I will present the following to the
Quest Club in Bakersfield,
California May 20, 2010. I will celebrate my joint birthday with my father in Bakersfield May 19 and attend my 50th high school reunion May 22.
"Where Should We Go From Here? Inflation, Regulation, and Debt" Quest
Club. Bakersfield, California. May. 2010.
Available at: http://works.bepress.com/warren_coats/19
Our behavior is profoundly influenced by the incentives we face. Money is a very important motivator but money is not everything. Our behavior is also influenced by prestige, power, benevolence, and all the feel good stuff. All of these help determine the incentives we face to work hard for our own benefit and for the good of man kind. Our cultural and moral values are also important more directly for the quality of our lives and for the success of any economic system—capitalism or socialism—by supporting or failing to support voluntary compliance with the needs of that system. They provide the lubricant that helps the economic system function smoothly.
Knowing that I favored market economies, a bright and idealistic young man in Kenya asked me recently if I thought capitalism encouraged immoral behavior. I don’t think he had the Madoffs and Stanfords of the world in mind as that kind of criminality exists everywhere (though generally on a smaller scale). He was reacting, I think, to his impression that the profit motive had driven many greedy players on Wall Street to risk and lose a lot of other peoples’ money. He was reflecting an image of capitalism as greedy and socialism as benevolent.
My reply to him had two parts. The first part was that I see capitalism as driven primarily by the nexus of service and profit (the better we serve the wants of others the more we profit) and of socialism by the nexus of need and power (those in power politically define what we need and strive—in the best of worlds—to satisfy them). The second part was that capitalism and socialism are economic systems, not moral systems. Societies with either economic system will be more successful if their citizens also largely embrace cultural and moral values that respect honesty and the rights and property of others.
From the beginning of time societies have enforced rules of behavior meant to protect and enrich their existence. The more successful they were in convincing their members to voluntarily live by these rules, the less time and resources they needed to spend on their enforcement. Such societies prospered relative to others. If every member of society were totally honest and lived by the Golden Rule, the substantial share of our resources devoted to our security and enforcing rules and agreements (military, policy, courts, security equipment, fences, etc) could be used to produce goods and services we would actually like.
People and their values differ but also have much in common. Almost all of us work hard to survive (feed and cloth ourselves and our families) and when possible to live more comfortably. But most people are also genetically hard wired to please others. Once we have satisfied our basic needs, we desire to win the approval of our families and friends and to make the world a better place, not just make a better living. In his new book “Drive,” Daniel Pink “argues that the most powerful emotional motivators are the desire for
autonomy, the satisfaction that comes from mastering a skill or a task, and the need to serve some larger social purpose.” Capitalism better aligns these motivators with economic success. Those people and firms that are the most successful in providing other people with what they want at the lowest cost are the most profitable and the most likely to survive. Capitalism rewards virtue and thus encourages virtue.
Socialism starts out proclaiming the virtue of sharing—giving—but does not reward it and thus provides little incentive to achieve it. In its fully egalitarian form, it provides no reward for harder work and effort at all, leaving every thing to our good hearts. Power—the control of the levers of government—displaces profit as the system’s most tangible reward. The best but imperfect example of a capitalist nation is the United States and of a Socialist nation was the USSR. The results speak for themselves.
While capitalism’s profit motive rewards and thus encourages virtue, without supportive moral values it can promote and inflame greed. Economists often look at capitalism (competitive, market economies) as directing man’s natural greed (self interest) to the service of the public good (Adam Smith’s invisible hand). Before he wrote his most famous work, The Wealth of Nations, Adam Smith wrote the Theory of Moral Sentiments (1759). It provided the ethical, philosophical, psychological, and methodological underpinnings to his later works, including The Wealth of Nations (1776). In it he elaborates far more fully his views on the supportive and reinforcing relationship between man’s nature (self-love, reason, sentiment, etc.) and morality (propriety, prudence, benevolence, etc.) and the invisible hand of the market place that leads mans’ quest for personal gain (profit) to serve the public good.
But whether capitalism tends to promote morality or not, any economic system will perform better if supported by moral values of mutual respect, compassion, and honesty. Our persons and our other property—our very lives—are best protected by the voluntary respect and honesty of our neighbors. If everyone (or almost everyone) is honest and does not steal, our property can be protected at negligible cost and we will all be wealthier. Today’s need to imbed security sensors in merchandize is a cost of business, like a tax, necessitated by weakened public morality and it makes us poorer. It is a cost with no benefit other than counterbalancing a failure of morality. Whether capitalism makes us more virtuous or not, the quality of our lives will be better in a moral society than an immoral one. Thus we need to be concerned with the inculcation of such values in each generation as much as with the preservation of free markets.
Beyond some point, a larger government, responsible for more and more of our needs and behavior, begins to displace and to undermine the morality that supports our prosperity. Our sense of self-reliance and personal responsibility begins to give way to reliance on others through state institutions. Profits become more reflective of the ability to gain favors from the state than from satisfying the wants of our neighbors. The incentives for corruption thus created bring forth more corruption. Capitalism begins to slide into socialism.
I replied to the young Kenyan man that capitalism is not immoral nor does it encourage or promote immorality. But it is not in itself a set of moral principles that any society needs to be prosperous and good. We need to worry about preserving such values as much as our freedoms to develop our talents and serve our fellow man as we each see fit.
http://www.compasscayman.com/cfr/2010/01/05/Do-we-need-a-new-global-currency-/
Banks should never be pressured to lend. Their first
obligation should be to protect their depositors’ money.
For several years in Iraq I worked with the central bank of
Iraq to fight off pressure from the government of Iraq (and some loose canon’s
in the U.S. Government) to force banks to lend more. Their lending record was
indeed pathetic. From the beginning of 2005 through the end of 2008 bank
lending as a share of total bank assets rose from a pitiful 5% to a mere 8%. For
comparison, U.S. banks’ lending was about 60% of their total assets at the end
of 2008.
Iraq desperately needed (and still needs) to create jobs and
to many it looked like the banks were failing to do their part to help finance
the enterprises that are the basis of real jobs. There was also a dispute over
whether the Central Bank of Iraq was keeping interest rates too high when
setting the rates it paid banks to deposit funds with the Central Bank (they
were actually lower than the inflation rate, i.e., negative in real terms). I
mention all this because it sounds to me like the same loose canons are still
roaming the halls of the U.S. Treasury. In a note to the U.S. Treasury at the
time, I noted that we should be thankful that the banks were not making loans
they did not consider safe. The “security situation” in Iraq was by no means
the only risk of lending. Contract enforcement was highly uncertain. Many of
the laws on which lending is based and secured did not exist or were seriously
deficient. Reliability of court enforcement of existing laws was far from
established. Policy, I argued, should focus on making it safe to lend rather
than forcing banks to lend.
Fast forward to Monday’s meeting between President Obama and
the big bankers. The Washington Post’s front page article proclaimed: “Obama
calls on banks to ramp up lending.” Sam Stein in the December 13 Huffington
Post headlined his column: “[Larry] Summers: Obama will Persuade Bankers
Because ‘We Were There From Them.’” But “Bank executives say they itch to make
profitable loans, as many as possible, but are struggling to find qualified
borrowers. They also say that the administration is asking for increased
lending even as it pursues financial reforms that will limit the ability of
banks to make loans.”[1] The Post’s
editorial Monday it stated that; “in a recent survey by the
National Federation of Independent Business, tight credit ranked well down the
list of small firms’ concerns, after poor sales, taxes and regulation.”
This is all pretty depressing stuff. The economic and
financial crisis of the last two years started with a housing price bubble
fanned by the federal government pressuring banks to lend more to marginally
qualified homebuyers. So, assuming the government would stand behind the risks
it was asking banks to take, subprime loans exploded (especially when the
Government Sponsored Enterprises, Fannie Mae and Freddie Mac started buying a
lot of them). When the housing price bubble burst, banks and other investors in
Mortgage Backed Securities suffered much larger losses than they had bargained
for. Covering these losses absorbed funds banks might otherwise lend and
reduced their capital. Everyone woke up to the fact that many were over their
heads in debt. Their attempts to reduce it (deleverage) made normally liquid
financial assets hard to trade. Even after the Federal Reserve relieved this
liquidity squeeze, some banks no longer had sufficient capital to continue
lending given the prudential capital adequacy requirements of the regulators
(and good sense).
Some banks avoided these toxic assets and managed the risks
they took prudently; some did not. The market is supposed to reward the
virtuous and punished the profligate, and thus keep the system healthy. Banks
needing more capital to continue lending can almost always find it in the
market at a price that reflects the market’s assessment of their fundamental
soundness. However, the government stepped in and bailed them all out (if they
were big enough), thus proving the high risk takers right. Ops, then there was Lehman
Brothers, which was allowed to fail, catching the market off guard.
So the government has been rewarding bad behavior (excessive
risk taking) in the market some of the time, but not all of the time. It is
thus encouraging more bad behavior while keeping the market guessing about what
it will or will not do. Do we really want to start this cycle over again?
The economy cannot recover in a sustainable way until
households reduce their excessive indebtedness (which must be done over time)
and their lower rates of consumption are replaced by increased exports and
domestic investment. The so-called “weaker dollar” (a depreciated exchange
rate) is helping to increase exports, as is the gradual recovery of demand from
the rest of the world. An increase in investment will come (financed by the
increased savings from households) when entrepreneurs have sufficient
confidence that they can make money in the future from doing so. The government
seems to be doing every thing under the sun to keep them guessing. How much
will they be taxed? What risks will be underwritten by government bailouts? The
incentives the government has created are seriously distorting economic
decisions in the market and promoting a return to excessive risk taking. We
urgently need certainty from the government about the rules of the game and if
those rules don’t provide incentives for proper behavior our recovery will lay
a weak foundation for the future.
[1] By Binyamin
Appelbaum and Michael A. Fletcher,
"Obama
calls on banks to ramp up lending" The
Washington Post, Dec 15, 2009, page A1
Warren's space 