Testing Times for the Clever Country

I guess not many people knew that bank deposits in Australia have hitherto not been guaranteed, until the government announced that they would now be. The other marvel, of course, is that when a guarantee exists, it will probably not be resorted to. The government's statement is purely to shore up confidence in the financial system and prevent a run on the banks.

Of course, there's the fine print. The Australian government will only guarantee deposits in Australian-incorporated banks, so we could still see a run on foreign-owned banks like Citi and HSBC. Still, it's a much-needed affirmation from the government, and will do much to keep the financial system on its feet.

I guess we're entering a phase when the "Australian model" is going to be put to the test like never before. Prime Minister Kevin Rudd has said he doesn't consider the budget surplus as something to defend in its own right. He's willing to use up the surplus if that's what it takes to stimulate the economy and prevent a deep recession.

Quotable quote: "How long have you all heard me say it is good to have a surplus ... as a buffer for the future? Well, the future is here."

The biggest fears now are a slowdown in growth and a rise in unemployment. The Reserve Bank has done its bit to stimulate growth by slashing interest rates by a full percent, something normally unheard of. The upside of having had high interest rates in the recent past is that there's sufficient leeway to move rates down, a luxury that the US doesn't have. If the PM and his Treasurer Wayne Swan play their cards right by operating the right fiscal levers (and they can spend a fair bit without running up a budget deficit, unlike the US government, which has dug itself into a deeper deficit hole), they can keep the Australian miracle going, and in the process, ensure their own places in history.

It's a difficult time in world history and no time to be partisan, but if Australia comes out of this crisis in better shape than other nations, it will be a powerful lesson in the benefits of good economic governance. I.e., avoid a budget deficit at all costs and tweak interest rates constantly to encourage growth without provoking inflation higher than 2-3%. (And let me add my Liquidism mantra like a broken record: maintain high levels of market liquidity through aggressive antitrust if need be. A thousand blades of grass will weather a storm better than a few oak trees.)

The Australian financial sector has also been prudently regulated and the "toxic assets" of other economies haven't been ingested to any significant degree here. To some extent, this hides the problem of oligopolistic conditions in the market. I wonder if we will have to wait for a different crisis before we learn that lesson...

My Economic Philosophy - 8 (Beyond Socialism and Capitalism)

(This is the eighth of n pieces on my emerging economic philosophy called Liquidism.)

I came across this hilarious illustration today:

While funny, it's also sad that both systems have come to represent a zero-sum game in the eyes of many people, a belief that one person's gain must always result in another person's loss. I don't believe this is true. I believe that wealth is potentially infinite, and human civilisation is constantly improving the incentive systems that cause us to apply our ingenuity and industry to increase our collective wealth, with everybody being better off as a result. I believe in the capitalist ideal based on competition and liquid markets (not the cronyism and oligopolistic markets that pass for capitalism nowadays). At the risk of appearing trite, I can sum up my economic philosophy with another illustration:

It could be argued that what I call Liquidism is just "capitalism done right", but it does involve some non-intuitive aspects. I arrived at this economic philosophy in stages, and it's the fortuitous result of many coincidental experiences in my life.

My journey began when I realised that "freedom" could mean two very different things, and that one kind of freedom is higher than the other. A freedom that cannot be taken away is superior to a freedom without restrictions. I thank the Free Software / Open Source software communities for sensitising me to this difference.

Then I discovered the beauty of Ayn Rand's philosophy (and its limitations). Ayn Rand opened my eyes to the fact that capitalism was not just an economic system but a political philosophy grounded in the notion of individual freedom. The economic aspects of capitalism flow out of the political philosophy.

With that insight, I tried to derive (from first principles) an economic system from a philosophy of freedom, but using the higher of the two kinds of freedom I talked about earlier. In essence, I was trying to redefine a "free market". In the process, I realised that a truly free market had to be a guaranteeably liquid market, not a market without controls. That meant that there was a legitimate role for government (in the absence of any self-correcting behaviour on the part of the market) to step in and enforce liquidity whenever required. In other words, antitrust is not an enemy of the capitalist system (as libertarians make it out to be), but its saviour. That's where Ayn Rand is wrong.

From there, it was only a short step to realising that Liquidism is the next logical step in prudent economic policy, taking the "Australian model" of prudent fiscal policy (avoiding budget deficits) and prudent monetary policy (keeping inflation low through alert interest rate manipulation) to its natural conclusion by ensuring high market liquidity as well. I have been privileged to be part of the Australian economy for over a decade now, and I marvel at the simple yet effective way in which the Australian government and central bank have together kept the economy consistently booming in the face of worldwide boom-bust cycles. The Australian model has many aspects of a welfare state, but that welfare state operates within the discipline of a balanced budget. Australia has shown the world how to reconcile capitalism and socialism. However, many segments of even the advanced Australian economy are held to ransom by oligopolies.

It's unfortunate that nowhere on earth can an example be found of the perfect economic system. Worse, very few people have shown an interest in getting there. Until now.

I have finally seen the vindication of my philosophy in the market failures of 2008, and I realised (as did an eminent economist and old classmate of mine), that capitalism has to be saved from the capitalists. In a truly liquid market, the effect of a single player (or even a few players) has no perceptible impact on the market as a whole, so bailouts using taxpayers' money are never required. But in our imperfect world, large players always act to preserve their oligopoly, by making it harder for themselves to fail (governments are forced to prop them up using taxpayer's money in the larger interests of market stability, making a mockery of the free market in the process) and by erecting scale barriers to newer entrants. I'm sure the downsides of having extremely large players in the market has become apparent to others as well. We just need to join the dots and go where the logic leads us, i.e., to a guaranteeably liquid market, where no player can ever become large enough to unduly influence the market.

However, entrusting the role of market "liquefier" to governments is fraught with danger. Governments are corruptible, as we all know. The timidity of competition watchdogs in our economies is testament to the power of incumbent market players to protect their interests. Governments and legislative bodies are influenced more by market incumbents than by companies yet to be formed. Therefore, liquidity-seeking behaviour needs to be driven into the DNA of the basic unit of capitalism itself - the corporation. Corporations need to have an "amoeba gene" that causes them to grow and split ad infinitum, rather than grow and merge. This is the only way that the market can inherently (i.e., without external intervention) be prevented from consolidating into an oligopoly or monopoly. Such a solution would satisfy Ayn Rand as well. In this context, it must be pointed out that divestitures do not reduce shareholder wealth. On the contrary, new wealth can be released when diseconomies of scale are eliminated and competitive energies are unleashed. The few examples we have of corporate breakups (such as AT&T in 1984) bear out this optimism.

I think it's time the world innovated a new kind of corporation that contributes to market liquidity instead of opposing it. This may need to be defined and enshrined in law, just as the notions of "joint stock company" and "limited liability" were previously formalised through acts of legislative bodies. The capitalist system can then be relied on to generate wealth in a sustainable way, without needing constant government oversight and intervention, and without suffering the periodic system-wide collapses it is prone to in its current suboptimal form.

My concept of Liquidism has been a gradual awakening rather than an epiphany. I still read semi-informed (yet heated) debates in many forums about the merits of different ideologies and varied reasons for our recent financial crises. Although I don't want to sound overconfident, I'm increasingly convinced that I have found the answer to these questions. I think Liquidism is the key to future financial stability and world prosperity.