Opinion: Fed Back in the USSR?

We celebrated the collapse of the Soviet Union. Now look at us. Central planning, anyone?
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We really owe the Soviet Union an apology. For 50 years, we fought them around the world. We called them an Evil Empire. We celebrated their collapse and claimed victory for our capitalist economic system. American pundits mocked their socialist system, especially the way that they consistently spent valuable resources trying to fix prices and prop up inefficient industries.

The big joke about the Soviet economy was that they were experts at turning $1 into 20 cents after a lot of hard work and effort and government meddling in the economy. However, we are now resorting to almost exactly the same economic policies as we try to claw our way out of the very deep financial hole that we have dug for ourselves. It seems that fate and history are not without a healthy sense of irony.

What am I talking about, specifically? For starters, the American auto industry. Independent analysts have calculated that it has burned up hundreds of billions of dollars of capital during the past 25 years and has nothing to show for it. It is a black hole of waste, inefficiency, entitlement, incompetence and corruption. It also happens to have very good lobbyists and many politicians, including the leadership of the Democratic Congress, in its pockets.

That is the only reason they kept getting more and more taxpayer bailouts over the past decades. Market economics very clearly tells us that the failure of poorly run businesses that waste capital is actually very positive for the overall health of an economy. Since

Ford

(F) - Get Report

and

GM

(GM) - Get Report

and

Chrysler

definitely fit that category, the U.S. economy should actually be better off if they fail.

What would happen if the Big Three were allowed to fail is that

Honda

(HMC) - Get Report

,

Toyota

(TM) - Get Report

,

Hyundai

,

Nissan

(NSANY)

and others would fill the void and employ many of the displaced workers who deserve jobs. Capital would be allocated more efficiently. Car prices would be lower. Quality would be higher. Everybody would be better off.

Unfortunately, this is not going to happen. Instead, the U.S. government is going to continue these Soviet-style policies of stealing from hard-working Americans to support the boondoggle that is the American auto industry. It is shameful, pathetic and revolting. More importantly, it is not helping the U.S. economy. If it were, the Soviet economy never would have been in trouble because it pursued exactly the same policies.

Soviet-Style System Hits Home

But our Soviet-style system doesn't stop with the car companies. There are also the homebuilders. Most of the large homebuilders should have already declared bankruptcy and been liquidated because they are insolvent by any reasonable measure. They haven't because their lenders are giving concessions and forbearance agreements, and the government is giving them indirect subsidies through buying residential mortgages and forcing down home mortgage rates with money-printing operations.

Homebuilders are now in Washington with their lobbyists trying to get their hands directly on some of your taxpayer money through the Troubled Assets Relief Program (TARP). Once again, in America it pays to have good lobbyists and no morality. This is only happening because there is enormous pressure on lenders and the

Fed

from the government not to do anything that would further harm the housing market or reduce housing prices.

My question is why? These companies are broken. They are poorly run. There is massive overcapacity in homebuilding. The way to fix that is for more homebuilders to fail. Also, capital needs to be allocated more efficiently to companies and industries that actually know how to make money rather than lose it spectacularly, which is what the big homebuilders have been doing for years.

Who Really Benefits?

There are some good homebuilders and they should survive, but most of them should not. The only beneficiaries of these market manipulations are companies that should go out of business, their investors and their executives.

The employees ultimately will be worse off even if they temporarily keep their jobs because eventually the market will catch up to these companies, and their jobs will disappear. Consumers are not really better off because really the last thing most Americans need right now is to take on even more debt to buy a house.

The focus of average Americans, who care about their long-term financial security, should be generating more sustainable income, saving and investing to protect the value of their capital from a government that is printing trillions of dollars per month in an effort to make Weimar (historically known as one of the worse hyperinflationary governments in history) look like a sound money regime.

Borrowing money to speculate on houses is the last thing we need, and we should not be subsidizing it or the homebuilders that try to keep themselves on life support by playing along with this senseless government policy. The irony of all of this is that by propping up the homebuilding companies, which have no other purpose except to build homes and further increase housing supply, the government is actually further contributing to declines in housing prices. Soviet economics has a way of creating unintended consequences.

Of course, the real hard-core Soviet economics in America favors the financial industry. It was actually very similar in the Soviet Union. Most of the bizarre, money-losing and value-destroying enterprises supported by the Soviet state were also indirectly supported by their government-controlled banks that were basically shills for the Kremlin. Does this sound familiar to anybody yet?

The Fed is following in the storied tradition of the Soviet state-owned banks by fixing the price of money at 0%, or negative on an inflation-adjusted basis, and by handing out literally trillions of dollars of unsecured or poorly secured loans to obviously insolvent, poorly run, inefficient and often corrupt Wall Street firms and big banks like

Citigroup

(C) - Get Report

that have good political connections.

Unfortunately, that tradition doesn't exactly have a very good track record for creating sustainable economic growth.

No Such Thing as a Free Lunch

The basic problem is that subsidizing poorly run companies that waste capital is not free. Although the Fed and Ben "Commissar" Bernanke would like everyone to believe that there is no cost to printing money and giving it to these banks to prevent them from failing or, more accurately, so they can keep paying huge bonuses to employees and executives, there actually is a very substantial cost to the U.S. economy.

First, printing all of those dollars is causing our currency to once again start collapsing in value. This makes everyone who holds dollars worse off. Second, fixing interest rates at negative levels destroys the standard of living for anyone trying to live on a fixed income from interest, such as senior citizens and many retirees. Third, negative interest rates encourage yet more speculation rather than saving and real investing.

That is how we got into this mess in the first place. Lastly, that money could be given to other people in our economy. Instead of giving trillions of dollars to their well-connected friends at Citigroup,

Goldman Sachs

(GS) - Get Report

,

Morgan Stanley

(MS) - Get Report

,

JPMorgan Chase

(JPM) - Get Report

,

Bank of America

(BAC) - Get Report

, and other financial giants, that money could have gone to small businesses or invested in the technologies and industries of the future. This is how you create real growth in an economy. You subsidize productive businesses that have good ideas.

Instead, we're doing just the opposite and subsidizing unproductive businesses that have no ideas and have already racked up a horrible track record of destroying capital because those companies are politically connected. The Kremlin couldn't have done it any better, even if we brought back Leonid Brezhnev (one of the last and most incompetent heads of the Soviet Politburo) from the dead.

The bottom line here is that there is no such thing as a free lunch, no matter what the Fed and the Treasury try to tell us. There is a cost to printing money and borrowing money. Also, there is a cost to deciding to give that money to certain companies or people instead of other companies and people.

The way to create long-term prosperity is to make wise decisions about the allocation of capital and other resources. In a market system, those decisions are supposed to be guided by the track record and the realistic future prospects of those companies and other users of capital and resources as opposed to political connections.

Unfortunately, our current regimes at the Fed and Treasury have forgotten the lessons of the Cold War and the disastrous Soviet economic system that allocated capital based on politics rather than economics.

At the same time, the former communist Chinese are more closely following market principles and making much better decisions about how to allocate capital and resources. Maybe this is why their currency is appreciating and their economy is still growing at a decent rate, while our currency and economy are sinking. Once again, it seems that fate and history are not without a very stark sense of irony.

Christopher Grey is a managing partner of Third Wave Partners. He currently has no positions in the stocks mentioned in this article. This article should not be interpreted as personal investment advice or a recommendation to buy or sell any security. Interested readers may contact the writer by emailing cg@thirdwavepartners.net or visiting the company's Web site, www.thirdwavepartners.net.