Tuesday, August 11, 2015

When the state intervenes in the economy

Today China devalued the yuan, and the news had an immediate impact, with the yuan falling nearly 2% against the U.S. dollar. It marked the biggest one-day plunge since 1994. Romain Hatchuel writes in the Wall Street Journal that
China’s interference in its stock markets reflects a global trend of states trying to govern economic activity.

In a normal market economy, prices of goods, services and assets are determined freely by supply and demand. For every seller, there has to be a buyer, and the direction prices move usually depends on whether sellers outnumber buyers, or vice versa. But monetary policies and government action can disrupt the buyer-seller relationship in a number of ways.

One way is by expanding the base of eligible consumers by providing ultracheap credit. A central bank cuts its main interest rate to an abnormally low level, and the number of potential buyers of homes, cars, smartphones and other products starts to rise.

Since 2008 the Federal Reserve, the European Central Bank, the People’s Bank of China, the Bank of Japan and the Bank of England have all cut their interest rates drastically. While these lower rates have supported consumption, they have primarily benefited financial assets, which have rallied for six years with only rare corrections.

The second way governments and central banks can alter normal supply and demand dynamics is by becoming buyers themselves. And many of them have been on a frantic shopping spree these past seven years. Governments increased public spending through fiscal stimulus plans, while central banks implemented aggressive quantitative-easing programs, which translated into colossal purchases of financial assets. Since 2008 the combined balance sheets of the world’s five leading central banks have increased by a staggering $9 trillion.

But if incentivizing buyers, or acting as buyers themselves, isn’t enough, governments and central banks can always forbid sellers from disposing of their securities, or make those securities unavailable for trading. China isn’t the only country to have used such subterfuges. There have been several short-selling bans in the U.S. and Europe since 2008, and while milder than prohibiting actual stockholders from selling, these bans are a similar way of intervening in markets.

...Unprecedented monetary easing, high public spending, repressive regulation and automatic debt forgiveness, while arguably useful in the midst of a severe crisis, cannot be sustainable remedies in the long term—that is unless one believes the world should do away with free-market principles altogether. Those who continue to advocate such measures, more than seven years after the global financial crisis blew up, should at least admit that what they really want is a profound and permanent change in the system.

Maybe they know something I don’t, but it is fair to ask whether these extreme interventionist policies have become part of the problem rather than the solution, and if we shouldn’t instead revert to what remains the most successful economic system ever tried—the free market.

As far as the U.S. and its slow but steady drift away from market fundamentals is concerned, the Federal Reserve’s future interest-rate decisions and the coming presidential election will provide important clues as to where the nation, and its still unsteady economy, is headed.
Read more here.

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