INSIGHTS: THERE’S NO SUCH THING AS AN UNREGULATED MARKET It’s a choice between regulation by legislators or by consumers
By Guest Columnist Howard Baetjer, Jr.:
Lecturer in the department of economics at Towson University and a faculty member for seminars of the Institute for Humane Studies. He is the author of Free Our Markets: A Citizens’ Guide to Essential Economics.
This article was reprinted with permission from Howard Baetjer, Jr. and theFoundation for Economic Freedom (FEE)
A big economic problem the world faces is semantic. That is, “regulation” has come to mean “government regulation.” We don’t seem to be aware of the alternative: regulation by market forces. That’s a problem because it leads us to accept so much government meddling that we would be better off without.
We want the aims of regulation — regularity and predictability in markets, decent quality and reasonable prices for the goods and services we buy — and thinking that government regulation is the only way to get those, we accept a vast array of unnecessary, wrongheaded, and usually counterproductive mandates and restrictions.
But government regulation is not the only kind of regulation.
To regulate is to make regular and orderly, to hold to a standard, to control according to rule, as a thermostat regulates the temperature in a building. Market forces do this continually as competing businesses offer what they hope will be a good value, then customers choose among the various offerings, then the competing businesses react to customers’ choices. That process is the market’s regulator.
Markets regulate prices
To take an example of market regulation so ubiquitous that many people are as unaware of it as a fish is unaware of the water it swims in, market forces regulate prices. In healthy industries, market forces are the only regulator of prices (and it’s common in economics textbooks to find that the moment governments start to restrict prices, the result is surpluses or shortages). The terms of exchange offered by some sellers restrict the terms of exchange other sellers can offer in any realistic hope that they’ll be accepted.
If the Giant supermarket near my home is charging $2.00 a pound for red peppers, the more upscale Eddie’s Market will not be able to charge a whole lot more than that and still sell many peppers. Neither will other grocery stores or the farm stands that open nearby in the summer. All will charge nearly the same price. There is strong regularity to the prices of red peppers at any place and time. This regulation is accomplished by each seller’s reaction to the actions of his customers and competitors.
Markets regulate quality
The same goes for quality. My wife won’t buy peppers that aren’t fresh and firm as long as she thinks she can get better peppers at some other store. The grocers might wish they could sell last week’s peppers that are getting soft on the shelf, but customers like my wife, along with the self-interested actions of other stores, won’t let them. Their customers’ choices and competitors’ actions restrict (that is, regulate) even the quality of produce they can offer for sale — let alone actually sell — because customers like my wife spurn stores whose produce is shabbier than that offered nearby. Stores in competitive markets cannot afford to put off customers like my wife, so they maintain decent quality, even if they would prefer not to. In this manner, market forces regulate quality.
Government regulation hampers market regulation
Regulation by market forces weakens as a market becomes less free. Imagine a grocery store with a legal monopoly on red peppers. Such a store, lacking competition, could charge a wide range of prices, offer a wide range of quality, and still be able to sell. Legally, its customers would have nowhere else to turn.
The same would apply if there were competing grocery stores, but restrictions on importing peppers: The pressure on domestic producers to maintain quality and hold down price would be reduced. That is to say, quality and price would be less tightly regulated.
Freedom of exchange makes regulation by market forces tight. Where competing grocery stores are free to sell red peppers, and red pepper customers are free to take their business elsewhere or go without, prices and product quality are tightly regulated. This beneficial regulation by market forces weakens as markets become less free.
So we have a paradox: the less a market is regulated — no, that’s not the right word; the less a market is restricted — by government, the more it is regulated by market forces. Conversely, the more government restriction, the less regulation by market forces. There is a direct trade-off between the two.
We never face a choice between regulation and no regulation. We face a choice between kinds of regulation: regulation by legislatures and bureaucracies, or regulation by market forces — regulation by restriction of choice, or regulation by the exercise of choice.
There is no such thing as an unregulated free market. If a market is free, it is closely regulated by the free choices of market participants. The actions of each constrain and influence the actions of others in ways that make actions regular— more or less predictable, falling within understandable bounds.
Government regulation is not the only kind of regulation; market forces also regulate. Recognizing this, communicating it to others, and getting the awareness into public discourse are key steps toward greater economic liberty.
The benefit of this semantic change — opening up the meaning of “regulation” to include regulation by market forces — is to raise the question, which works better? Regulation by market forces works better, but that’s another argument. The first step is to recognize that market forces regulate, too.
ON THE ECONOMY: MONEY FOR NOTHING
By John Dunham:
Managing Partner, John Dunham & Associates
Now look at them yo-yo’s that’s the way you do it, you play the guitar on the M.T.V. That ain’t workin’, that’s the way you do it. Money for nothin’ and your chicks for free. Now that ain’t workin’ that’s the way you do it. Lemme tell ya them guys ain’t dumb. Maybe get a blister on your little finger, maybe get a blister on your thumb.
The Dire Straits song written by front man Mark Knopfler and Sting, headlined the band’s 1985 Brothers in Arms album and was the first video played on the European version of MTV. The song may have anticipated the futility of US monetary policy over the past quarter of a century.
Last month, the Federal Reserve raised the target Federal Funds Rate (FFR) by 50 percent, from 25 basis points to 50 basis points. Following this increase there has been a plethora of media speculation on how this would impact various aspects of the economy. At the same time, the equity markets have fallen dramatically, an event that many have blamed on the change in the FFR. This echoes earlier acclaim for monetary policy under Chairmen Greenspan which was lauded by many as creating the great moderation, or by Chairman Bernanke, who was credited with saving the country from the next depression.
The truth about Federal Reserve policy is much less astonishing. Instead of setting interest rates, or telegraph future changes, the FFR is really a lagging indicator of actual interest rates, which are set by the market rather than government fiat.
Consider first what the FFR actually is. Rather than a market interest rate paid by consumers for home loans, or credit cards, or paid by businesses for lines of credit, the FFR is actually the interest rate at which banks lend reserve balances to each other overnight. Since reserve balances are held by the Federal Reserve to maintain reserve requirements, the FFR is little more than a rate that funds within the Federal Reserve System are lent. Even this rate is not set by the Federal Reserve but rather by the banks themselves as they either require funds (or have excess funds) available to meet reserve requirements.
As the actual demand for loans is currently well below the juiced up money supply being held by banks, the recent change will have virtually no impact. In fact, since the end of the last recession, the yield on the 10-year note has averaged about 2.6 percent, while mortgage rates have been just 4.24 percent. During this entire period of 84 months, the FFR stayed fixed at just 25 basis points and the effective FFR, or the rate actually charged by banks never even reached that low point. The effective FFR still is lower than 25 basis points.
The fact that FFR announcements are not particularly important can be seen in the above graphic. The data show a very strong correlation between the target FFR, the actual FFR, the London Interbank Offered Rate (LIBOR), the yield on the 10-year note and even 30-year mortgage rates; however, a stronger and more significant correlation can be seen in a quarterly lag between the long term rates and the short term FFR. In other words, over the past 30 years, the FFR has followed long term interest rates both upward and downward. The data suggest that a sustained increase of about 10 percent in the rate of the ten year note will lead to a lagged increase of roughly 2.5 percent in the FFR, and a rise of 10 percent in the 30-year mortgage rate correlated to a roughly 17-percent in the lagged FFR. This holds across administrations, and in good and bad times. I would argue that in spite of all of the effort spent by pundits, bank economists and others attempting to decipher the mumblings of the Federal Reserve Board of Governors, minor changes in the FFR do not impact economic conditions.
Monetary policy can change lending behavior at the margins. When a market is overheated, providing banks with high risk-free returns can help reduce capricious lending, while in a more stagnant market, forcing negative returns on bank monetary holdings (as is the case now) can encourage them to loosen lending requirements. But this is at the margin. In more general terms, markets set interest rates. As the economy has begun to reach the peak of a very weak business cycle, there has been some pressure on interest rates, with 30-year mortgage rates coming back to 4 percent toward the end of 2015, and 10-year bond yields that began to approach 2.3 percent. Even at these levels interest rates were remarkably low and barely positive in real terms. But they were higher than the FFR has reflected for some significant time. In addition, federal authorities from the Administration, to the Treasury Department to the Board of Governors of the Federal Reserve itself were all suggesting that the economy had been expanding for years. In order to maintain even a modicum of credibility, the Federal Reserve had to raise the FFR by at least a few basis points.
The FFR increase is simply not going to change the economy. As Dire Straits might have said that ain’t workin’ that’s the way you do it. But lemme tell ya them guys ain’t dumb, the Federal Reserve will continue to issue arcane statements to try to suggest that markets don’t matter, but they always will triumph over government fiat.
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