OK, I WOULDN'T VOTE FOR THE SENATE'S BAILOUT BILL. HERE'S WHY ... (Part I)

Last night, after taking a quick look at the Senate bailout version I wrote that, in spite of the pork included, I might support the bill if I were in the House of Representatives. There's too much at stake (and there is). However, after getting a closer look, I have to say that I would not support this bill. Before I provide the specifics - which I will do in my next post - we need some history.

In a few words, what we are being asked to bailout is a market environment that is no longer focused on the production of goods & services. What we have in front of is, and what helped create this mess, is a market driven by gamblers bent on extracting wealth. The Senate bill not only fails to punish what can only be called 'pirate economics', it pretty much rewards it.

A little bit of history helps us understand my thinking here, and how we got to this point. I'll address the specifics of the Senate bill in my next post. The following is from Chapter 4 of my forthcoming book, The Roots of Markets & Wealth ...

In A Short History of Financial Euphoria, John Kenneth Galbraith discusses the famous case of “Tulipomania” in Amsterdam at the beginning of the seventeenth century. What started as simple prestige for those who possessed novel tulip bulbs turned into wild speculation over successive price increases throughout 1636. Specifically, competition over tulips turned into mania, with single bulbs trading for new carriages and homes, or fetching as much as $25-50,000 each. Demand reached such heights the Amsterdam Stock Exchange developed a futures market for the bulb. 

This market, as well as the dreams of many speculators, would collapse under the weight of its own nonsense and spectacular avarice. As sellers demanded their tulip contracts be enforced, they were disappointed when their petitions fell on the deaf ears of the courts. Because the market had little to do with the production of actual goods and services, the courts viewed Tulipomania as little more than a gambling operation. As is the case throughout these histories, panic, default, and bankruptcy followed. Galbraith wrote “no one knows for what reason” the speculation and mania ended, but there’s little doubt common sense finally prevailed in a market spun out of control by deluded buyers and sellers. 

Fast forward almost 340 years. We find the creation of another futures market, but this time in U.S. dollars. In The Vandal’s Crown: How Rebel Currency Traders Overthrew the World’s Central Banks, Gregory J. Millman tells the story of how a glut of U.S. dollars (see Chapters 10 & 11) helped turn the world’s anchor currency into another commodity, just like corn and beef. Driven by the need to pay for the defense of the West, while attempting to solve social problems at home, by the mid-1960s the U.S. government had put too many dollars into circulation. Because too much of anything drives down its value traders knew the future price of the dollar would both fluctuate and drop, especially with persistent U.S. budget deficits and growing debt.

Like all good entrepreneurs traders wanted to profit off of these dynamics but needed to go beyond what traders in the Euro-Currency markets were doing (trading currencies to cover commercial transactions). They wanted to trade dollar futures. By 1970 they were looking to trade and speculate on the dollar like Chicago Mercantile dealers who bought and sold pork bellies and cattle. To do this, they needed to convince the Nixon administration that speculating on the value of the dollar was a good thing. They would say nothing about what made trading on the dollar so profitable – the underlying irresponsibility of bloated budgets, growing debt, and price fixing.

For $5,000 (paid by traders) Milton Friedman was goaded into writing a paper which argued that a futures market in dollars was a good idea. Friedman would ignore the underlying irresponsibility of bloated budgets and growing debt. Friedman’s paper was sent to Nixon’s Treasury Secretary, George Schultz, who bought into the idea, stating “…if it’s good enough for Milton [Friedman], it’s good enough for me.”

The result was an explosion in currency trading and other “innovative” financial instruments whose value now outpaces the value of goods and services produced around the world. Today, an entire industry of traders, analysts, and lawyers make their living off of what Peter F. Drucker called a “symbolic economy” (discussed in Chapter 11). Ignored is how little the average person understands this part of the economy, and how bloated budgets and growing debt feed it. Also left unaddressed – if not conveniently ignored – is how continued deficit spending and bloated budgets virtually insure the precipitous decline of the dollar. These dynamics fly in the face of what Adam Smith had to say about the importance of knowledge, transparency, and information in capitalist markets.

Given these cases (and there are more), do we simply trust all market players to do what’s right and not succumb to speculation, greed, and the herd mentality that overtook Holland’s tulip traders? If history – and current events – has taught us anything it’s this: The further a generation gets from the great financial disasters of the past the more their confidence grows in the brilliant and innovative discoveries they’ve made in the markets of their day. Past experiences and skeptics - as JK Galbraith put it - are “dismissed as the primitive refuge of those who do not have the insight to appreciate” what the new wonderkinds have fashioned ...

- Mark