Watching CNBC lately has been pretty amusing. Billionaire after billionaire comes on for an interview and expresses huge confusion about the credit markets. The emperor of debt himself, Donald Trump, expressed confusion a year ago that “money is cheap”.....yet… “unavailable.” Heck, cheap but unavailable seems to be the new mantra of the leveragati (think “literati” with more debt).

The answer to this “conundrum” is simple. The Federal Reserve is in the price-fixing business, and we all know that when you create a price ceiling, that supply shrivels up.

Similarly, interest rates are the price of money. When the Fed creates, in essence, a price ceiling on money, it won’t be supplied by the private market, but only by idiots, or by the Fed (but I repeat myself).

So essentially, by artificially lowering the price of capital (interest rates) supply dries up, as it does in every market where price fixing is allowed. If you can’t earn a decent return on your money, why would you take it out of your wallet? We then have an artificial “liquidity crisis” and the socialists come out of the woodwork and demand that the government “DO something” to assure that “this never happens again,” this “problem” of recurring expansions and contractions.

I have a question for the Congress. If you don’t let them lose so much money that they’re fired from the banks, how do you prevent them from over-leveraging themselves in the future? And to the point of expansions and contractions, you can no more legislate them away then you can legislate away the tides of the ocean. Perhaps Congress believes it can make fear and greed illegal. Rather than go down a road of ever-complex, misguided regulation, remove leverage from the system with simple, yet strong regulation. Requiring 20% down on mortgages would be a start.

But what the government is doing is finding surrogates in order to spur lending at uneconomic rates. Fannie (FNM) and Freddie (FRE) are perfect examples. Their interest rates are too low and they will require more and more government funding due to this fact. They are essentially lending agents of the Treasury, not private actors engaged in lending at rational rates.

Congress misses the point when it complains to the Treasury and the Federal Reserve that banks are not lending. The very clear, but unstated policy of the Treasury and the Fed is the “money gift.” As Wikipedia accurately describes,

In a liquidity trap, banks are unwilling to lend, so the central bank’s newly-created liquidity is trapped behind unwilling lenders.

What is the solution? The “money gift.” The U.S. government is gifting money to the banks in highly complex ways to make it appear more politically tenable to the populace. But make no mistake about it. It is a gift. Once the gifts exceed levels that the banks need to replenish their capital (either through the giving of dollars outright, or in the form of an artificially widened net interest margin due to low rates), then, perhaps, the money gift will “increase housing prices.” Of course, it won’t be a real price increase at all. It will merely be inflation.

The effect is to penalize the virtue of savers, who are caught in the double-whammy of the debasement of the currency and ridiculously low interest rates, thereby earning highly negative returns on their savings. This is not just China. These savers are ordinary Americans who do not over leverage and did all the right things. They are often the elderly on fixed incomes. This inflation is a taking (theft) from savers and a gift to all those who have borrowed money. Their debts are fixed, but the money they must repay in becomes steadily less valuable. It is yet another form of wealth transfer (theft) from those with virtue to those with vice.

And don’t be naive. Homeowners are not the real targets of the money gift. Think AIG, Citigroup (C), Bank of America (BAC), et al. The bank lobby pulled off the greatest heist in the history of the world. And they got the government to sanction it.

But you may say, “sure these savers lose out, but we can increase employment with some inflationary increases in the money supply.” This seeming “logic” is as widespread as it is wrong. Inflation kills demand in terms of the aggregate quantity of goods citizens can afford. It doesn’t spur it.

For instance, for families with fixed budged constraints (a fancy term for incomes), if the price of Tide goes up by 20%, the family either buys 20% less quantity of Tide, or less of something else in order to still afford it. But their income is unchanged. They can afford less of everything. The economy is hurt, not helped. When citizens can afford less goods, businesses lay off even more workers. Less quantity of goods can be afforded, businesses earn less or go broke, more workers are laid off. It’ a simple and vicious cycle.

But, the socialists will proclaim, incomes will rise as well, negating this effect. Go to your boss and ask for a raise. See what happens. Inflation kills economies. As Milton Friedman recollected of du Pont’s famous adage “we do not have to be gracious at all to inconsistent logic or absurd reasoning. Bad logicians have committed more involuntary crimes than bad men have done intentionally.” No society has ever prospered from inflation.

Contrary to popular belief, the sun will rise in the morning even if financial institutions fail. What we have done is to create affirmative action for the rich and stupid. The government has essentially asked, “Are you rich? Are you dumb? Did you invest in a bank? Are you a trader at one? Here’s some money.” Taking money from the populace and giving it to such sophisticates is lunacy. It is also gangsterism, not government.

Thomas Jefferson once opined that the foundation of a Republic is the virtue of its citizens. He wrote

When virtue is banished, ambition invades the minds of those who are disposed to receive it, and avarice possesses the whole community.

He might have been discussing the banking lobby.

The government cannot penalize virtue and reward vice and expect good results. I fear that we have lost the will to win as a nation. We have elected leaders who are not willing to endure short term pain for long term prosperity. The stimulus we are seeing is rather like crack to a drug addict. It may amp up GDP temporarily, but does damage to our economic system longer term.

When there is a cancer growing in a patient, the answer is to excise the tumor, not keep it alive, as we are with problem banks. The FDIC can easily seize the deposits of large institutions. They are not doing so, because of political pressure from the well-connected, which makes “saving” bad banks more politically tenable.

Placing formerly concentrated deposits with a myriad of healthy banks would place this capital in more capable hands and fix the probem of too big to fail in one swoop. These good banks would be much better able to direct rational lending in the future—they have done so in the recent past. Think banks like Hudson City (HCBK).

With all of our mathematical pretensions about business cycle theory and economics, it comes down to a very simple, very human phenomenon. We have contractions because people become too greedy when times are good, over-expand, and borrow too much money, and pay prices that are too high. We have expansions because during contractions, prices get too low when people panic and sell things for prices that are below what they are worth, and more rational people shrewdly buy and expand businesses, leading to recovery.

You can’t banish fear and greed, intelligence and stupidity. They are as old as time itself. People of discernment recognize that you cannot legislate them out of existence, only try to educate people to immunize them as much as possible from following others like lemmings off of various economic cliffs. You also cannot reward vice and punish virtue. If government is the referee in the national morality play, every character must get what they deserve.

The 20th century ushered in a curious phenomenon to which we are all witness, in its ridiculous, irrational, myriads forms. Personal shortcomings are now seen as social problems. We can’t perfect humans, but we think we can perfect society. In this fantasy world, personal greed is “market failure” and panic is a “liquidity crisis.” Formerly wealthy institutions which might become poor are “too big to fail,” rather than dumb. We need to start seeing things for what they are and to start calling them by their true names.

Perhaps Sir John Templeton said it best when he declared that

Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.

The same might be said of nations.