Free Market Spiral

This is such a momentous period in history. I've often thought about it hypothetically but I never believed that it could happen.

The Free Market Spiral.

Free markets in my opinion are the greatest and most efficient allocation mechanism in the entire world. Using the concept of utility, which is the satisfaction that an individual derives from a good, the market it able to use a price mechanism to indicate their level of utlity and thereby promote the allocation of resources to the production of the good. Using an established demand curve derived from utility and a supply curve derived from cost of the resource, we can attain an equilibrium where the market pays for exactly what that good can provide in terms of utility.

If we're in an agrarian or pure production state, this would have been pretty straightforward.

Then enters the complex world of commerce and leverage. With the establishment of banks that are able to collect deposits and make loans based on the fact that not everyone will draw their money out at the same time, we now have essentially a system that runs excesses or what I call money in circulation. Because of the innate and inherent trust in the system, everything will be fine and dandy.

Unfortunately, this is no longer the case in recent times. With fear at all time highs, the trust to lend has corroded. This seizes up the circulation of the financial system and basically disrupts the price mechanism. Eventually, this will warp the notion of utility and shift the demand curves itself and reset the equilibrium. In real terms, the financial crisis will damage the brick and mortar business as well.

People have been mistaken all this while, thinking that they have a free-market economy but have actually been living with an anomaly which is known as the banking system which is not based on 'real' resources but on a flow model. Hence, the free-market model is not really free and that this banking system is guarded by a regulator which is the central bank, otherwise known as the lender of last resort.

Today however, we witness something quite remarkable which I see as a real paradox. The democratic system (a political equal of the free-market) has been exercised by the people to curtail the government and in doing so tied the hands of the regulator who has been doing the job of regulating and mitigating the quasi-free market/banking system.

The end result is the demise of the effectiveness of the very system and the potential destruction of the ideology.

I guess people have forgotten that it was not idealogy failure that lead to the fall of communism but more of the lack of pragmatism that lead to its demise. It's only attractive when it works.

Hence, I leave you with a nice Op-Ed from the Asia Journal of Public Affairs. The emphasis that good governance is a necessity, because nothing is a given.

http://www.lkyspp.nus.edu.sg/ajpa/issue1/Dean_Op_Ed.pdf