Archive for December 3rd, 2011

Price Controls Never Work

When Richard Nixon signed the so-called Economic Stabilization Act of 1970 into law the hope was that wage and price controls would put a halt to rising price inflation.  The program was a reaction to the spendthrift ways of the federal government in the 1960s that attempted to finance both the Vietnam War and Lyndon Johnson’s so-called Great Society.

Nixon’s plan to impose his will on the economy ended in utter failure.  For instance, his price ceiling on red meat did not stabilize the price of beef, it kept rising.  What it did do was put many small plants out of business because they found themselves selling on smaller and smaller margins.  No amount of price controls could remedy the overall price inflation of the 1970s.  It wasn’t until the double-digit interest rates of the early 1980s that it finally subsided.

The President’s economic advisors should have known better.  Besides many instances throughout history where price controls have caused much more harm than good, all they had to do was study rent control effects in New York City since World War II.  Again, the effects of price controls have been an utter failure.  While stabilizing prices at the proscribed government level, rent price controls negatively affect the very low-income renters they are meant to help.  Because landlords are required to rent their properties at below market prices, they provide inferior dwellings in short supplies.  While a 7 percent vacancy rate is considered normal and non-rent control cities like Dallas, Houston, and Phoenix often have vacancy rates about 15 percent, New York City has not had a vacancy rate above 5 percent since World War II.  Any way you look at it, government price controls distort the market and cause much more harm than good.

The reason is because they abrogate the important relationship between supply and demand.  Economics 101 tells us when government mandates a price for a product that is above market value a surplus results.  Since the 1920s, government farm price supports have caused prolonged surpluses in agricultural goods.  Conversely, when government mandates a price below market value shortages arise because consumers are willing to buy more than what suppliers are willing to provide.  At the end of the day, price supports always disrupts the link between supply and demand that the market relies upon to run efficiently.

Even most mainstream economists agree that government price controls are bad because they cause dislocations in the economy.  However, what’s funny is they don’t see how the actions of the Federal Reserve Bank are essentially price controls of our money that also cause much more harm than good.  When the Fed sets interest rates, buys and sell assets, monetizes federal debt, or simply creates money or credit out of thin air it is setting a price level for the cost of money either directly (interest rates) or through the supply of money in circulation.  In other words, mortal men and women are fixing the price of money not the market.

The result of monetary price fixing by the Fed has been no less damaging than government’s price fixing of goods.  It is responsible for a continuous cycle of booms and busts in our economy.  The scenario that is repeated time and again is as follows:  usually in response to a downturn, a sluggish economy, or a crisis, the Fed sets interest rates artificially low; a cheap and abundant money supply promotes mal-investment into unproven enterprises like the dot.com bubble of the 1990s; a cheap and abundant money supply also promotes irresponsible investment and speculation like the housing bubble of the 2000s.  The fake boom ends when bank credit expansion ends.  That is to say, the bust begins when adequate returns on investments can no longer be found at prevailing interest rates.  What is then needed is a liquidation of all the mal-investments made during the boom.  This is referred to as a recession.  The ensuing recession starts the cycle over again with the Fed lowering interest rates to stimulate growth.

The booms and busts caused by Fed price fixing of the dollar have serious consequences.  Besides the up and down economy, savings rates remain low because it doesn’t pay to put your money in a low-interest bearing bank account.  This in turn denies start-up capital to the markets.  The Fed then prints more money and its member institutions use fractional reserve banking to increase the money supply.  This accelerates general price inflation.  To put it in perspective, the dollar has lost over 95 percent of its value since the Fed began operations in 1914.  Much of that erosion has taken place since Nixon closed the gold window to foreign redemption in 1971.  The result has been a declining standard of living for most Americans and an ever widening gap between rich and poor.
What is needed is a free market approach to money where the market dictates the price of a dollar, not central bankers.  Thus, the Federal Reserve should be abolished and with it the practice of fractional reserve banking.  In its place should be a 100 percent gold convertible currency.  Since market forces push the market to equilibrium, boom and bust cycles would become a lot less pronounced.  A gold backed dollar would protect savings and investments from the ravages of price inflation and provide an ample pool of capital for entrepreneurship.  At the end of the day, Washington abandoned product price controls because they failed to end the price inflation of the 1970s.  Now, it should abandon monetary price controls because they have failed to give us a prosperous economy.

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