Bubbles, Booms and Crashes part 4. Political factors

Political factors may include more than just politicians. These include e.g. society's attitudes towards property, other regulators and price formation mechanisms. By the first, I mean whether individual citizens or businesses have a right to their property. In socialist states, it is almost impossible for bubbles and booms to occur because the state owns everything. They may have distorted supply and demand imbalances in the form of high prices or shortages. When the state sets prices, no bubbles or booms arise. In other words, the right to private property is essential for bubbles, booms and crashes.

Politicians can decide to socialize or liberalize property rights. They can also decide how much of the revenue generated by private citizens and businesses will receive by deciding on tax rates or seizures and exemptions of property. Increasing ownership or revenue for individuals and businesses can be drivers of bubbles and booms. Reducing them can cause crashes. The former concern not only the rights of domestic operators but also foreign ones. Opportunities for action can be limited e.g. customs duties.

Politicians can decide on other regulations, such as bank solvency requirements. In addition, they decide on government indebtedness which can increase or decrease the likelihood of bubbles, booms, and collapses. More on that later. Politicians are also responsible for managing state-owned companies, facilitating, impeding or closing down private companies. The above reinforces extremes. They are rarely the decisive reasons for their emergence. They are more common as boom reinforcers, but are less used during bubbles.

Law-deciding politicians, central bankers, and other regulators are also responsible for the moral hazard strengthening bubbles and booms, with risk-takers reaping the greatest benefits while taxpayers offsetting much of the losses. The amount of insanity can multiply due to moral hazard. This can be seen e.g. guarantees provided by state-owned companies, compensation for capital required by bank losses, and other business support during collapses.

In addition, central bankers can increase money supply to support businesses or reduce their debt service costs to help businesses survive bankruptcies. For example, it is reasonable to see Alan Greenspan, initiating the current moral hazard in the United States, announcing his readiness to lower the cost of debt management for investors in the 1987 stock market crash. Since then, rescuing investors has been one of the Fed’s most significant ways to keep financial markets working. At the same time, moral decay has been created.

The role of regulators is reflected in the failure to control new investment products in bubbles and booms. New investment products increase the amount of money on the market, hiding risks. They must prevent the risks posed by complex investment products from being passed on from sellers to buyers and kept so small that they do not pose a risk to the financial markets as large losses. Complex products contain thousands of pages of information and figures. Regulators do not always know their content or risks. In other words, regulators should actually make sure that not a lot of them are put on the market. Unfortunately, this does not happen during booms except in exceptional cases.

The role of central banks in setting the price of money through changes in money supply and interest rates is undeniable, although banks can change their margins when lending money forward. There is no cheap money without low central bank interest rates or the “rumble” of the printing press. Controlling the price of money can have surprising consequences, as banks, companies that borrow money from them, and consumers can misinterpret price signals, making bubbles, booms, and crashes more likely to occur. The worst part is that they have no part in the models that central bankers use to decide the price of money.