"THERE ain't no such thing as a free lunch." That is what economics teaches, and some might even argue that wisdom itself is nothing more than the genuine understanding and acceptance of that unglamorous principle. Even so, economists on the whole seem to lack appreciation for human irrationality, if defined as our desire to deny the existence of fundamental scarcity and to continue to believe in the ultimate free lunch.
To better see human irrationality, one would have to look at those who hired the economists and have the final say over what we do with or to the economy -- one has to study those who run the insane asylum, and turn from economics to politics. It is not surprising, then, that an economist who ran the Federal Reserve under four presidents, and who had the political power that implies, should show an unusually good appreciation of the place of economics within the larger and more revealing political world.
Alan Greenspan, in his "Age of Turbulence," points out that the Fed's statutory mission, "to put in place the monetary conditions needed for maximum sustainable long-term growth and employment," conflicts with the populist pressures of democracy. Long-term growth requires stable prices and hence low inflation, but the political demand in a democracy is always inflationary: for looser and easier money and for faster and more immediate growth. Not unlike children, people want their sweets now, yet cry out against both the bellyache that inevitably follows and the discipline that could have averted it in the first place.
The success of the Fed, given its essentially unpopular and anti-democratic responsibilities, is precarious. The Fed is the creation of a 1935 act of Congress, and a simple majority could destroy it. It nonetheless has a good degree of political independence because its members serve for long terms -- 14 years -- and because it controls its own purse strings, rather than depend on Congress for its money. Even so, it took, as Greenspan observes, the character and insight of a Paul Volcker, appointed chairman in 1980, to win the high independence and authority it currently enjoys. Faced with the disastrous inflation of the Carter years, Volcker insisted on clamping down on the money supply to "slay the inflationary dragon," even at the price of triggering a severe recession that caused much unemployment and hardship. Thanks to Volcker, interest rates rose to over 20 percent and unemployment to 11 percent. Millions lost their jobs. But this bitter medicine worked: After peaking at 15 percent in 1980, inflation gradually began to subside.
At the time, the patients were not happy with their doctor. Volcker was hauled before Congress for a whipping by a long line of senators. Then Sen. Mark Andrews told Volcker bluntly: "You're high on the hit parade for lynching." A number of bills were soon introduced to end the independence of the Fed, but the 6-foot-7 Volcker held firm, and his policy began to work before the bills were adopted. Unfortunately, the patients also lost memory of the shortsightedness of their anger.
Since then, actions by the Fed to restrain inflation have been much milder. As Greenspan explains, we have been spared the need for severity because the collapse of communism created a huge deflationary effect by vastly expanding the market and the labor pool, keeping wages and prices low. But that globalization of the free market is the result of a one-shot political event, our victory in the Cold War, and the future will see a return to the old democratic inflationary pattern.
In the meantime, we have forgotten the lessons of our inflationary past. Undisciplined lending and borrowing led to the current crisis over the collapse of the subprime housing market, as in the previous Savings & Loans debacle. As stock ownership has exploded, so too have the risks from the crowd's "irrational exuberance" in episodes like the dot com bubble.
But our biggest economic bubble may come from the mutual fraud of getting together to buy ourselves presents with the money we don't have. Government spending has exploded in order to gratify farm state constituencies ($250 billion) and to give even well-to-do members of AARP free prescription drugs to be paid for by their poorer and less politically astute grandchildren ($1.2 trillion -- a trillion here and a trillion there, and pretty soon you're talking real money). And this was by a Republican president and Congress, while the Democrats for their part propose the expansion of Medicare and Medicaid, an unpredictable open-ended entitlement, and the provision of free health insurance to the children of middle-class parents. For now, we still have numerous and highly skilled baby boomers paying into the system, but what happens when they retire, turning from pillar to drain? These "baby boomers" didn't bother booming out babies themselves. What happens to our great Ponzi scheme then?
The economic solutions are obvious, but our problems are political.
Manuel Lopez is a Cavalier Daily viewpoint writer. He is a visiting graduate student studying political philosophy.
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