The Human Condition:

Markets ’R’ Us – August 16, 2015

Market in France

Free and open markets present a problem for people who vote on the left side of the aisle and follow progressive tendencies. And it’s not hard to see why. Markets do not respect individuals, do not guarantee any particular result, and often create personal disappointment and unhappiness. In a world that should be nice, with the best possible outcome for the greatest number of people, markets would seem to be cruel, unforgiving, and unfair.

In this way, the operation of a free market and unfettered economic choices most closely resembles the mechanism of chance and fitness for purpose that drives evolution. Evolution operates in the aggregate, on the species level, and cares nothing about the individual members of that species except when they survive and contributes their genetic makeup to a new generation. Genetic mutations are the mindless engine of variability that permits new generations to adapt to changing conditions—or not. If a bad mutation snuffs out an innocent life or dooms it to a permanently marginalized condition, evolution cares not. And if the mechanism of evolution operates too slowly and erratically to permit a promising species to survive rapid change in the environment—think of the dinosaurs at the Cretaceous-Tertiary boundary, or any other species in a period of mass extinction—evolution sheds not a tear. The planet is always changing, and the biome always has more raw material, other developing species, waiting in the wings to exploit the new ecological balance.

Markets as an expression of economics operate in the aggregate, too. Individuals have meaning only as long as their behavior conforms with one or another force in the marketplace: producer or consumer, seller or buyer, investor or borrower. An exceptionally smart or skilled individual can try to stay on the right side of the market’s movements: being in a position to sell when the price is high, or buy when the price is low, or have cash to loan out when the economy is heating up, or hold reserves to draw upon when the economy is slowing. But no one’s insight is perfect, and everyone gets caught out of step occasionally. Every player eventually ends up holding an unsalable supply of product, or needing a scarce commodity, or having too much cash or not enough when the tide turns.

In this manner, like the impersonal forces of evolution, the market is an equal opportunity creator and destroyer. Nobody has a favored position. Nobody gets a free pass for life. Risk, reward, and retribution are distributed impartially—although, of course, that doesn’t keep people from trying to game the system.

Think of the U.S. Federal Reserve in today’s economy. For the past thirty years or so—approximately since the United States abandoned hard currency and the Bretton Woods agreement, adopting instead a fiat currency based on nothing more than our own productivity and international trade—the Fed has tried to manage the business cycle by manipulating the money supply and the cost of borrowing for banks, businesses, and individuals. In that time, we’ve seen successive economic bubbles—first in tax shelters, then in computer technology, next in internet schemes, and finally in housing stocks—each one followed by a bust in the market. The Fed keeps trying to suppress the waves and tame the business cycle, and each time it works for a while, and then the pricing system stagnates, then inflates, and then explodes. The Fed’s efforts are like trying to suppress the ocean’s waves and their effect upon the shore, turning the ocean into a safe millpond. In the end, you risk creating a tsunami.

People are just so pesky! In a time of easy money, they won’t be happy with their lot in life and live quietly while the nation slowly and gracefully booms without disruption. Instead, they borrow to the maximum allowed and put that excess cash into technology stocks, internet startups, rental housing … just as once the Dutch invested in coffee futures and tulip bulbs—whatever promises a higher return on their investment.

Think of the financial wizards at Long-Term Capital Management back in the ’90s. They tried to keep their market plays afloat indefinitely by hedging every downside with an upside—and vice versa—and then borrowing to leverage their positions. They had elaborate economic models to show how they could contain and overcome the risks inherent in the marketplace. As one observer noted, after their scheme had gone bust, instead of containing the risk and rolling with it when they lost ground—as every other investor must do—LTCM’s managers created “moving vans of risk” that swelled until those vehicles exploded and buried them alive.

In laymen’s terms, you can toss heads fifty times with a penny and count yourself lucky. You are playing as an amused spectator, and the most you risk is coming up tails on the fifty-first toss. But don’t try to iron out the natural rhythms of probability—or of commerce at an industrial or national scale—in order to avoid all risk of your occasionally buying a goat. That way lies a whole flock of goats.

Think of the Hunt family and their Arabs partners in the late ’70s. To shield themselves from the inflation created by the federal government’s printing of dollars, they tried to “corner the market” in precious metals, particularly silver. As they acquired more and more, limiting the supply of a metal that also has important industrial uses, the price per ounce went up. But a funny thing happens when you try to become the only supplier and at the same time the only buyer of a commodity: the price becomes irrelevant. People stop playing when there’s no action. They find alternatives to that commodity, and the market moves elsewhere.

In laymen’s terms, you can run a casino and attract gamblers only so long as they think they have a chance of winning. Yes, the house makes its two percent—or whatever the margin is on average over the variety of games the casino offers—but the individual gambler still sees the possibility of a jackpot, of coming out ahead. But if the house rigs all the games so that it never loses and ends up keeping all the chips, then the betting is over. Everyone goes home.

Markets are simply the expression of popular will when it is aggregated, averaged, and accounts for all the outliers. The activity in any market and in the economy as a whole represents what “the people”—in their purest form, the ultimate composite—desire, decide, and do. If you dislike the action of free and open markets, then you reveal yourself as distrusting the instincts and desires of people as a whole. In their place, you want to create an artificial set of winners and losers in order to promote some notion of market safety, or fairness, or everlasting upsides and bright skies.

Governments do this all the time. The Department of Agriculture—with everyone’s tacit blessing—attempts to manipulate crop yields and limit supplies brought to market in order to keep commodity prices high in times of bounty and keep supplies available in times of drought. As a society, we all agree to pay a little bit more for sugar beets or corn syrup in order to keep the farmers solvent through the lean years, and the farmers agree not to try making a killing on a bumper crop in the fat years. I’m not a purist about economics, and I see nothing terrible about all this. But it’s essential that we all understand as a society what’s going on and are able to judge when the manipulation becomes too steep and hurtful.

We have the recent example of the Chinese stock markets to show when that point is reached. This past June and July the Chinese government tried to maintain the value of stocks on the Shanghai and Shenzhen exchanges through easy money at a time when people’s instincts said prices were too high and it was time to get out of their individual positions. Locking investors into a set of trades they don’t want is a sure way to destroy the market. And enticing them to buy even more heavily with excess money does nothing to allay their fear of holding an overvalued position.

And finally, we have the current desire in this country to create a “living wage” by setting a fixed, entry-level price for all workers despite their individual knowledge, experience, and skills. Like propping up the stock market with easy money, it will work for a while. But eventually the manipulation is doomed to failure. For one thing, it simply ratchets up the entire wage scale over time. Consider the store manager who is making $15 an hour in a fast-food restaurant where the register clerk or fry cook makes the current minimum of $7.15. With a federally mandated jump to $15, the manager is no longer happy doing the extra work and taking on the extra responsibility of his or her position while being paid no more than entry-level subordinates. So the wage scale goes up. The price of hamburgers and other goods goes up. And the economy simply settles in a higher groove where $15 an hour is now considered poverty wages. Declare a minimum wage of $100 an hour, and that will be the new poverty level in a vastly inflated economy.

Advocates of the living wage counter by declaring that the store owner or franchising corporation is rich enough to pay the higher wages without raising prices. But those pesky people just won’t stand still while you try to do the economic equivalent of nailing their feet to the floor. Yes, the owners and investors will pay the higher wage and hold the line on prices for a while in the interests of selling burgers, but eventually they will stop building new stores under the changed conditions or they will invest instead in robot systems to cook the burgers and take the customer’s money without human intervention.

The more strictures, regulations, and controls the government puts on the marketplace to resist these natural tendencies, the more the effort resembles trying to flatten the ocean or corner the market in wages. It will work for a time, then kablooey.

Now I am not such a Pollyanna about economics that I don’t see flaws in the system of open markets. My faith in the direction and corrective action of the marketplace is not absolute. One of the biggest problems with an open economic system is the issue of transparency and market intelligence. The seller may know things about his products that the buyer does not and cannot perceive—that, for instance, this Gucci handbag is actually a knockoff, or that lot of grain is contaminated, or this computer was assembled with bootleg chips that failed during quality control testing—and so the flow of energy in the market turns out not to be fair and impartial. Similarly, the buyer may know things about the transaction of which the seller is unaware—that the government is shortly going to ban the product, or that flooding in the next state will likely destroy half the crop, or that the company is about to report high earnings and the stock take off—and so the individual with inside knowledge will profit unfairly. Governments need to set rules and regulate products and transactions in order to prevent unfair advantage on both sides of the deal.

But a government that attempts to manipulate prices and supplies in order to favor some group or achieve some vision of utopia is simply subverting the largest expression of popular will, cheating and fooling people, and creating conditions the individual participants ultimately do not want. And that’s no more honest than the butcher putting his thumb on the scale or the baker using flour after the weevils have gotten to it.