To Ease the Credit Crunch, Let It Be
Governmental price controls are problematic in two ways. For one, prices of goods reached naturally in the marketplace are essential signals that producers rely on in order to give consumers what they want. When governments seek to block out the message of the market, future scarcity is a certainty due to the inability of producers to achieve the profits that would normally prevail, and which give them the incentive to produce what we want to begin with.
Worse, when governments seek to control prices during periods of crisis, there’s a certain misallocation of goods that similarly leaves the consumer worse off. If a hurricane in Louisiana makes gasoline scarce, rules that prohibit “price gouging” by gas-station owners insure that gasoline consumers will have no incentive to be circumspect with regard to the amount of petrol they purchase, meaning many customers will be unable to purchase fuel altogether. And much like the above example, if station owners can’t profit from the market anomaly wrought by a hurricane, they’ll have no incentive to replenish the very fuel supplies that would enable them to best serve their customers.
So in periods when gasoline is in short supply, the natural spike in its price is the happy market signal that scarcity will eventually be relieved with new supply. The spike or fuel "crunch" serves as an incentive for producers to bring new fuel to the market. If price increases are not allowed by bureaucrats, continued scarcity is a certainty.
The notion of price controls is critical at present given the seemingly bipartisan view that the federal government must use resources taken from the private sector to ease what many deem a “credit crunch.” The view held by many is that our federal minders must “normalize” credit markets in order to insure that businesses are able to access capital to fund their operations and growth. So if we ignore the obvious contradiction suggesting capital expropriated from the private sector by the federal government can somehow be used to fix the economy from which it was taken, we can then ask if these activities aren’t bringing major harm in the way that simple price controls do. Logic says they are.
First off, there’s no way the federal government can “normalize” any market, let alone our credit markets. When the cost of credit rises, that is the market for credit; meaning efforts to normalize natural market prices are in fact distorting the very price signals that tell those with capital where to invest most profitably. Future credit scarcity is also a certainty given the reality that those with money to invest have no incentive to offer up capital in markets where rates are being unnaturally held down by federal bureaucrats.
And as the present credit situation is deemed crisis-like by many, the same scenario as the one with regard to gasoline in hurricane season applies. Just as rules against price gouging by gas-station owners mean that those with access to gasoline will irrationally consume it at the expense of others, so do government attempts to fix the credit markets insure irrational consumption of capital.
Indeed, if capital is made abnormally cheap in times of crisis, those able to access it have no incentive to be circumspect in their borrowing. Rather than more aggressively selling off inventory or collecting on dated accounts receivable, those with the best pipeline to cheap money have the incentive to borrow as much as possible. This insures that many businesses will go without capital due to artificially low rates.
When we bring entrepreneurs into the equation, by virtue of them pursuing disruptive concepts (Silicon Valley is littered with venture capital firms that turned down Google’s request for funds) that may at first glance seem far-fetched, it’s tautological to say that they must routinely borrow at relatively high rates in order to implement the very ideas that change the commercial structure. But when available capital is being aggressively borrowed by established businesses, entrepreneurs must to some degree go without.
And for the businesses able to borrow at artificially low rates, the government is creating a scenario whereby it’s easier for the big to survive at the expense of the small and unformed. This works at cross-purposes with governmental initiatives in favor of helping the little guy, not to mention job growth given the consensus that small businesses are in aggregate the greatest job producers in our economy.
Worse, and particularly in times of crisis, when governments foster artificially low rates, they are subsidizing the “zombie” businesses that hog limited capital, and as such, slow economic growth. Better it would be if costs of money were left untouched by Washington. If this means that certain large, struggling businesses go bankrupt, we shouldn’t fret. Rather than vanish, the beauty of credit crunches when it comes to economic growth is that poorly run firms are blessed with new management more able to raise money in order to buy the firms poorly managed.
The above is very important. Indeed, contrary to all the apocalyptic talk about the economy collapsing if certain large firms aren’t saved, the simple truth is that if the federal government stands aside, all the human and physical capital that made once prominent businesses flush would still exist. The only difference would be in terms of new owners making work that which the previous owners could not.
So when we consider what is deemed a credit crunch, government attempts to fix the latter are every bit as impoverishing as similar efforts to fix rising gasoline prices. In the end, artificial controls lead to scarcity and less capital for all.
The better solution for tight credit is acknowledgement that tight credit itself is the path to more easy access to capital. When the price of any good is high, that’s the signal to producers and investors that there’s an unmet market need that will be rewarded with high returns. Just like the gasoline example, abnormally expensive credit is the flashing market signal telling us that if left alone, new sources of credit will soon enough come online.
Ultimately there’s no capital without risk, and when governments seek to normalize the cost of the former, they foster misallocations followed by capital scarcity. In short, the solution to the credit crunch is to let it be.