The 18th Century Scottish poet, Robert Burns, could well have had modern attempts at social engineering in mind when he wrote:
The best laid schemes of mice and men
Go often askew,
And leave us nothing but grief and pain,
For promised joy!
The best laid schemes devised by governments to improve social outcomes by meddling in peoples lives regularly, in their wake, leave us nothing but grief and pain. Politicians and officials are invariably distressed, often outraged and, sometimes, even terrified by the consequences of and the way people respond to, the incentives and disincentives they create in laws and policies.
It was not the intention of US politicians and officials to fashion a fuse to set off a world financial crisis when they pursued their low-interest housing mortgage loan programme. Alan Greenspan did not intend to magnify the problem when, as Chairman of the Federal Reserve Board (the Fed), he drove interest rates down to artificially low levels in the only way possible - excessive printing of money.
And, when Richard Nixon, in 1971, closed the gold window, it was most probably not his intention to create the circumstances that forty years later would grow into the daddy of all bubbles, the fiat money bubble; a bubble that threatens to bring all of the worlds financial systems crashing down about our ears. The intentions behind these instances might have been good or evil, but that is of no consequence except to historians; it is the lethal results that we have to worry about.
The fuse for the current financial crisis was the low-interest housing mortgage programme, intended to help poor people buy houses. It induced people to buy houses they could not afford at normal interest rates. Because of the cheap money, a situation exacerbated by the Feds low-interest policies, housing prices rose and kept rising, giving the average American the false impression that the trend would never stop. Homeowners acted as they would never otherwise have done, borrowing against their properties to pay for holidays and all sorts of luxuries, making hay while the sun shone. When the value of homes started tumbling, thousands of homeowners found themselves with mortgage loans that were greater than the value of their homes, a situation that is known as negative equity. All this was done in good faith, in the belief that the people up there knew what they were doing.
Homeowners were not the only ones to be lured by cheap money. Otherwise prudent bankers relied on an implicit government guarantee that supposedly backed the uneconomic loans, and succumbed to the promise that it would be safe to lend money to people they would otherwise have turned away.
When the Fed attempted to correct the situation by increasing the Fed Fund Rate to a high of 5.26 per cent in February 2007, it caused the people such large-scale grief and pain that the rate was hurriedly ratcheted down again to a low of 0.15 per cent in January 2009. These still-continuing low interest rates merely fuel the flames of the looming disaster.
The current financial crisis will not go away until interest rates are back to some semblance of normality (the current interest rate at which US banks borrow from each other, the Fed Funds Rate, is 0.25 per cent, and the rate at which they borrow from the Fed, the Discount Rate, is 0.75 per cent). Some form of normality can only return when interest rates are continuously above the rate of inflation, allowing savers to earn a return on their investments.
Rumbling beneath all the economic mayhem we have witnessed, are the events that followed de-linking the dollar (the worlds reserve currency) from gold. Had gold remained a disciplining factor in world currencies, none of the current financial disruption would have happened.
Between 1934 and 1971, foreign central bankers could purchase gold from the US at $36.0875 per ounce. This meant that if central bankers concluded that the Fed was inflating the dollar, they could discipline the Fed by exchanging their dollars for gold. France, Germany and Switzerland did just that in 1970/71. The Fed had to stop printing dollars or the US would have lost all its gold. To escape the discipline of gold, Nixon unilaterally ended the convertibility of the dollar into gold on 15 August 1971, ushering in the fiat (inconvertible paper) currency world. From that date onwards the world became entirely dependent on the self-discipline of governments and their central banks to refrain from the currency debasement that has plagued the ordinary man-in-the-street since time immemorial. Roman emperors clipped coins and mixed precious metals with base metals to steal from their citizens; today the process of debasement is more rapid and difficult to detect; it is all done by printing notes and government securities.
Debasement of a reserve currency, such as the US dollar, has more serious repercussions than (say) the debasement of the Zimbabwe dollar. Many prices, such as the price of oil, are quoted in dollars and sales of such commodities are concluded in dollars. For purposes of international trade, a minimum level of reliability is required in a currency that is used extensively. Already, traders are starting to use other major currencies for concluding transactions in preference to the US dollar.
Republican Ron Paul, a long-time critic of the Fed, has been named chairman of the House of Representatives sub-committee on domestic monetary policy, which oversees the Fed as well as the currency. Many Americans, and probably even more non-Americans, are hoping that he will be appointed and will be able to help to save the dollar and rescue its reserve currency role.
The harm that has been done to the economy and the US dollar by years of social engineering cannot be easily undone. There will be further grief and pain, that is unavoidable. Our best news for the New Year would be for Americans to stop or curtail the recurring and harmful interventions, such as the $600bn so-called quantitative easing that is scheduled to occur in the first half of 2011. It would also be comforting to know that politicians and government officials everywhere have recognised that government social engineering was the fundamental source of the current world financial crisis, and that they will behave responsibly and stop harming citizens with their well-intentioned meddling.
Author: Eustace Davie is a director of the Free Market Foundation. This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author's and are not necessarily shared by the members of the Foundation.
FMF Feature Article / 21 December 2010
Eustace Davie is a director of the Free Market Foundation.
Publish date: 25 December 2010
The views expressed in the article are the author’s and are not necessarily shared by the members of the Foundation. This article may be republished without prior consent but with acknowledgement to the author.