By Russell Lamberti

Unregulated economies are a mess.  They’re bound to generate harmful excesses, blow up bubbles, create unpredictable business cycles, and render producers confused and entrepreneurs lacking guidance to make sustainable and successful decisions.

Our economies need to be planned and regulated daily, even hourly, if we are to have any chance at success.  They need to be micro-managed, scrutinised and guided by intelligent leaders.  Success can only come by astute planning.  We simply cannot abide any longer a hit-and-miss, unfettered economic system, fraught with greed, special favours, oligopolistic cronyism, and one that allows economic excesses to run rampant and unchecked.

This is why we need free markets.

Mankind has not yet discovered a better regulator than the free market.  The free market economy, contrary to the popular narrative, is not some wild frontier of unrestrained greed and excess, but is in fact a regulatory task master par excellence, punishing foolish, greedy, lazy and fraudulent behaviour swiftly and ruthlessly.  In fact, greed, imbalances and economic criminality go manifestly unchecked when the state distorts markets by arbitrary dictates and intervention which allow it to selectively evade economic consequences for itself and favoured cronies.

“Regulate” is derived from the Latin “regulatus” or “regulare”, from which we also get the modern word “regular”.  The Latin terms themselves are believed to be derived from the Proto-Indo-European (dated some 5,500 years ago) prefix “reg-”, which means to “move in a straight line.”  The essence of regulation then is that it manifests in regularity and greater predictability, and less distortion, chaos and volatility.

State economic intervention then is the very antithesis of regulation.  Not only does it change from one year to the next on the whims of politicians, but the myriad of price controls, subsidies, tariffs, licences and the like only serve to distort market prices and processes from reality, skewing incentives, fostering entrepreneurial error, making price discovery opaque, and as a result raising rather than lowering irregularity and uncertainty.

Those who favour economic planning and regulation should favour free markets.  No other system exacts such a high standard of safety, product quality, and consumer protection.  No other system has such a micro-managed structure, where all production is controlled by millions of line managers, factory managers, product managers, marketing managers, logistics managers and so on.  No other system generates such meticulous planning as does the one in which millions of entrepreneurs pour daily over supply decisions, financial models, earnings projections, labour wage negotiations, capital investment plans, and new marketing strategies.

On the other hand, those who favour the unshackled and unregulated economy should favour state intervention, industrial policies, subsidies, tariffs, price controls, red tape, and petty rules.  No other system displays such signs of unfettered chaos.  No other system distorts market incentives so greatly so as to generate excesses and imbalances, gluts and shortages, bubbles and busts.  No other system rewards inefficiency, bad behaviour, and greed – not only rewards it, but encourages more of it!

The essence of our economic woes today stem from unrestrained and unchecked economic excesses and distortions: Too much debt, too little saving.  Too much consumption, too little investment.  Too much greed, too little honesty.  Too much unemployment, too little productivity.  Too much erosion in living standards, too much money concentrated in the hands of a few.

But we need to understand that the free market will never let these excesses reach such awful proportions as we currently see in our broken state-controlled global economy.  When, for example, debt begins to rise and saving begins to fall, the free market for loanable funds begins to feel a shortage of supply of funds and a glut of demand for funds at the prevailing price for loanable funds (interest rate).  Very quickly the price of loan funding will rise, discouraging at the margin those marginal and potentially unsound investments/expenses, but also encouraging new savings so as to eventually contain the rise in interest rates.  We would find that in a free market for loanable funds, not only are investment bubbles unlikely or very short-lived and contained, but interest rates would actually be quite stable (regular), allowing entrepreneurs to make far better investment decisions over a more predictable time horizon.

Instead we live in a world in which the central bank manipulates interest rates to serve myopic policy goals which more often than not leads to the price of loanable funds either being held too low or too high for too long.  Like any price control in the economy, the result of interest rate price controls is predictable.  If forced to stay low while debt increases and saving falls, there will be no natural restraint on new debt spending while at the same time no incentive for savers (who need to earn interest) to save more.  There will be a glut of demand for funds but insufficient supply, frustrating entrepreneurs.  Even worse, for the central bank to keep interest rates artificially low, it must print money in order to pretend that there is more savings than there really is.  This printed money is loaned to borrowers as if it were real savings, but because it is not real savings (and therefore not income diverted from elsewhere in the economy) it can only compete with all the money already in existence for scarce resources, driving prices higher than they otherwise would have been.  Borrowers who borrowed too much because of mispriced loanable funds now face rising costs of living which erode the purchasing power of their incomes and undermine their ability to service their debt, creating a debt crisis.

One can see how the free market would have avoided this problem by responding far more dynamically and by regulating the demand and supply of loanable funds far more rigorously.  The ‘regulation’ provided by the central bank turned out to be of disservice to the economy, not managing adequately to curb the excesses of individual actors responding rationally to false price signals.

To take another brief example, suppose the state wishes to regulate and support textile manufacturers by placing tariffs on imported textiles.  Watch how the state-controlled system cannot control excesses and unhealthy distortions, the very things proponents of state economic regulation claim to be able to achieve.

The tariff on cheaper imports raises the price of textiles to consumers above the free market price.  This makes producing textiles more attractive and encourages more supply to come on-stream.  However at the same time, the higher price of textile goods deters marginal consumption, reducing demand.  Textile manufacturers are now producing more for a market that wants less, leading to a glut of production, unsold inventories, and a cash flow crisis, potentially leading to failed businesses and rising liquidations.  Moreover, to the extent that demand for textiles is, say, relatively inelastic, even though demand falls, consumers as a whole still spend more of their incomes buying clothes, meaning that income is diverted away from other products.  The producers of these other products suddenly experience a surprising drop in demand for their products, meaning that they now have to retrench staff, downsize operations, liquidate capital, and reduce output.

The net result is that some local textile manufacturers survive but may have to reduce output, while others may go out of business altogether as consumer demand falls, and at the same time producers of other products are forced to downsize operations or even, in the case of marginal producers, close down altogether.

This is not economic regulation, but economic degradation and unfettered folly.  The market would instead play a tight regulatory role, forcing uncompetitive domestic firms to improve their quality per unit cost or reduce their prices outright by generating greater cost efficiencies.  Firms that could not do this would be forced to liquidate, meaning that his entrepreneurial efforts, his capital, and the inputs used in his endeavours (including labour) are better allocated elsewhere in the economy to more efficient and productive ends.

It is time we got perspective on what true regulation is and what it is not.  Regulation is not some government bureaucrat placing ‘necessary’ shackles on the ‘wild and untamed’ free market.  State intervention is actually deregulation, removing the natural and unrivalled regulatory role played by the free market in coordinating billions of micro decisions into a coherent whole.  Real regulation, a vital service to society, can only be rendered by the free market.

Free markets reward prudence, thrift, low time preference (i.e. willing to wait for gratification), caution, planning, management, honest business relations, careful risk assessments, careful lending, careful borrowing and so forth.  In a free market, fraud, greed, impatience, excessive debt, recklessness, imprudence, mismanagement, theft, sub-prime lending, and thoughtless borrowing will not long go unpunished.  Resources are always allocated rather quickly away from the scoundrels, free-riders, lazy and incompetent, toward the most capable possessors, the dynamic entrepreneurs, the honest, the industrious, the creative, and the prudent.

The longer the state tries to interfere and deregulate the economy, the more risk we face of economic imbalances, excesses, and structural deficiencies.  We need much more and much better regulation, and only allowing markets to be unhampered, to meet out consequences, good and bad, swiftly and justly, without prejudice, can provide the kind of 21st century regulation our dynamic, fluid, and wonderful economies deserve and need.

Russell Lamberti is Head Strategist at ETM where he heads up the ETM MACRO STRATEGY service.  He moved to ETM after spending two years with Johannesburg based consulting economists, Econometrix, where he was involved in macroeconomic research, forecasting, and consulting for private and government clients.  Russell specialises in monetary economics and political economy. Follow him on twitter @RussLamberti and visit his website RussLamberti.com.