by James E. Newton, Commerce National Bank Chief Economic Advisor

Throughout much of the past year we have all probably heard that the American form of free-wheeling capitalism has been rendered obsolete. We are told with increasing frequency that what we are seeing is the failure of markets to properly accommodate for rapidly changing circumstances and we desperately need change that we can believe in; one where government takes a more activist approach so as to more properly guide the allocation of real and financial assets.

In short, Americans have come to believe that we should never be denied our “birthright” of prosperity and ever-increasing living standards. And if we are unable to support this birthright via America economically indefensible stock prices and homes values (as in the 1990s and 2000s) then we will do it with massive government spending projects.

Unfortunately the latter approach is likely to prove just as failed as the former two and will simply put off the day of reckoning that eventually must come. Sadly, with each attempt to reclaim our “birthright”, Americans are witnessing a more accelerated pace of adjustments to every new effort to by-pass the role of failure within markets. Stated differently, markets continue to function well. They reward success and punish failure. What has experienced since the summer of 2007 is the inevitable consequence of failures within markets, not a failure of markets.

Of course, this is not to say that market adjustments cannot be “smoothed out” via government regulations to help eliminate the excessive high and lows that may result from an unbridled reliance upon markets. Most particularly this involves the government keeping a consistent and light finger on the pulse of the nation's economy via regulatory oversight and the proper application of antitrust statutes. And, to be sure, it also involves the need to properly identify the “lightness” of this function and not overcompensate by implying that government has the ability to fine-tune the economy and guarantee at all times that presumed “birthright” of prosperity and ever-higher standards of material well-being. Were such outcomes truly possible, all societies around the world would instantly strive to achieve such results via heavy-handed government-sponsored-activities.

A few notable examples of recent U.S. government mismanagement of its responsibilities include:

So where does this leave the U.S. economy as it attempts to unwind the damage created by years of government mismanagement? Why, with the expansion of the government's role in manipulating the economy, of course.

Specifically, the federal government has bailed out companies that were failures within their markets and even threatens to take an equity position in such enterprises so as to make them more “successful” in helping to procure the American dream. But not being content to simply take over failed institutions via (present and/or future) taxpayer funds, the government will reinvigorate the economy with massive spending increases and tax cuts amounting to as much as $1 trillion over the next two years. In fact, to demonstrate the belief that government can easily manipulate the economy into submission in providing us our “birthright” the Obama Administration announced in December that their goal of saving/creating 2.5 million jobs over two years was being increased to three million jobs given the deteriorating state of U.S. labor markets (gosh, why not just expand that number to 4 million just to provide a little cushion?).

And finally, given the success of maestro-management policy actions at the Federal Reserve in the early 2000s, the current baton-holder is flooding the financial marketplace with liquidity in the form of a nearly-zero percent federal funds rate and “quantitative easing” to stave off severe recession and deflation (sound familiar?).

And what will likely be the longer-term implications of all this government action? Of course nobody knows for sure, but most probably an extended period of economic stagnation, high unemployment, and widespread lack of confidence. We are already witnessing some of the early signs of a market backlash as financial institutions refuse to increase lending activities despite the infusion of government funds and extremely low interest rates, both short and longer-term.

As well, foreign exchange markets are signaling their displeasure of present and anticipated future policy actions by driving down the value of the dollar. In time, as excessive risk avoidance unwinds, a quick exit of some foreign funds from U.S. financial markets will occur, interest rates will rise, and some portion of the much-desired recovery will be choked off.

So despite the developing belief that markets are a failure, we are likely to witness just how brutally efficient they truly are. Sadly, the recognition will come far too late.

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Dr. James E. Newton, a professor at the Ohio State University, serves as Commerce National Bank's Chief Economic Adviser.