Government is Doing Something!
(It’s Misallocating Resources)

There are two ways to allocate scarce resources:

  1. the market allocates resources (supplies) using the price mechanism according to customer demands. It uses entrepreneurs to perform this task. If an entrepreneur fails to satisfy customers, he loses money, and if he continues on his errant course, goes bankrupt. If he succeeds at fulfilling customer demands, he earns a profit.
  2. by government edict; i.e., the use of force according to the dictates of some bureaucrat or political body that thinks it knows what is best for “the people.” Whether a government fails to satisfy its “customers” or not, it misallocates resources. In many cases, customers either have to find a way around the government (thus breaking a law, risking spending time in jail) or do without the assets that were misallocated. Furthermore, should the government misallocate resources, its constituents may have to pay a higher price in the form of higher taxes, additional paperwork, and regulatory costs, to cover the government’s losses.

Let’s consider a recent example in the United States. To encourage Americans to own their own homes, Congress established FNMA and FHLMC to subsidize housing while the Fed lowered interest rates below the market rate. And it worked, to a point. Unfortunately, some people were encouraged to make purchases they couldn’t afford while interest rates were being held (by government edict) at artificially low rates. Others used their homes as ATMs and consumed their equity or speculated in stocks. Among Austrian economists, this is known as a misallocation of resources, a government induced perversion of the market’s invisible hand.

When borrowers defaulted on their debts, the banks (lenders) experienced financial difficulties. Trillions of dollars were lost as real estate prices plummeted. The market was trying to correct for the government’s misallocation of resources. Once again, the Fed (and Treasury Department) stepped in to defy the market’s will and prevent the banks’ failures. So while the market is saying, “These banks screwed up and lost billions of dollars,” the government is saying, “We don’t care. We like these banks and we’re going to help them continue to screw up, (or, “Now it’s our turn to fight the markets”).

When the auto industry realized that the market no longer demanded as many automobiles, what did it do? Did it cut production and costs and live according to market demands? Yes and no. It cut back on production, but not enough. Instead, automakers went to Washington for another misallocation of resources (taxpayer resources).

In a misguided flight to safety, some people are panicking and putting their money into U.S. T-Bonds (they have faith in the government’s force and ability to repay its debts), while others are liquidating their remaining assets to pay down debts. Is this another misallocation of resources? How long before the T-Bond market corrects for this bubble?

And now we have a new president who wants to stimulate the economy by rebuilding infrastructure and escalating the war in Afghanistan (more government make-work projects). It seems that each market interference leads to another. Unfortunately, the U.S. has gone way beyond a misallocation of resources—it is spending resources it just doesn’t have and it’s going deeper into debt to cover these misallocations. At some point, when other countries realize that the U.S. government can’t repay its debts, they will stop lending (buying T-Bonds) and the bubble will burst. Simultaneously, the dollar will experience a vertiginous drop relative to the market’s money (gold and silver).

Every time a government steps in to “do something,” it fights the markets and misallocates resources. If instead, governments would do nothing, they would let the markets do their job of allocating scarce resources according to consumers’ demands. There wouldn’t be a misallocation of resources. But, of course governments have been meddling in the markets for a long time and it appears the weight of those misallocations may be at its limit. Somehow, over time, more people have developed a faith in government force than have acquired a faith in the markets’ ability to allocate resources. That’s unfortunate, because in the long run, the markets will win—maybe not in the United States, but somewhere where honest money and freedom are valued above government force and fiat money.

Robert Jackson Smith

Rate This Article Anonymously!