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Good Riddance, Cash for Clunkers

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As you may have noticed, the Federal Reserve not only fueled the housing bubble, but then also transformed from central banker into a central planning agency, specializing in corporate welfare. Since the onset of the financial crisis the government has become the nation's biggest mortgage lender, guaranteed nearly $3 trillion in money-market assets, and took in some $600 billion worth of mortgage-backed securities. It has also taken equity stakes in nearly 600 banks, numerous insurance companies and both car companies.

Most obscene is the rescue of financial firms that behaved recklessly. AIG alone received about $180 billion; that is almost $2,000 for every American household. Normally, profits encourage risk-taking and losses encourage caution. By removing profit and loss motivations, the government also removed the incentive for those financial institutions to restrain themselves, and in effect teed up the next financial crisis.

As if all that was not enough, Washington is experimenting with bogus stimulus, such as the "cash for clunkers" program. Taxing Peter to subsidize Paul's new car is not a recipe for sound economic growth. And there is never a free subsidy. Resources used to subsidize one industry always come at the expense of another. Such subsidies might enable their recipient to produce more and sell at lower prices than they otherwise would, but they artificially raise the costs for other industries. As businesses are hindered from developing skills that would make them more productive, the welfare and wealth of the entire country is reduced.

Another recent knee jerk reaction has been the rise of protectionism. However, subsidies are wrong even if they come to the aid of an industry exposed to unfair competition from abroad, such as one supported by a foreign government.

Protectionists typically rely on casuistry to defend their position. The idea of comparative advantage is lost on them. Adam Smith wrote The Wealth of Nations to explain that free trade expands the size of markets, making capital investments possible and improving skills of specialized workers. Confining economic activity to the local level keeps the market artificially small and reduces opportunities for investment and specialization. It also curtails personal freedom.

If I had the choice, I would prefer we had a trade surplus with China. The world would be much better off if everyone engaged in free trade (and the Chinese would benefit the most, as their misguided trade policy is most damaging to themselves). But responding with protectionism and subsidies is not in our best interests.

If your neighbors saved more you'd be better off, because their added capital would generate productivity. But you can't control your neighbors' saving habits. Would you reduce your own savings in response to your neighbors squandering? That makes no sense.

After all, the purpose of economic activity is not to sell as much as possible in exchange for as few goods and services as possible. It doesn't matter how many pieces of paper money are being moved, but what they buy. Voluntary exchanges are not zero sum. Both sides benefit from them, or they would not freely choose to engage in them.

And our trade deficit is not tantamount to debt. Foreigners often use the cash they get from us to hold dollars or buy dollar-denominated equities or real estate, thus increasing our current-account deficit without any increase in debt.

In fact, U.S. current account deficit has actually halved from $829 billion is June 2005 to $409 billion in the first quarter of 2009. At the end of May, China held $801 billion in treasury debt, but domestic savings are increasingly replacing foreign lenders, and treasuries are still only about 1% of total household assets.

So instead of fretting about the policies of other countries, we should avoid making our own blunders. Transferring wealth from tax payers and consumers to large corporations, as the "cash for clunkers" program did, we are compounding the situation to the detriment of all involved, except the special interests and lobbyists.

Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment firm. Email at