We hear a lot from the right that, if government would just stop meddling, the markets would correct themselves and everything would be hunky-dory. Today I’m going to try to break down, in the most basic way possible, why the free market, especially in the form of the stock market, inherently tends towards the catastrophic situation we’re in now.
Remember, I’m making the most basic argument for government regulation of the markets. I’m not an economist, and I don’t understand the crazy things going on in the upper echelons of finance these days, but I don’t think that’s really necessary to understand why the market inherently tends towards bubbles.
First off, the free market assigns all goods a monetary value. Obviously, there is no way to perfectly tie the money value of, for example, an umbrella, to what the umbrella is actually worth. Conservatives will try and talk about the markets correcting themselves through supply and demand, but the underlying truth is that the money value of an umbrella is never a perfectly accurate reflection of its worth.
So, when merchants buy a product, they can mark up the price and try to convince someone else that that’s what it’s really worth. With something like an umbrella, the markups eventually stop, because you, the consumer, buy the umbrella and put it to use. In the stock market however, the markups keep going on and on, with each stock broker trying to convince the next guy in line that the stock is worth more than it was originally purchased for.
The seller always has a strong incentive to inflate the actual value of what is being sold. As a result, there is an inherent tendency in the market towards bubbles: the seller can sell for whatever price he can convince someone else to pay, no matter how ridiculously inflated and abstracted from the original value of the product it actually is. Making matters worse, today, we have all sorts of strange financial products that aren't even based on something concrete like an umbrella. That makes it even harder to tell what the thing being sold, for example a bundle of mortgages, is actually worth. As we've seen, it's pretty easy to hoodwink people into thinking it's worth a heck of a lot more than it is.
So, the markups go on until eventually some schmuck buys the stock for a price that no one else in their right mind would ever pay.
So when a conservative tries to tell you that the market regulates itself, you should translate it to mean, “Eventually, in the free market, some poor schmuck gets burned.”
If you think grade inflation has been a problem recently, you should take a close look at the stock market before 2008. Since everyone is trying to convince the next guy in line that the stock is worth more than it was originally bought for, the markets are inherently optimistic: "sure it's not worth $100 today, but tomorrow you'll definitely be able to sell it for $110." And I don’t mean optimistic in the sense of the glass is half full. I mean deliriously optimistic, the kind of optimism that lives through three nuclear wars and still comes out thinking the human race is God’s most perfect creation. It’s cockroach optimism.
Well, it’s cockroach optimism combined with the herd mentality of lemmings. Because, after 50 years of generally positive economic growth, pretty much everyone started thinking that the markets could only go in one direction: up. Everything was based on the fundamental assumption that if you bought something today (especially houses!), it would be worth more tomorrow, so you were fine taking out loans to buy it today. A lot of people got hugely indebted, and enough people got burned to make us all feel the pain as the shocks spread through the markets to the rest of the economy.
Cockroach optimism + lemming herd mentality = 7 billion schmucks.
If we’re going to have stock and financial markets, it’s absolutely necessary for the government to regulate them. Without government intervention, there is an inherent tendency towards bubbles, or “corrections” as conservatives will name them. Right now, China, which has a much more realistic approach to government intervention in the economy, is intervening in its markets to slow down overinflated growth that might otherwise generate a nasty bubble.
In America on the other hand, the bubble burst in 2008 and we’ve just rolled over and said, “Gimme some more!” If you haven’t already seen John Oliver’s skit on the Obama administration’s efforts at regulating the markets, you really should: http://www.thedailyshow.com/watch/thu-july-28-2011/dodd-frank-update
(Obviously, I haven’t even mentioned insane things like derivatives, futures, and all the other abstract financial products and bets that are out there and were major players in 2008. Let me just say that, when I was studying political theory in college, business majors used to always tell me the things I was studying were too abstract. Well, I think we all know now that some of the esoteric things going on in the market make Aristotle look like a block of concrete.)
What to do?
If we want financial regulation, we’re going to have to make a much stronger argument for our vision of government. The left is on the defensive: we're having to justify all the things the government is already doing. Until we turn that discussion around, we won't be able to talk about how we want to expand the role of government in the stock and financial markets. We've got to speak out a lot more and try to make basic arguments that most people can understand if we're going to have any hope of changing the political dynamic in this country. Let's get to it!
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