c2c: Dr. Walker, the past year has seen stock markets around the world drop by 40% or more, bailouts of financial institutions in the U.S., Europe and beyond, and an American economy that was recently confirmed to have been in recession since December 2007—and may be in a recession until some time in 2009, which would make it one of the longest recessions since the 1930s Great Depression. What led to this state of affairs?
Dr. Michael Walker:It would take a long time to detail the story. Instead of that I will just refer you and your readers to an excellent study, “Anatomy of a Train Wreck” recently published by the Independent Institute. The basic point is that well-meaning people trying to shoehorn low income and ill-prepared people into home ownership, sacrificing the fundamental prudential basis of the international mortgage market. Facilitated by Fannie Mae and Freddy Mac, and by the invention of a new, but not improved, form of bankers’ acceptance, mortgage pools of increasingly poor quality were passed throughout the financial system and upon their collapse have jeopardized the fundamental survival of the system.
c2c: Every federal political party in Canada is now advocating some sort of stimulus to soften the blow of the recession. What’s your view on such calls?
Walker: The basic threat posed by the poisonous mortgages was to the stability of the balance sheets of the banking system. The other side of the balance sheets of the system is the money supply for all advanced monetary economies. The maintenance of the banking system’s integrity is key to our collective survival and so we have to do whatever it takes to keep that whole. While people have talked about them as subsidies, the open access to funding for banks is the appropriate responsibility of government in the context of a fractional reserve banking system. That does not mean that after the smoke clears we should not examine where and to what extent the mortgage backed asset problems were due to fraud or sharp dealing by those who had a fiduciary responsibility to uphold the quality of the assets, but for now the important thing is not to allow the size of the banking system to shrink.
The issue of subsidies is separate and apart from this. And, generally subsidies to industry have not been found to be very effective, certainly, not nearly as effective as a reduction in the tax burden borne by consumers and investors. If a countercyclical policy is going to be followed, and I think that must be given serious consideration, the way to do it is to reduce the fiscal drag created by government. I am sceptical that any expenditure program undertaken by government would do much good since they don’t know how to spend money carefully and certainly never know where to spend it.
In particular, subsidies to industries like auto assembly, which were in big trouble long before the slump should not be the objective of any programs. Help the workers from these industries to get retrained and let them migrate from manufacturing to other sectors that will soon be hiring as the trough of the business cycle passes. Do not use scarce resources at this juncture to bail out the capital owners in the industry who have already been big beneficiaries of government largess. They need simply to lose the capital which they have invested, or some portion of it because their industry is no longer competitive.
c2c:: Is there a particular course of action you would advocate? And should that action be similar in Canada and the U.S.?
Walker: Tax cuts and maintaining the integrity of the financial system are as much as governments can do. This may require the running of a deficit and as long as it is recovered back to a surplus level after the slump passes that would be acceptable.
c2c: It took a very long time for the political class and voters to be weaned off deficits. That was a hard-fought battle. Should federal and provincial governments now run in the red again – for any reason?
Walker: Well, I have already answered that. But it is worth noting that this is not a risk-free strategy either. The main point is that the increased supply of bonds used to finance the deficit will provide investors with a comfortable investment vehicle and that may reduce the extent to which investors make capital available to the private sector. This crowding out effect was quite evident in some past periods, so the extent of deficit financing should be kept modest and care should be taken not to have the government aggressively pursue capital with interest rates with which private investors would have trouble competing.
One of the collateral concerns is deflation, which would raise “real” interest rates to high levels. The way to deal with this is to have the government sell its bonds to the Bank of Canada and not to the private market. While this would increase the money supply, that would have the desirable side effect of preventing deflation from becoming a problem.
c2c: President-elect Barack Obama has chosen famed value investor Warren Buffet and former Clinton-era Treasury Secretary Robert Rubin as some of his key economic advisers, and Lawrence Summers for his pick as Chairman of the National Economic Council. This seems to reassure some people. Do so such picks reassure you?
Walker: Larry Summers is one of the best economists and most courageous individuals I have ever encountered and he will do a great job as Treasury Secretary.
c2c: Six months ago, almost no one thought oil would go below $100 because of supply constraints and growing developing nations such as China and others in East Asia. Any thoughts on where you think prices for natural resource and commodities are headed in the next year – and next five years? Is the seven-year commodity boom at an end for the next several decades akin to what happened after the early 1980s bust?
Walker: The real price (the price of commodities divided by the general price of all things produced) of all commodities has been falling for as long as we have statistics. There are temporary rises in the real prices when there are supply disruptions, as happened with energy prices in the 1970s, or demand disruptions as happened in the early seventies and more recently, but the expectation is that commodity process will fall. The main reason is that we never know how much of a commodity there is until the nominal price gets to the level that will elicit the supply. Similarly we have always underestimated the cost-driven ability to reduce the demand for things by finding substitutes for everything.
We tend to forget that the market is a ceaseless, non-sleeping remorseless scavenger scouring the earth and the imaginations of all of the people who live in it in trying to find cheaper – i.e. more profitable, ways of doing things and replacing expensive bits with cheaper bits. I see no practical limit, on the basis of 45 fascinating years watching the process working, of the extent to which the market can improve productivity. That means getting more with less and less and less.
Recently, within the past few months really, staggering developments in reducing the cost of extracting shale gas have simply turned the North American energy market on its head. And, we have only just got a glimpse of this new approach, which will eventually be used throughout Europe and Asia and Africa to bring new supplies of energy into the market.
I think that energy prices and materials prices have now been oversold to some degree but a sustained return to the speculative bubble prices of the recent past is highly unlikely. The best long-term predictor of the future of commodity prices is the past behaviour of real commodity prices and that trend is down.
c2c: Politicians don’t always do the economically rational thing, even though that would be a country’s long-term interests. Chances are very good that the federal government will shortly pump billions into the automotive, aerospace and forestry sectors and add tens of billions to our national debt in the process. How would you advise the federal Minister of Finance to decline the siren calls for more subsidies and bailouts to those sectors and how would you advise him to remind the public of why such calls should be resisted?
Walker: As I have noted, the big-three auto industry has been in trouble for a long time. Self-inflicted cost handicaps arising from the mismanagement of labour agreements are going to prove fatal. The managements who made those deals and the shareholders who tolerated them may have to be swept away so that the workers in the industry can be released into the labour pool where they can, by demonstrating their productivity, maybe work with other managers and under more sensible contracts to produce competitive automobiles.
There should be no subsidization of the auto industry. Nor should there be any particular subsidy for the autoworkers displaced. They can use the general unemployment insurance system to facilitate their transition to new auto sector jobs or to productive work in another sector.
The forestry industry situation has been the subject of a very careful analysis by Daniel Veniez in the Financial Post for the 9th of December and he shows clearly why subsidies from the feds are neither necessary nor likely to be effective. I cannot add anything to what he has written.
The aerospace industry has been senselessly subsidized by federal governments as part of the Parliamentary hostage system, which was established in 1858 by John A. Macdonald and Etienne Tache in anticipation of Confederation. Its time to end this extortion as we now come face to face with the results of this in the current Parliament.
c2c: The interventionists are back in a big way. Whether protectionist Democrats, big labour, those who think more regulation is needed, or businesses looking for handouts, they’re all out in force again. Is the threat to freedom and economic prosperity from such interests as severe now as it was in the 1970s or are there limiting factors this time?
Walker: I think that the big difference is that in the 1970s people sincerely believed that intervention could solve problems. Today we have the failure of the dirgiste communist systems of Europe and Asia and the subsequent success of markets to remind us that while it has its imperfections, reflecting the imperfections of human nature, the invisible hand of the market is more reliable than the heavy hand of government fishing in one persons pocket to place a much reduced amount in somebody else’s. Of course that does not mean that there will not be calls for government to do something – it’s just that most people now have very few illusions about what is actually being done and they won’t support it as enthusiastically as in the past, if at all.
I was quite impressed with Prime Minster Harper’s interview with Peter Mansbridge leading up to the last election when he gave a very good explanation for what government could, should and could not do in the present circumstances. He rightly noted that the best thing governments can do is to provide a sound framework within which people can plan and create wealth. That is what he has done for the most part.
c2c: On a personal level, you’ve met plenty of leaders over your career. Does any one leader stand out in your mind and why?
Walker: I have been privileged to meet many politicians and other leaders in my lifetime. There are different kinds of leadership. Political leaders have to be able to get people to follow them, and often down long, potentially dangerous and poorly-lit trails. Undoubtedly Lady Thatcher and President Reagan will be remembered for their courage and their foresight in this regard.
But I think that the real leaders were the people that mapped out the path for these political leaders to follow. By challenging the conventional wisdom and setting out unpopular but correct economic and social policies people like Professor Milton Friedman in the U.S. and Professor Hayek in the United Kingdom inspired their political friends while they struggled for many years in the academic wilderness while being shunned and vilified for their views and their proposals.
c2c: One last question Dr. Walker, after your long career as head of a think tank that you built from scratch into one of North America’s most influential institutes, what do you do for an encore – i.e., what are you up to these days?
Walker: I am doing everything I can to ensure that I do not encumber my successor, Dr. Mark Mullins, as he does a fantastic job of leading the Fraser Institute.
So, I have enrolled in the commercial pilot program at the flying school where I got my private pilot’s licence, I am puzzling about esoteric things like how to extend our very successful Economic Freedom of the World Index to other freedoms and reading a lot in subject areas that I did not have time to pursue when full time at the Institute. I also have three wonderful grandchildren and three businesses that keep me from getting into trouble and tennis partners for every day of the week to keep me fit.