One of the major contributions of the renowned
Austrian-British economist, political philosopher and a proponent of liberal
democracy and free-market capitalism, Friedrich von Hayek, to economic and political
thought was his notion that the scope of knowledge required for making decisions
on the efficient allocation of resources in society is inherently decentralized.
Mr. Hayek, the co-recipient of the 1974 Nobel Prize in economics, argued that
the planners in a centralized government will never have enough information
to carry out this allocation reliably. Efficient exchange and use of resources,
he claimed, can be maintained only through the price mechanism in free markets.
That Mr. Hayek's ideas have been very helpful in explaining social, economic
and political events was demonstrated in a very dramatic way in the collapse
of the communist systems and the efforts during the Reagan-Thatcher years (which
continued under their Clinton-Blair successors and are now taking place under
Nicholas Sarkozy in France) to reform and deregulate the more centralized economies
that have evolved in the West after 1945.
But what some of the promoters of the free markets fail to understand is that
Mr. Hayek's ideas can and should be applied not only to the economic sphere
but also to other areas of societal decision-making, ranging from welfare and
education to national security and even foreign policy.
Indeed, it is intriguing to watch advocates of free markets in the United States
ridiculing the view that the federal government in Washington can supposedly
"fix," say, the American energy markets or its healthcare system, but cheer
the Bush administration's suggestion that the very same federal government in
Washington can use military power to engage in "nation building" in Iraq and
"democratize" the Middle East.
Take for example two issues that are on the minds of the American citizens
and their representatives in Washington: the mess in Iraq and the mess in the
subprime housing market. Ask yourself who seems to be responding in a more effective
fashion to each of these crises that reflect in different ways a very similar
problem: the recognition that there are enough available resources to allocate
for certain purposes.
Although it has not been drawing as many headlines as the war in Iraq, the
crisis in the subprime housing mortgage markets has been a concern not only
to homeowners and the real estate industry but also to many investors, and in
particular to bond traders.
Indeed, this crisis is a reflection of a wider problem, that of excess liquidity.
The continuing availability of cheap credit, a.k.a. "easy money," has energized
the economic boom of recent years, especially in the American real estate market,
and in that context, has also been responsible for the creation of pools of
debt assets in the form of mortgage-backed collateralized debt obligations that
helped fuel the subprime housing market where loans were offered to potential
buyers with no credit history.
The crisis that the subprime-mortgage market is facing is just one more sign
that the never-ending supply of credit that has helped create a boom in consumer
spending as well as in speculative investments is coming to an end. As credit
conditions are starting to tighten, it is becoming clear that lower-quality,
higher-risk assets such as subprime bonds have been losing their value at the
same time that many companies are limited in their ability to raise and issue
All of this does not amount to a pretty picture. But that much of the economy
continues to do well and to grow, unemployment is low, inflation remains relatively
low, and that the markets, including the stock markets, remain calm, is a testimony
that the mechanisms of the free market – upward pressure on interest rates,
the tightening of lending standards, the falling prices in the housing industry
– have been working.
There are signs of weakness in commercial real estate, and lower-quality corporate
debt is certainly raising concerns in the financial markets. But no one expects
Washington to get into the picture and "do something" dramatic. Indeed, lawmakers
and policy-makers are proceeding slowly to restrict the sort of lending that
contributed to the problems in the real estate market.
But as Federal Reserve chairman Ben Bernanke said in his Congressional testimony
last Wednesday, those who made decisions in Washington "have to make sure
we find ways to prevent the bad actors, the abusive lending, while preserving
this market, which is an important market." Yes, there is a lot of talk
on Wall Street and elsewhere about the potential for the current crisis in the
subprime-mortgage market turning into a rerun of the collapse in 1998 of the
hedge fund Long-Term Capital Management, which ended up producing devastating
turmoil in the financial markets.
But the lessons of that systemic crisis have been absorbed by the markets,
leading to more diversification of financial institutions and more investment
in risk management.
That does not mean, of course, that the more risky parts of the capital markets
will not continue to experience more shocks that would certainly affect the
private equity. But consumers and business are still borrowing, perhaps in a
lower rate than before, and the US real estate market is still healthy.
Less credit will be available and as interest rates continue to rise, consumers
and companies will have to adjust their spending and investors will be less
But overall, this will be a self-correcting process that will be driven by
the markets, and not by government. That is, the government that has been entirely
responsible for the series of decisions that have produced the current US military
quagmire in the Middle East, measured by hundreds of thousands of casualties
and hundred of billions of US dollars: intelligence agencies reflecting bureaucratic
incompetence and bowing to politicians who warned of weapons of mass destruction
in Iraq and links between Saddam Hussein and Osama bin Laden; a government and
a military that failed to prepare for the requirements of a long occupation;
the mind-boggling faith of the American leaders in their ability to "transform"
Iraq and the Middle East into a democracy; the inability of US Congress to "check
and balance" the Bush administration.
These and other political and military debacles that we have witnessed in the
last four years – the response to Hurricane Katrina is just another example
– and what seems to be the inability of the Bush administration and Congress
to get out of the mess in Iraq – highlight the weaknesses that, according to
Mr. Hayek, governments and political institutions tend to exhibit in general.
That does not mean that governments under certain conditions and led by competent
and industrious leaders and bureaucrats cannot accomplish big objectives. And
no one seriously suggests that private companies can lead nations into wars.
But the fiasco in Iraq does teach us the following lesson: leaders of governments
who recognize their weakness should not rush into war, which is probably the
hardest and costly project that any society takes on itself, unless the nation
is facing, indeed, a clear and present danger.
The good news is that the signals that are being sent by a market that may
be facing a credit crunch – that the Bush administration may have less to finance
military adventures around the world and by extension, its rising budget deficits
– could put pressure on Washington to start making the cost-effective decisions
it needs to make in Iraq. But do not hold your breath.
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