What’s So Free About Crashing Free Market?

One of the more revealing bits of debris from Monday’s stock market crash wasthe Wall Street Journal story reassuring readers that the dive did not portend a repeat of the Great Depression. The reason, explained the Journal, was that the economy now benefits from a variety of regulatory stabilizers: federal deposit insurance, regulatory limits on margin, a wall between investment banks and commercial banks, “a host of government income maintenance programs--Social Security, unemployment insurance and welfare benefits . . . “ and the fact that “total government purchases of goods and services have risen to about 20% of GNP, from 8.6% in 1929, thus providing considerable economic momentum.”

What exquisite free-market chutzpah!

Basically, what stands between us and a repeat of the 1930s is the entire structure of government spending and regulation that the supply-siders of the Journal’s editorial page regularly rail against.

For two generations, economics students and investors were taught that a great crash simply could not happen again because all these stabilizers served to tame the raw energy of capitalism and create a “mixed economy.” But since the Adam Smith people came to power, ignorant of history and preaching the gospel that free markets can do no wrong, the government has both dismantled many stabilizers and allowed markets to invent new destabilizers.

The free-marketeers running the government deregulated industry after industry. More perniciously, they allowed financial markets to invent new, highly speculative devices like computerized trading programs, highly leveraged financial futures markets and free-floating exchange rates operating in newly deregulated global money markets. They waived the limits on margin in one special case: If you wanted to take over the whole company (rather than merely some of its stock), you were welcome to borrow the entire amount.

The deregulators dismantled specialized savings institutions, encouraging savings-and-loan bankers to become more “entrepreneurial.” They got rid of regulations limiting interest rates and encouraged the creation of uninsured money-market funds. Had the crash come in another year or two, they would have completed the dismantling of the already weakened regulations on bank holding companies, and of the barriers between finance and commerce, as quaint vestiges of a depression mentality. But the removal of all these barriers only ensured that once investor confidence dropped, the market would go into free fall.

The stage for this crash was also set by the other pillar of Reaganomics--the supply-side tax cut.

For a while, irresponsibible deficit spending--far more extreme than anything that a Keynesian might have proposed--combined with the internationalization of finance to underwrite an artificial boom. Most responsible eocnomists have been warning that foreigners would not keep financing our binge forever, but President Reagan insisted that the only peril was a tax increase.

Now that the financial crash has come, a reckoning in the real economy cannot be far behind. Had Reagan agreed to a more prudent budgetary policy a year or two ago, the stock market might have avoided both its inflation and its destabilizing plunge.

But delaying that reckoning must make it more severe. The danger now is that an austerity mentality will replace the giddy supply-side mentality and deepen the coming recession. As the supply-siders have finally been disgraced, their place is being taken by more traditional conservatives like former Commerce Secretary Peter G. Peterson, who counsel that the only prudent course is austerity.

But the economics of Hoover are no cure for the economics of Laffer. There is still time for the United States, Japan and West Germany to unite behind a common program of economic stabilization and high growth. That will entail a big domestic tax increase, but most of that money should be used to finance long-deferred public needs, and not just to cut the deficit. It will require stabilization of exchange rates, and re-regulation of speculative money markets and an attitude toward the Third World debt that stresses recovery and not just debt collection.

It is not at all likely that the Reaganauts who brought us the Crash of ’87 will embrace such a program, but the choice is theirs. The stock market has signaled a warning: If they continue the economics of fiscal fantasy and extreme laissez faire, depression will follow market crash as surely as it did last time.