20 May 2010

Blaming the messenger

Wolfgang Schaeuble, the German finance minister, has figured out the reason financial markets are tanking. The problem, of course, is the markets themselves.

I’m convinced the markets are really out of control. That is why we need really
effective regulation, in the sense of creating a properly functioning market
mechanism.

The solution, according to Herr Schaeble, is more extensive regulation, and some kind of transaction tax, which will make it much more costly for evil speculators to disrupt the plans of great nations.

According to this form of logic, I suppose we should start blaming fevers for illnesses rather than the underlying disease. This kind of talk is nothing more than populist claptrap, and not only mis-represents what is happening in the economy (and how markets work), but will very likely lead to policies that will only make things worse.

Transaction taxes, and greater regulation, is a sure-fire way to strangle the financial markets even more, and convince investors and financial institutions to just sit on their cash rather then take any sort of risk.

I'll be the first to admit that markets don't always move in directions that "make sense" at the time. I was baffled for years as to why stocks kept rising when the underlying assets, and economies, were getting weaker. But markets tend to overshoot, and make up for lost time, when they do react. Just where was Wolfgang when markets were irrationally rallying? It speaks volumes that markets only get blamed when prices are in decline.

Quite simple, the global markets aren't going to recover until all the bad debt has been purged from the system. Unfortunately, there have been so many mal-investments made over the last 15 years of credit binging (on everything from empty Chinese mega-malls, to US houses and Greek bonds), that there is a LOT more pain ahead. No amount of scapegoating will change this fact.

What finance ministers ought to really be doing is finding ways to make th liquidation, and dismemberment, of banks and companies as smooth as possible, so that the process of debt write-offs can get itself over as quickly as possible. Let's stop repeating the mistakes Japan has been making for 20 years, by failing to shut down insolvent banks and corporations (or forcing them to mark their assets to market), and continually pumping stimulus into a corpse.

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