Monday, January 26, 2009

Rules of the Game

In systems theory, rules determine the relationships between the system and its sub-systems, between the system and its environment, and inter-relationships among the components of the system. The "rule of law" is important, for it holds that the rules are the same for all, and aren't changed capriciously: they allow us to plan rationally for the future.

Wretchard quotes management guru Peter Drucker (H/T Dr. Sanity):
Economic activity, by definition, commits present resources to the future, i.e., to highly uncertain expectations … While it is futile to try to eliminate risk, and questionable to try to minimize it, it is essential that the risks taken be the right risks … We must be able to choose rationally among risk-taking courses of action rather than plunge into uncertainty on the basis of hunch, hearsay, or experience, no matter how meticulously quantified.
If we don't know what the rules of the game are, we can't choose rationally among the courses of action before us.

One of the reasons societies spawn governments is to have the means to set, and enforce, the rules by which the society operates. In complex open systems such as our society, legislation and regulations affect behavior for good and bad:
The growth of litigation and regulation has injected a paralyzing uncertainty into everyday choices. All around us are warnings and legal risks. The modern credo is not "Yes We Can" but "No You Can't." Our sense of powerlessness is pervasive.
[...]
We have lost the idea, at every level of social life, that people can grab hold of a problem and fix it. Defensiveness has swept across the country like a cold wave. We have become a culture of rule followers, trained to frame every solution in terms of existing law or possible legal risk. The person of responsibility is replaced by the person of caution. When in doubt, don't.
Right now, we are in a period marked by grave doubts about our entire economic system. In the face of massive uncertainty, people prefer to sit on their hands and their cash. They stop spending money, banks quit lending money, and suddenly there's less money changing hands in a given period of time (measured by "velocity").

Over at The Corner, I finally found someone talking about the crash in monetary velocity, economist Bruce Bartlett:
I think Friedman would tell the Fed to pump as much liquidity into the economy as possible. His Monetary History of the United States proved that a shrinkage of the money supply was at the core of the Great Depression and that the Fed failed the country by not increasing the money supply. I believe we are in a similar situation. The problem has been a sharp decline in velocity—the ratio of the money supply to GDP—which has economic effects identical to those that would result from a decline in the money supply. When velocity falls, GDP will fall unless the money supply increases enough the maintain GDP at the reduced level of velocity. The real problem is that the Fed is having difficulty getting money circulating because interest rates on Treasury bills are close to zero. Under these conditions, monetary policy is impotent. It is like pushing on a string.
In "The Forgotten Man" by Amity Schlaes, she points out that FDR did a lot of experimenting to the detriment of business and the economy; her theory is that he actually prolonged the misery by doing so.

The current economic uncertainties with the failures of Fannie Mae and Freddie Mac, bank seizures and fire sales, and ill-crafted "bailout" legislation passed by Congress aren't helping this consumer's confidence because the solons in Washington and New York keep telling us that there's more intervention -- with more changes in the rules -- yet to come.

I can't plan because I don't know what the rules will be in 3 months. And neither does anyone else.