Tuesday, October 25, 2011

Catastrophe is vital to a free market system

Greece is broke and owes more than anyone believes it can ever pay back. They got there on sales of bonds to investors, which include nations, banks, businesses, organizations and individuals. These investors fear the consequences of having to actually realize the losses they've incurred. It's a very similar scenario to the pre-TARP days here in the United States. The investors argue that it would not just be a financial loss to them, but a shock to the whole system as a consequence of their failure. They hope the general fear will be equal to their own and everyone will work to cushion the blow. Cushioning the blow means transferring the loss to the general public to the largest extent possible.

This has worked in the sense that large businesses have been spared the calamity of letting nature run its course, and the system is in a long term funk rather than getting a short term wallup. The problem is that the bad ideas don't get the drubbing they deserve. The status quo, which failed, is kept alive. Nothing is learned. Innovation is not incentivized. Proven failures in policy are kept in place and even expanded upon. No pain, no gain.

Physical pain, is in one regard, a warning to the occupant of the body: "Don't do that." or "Don't do that again". It has a purpose. In fact a human, on it's own, without the capacity to feel pain would not likely live very long. Even mental pain and regret serve a purpose. The message is: "That course of action was a mistake. Don't do it again."

Fiscal pain serves a similar purpose in the market place. At the transaction level, if a consumer feels like he or she got less value than he or she anticipated, that's regret and will prevent the consumer from buying the product or service again. Bad value propositions die out over time. Now if the government stepped in and offered to pay half the purchase price for you, you might change your assessment of the value proposition, and the bad model is saved. Incompetence, deception, low quality, bad ideas are kept alive and well.

At the government level, the same dynamic is at work. Their ability to borrow is based on the market's confidence in their ability to make good on the bonds over time. If the bonds are backstopped, guaranteed or insured by a group of other governments, investors need not worry about whether or not the system of government can produce a viable, vibrant economy. Succeed or fail, they're going to get paid. Failed policies live on. Unsustainable governments are sustained. Bad ideas are reinforced.

The marketplace of ideas is directly connected to the actual marketplace. You have to acknowledge and remove the trash periodically or you will simply wallow in trash. Free market forces are very efficient at spotlighting the trash. Committees, elected or otherwise, are not. In fact, many governments prefer to deny the existence of trash to having to actually point it out or acknowledge it. Care free investors enable this approach. Investors are care free when taxpayers absorb their losses.

Imagine if investors actually had to consider whether or not a system of government would produce happy, productive citizens with a desire to excel. The only way to get that back into the equation is to take away the safety nets. Pain hurts. That's why it's effective. Making ourselves numb is not a path to a better future.

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