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 debt.
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 exuberant.
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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