It’s Not Nice to Fool the Free Market

The economic woes of California are back in the news yet again.  This time it is high gas prices.  Of course, the Golden State usually has the highest prices in the country, but recently prices at the pump have skyrocketed – increasing on average by 50 cents in the last week and reaching almost $6 a gallon in some areas of the state.

The senior senator from the state, Dianne Feinstein has predictably called on the Federal Trade Commission to investigate the possibility of price gouging.  She, like all statist politicians, doesn’t understand the workings of the free market. When their statist schemes backfire, they immediately blame the usual faceless enemies – unscrupulous suppliers, manipulators, and speculators.  Once again the public is being subjected to this tirade when as always the fault lies with Feinstein and her ilk.

You see, California, as this commentator has written before, has a crippling regulatory environment.  The environmental fringe has hijacked state government and squashed all reason and economic sense.   Gasoline suppliers outside the state are unable to ease the burden of short supplies in the state because they are not equipped to produce the cleaner-burning gasoline required by bureaucrats in Sacramento.

And there is a shortage of gasoline right now in California because the state has just enough refining capacity to fill its demand due to stiff environmental regulations.  When Exxon Mobil’s refinery near Los Angeles experienced a power failure which cut production and Chevron’s plant near San Francisco suffered a crude-processing unit shut down due to fire, supply was curtailed and prices rose drastically.

Thus, Feinstein’s faceless, nameless perpetrators of higher gasoline prices are non-existent.  The cause of higher gas prices in California is a lack of supply produced by the policies of statist politicians like her.

In fact, to increase supply the first thing Governor Jerry Brown did was order regulators to relax smog controls and allow refiners to begin, earlier than usual, producing cheaper winter-blend gasoline.  His actions are an acknowledgement of where the real problem lies – with government policy, not fictitious bogey men.

The free market, like nature, is an all-powerful force.  Human manipulation of either spells trouble.  Politicians will always blame someone else when their manipulations go astray.  Whether it is higher gas prices, housing market busts, or a drop in the value of the dollar, they point the finger at unscrupulous suppliers, manipulators, and speculators.  Instead they should look in a mirror and then point their fingers.

Article first published as It’s Not Nice to Fool the Free Market on Blogcritics.

Kenn Jacobine teaches internationally and maintains a summer residence in North Carolina

Could Fed Style Banking Save California?

As was mentioned in this column last week, given the defeat of tax hike propositions in California, the state is in a real quandary to find $24 billion dollars by July to close its budget gap.  Without those funds or new debt guaranteed by the federal government, California will face insolvency by mid-summer.  Unlike Washington, Sacramento cannot just print money out of thin air to put off paying its bills indefinitely.  Even that technique of monetary policy is about to catch up with the entire country soon when people begin spending and prices hit the roof.  No, it seems the only way for the Gold Plated State to settle its fiscal woes is to cut payrolls and services.

Not so fast you doomsayers, Ellen Brown, author of Web of Debt, and blogger on the leftist Huffington Post believes she has come up with a scheme to keep the socialistic gravy train in the state rolling without interruption.  She admits California cannot print its own money, but it can open a state owned bank that can create money through credit entries on its books.  To explain how it would work she quotes the webpage for the Federal Reserve Bank of Dallas:  

“Banks actually create money when they lend it. Here’s how it works: Most of a bank’s loans are made to its own customers and are deposited in their checking accounts. Because the loan becomes a new deposit, just like a paycheck does, the bank…holds a small percentage of that new amount in reserve and again lends the remainder to someone else, repeating the money-creation process many times.”

Pretty neat huh, new money is created by a simple accounting entry and then loaned out again.  Because it owns the bank, the state could afford itself a sweetheart deal by giving itself rates below market value and then roll those loans over as needed until revenues had been generated to pay them off.  Brown credits the state owned bank in North Dakota for that state being one of only 3 currently that are solvent.  She also believes North Dakota’s GNP and personal income growth is directly related to the bank’s operation.  One can have their cake and eat it too in the Peace Garden State.

Now, on the surface, Brown’s assertion that the difference between North Dakota’s solvency and the 47 states that are insolvent in this economic crisis is the state owned bank seems legitimate.  However, upon closer inspection this is proven inaccurate.  First of all, North Dakota is the 3^rd least populous state in the union.  It doesn’t even have a million people.  There is little crime, hardly any costs associated with illegal immigration, and much less of a need for social programs.  It is after all a conservative Midwestern farming state.  

Indeed, it is probably because of the state’s two biggest industries, agriculture and petroleum, that North Dakota is doing so well.  These industries have done very well in recent years and would account for the huge growth in the state’s GNP and personal income.  Incidentally, the exclusion of food and energy costs from the consumer price index has contributed to moderating the national inflation rate at a time when both commodities’ costs have been relatively high.  As far as the solvency of the state is concerned, North Dakota is not a low tax state and given the prosperity of the two aforementioned industries it’s no wonder the state’s coffers are overflowing.

Secondly, what Brown is suggesting is responsible for North Dakota’s prosperity is really just fractional reserve banking albeit through a state run bank instead of the private system.  Fractional reserve banking is nothing new and in fact is what the Federal Reserve System is based on (hence the quote from the Dallas Fed).  It is a monetary scheme whereby banks keep only a portion of all its deposits (currently approximately 10 percent) in reserve and loan out the remainder while at the same time maintaining their obligation to pay on demand all deposits to savers.  There are two problems with fractional reserve banking: Loss of liquidity and inflation.  The Fed maintains what is called a discount window for banks to use to borrow short term from the Fed when their liquidity is insufficient.  Fed chairman Ben Bernanke has been asked several times by Congress to divulge the names of banks that utilize the discount window.  He refuses on the grounds that the information would unnecessarily cause a lack of confidence in those banks and put them at risk of real insolvency.  However, it is more likely that the number of banks utilizing the discount window is immense primarily because of fractional reserve banking and to make that information public would destroy all confidence of Americans in the banking system.  Think about it, when a bank writes down a bad loan it is also writing down a deposit it must eventually make good on.  How many banks have written down bad loans in the current crisis?

But fractional reserve is a funny money scheme for another reason.  It is a hidden tax because it leads to general price inflation.  It probably is more responsible for the increase in money supply than low interest rates.  As banks create new money through creating credit out of thin air the value of every dollar is decreased.  It then takes more dollars to purchase the same goods if the supply of those goods has not increased.  More research would be needed, but the Bank of North Dakota’s inflationary policies are probably being offset by the high market prices of their two main industries – food and petroleum.  In any event, besides Alan Greenspan’s artificially low interest rates of the early 2000s, fractional reserve banking also contributed to the housing bubble and will be a contributing factor to the inflation the U.S. will face in the future.

Statists are good at devising schemes to prolong their wasteful policies.  Ellen Brown’s funny money scheme is just the latest.  It won’t work for California because it hasn’t worked for America.  A bailout of the state should be out of the question.  The voters have spoken and they have said no new taxes!  The only thing left for the benevolent politicians in Sacramento to do is to free thousands of non-violent drug offenders, lay off thousands of state workers, and end welfare as they know it.  Maybe then California can be known again as the Golden State.

Let California Fail

It is ironic that the federal government is substantially meddling in the financial affairs of other entities given the dilapidated state of Washington’s own finances.  First, there were the banks, investment houses and insurance companies – the most notorious being AIG.  Then the auto companies weighed in getting their piece of bailout funds from Uncle Sam.  Now, it seems the states will be next to tap the national treasury for funds that do not exist. 

There is a saying, “As California goes, so goes the rest of the nation.”  How true these words have become since both are completely bankrupt.  With the defeat this week by voters in the Golden State of ballot initiatives that would have drastically raised taxes to close a $24 billion budget gap, the state is on course for a complete financial collapse by July.  Unlike the national government, California can’t print money to buy more time either – no pun intended.  It must find a way to raise the funds otherwise millions of Californians will not receive checks.

But, not to worry, Governor Schwarzenegger, Senator Boxer and other Golden Staters are putting the squeeze on Treasury Secretary Tim Geithner to guarantee emergency loans that California needs to meet its obligations.  With the state’s credit rating in the toilet, some analysts believe federal backing is California’s only hope to secure the loans it needs to pay its bills.   The proposal would collateralize U.S. taxpayer funds to guarantee private lenders that they would be repaid if California defaulted.  The concept is to take the risk out of lending to California for banks and place it squarely, again, on the shoulders of American taxpayers.

Of course the leverage state officials are using on Geithner is that California is “too big to fail.”  They claim if the state were to go belly up it would send ripples through the rest of the country and even the world.  Further, if Washington allowed the collapse to take place imagine what that would do to the confidence the rest of the world has in us to lead economically.

Clearly the feds are in a totally unenviable position.  If they don’t bail Sacramento out they will look really bad given their enormous generosity towards unscrupulous bankers, and inept carmakers.  Since most of the money California needs to borrow will go to ordinary folks, teachers, cops, government workers, Washington can’t be seen again to favor the interests of Wall Street over Main Street.  Thus, I believe there is no question that the Obama Administration will bailout California.  Naturally, this is a big mistake.

In the first place, if Washington succumbs to the “too big to fail” ploy with California, then what happens if say Wyoming asks for bailout funds.  Can it be denied because its economy is not nearly as important as California’s to America’s health?  Is it proper to favor one group of Americans over another simply by virtue of where they live?  I realize we do that now with things like highway funds, but saving one state and letting another go is a horse of a different color.  What about Wyoming’s portion of the federal bailout funds for California?  If Washington submits to Schwarzenegger’s request it will open up an array of ethical and legal questions pitting states against each other.

Then there is the “moral hazard” that would result with a California bailout.  Given that politicians are not very courageous when it comes to making touch choices, state bailouts by the feds would allow state officials to manage state funds even more irresponsibly.  California is a perfect example.  The statist politicians there have overpaid public employees, spent generously on social services, and overregulated business and the environment.  Bankruptcy is the perfect solution to their reckless spending.  It is what ended socialism in Eastern Europe; it should be used to end socialism in California.  Without it, politicians of all stripes will believe that Uncle Sam will catch them when they fall.  This will impede economic recovery and perpetrate the myth that Washington has a bottomless bank account or a bank account at all.

Which brings us to the question of where does California think the feds are going to get this money anyway?  Our leaders have become oblivious to our financial condition.  When you can’t pay your bills you are bankrupt.  Washington has been bankrupt for a long time, but again has had the means (printing press) to put it off.  And put it off the politicians have.  That is why we now face the economic situation before us – a lower standard of living, mountains of debt both personal and national, and a gigantic task of rebuilding our industrial base so that we can compete again.  You see the politicians since at least 1971 have mortgaged our future; those bills have come due; and we don’t have the money to pay them.

So, California is not alone.  “As California goes, so goes the rest of the nation.”  Both entities are broke.  Perhaps instead of groveling to Washington to bail them out with funds Washington doesn’t have, the politicians in Sacramento can set an example for Washington to follow – deregulate, end the welfare state, disband public unions, and live within your means as a society.  Wouldn’t it be nice if California led the nation in a positive way for a change?