Whatever happened to Adam Smith’s concept of Laissez-Faire?

By: Daryl Ching, Clarity Financial Strategy

It’s funny how we preach one thing when times are good and completely flip when times are bad. As North Americans, we pride ourselves on an open market economy with minimal government intervention in our capital markets… until things get ugly.

Let’s start with Central Bank. My understanding is that the Central Bank’s role is to use monetary policy to control inflation – full stop. They are not responsible for avoiding recessions or boosting the capital markets. On Tuesday, the Feds did a surprise 75 bps rate cut. Bush and Paulson have announced a $150 billion stimulus package, are trying to push a 5-year subprime mortgage rate freeze and are now pressuring the US banks to bail out the monoline insurers.

Up here in Canada, I will say that the Bank of Canada looks more like they are playing the role of a Central Bank. We dropped a modest 25 bps, despite a 600 point drop in the TSX on Monday, and they are carefully watching core inflation. However, we saw the federal government apply pressure on the big banks to participate in a margin facility for the ABCP restructure, that they don’t want to be involved in.

Should we rewrite the economics textbooks to say that “Laissez-Faire” only works in good economic times? Let’s just say for the sake of argument that all the government intervention we are seeing is successful in preventing a deep recession. What message are we giving to the market participants? Don’t worry – the next time you underwrite junk product and create a bubble, we will bail you out again.

Intuition tells me that business cycles will never go away. We will see peaks and troughs. In order for the capital markets to improve, people need to feel the pain, and there is no better way to learn than to get snake bitten. Like the technology crash in 2000, people need to learn that what goes up, must come down. Double digit appreciation in the real estate market for six consecutive years is unsustainable. We then revamp ourselves, do more due diligence and purchase products that make sense.

As a believer in an open market economy, I think the best course of action in times like this is to let capital markets correct themselves. This will weed out the participants that have made poor decisions and reward those that resisted the temptation of taking on unnecessary risk. Only then can we really call ourselves a capitalist open market economy. Until then, let’s not pretend to be something that we’re not.