Wednesday, November 21, 2007

Paul A. Samuelson and the right balance between market forces and regulation (amv)

Nobel Laureate Paul A. Samuelson has published an op-ed in the International Herald Tribune. There he suggests to 'balance market freedoms,' that is, to find an optimum level of financial regulation which allows for the blessings of capitalism while it expels the burlesque on Wall Street, where financial innovations habitually outstrip any present regulatory framework. Samuelson indeed plead himself guilty of being involved in designing "today's newfangled securities." Now, after the subprime crises has proven just the most recent case in which reality has outpaced regulation, the latter has to be adjusted accordingly. "The best policy," he claims," is actually the middle way: not too much freedom for market forces, and definitely not too little freedom."

It is nothing unusual that the call for regulation becomes louder after the experience of financial turmoils. Yet, bubbles cannot occur without credit expansion induced by monetary policy. Without increasing money in circulation any demand-driven increase of asset price has to be accompanied by an decrease of demand somewhere else (financial or good markets). It is the most important insight of the Currency School-Banking School Controversy (which the former won on theoretical grounds, while the latter won the layman's heart by mimicking his habbits of thought) that any nominal blowing up of the system (i.e., any inflation) is due to money, money, money! Samuelson reminds me of Oskar Lange (among others), who also had an alternative to capitalism in mind, an alternative that keeps the strength of the allocative price system while avoiding the drive towards monopoly, exploitation and the business cycle. His concept was 'market socialism,' the attempt to organize the economy according to the textbook principles of static general equilibrium theory. As Hayek has pointed out however it is impossible to play market since the informational requirements can never be met. Not even the wisest man or group of experts can ever centralize the knowledge needed to carry out the efficient allocation of scarce means to alternative and insatiable uses. No wonder, it was the same Samuelson who propagated to the many vintages of economic professionals who were 'produced' by means of his famous textbook that socialism is more efficient than capitalism and who before the collapse of the soviet system still believed that Russia is outpacing the Western World (blindly believing the manipulated data of the soviets).

Instead of regulating markets, that is, to disturb the allocation process, the focus has to be shifted to the kind of monetary regime (i.e., regulation!) which brought about all the recent boom and bust cycles on Wall Street. This is the right balance between market forces and regulation: Minimize the latter to allow the play of the former.