The Choice: Capitalism or Regulation

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Americans face the most important choice of a generation. Our economy is not performing as we would like. Inflation is too high yet home prices are falling. The credit markets are frozen as banks retrench from losses generated by past, ill advised loans. Income and wealth inequality have risen. Real wages are essentially stagnant. The government has rescued Bear Stearns and now Fannie Mae and Freddie Mac. This is not how things are supposed to work in America. The American dream is turning into a national nightmare.

If we are to choose a proper remedy for our current economic ills, it is essential that we analyze properly how we arrived at this point. Many, maybe even a majority, have placed the blame on the free market. Those who adhere to this viewpoint believe that it is deregulation, specifically of the financial sector, that has brought us to this denouement. Better regulation would have prevented the housing bubble and its subsequent collapse. Banks would not be sitting on unknown amounts of bad loans had regulators been empowered to control their activities. Unwitting borrowers would not have been enticed to purchase homes beyond their means absent unscrupulous real estate agents and mortgage brokers.

Income and wealth inequality are blamed on a tax code believed to be insufficiently progressive. Slow wage growth is blamed on greedy corporations and CEOs capturing all the gains for themselves. Job losses, especially in the manufacturing sector, are blamed on outsourcing, The market is also blamed for the other supposed difficulties facing our economy. a result of too much free trade. Expensive health care is blamed on greedy, callous insurance companies. For those who believe we’ve had too much of the free market, the answer is obvious – government must become more involved in directing the course of the economy and consumers need protection from the predators practicing lassez faire economics.

This narrative is believed, fervently in some cases, by those who see government as a benign entity – if it were only populated with more of the enlightened politicians of a particular party. Unfortunately for them, we do not live in the free market world they describe and the benign government they envision does not exist. Our problems have been caused not by too little government, but too much. The politicians that populate the halls of power, no matter their party affiliation, are not the idealistic individuals naïve voters conjure in their dreams of power.

The prescription offered by these idealistic, if misguided, individuals is a familiar refrain. Raise taxes on the rich to reduce inequality. Increase regulatory oversight in all areas of the economy. Increase government spending on infrastructure. Increase government directed investment in favored industries. Protect American jobs by raising tariffs against low wage countries. Increase union membership and raise the minimum wage through legislative action. Increase healthcare coverage through mandates and direct government spending. Increase taxes on “bad” industries and transfer the revenue to “good” industries or consumers.

These solutions may make us feel better about ourselves, but if we are to get this right, we need solutions that work. The solutions offered have already been tried, here and in other countries, and found lacking. After the collapse of twin stock and real estate bubbles (sound familiar?), the Japanese government propped up failing banks, raised taxes, increased government spending on infrastructure and ultimately reduced interest rates to 0%. The result is an economy that is still struggling and a stock market still less than half its peak value. They’ve only avoided high unemployment because of low growth of the labor force due to aging and low population growth. Furthermore, Japanese government debt is now 180% of GDP. Is this the example we want to emulate?

Increasing regulation raises the cost of doing business and reduces job growth. Raising taxes and increasing tax credits for the poor takes capital from those who will invest it in productive, job producing enterprises and transfers it to those more likely to consume. Raising wages for existing workers benefits those already employed at the expense of those who are not. Raising tariffs reduces the variety of consumer goods while limiting the potential markets of exporters. Investing tax dollars in infrastructure and alternative fuels merely diverts investment from productive private uses to inefficient public uses. Mandating health insurance coverage by private employers reduces wage growth.

One of the reasons that Americans increasingly reject free market principles is because they have been convinced that the free market reforms of the Reagan generation have failed. Those reforms - less regulation and lower taxes - are seen as the cause of our problems. Looking at today’s economy one is tempted to agree, but that simple analysis ignores the fact that the Reagan revolution failed in two important areas that are required for the very long term health of our economy: a balanced budget and a stable currency.

Since President Nixon removed the dollar’s last link to gold, monetary policy has been seen by our politicians as the first, and for many the last, tool of economic policy. The only exception is the first term of Ronald Reagan which saw dramatic tax cuts and deregulation of various industries. Those tax cuts and deregulation unleashed a wave of investment from which we still benefit today. Unfortunately, the gains of the Reagan revolution were limited by the lack of monetary reform. Since that time, every economic hiccup has been “solved” by an increase in credit from the Federal Reserve. Meanwhile the value of the dollar, however you define it, has gone through 5 major cycles. It fell after the end of Bretton Woods, rose during Reagan’s first term, fell through the first Bush administration, generally rose during the Clinton years and has fallen again during the second Bush administration.

At the same time, our government has become increasingly reckless with the public purse. From the end of WWII to the end of Bretton Woods, the federal budget quadrupled. That included two wars (Korea and Vietnam) and the budget alternated between minor deficits and minor surpluses. Since ending the last link to gold in 1971, the federal budget has expanded 12 fold and run deficits in all but two years.

The path to recovery for our economy is well worn and proven. Corporate taxes should be reduced dramatically or preferably eliminated. Individual taxes should not be raised and preferably reduced. Regulation should be limited and effective. Banking reform should include a gradual increase in capital requirements. Trade should be expanded, not limited through tariffs and stealthy “fair” trade laments. Most importantly, the Federal Reserve should be reformed and given one mission – a stable currency. Not a rising dollar, not a falling dollar, but a stable dollar. The best way to accomplish that mission is by stabilizing the price of gold. A stable currency, once again linked to gold, will eliminate inflation and limit government spending.

The policies that advocate more government are borne of fear. The policies of the free market are borne from optimism. America is not a place that was built on fear. Our choice is clear.

Joseph Calhoun is CEO of Alhambra Investment Partners in Miami, Florida. He can be reached at

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