Capitalism's Fundamental Flaw

"The banks, however, are another matter altogether, and this is where I think capitalism has hit a roadblock. The government has intervened to save many of them, and now, these bailed out banks want to hand out billions in bonuses to their non-performing employees. Capitalism gave way to welfare economics, and now the government has to intervene further to limit these looters from behaving badly by imposing taxes and regulations."

If the government hadn't intervened in the first place, and instead let these irresponsible banks fail, then the transfer of taxpayer money in the form of bonuses never would have happened.

What she's describing here is, in actuality, yet another flaw of government intervention.

If I'm in a start up, which we would probably consider to be very high cleverness to reward leverage, it can take a long time and have lots of randomness to get the big payoff, e.g. Kiko.

Now, compare that to being an employee, where to get enormous payoff you have to climb the ladder into stock options land.

The article's point is that this is not how the world should be, but markets cause this by construction: If I'm stranded on an island with a bunch of Robinson Crusoes I'm going to try swapping coconuts for mangoes across the island before I start experimenting with cross breeding them.

From a welfare perspective it even makes sense to do the easy things first (trade) and the hard stuff next (R&D) because effort is more likely to be rewarded in the former than the latter.

One could also complain about how all the socially well connected are lobbyists instead of high school teachers and the beautiful are in pharmaceutical sales rather than portrait modeling. Sure it's sad, but also mostly inevitable.

You don't make money because an asset you own rises. You make money because someone buys it at that price. (That's the same, I know, but it's an important point to understand - it's NOT just numbers going up and down in a computer, at the end of the chain there's actual liquid money changing hands).

Now we've lived through two financial bubbles right after each other, and one can hope that people will learn that sharp rises in the value of an asset are often inflated, and stop putting their money into the game. After all, those who bet and then hedged their bets on real estate (this time) and .coms (last time) were also (generally!) the ones who lost the most.

While we trip over ourselves (as a society) to give up our freedoms and grant ever more sweeping power to "leaders" to save us, we will reap what we deserve -- ever greater examples of waste, bungling, abuse, malinvestment and looting, on scales simply unimaginable just a few years ago.

We gave up our ability to directly monetize wealth 2 or 3 generations ago -- what features of our present financial system makes you believe that it is "Capitalism"? Government giveth, and government taketh away. Sounds like good, old-time kingly Mercantilism to me...

During the last boom a full 40% of all of the profits in the system came from the non-productive activity of people manipulating cash flows. This is simply not a sustainable financial structure. History shows that economies that are based on financial manipulation rather than production don't last. The USA isn't the first to combine of financial manipulation along with the export of production and the knowledge that previous lead to persistent economic advantage. In the last several hundred years Spain, Holland and England did this. In all previous cases it was a big factor leading to financial collapse and the loss of empire.

Is there any reason to believe it will work any better for us?

Greed is tempered by risk when the government can't save you.

The way the financial system is currently "architected" (a strange term, but I'll use it) it has as a class an inordinate amount of negotiating power vis-a-vis everyone else (!), and thus is able to capture much of what ought to be consumer and producer surplus.

As much of the value it adds is due to network effects just going to a gold standard (which is a popular cure-all on the internet) wouldn't change much, even if you thought that was a good idea; there's still the same tremendous problem of coordinating trade in the same complex, highly-specialized economy and the central switchboard is still ideally placed to extract most of that value.

The easiest-to-envision solution is to forcibly unbundle the basic storage-and-transmission of credits between accounts (full-reserve checking accounts, basically) and run that infrastructure as a public utility (a handful of mainframes in the fort knox). Let the private sector sell value-added services on top of this, but don't leave the basic infrastructure of value-exchange in the hands of the private sector, who will retain the ability to hold the country up for ransom.

It's an easy solution to envision but it's hard to see much happening; it is too radical a shift to go down easily (and all that surplus value captured funds a lot of lobbying) and it too closely resembles socialism and other bugaboos to be an easy sell to the public at large.

(!) Where we are now is pretty analogous to having the local power company -- which provides necessary services to its area of operation -- also involved in speculative ventures that backfired enough that its continual operation is threatened; having the ability to turn the lights off would naturally give the local power company a lot of leverage negotiating for a bailout.

Suppose that the "too big to fail" banks were allowed to fail, and there was temporarily a severe disruption in the banking system. How would you propose that federal, state, and local law enforcement and other "essential services" get paid? With cash -- dangerous and risky? With checks -- while the banking system isn't reliably working? Would you trust them to work without pay for very long?

(And if it remained lucrative, at least the government would be able to participate in the bounty that comes from skimming a few parts-per-thousand off the top of a very large cash flow.)

It is a hopefully temporary result of a world wide obsession with financial speculation.

Part of that is specific government policy resulting in financial speculation being more profitable then brick and mortar and bits and bytes businesses. I'm not just talking about the fed, and printing money, but also about trade policy.

The other part is lack of supply. When people can charge 2 and 20 and the 2 even if they suck, that means either there are a lot of people deliberately looking to lose money, or there is a shortage of hedge funds. And while those have exploded in number in recent years, that is not enough.

The government, through Ph.D. programs encourages education, some say this supply side intervention has the uninteded consequence of depressing wages for Ph.Ds. But what if the government strongly encouraged everyone to go into wall street? Politically it would be crazy to try and explain why we're paying for people to become bankers or fund managers. But a flood of talent is perhaps exactly what we need, to even out supply and demand.

Consider communism, ideally no one will worry about financial gain and everyone focuses on self actualization and innovation (because there's no monetary incentive, so only the truly altruistic thrive). However there's yet to be an implementation this ideal.

It's probably impossible to achieve a perfect system, so I think the answer lies in a more perfect balance of capitalism and communism.

That's not capitalism.

Abuse of money received from a government that shamelessly loots its people for the "common good" and through manipulation of a highly regulated system is no more an indictment of Capitalism than failure to run is an indictment of a man tied to a chair.

-Ben Franklin

The flaw in capitalism is us.

"She assumed integrity is implicit in the characters of the "leaders.""

I haven't read much Ayn Rand (i.e., none), but I've read a lot about what she has said and written. Is the quote from the article above dramatic license on the case of the author, or did Rand actually state that integrity is a required characteristic in the 'leaders'?

So presumes the author that the people who are ostensibly receiving "billions" in bonuses are the same people who pushed this over-leveraging scam. All bankers are equal, none managed wisely.

"And thus, we lose Berkeley Ph.Ds in nuclear physics to hedge funds and MIT computer scientists capable of delivering computing to 6 billion people to derivative manipulation on Wall Street."

So presumes the author that nuclear physics and democratization of computing are more noble pursuits than finance. What he forgets is that mortgage-backed derivatives really did reduce risk for really bad mortgages. This was a phenomenal development, we could get more people into houses while not losing our shirts in the deals. Unfortunately, those same mathematicians weren't the ones employing this great tool that they created. "When the only tool you have is a hammer, every problem looks like a nail." It's not that mortgage-backed derivatives were wrong or evil or bad, it's that they were grossly overused. They reduce risk, they don't eliminate it, so when the scenario in which that risk turned to losses came true, the losses were too much to handle.

But, few people saw the risk for what it was because the Fed suppressed the price of money to lower-than-market rates, explicitly encouraging this sort of speculation. Price floors lead to shortages, this is a basic tenet of Capitalism. Is it any wonder that the entire nation is over-leveraged? Without the manipulation of the Fed, the price of money (interest rates) would have been much higher and this sort of speculation would not have happened.