In 2012, governments should lessen their role in the economy

As we begin the New Year, it is a good time to reflect upon our past actions and decisions and hope to correct our past errors with good decisions in the future. To reflect on all of the errors created by government would require at least a ten volume series so I will narrow the focus of this article to the recent economic situation that the world faces which requires much reflection.

So how did we get here? One bad policy, though well intentioned, was the Community Re-Investment Act (CRA). Some defenders of this act claim that because it was originally passed in 1977 it had no impact. However, they ignored the changes that began in reaction to a 1992 Boston Federal Reserve Bank study which showed that there was discrimination in mortgage lending. To fast-track the history lesson, this revelation led to changes in 1995 that forced banks to show they made a large number of loans to low and moderate income borrowers. To attract business, banks would have low interest rates and soon provide low interest loans to everyone with better credit too. Additionally, an affordable housing mission was added to the public-private corporations Fannie Mae and Freddie Mac. By 2007 they were required by law to show that 55 per cent of all of their mortgage purchases were loans to people of low and moderate income.

With the increase in demand for homes came the rise in housing prices —a healthy investment as seen by investors. Houses require a lot of materials so all of the businesses producing goods used in homes or home construction would have seen increased demand, leading them toincrease their prices and attract investors. This is a bubble. When it burst because people could not afford their mortgages, housing prices fell and stocks plummeted. We all know the story; the banks left with these mortgages went bankrupt and the government bailed them out. The initial intention of the government to ensure poorer people received loans lead to unfortunate consequences.

Now into a recession, the government felt the need to take action. First was more regulation as opposed to getting rid of the regulation that created the mess. The second action which was really unfortunate was stimulus spending. People argue for stimulus because it will increase confidence in the market by creating a bull market encouraging investment. Its other goal is to decrease unemployment. Think about this logically though. If the government builds a building for a program it wants implemented it calls it stimulus. Contractors are needed to construct the building thus giving them jobs. More jobs are created within the building.

However, money needs to be constantly spent by the government to sustain it or else it will go bankrupt. Once they stop spending, the area which they were pouring money into, has less demand suddenly the shares plummet and another economic crisis ensues. Thus, the government creates booms and busts in the economy through spending.

The problem with taxing people so that the government can spend money elsewhere is that it actually shuffles money around it does not create wealth. The government can also tax indirectly through inflation. Jobs are created but the money comes from somewhere.

Let’s say the government taxes people to build a military base. Sure, the military base gets money and it creates jobs but that money would have gone to another good or service that also could have been valuable. Values are subjective and so people should spend according to their own needs and wants. It is their money after all. As Friedrich Hayek wrote in his Constitution of Liberty, “A society that does not recognize that each individual has values of his own which he is entitled to follow can have no respect for the dignity of the individual and cannot really know freedom.” Sure the government created jobs in one field but in doing so reduced them in another. This is the broken glass fallacy.

Now because countries cannot pay back what they own it has plunged the world into another crisis. Governments need to cut. It might result in a mild recession at first but the economy has been inflated by government spending and the only way to fix it in the long term is by reducing it and by allowing the market to work.

Going into 2012 we have a lot of opportunity to set things straight. Reducing the role of government in our economy and enhancing individual freedom should be our New Year’s pledge. Let’s just hope we take it seriously.