Financial Regulation and the "Money Power"

In the end, financial regulation will best serve the insiders, the "money power."

In one of his essays criticizing inflationary free-silver proposals in the late nineteenth century, the great laissez-faire champion William Graham Sumner wrote:

We hear fierce denunciations of what is called the "money power." It is spoken of as mighty, demoniacal, dangerous, and schemes are proposed for mastering it which are futile and ridiculous, if it is what it is said to be. Every one of these schemes only opens chances for money-jobbers and financial wreckers to operate upon brokerages and differences while making legitimate finance hazardous and expensive, thereby adding to the cost of commercial operations. The parasites on the industrial system flourish whenever the system is complicated. Confusion, disorder, irregularity, uncertainty are the conditions of their growth. The surest means to kill them is to make the currency absolutely simple and absolutely sound. Is it not childish for simple, honest people to set up a currency system which is full of subtleties and mysteries, and then to suppose that they, and not the men of craft and guile, will get the profits of it? [Hat tip: Larry White.]

It seems to me that this point is entirely applicable to the current debate over stepped-up financial regulation. In the end, it will best serve the insiders, the "money power."

No Shortage of Regulation

Let's begin by noting that there has been no shortage of financial regulation over the last 30 years. The much-faulted era of deregulation is a laughable myth. If anything can be said to have failed in the run-up to the current financial mess, it is the regulatory state. (Of course, much else also failed, including the Federal Reserve system and housing policy.) The idea that we suffer from a shortage of regulation is wrong. Therefore, the idea that we need more regulation to prevent a repeat of the debacle is worse than wrong.

Some advocates of regulation may agree that we don't need more regulation but rather better regulation. I agree. We do need better regulation. But what does that mean? Once we understand the nature of markets and bureaucracies, there's only one reasonable conclusion: Better regulation means regulation by market forces. Free markets are not unregulated markets. Instead, they are severely regulated by competition and the threat of losses and bankruptcy. Anything government does to weaken those forces simultaneously weakens the otherwise unforgiving discipline imposed on business firms (and their counterparties)—to the detriment of workers and consumers. Public well-being suffers.

Admittedly, this is a hard sell. Explaining how markets work when they are free of the government's easy money, favoritism, implicit guarantees, and other perverse incentives takes time and the listener's concentration. Denouncing markets, railing against greed (which of course never taints politicians), and calling for more government power makes for good sound bites. In the Internet and remote-controlled-cable-TV era, patience is a scarce commodity. So advocates of liberty have barriers to overcome.

Interference with Free Exchange

Of course government interference with free exchange (misleadingly called "regulation") is portrayed as necessary for the public good. A key to understanding why it is not is grasping the inability of bureaucrats to know what they would  need to know to do the job they promise to do. Markets–particularly financial markets–are too complex for government officials (or anyone else) to manage. No matter how much power they are given, they will not be able to see the future, spot "excessive risk," or anticipate how things might go wrong.  But they can be counted on unwittingly to interfere with innovation that would yield public benefits. Any move toward central direction courts disaster. Decentralization and the discipline of competition are our only hope for economic security.

If government management of financial activity does not serve the public, whom does it serve? This is where Sumner's quote comes in. He understood that government regulation creates a complicated web of rules and procedures and powerful bureaucracies, which in turn create rich opportunities for manipulation, advantage-seeking, and outright corruption. And who will be in the best position to game the system? The "money-jobbers and financial wreckers," that is, the insiders, the "money power." They will be closest to the regulators. They alone will have the information and incentive needed to turn the vague and complex rules–which they will no doubt help write–to their benefit. How many times must this happen before we learn?

As Sumner says, "The parasites on the industrial system flourish whenever the system is complicated. Confusion, disorder, irregularity, uncertainty are the conditions of their growth."

So, he asks, "Is it not childish for simple, honest people to set up a . . . system which is full of subtleties and mysteries, and then to suppose that they, and not the men of craft and guile, will get the profits of it?"

Suspect Power

The "money power" ought to be suspect in a corporatist mixed economy such as ours, with its central bank, cartelizing regulations, and "too big to fail" guarantees. Sumner is onto something when he says the "surest means to kill [the money power] is to make the currency absolutely simple and absolutely sound." But we should go further: Subject the financial system to the brisk winds of open competition, profit and loss, and bankruptcy.

We won't get that from government regulatory "reform." Rather, the money power will win again.

This column was originally published in 2010, in The Freeman.