"On the contrary, among the biggest supporters of both have been the world’s investors, at least insofar as their collective judgment "

Another good James Surowiecki post:

"Libertarians Against the Market

Tyler Cowen, in his ongoing effort to ensure that the government spends as little as possible in its attempt to stimulate the economy, cites approvingly a post by Arnold Kling arguing against a big fiscal-stimulus package, because the risks vastly outweigh the potential rewards (actually, Kling doesn’t really think there are any potential rewards from a stimulus plan). Kling enumerates those “risks” in a list. This is not a very useful list, because it contains absolutely no evidence for any of his assertions—he simply assumes the existence of his risks to be a fact—and no assertion about how likely any of these “risks” are, which makes it a little hard to do a cost-benefit analysis. Kling says that “on close examination,” the case for stimulus is weak, but, in this post, at least, he offers no such “close examination,” merely a laundry list of familiar (and unproven) criticisms of government spending.

The most curious thing about Kling’s post, though, is the way he closes—namely by complaining that even though he and his side “have logic on their side,” they will be “mocked and vilified in the media” for their opposition to a big stimulus package, and that that package will be pushed through as a result of “elite groupthink”—the same groupthink, in fact, that pushed through the Paulson rescue plan. The implicit assertion here is that the support for a stimulus package, as for the rescue plan, is driven by this élite group of interventionist economists and politicians, who are overriding what would otehrwise be commonsense economic policy.

What’s odd about this is that the support for the stimulus package, as well as support for the Paulson plan, hasn’t just come from liberal economists or Democratic politicians. On the contrary, among the biggest supporters of both have been the world’s investors( TRUE ), at least insofar as their collective judgment is reflected in market prices. As I showed yesterday, investors overwhelmingly supported the Paulson plan: it was only when it was killed, that stock prices really started their downward spiral( I AGREE ). And it was only after Obama unveiled his economic team and made clear how big his stimulus plans were that the market began its sharp recovery( I AGREE ) (the S. & P. 500 is now up twenty-five per cent since Nov. 20th). And as The Economist’s mystery blogger noted yesterday, anyone’s who’s paying attention to the stock market knows what would happen if Obama announced today that he was abandoning his plans for a major stimulus package:

Markets would plummet, with significant knock-on effects, based on the actual news that government spending would not nearly close the American output gap, but also given the signal that America was no longer committed to serious stimulus.( TRUE )

The point is that it isn’t just some group of pointy-headed Keynesians saying that a big stimulus package will be good for the economy: the collective wisdom of the market is saying the same thing( TRUE ). And it seems peculiar for a supposed believer in the efficiency and intelligence of markets—which, as a libertarian economist, I assume Kling is—to simply disregard what the market is saying in this case. In effect, libertarian economists are saying that they have a better sense of what’s good for the economy than the aggregated wisdom of investors does. And that makes them sound peculiarly like the Platonic economic planners that they typically decry( TRUE ).

There is no doubt that our Investor Class wants a government bailout large enough to stop both the Calling Run and the Proactivity Run. TARP and other various government actions have tried to stop the first, while the stimulus is an attempt to stop the second. Only explicit government guarantees and actions are believed to be sufficient enough to stop these runs. Leaving the two Runs to run their course could lead to extreme losses of wealth and jobs, large enough to effect social stability. This outcome must be avoided at all costs.

The Investor Class had no Plan B. They believed, quite correctly, that the government would have to intervene in a financial crisis. Investing has been done for at least the last twenty years with this understanding, as well as the understanding that government has an important role in funding and helping the Investor Class. They do not believe in limited or no government, and would have no idea to do business in such an environment. As Wittgenstein said, "If a lion could talk, we could not understand him". I say, "If the free market showed up, the Investor Class would not know how to do business in it". They are the ones with the money, not theoreticians.

In the future, we will need a LOLR and SOLR to undergird our financial system. The explicit conditions of these guarantees will be meant to prevent Calling and Proactivity Runs. This can work. In other words, the intent is to keep the government from having to actually spend money, by allowing time for financial knots to unwind at minimal cost and disruption. Only the government can do this. In order to keep moral hazard from being a consequence, a strict application of Bagehot's Laws and a strict regime of supervision, not regulation, which focuses on aims and methods, as opposed to relying on particular laws, can keep moral hazard from becoming a problem. For one thing, by the end of the process, the Investor Class members which need a bailout will essentially be bust. It will not be a pleasant experience for them, as opposed to TARP.

The current political culture is a result of compromises over time. It cannot be easily changed, and should not be quickly changed. But, over, time, the system can be made fairer and freer for most people. Starting out with the changes listed above would be an excellent down payment.