and other “Green” projects.

Why Green?

Generally the idea behind counter-cyclical spending is for the government to put people to work doing things that benefit the country as a whole-thus the idea of building roads, schools, or something else that will give a lasting benefit while helping invigorate the economy through the spending.  This is a win-win.  For those who are pro-Green, environmentally friendly projects seem like the perfect kind of project.  You can wean the country off oil, save the environment and fix the economy all at once.  But is this argument realistic? (more…)

  1. Forbes - Venture Capital Investment in Renewable Energy Exceeds $836.1M in Q1 2009 []
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The Difficulty of Investing in 2009

Photo by: Mel B.

2009 is a dreadful year to try to invest.  While we have seen a massive rebound in stocks, there are a variety of factors that make long term planning very difficult.

Asset Class Difficulties

The first thing that makes the current economic climate so difficult is the correlation between asset classes.  Under normal circumstances declines in one asset class involve money moving to another asset class.  Thus when stocks go down, bonds or gold or another asset class is usually the beneficiary.

What makes the current economy so difficult is that you see capital essentially being “destroyed” by the deflationary spiral.  Forced liquidation on the part of many funds caused by redemptions and margin calls contribute to this problem as well.  While this problem was particularly pronounced in 2008, you continue to see deflationary pressures affecting all asset classes.

Government Intervention

One of the most obvious difficulties of building a long term plan in 2009 is the frequency and fervor of government intervention.  Policy makers are attempting to walk several fine lines and thus are constantly exerting strong forces upon the market.  In their zeal they make it very difficult to draw long range conclusions about what makes sense.

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