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Paul Volcker … I know you’re out there. Please call Ben Bernanke and give him some advice on how to deal with the economic situation we’re in now.

I’ve been reading speculation that the Fed would cut interest rates significantly after an unscheduled meeting for around a month now. This morning, it happened (”Fed slashes rates“). Bernanke gave us a 3/4% drop in both the federal funds rate (to 3.5%) and the discount rate (to 4%). This is the largest cut in rates since 1984.

Treasury Secretary Henry Paulson, speaking at the U.S. Chamber of Commerce in Washington Tuesday morning, said that he hoped the rate cut would restore some confidence in the financial markets and U.S. economy. “I think it’s very constructive and what I think it shows to this country and to the rest of the world [is] that our central bank is nimble and able to move quickly to respond to market conditions and that should be a confidence builder,” he said.

I hate to rain on the parade, but does anybody remember what was happening in 1984?

To give you an idea … in 1979, Jimmy Carter appointed Paul Volcker chairman of the Fed. The previous occupant of that position, G. William Miller, had only held the position for about a year and a half because he twiddled his thumbs while the economy went down the tubes.

Volcker, on the other hand, did not twiddle his thumbs. He increased the discount rate from 11% to 12% (notice how much higher they were then than now). By 1981, he’d raised the rate to 20%. His actions severely contracted the money supply, and pretty much sent the economy into a recession. His actions were horrendously unpopular. Farmers drove their tractors to DC and blockaded the Fed building, and the brick layer’s union sent over loads of bricks with a note saying they didn’t need them any more.

However unpopular his move was, it had a positive effect on the economy. Officially, the recession ended in November 1982 (as if you can really put a date on these things). By 1984, the Fed was aggressively cutting back on interest rates because of the recovery. Volcker’s actions, as unpopular as they were, are widely recognized today as having been the right medicine at the right time.

So, dear readers, in 1984, the situation was drastically different than it was today. We had a recession and ultra-high interest rates from the Fed behind us. Although we weren’t out of the woods yet, so to speak, the economy was recovering and growing again. We, on the other hand, are in 1978 or so, waiting for our 1979 to get here, and Bernanke is doing the exact opposite of what the Fed should be doing (assuming for a minute that the Fed should be attempting to control the economy in the first place).

I suspect the path the economy takes now is not going to be one that makes Bernanke happy. I hope I’m wrong …

If you want to read more about Paul Volcker:
WikiPedia: Paul Volcker
Educate Yourself - Paul Volcker: Part 1 & Part 2

Back in Raleigh, NC (close to where I spent the majority of my life) we have a in-progress lesson in the sort of mess that ensues when government starts providing services that should be left to private enterprise. Specifically, I’m speaking in this instance about the water system.

Most of North Carolina has been in the midst of a drought for some time now. They’re not as bad off as we are around here (I think they ended up about 9-10 inches of rainfall below the average for 2007 … about 50% of our shortfall), but unfortunately for them, they’ve got a big, growing city and a reservoir on something that only barely qualifies as a river (the Neuse) and they’ve come pretty close to using up their supply of water.

So, let’s review. Why does government get in the business of providing services, like say, water? Well, because people want cheap water at a stable price.

As you’d expect, the City of Raleigh spent most of the summer and fall valiantly waving their hands and asking people to conserve. At first they wanted it to be a volunteer effort, but of course selfish people don’t think on the long term, and that didn’t help. So then they imposed restrictions, and of course some people ignored them. They tried their best to fine the scofflaws, but in the end, even if they had succeeded in getting everybody to comply with their conservation effort, they still were going to probably be consuming the water faster than it was being replenished.

Let’s step back from Raleigh for a minute. In a free market, what happens when the supply of something is not sufficient to meet the demand?

Yes, that’s right … the prices go up. If we’re talking about something like petroleum (let’s ignore the artificial scarcity created by OPEC for a moment), the prices go up, and smart people that want to save money cut back on driving, etc. and car pool, walk, etc. People who can’t cut back have to figure out what they are going to sacrifice in order to keep buying the gas they need. The not-so-smart people and those with money to burn keep consuming at the rate they were before, and then the petroleum companies get to invest those profits in attempts to locate more oil, upgrading their infrastructure to help meet the demand that they can’t meet right now, etc. Oh, and to a certain extent, their employees and executives get to enjoy the benefits of having a clientele that doesn’t mind paying the increased prices (I’m talking about the not-so-smart people and the people with money to burn here) by keeping their jobs or being rewarded for being smart enough to raise prices and do smart things like the aforementioned infrastructure expansion instead of trying to keep prices low and letting people consume petroleum at a rate that would exhaust the supply in the near- or long-term.

Yes, I’ve heard the complaints about petroleum companies making record profits. Just hold on to your panties, people … if they aren’t doing the smart thing by trying to help meet the demand, they’ll end up paying for their stupidity in just passing the money on to their brain-dead executives in a few years. Dumb businesses don’t stay in business (unless the government intervenes and props them up, and if that happens, you only have the government to blame). If they’re doing the smart thing, then we’ll reap the rewards down the road as the additional infrastructure comes online.

So, in conclusion, a smart business raises prices when demand outstrips supply and invests profits in trying to do a better job of meeting the demands.

But back in Raleigh, our intrepid government folks are busily trying to keep the price artificially low, and they’re shocked … SHOCKED! when people don’t cut back on their usage and when sending far too few folks out looking for conservation violations and their fines fail to stem the problem. Well, whaddy think, people? Rising prices are the economy’s way of saying “Hello, customers! Our supply is unable to meet the current rate of demand! This product is more valuable, so if you want to keep using it, you’ll have to pay more!”

As some of my friends know, I’ve been annoyed since at least mid-summer that the government wasn’t smart enough to raise prices and … no surprise here if you’ve been paying attention … invest the additional profits in enhancing the infrastructure … to pipe in water from somewhere else, build additional reservoirs … ship in water from somewhere else … anything that is a cost-effective way to help meet the demand. But wait … it’s really, really hard for government to do that, because people have come to think of cheap water as a right, and they scream like a stuck pig with the threat of price increases.

Which brings us to today, when the Raleigh City Council sent a proposal by Raleigh Mayor Charles Meeker to the Public Works Committee to … yes, that’s right, increase the cost of water by 50% to hit people in the wallet and encourage them to use less water, and yes, that’s right, to raise funds for the Department of Public Utilities (”Raleigh Might Pass Cost of Drought Onto Residents“).

Yes, finally, they’re doing the right thing.

The public response is predictable. Everybody is outraged! Just look at the comments on the story above if you don’t believe me.

Let’s review some of the real gems.

Whatever happened to people protests like in the 60’s and 70’s? I say let’s cut to the chase, go down to city hall and escort these folks out of the building and tell them to not come back. Ever!

Translation: “Let’s vote them bums out and replace them with people who will keep giving us cheap water until we run out, and then we’ll yell and scream and vote those bums out because they didn’t do enough to ensure we had water!!!”

So lets pass it on to the residents and not the businesses who use the most water!! Come on city council quit worrying about the business owners who if you think you’ll make mad they’ll pack up and leave.

Uhhh … if the businesses and residents who use the most water continue to use it at the rate they are right now, you will be passing the cost on to them. I know, I know, you think you should get cheap water while the businesses pay the big bucks, but how are you going to feel when you go to McDonald’s and they charge you $1.00 for that cup of water?

So the truth comes out, capital investments (towers, lakes, reservoirs) were put off.

Further, they had no back up plan for an extended drought, which is part of their responsibility. They have no ability to tier bill for higher use customers, so they intend to penalize all customers.

Typical failed government solution. Hope the people of Raleigh remember this type of government when they go to vote again, but I sincerely doubt it.

Yes, when they did want to expand the infrastructure, nobody wanted higher water prices or to pay taxes or buy bonds to support it. But yeah, let’s blame them for not spending money they didn’t have.

They want to charge us for using ‘more’…what about giving a discount for using ‘less’. This is a capitalistic country and money talks. If you want people to use less..make it worth their time and effort. Wake up people.

The lack of understanding of how free markets work inherent in the comment above is simply astounding. Yes, money talks. That’s why they’re raising the rates!

And my absolute favorite:

How does increasing the bill make people conserve??? If I have to pay more…..I am gonna use more, at least the normal amount. I will not conserve.

Duhhhh …. outside of the blinding contradiction in the statement “I am gonna use more, at least the normal amount.” … if you don’t understand how raising the costs encourages people to conserve, you might need remedial kindergarten.

And … I’ve only read through two pages of comments. There are still another two pages to go, and the story has only been posted a few hours.

So, why shouldn’t government dabble in the economy? The answer is if the government tries to do the right thing and it’s unpopular, the people vote them out, so there’s an incentive to not do the right thing when they start to scream. Then when the government starts to reap the consequences of not doing the right thing, the people get voted out anyway, and when the new people voted in try to do the right thing, the cycle begins anew. And that doesn’t even take into account corruption, etc.

End of lesson.