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The Lighthouse is the weekly email newsletter of the Independent Institute.
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Volume 10, Issue 42: October 20, 2008

  1. Must Central Bankers Undermine Financial Markets?
  2. The Consequences of Latin American Amnesia
  3. Candidates Pledge to Take False Step in Afghanistan
  4. This Week in The Beacon

1) Must Central Bankers Undermine Financial Markets?

The Federal Reserve Bank helped obtain a buyer for Merrill Lynch and in so doing may have undermined rival investment bank Lehman Brothers. Do double standards create uncertainties that weaken the integrity of the financial system? If so, why does the bailout bill expand, rather than reduce, the discretionary powers of U.S. financial regulators? Were he alive today, Walter Bagehot, the esteemed early editor of The Economist magazine, would be crying to the heavens!

Bagehot’s bête noire was the Bank of England, which he said created problems for the economy by dispensing special favors to select banks during financial crises. If England’s central bank couldn’t be abolished, he argued, the next best alternative would be for it to stop playing favorites. Bagehot recommended that the Bank of England offer loans to all troubled banks, but only at penalty interest rates and only if the borrowers put up good collateral to secure those loans. This advice is just as valid today, according to Independent Institute Research Fellow George Selgin, author of Good Money. (No less an authority than the late Milton Friedman called the book “a splendid piece of historical analysis” of how private enterprise solved a monetary problem that threatened seriously to retard the Industrial Revolution.)

Bagehot’s advice is helpful even if we don’t know exactly what “good” collateral looks like. That’s because we often recognize inadequate collateral when we see it. Selgin writes in a new op-ed: “While no one may precisely be able to define good collateral, and one can debate whether the rate at which banks offer to lend unsecured funds to other banks, known as the London Interbank Offered Rate, plus 8 percent constitutes a ‘penalty’ rate, who even pretends that recent central bank lending has been based on good collateral?”

Wasn’t the relaxation of loan requirements a key factor that got us into this mess in the first place?

Independent Institute Research Fellow Jeffrey A. Miron also notes that the bailout creates uncertainty in the banking system. “Government ownership means that political forces will determine who wins and who loses in the banking sector,” he writes in a piece published on CNN’s website.

“The government, for example, will push banks to aid borrowers with poor credit histories, to subsidize politically connected industries, and to lend in the districts of powerful members of Congress,” he continues. “All of this is horrible for economic efficiency. Government pressure will be difficult for banks to resist, since the government can both threaten its ownership stake or promise further injections whenever it wants to modify bank behavior. Banks will respond by accommodating government objectives in exchange for continued financial support.”

“Central Bankers Still Don’t Get It,” by George Selgin (Modesto Bee, 10/14/08)

“Why This Bailout Is as Bad as the Last One,” by Jeffrey A. Miron (CNN.com, 10/14/08)

Purchase Good Money: Birmingham Button Makers, the Royal Mint, and the Beginnings of Modern Coinage, 1775–1821, by George Selgin.

For an analysis of the U.S. government’s leading role in weakening mortgage lending standards, see “Anatomy of a Train Wreck: Causes of the Mortgage Meltdown,” by Stan J. Liebowitz (10/3/08)

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2) The Consequences of Latin American Amnesia

For Latin America to progress socially and economically, its citizens should remember and examine the region’s triumphs and disasters. Otherwise, they will continue to repeat each other’s mistakes, according to Independent Institute Senior Fellow Alvaro Vargas Llosa, who in his latest column shares lessons he learned this past year while filming “Consecuencias: Latin America Uncovered,” a four-part documentary series for National Geographic Channels International. (The series has been televised weekly in Spanish-speaking countries since mid October and will air in other countries in the coming months; check your local listings.)

“Brazilians, Mexicans, Argentines, Colombians, Peruvians, Venezuelans and the rest will need to have a much better understanding of the lessons of their neighbors and of the need to pass on their experience to the next generation,” writes Vargas Llosa. “Latin Americans will need to rediscover themselves.”

Political amnesia has cost Latin Americans dearly, Vargas Llosa argues. Venezuelans are in the grips of a megalomaniac populist because they have forgotten about (or never learned) how populism wrecked Argentina and Peru. Bolivians seem always on the brink of civil war because they haven’t learned the lessons of the Mexican revolution. And Argentines have put their economy at risk with policies that artificially favor commodity exports—though their neighbors regretted adopting similar policies in the 1920s, ‘50s, and ‘70s. In the struggle to improve the lives of ordinary Latin Americans, knowledge of other countries’ histories would go a long way.

“Rediscovering Latin America,” by Alvaro Vargas Llosa (10/15/08) Spanish Translation

Purchase Lessons from the Poor: Triumph of the Entrepreneurial Spirit, edited by Alvaro Vargas Llosa.

Purchase Liberty for Latin America: How to Undo Five Hundred Years of State Oppression, by Alvaro Vargas Llosa.

Attend the conference, “Lessons from the Poor: The Power of Entrepreneurship,” featuring Alvaro Vargas Llosa, former Bolivian President Jorge Quiroga, William Easterly, William Ratliff, George B. N. Ayittey, Fredrik Erixon, Gabriel Gasave, Daniel Cordova, Martin Simonetta, and Thompson Ayodele (Washington, D.C., 11/13/08)

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3) Candidates Pledge to Take False Step in Afghanistan

Both Barack Obama and John McCain say that if elected president they would increase the U.S. military campaign in Afghanistan beyond the 8,000 troops that President Bush plans to send. Their hope is that a troop surge would do for Afghanistan what it has done, at least in part, for Iraq. Leaving aside their overestimation of the role of the troop surge in the reduction of violence in Iraq, their belief that the U.S. strategy in Iraq could be implemented successfully in Afghanistan ignores important differences between the insurgencies of these two countries. For example, paying guerilla groups not to fight U.S. troops, a tactic that has met with success in Iraq, at least temporarily, would almost certainly fail in Afghanistan, according to Ivan Eland, director of the Independent Institute’s Center on Peace & Liberty.

“In Afghanistan, the Taliban and their Islamist fellow travelers are religious zealots who will not be so easily bribed,” writes Eland. “After all, in Iraq, the U.S. did not attempt to co-opt the similarly zealous al Qaeda in Iraq using bribery.”

Furthermore, the Taliban has advantages that Iraq’s insurgents lack, such as effective hideouts in rugged terrain and in neighboring Pakistan and probably support from Pakistan’s intelligence service. In addition, the U.S.-led war on drugs is driving Afghanistan’s poppy growers into the arms of the Taliban. Thus, concludes Eland, “The U.S. should withdraw its forces from Afghanistan and concentrate on pressuring the Pakistani government into finding and turning over bin Laden.”

“Will Transplanting the Strategy in Iraq to Afghanistan Save the Day?” by Ivan Eland (10/20/08)

Purchase The Empire Has No Clothes: U.S. Foreign Policy Exposed, by Ivan Eland.

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4) This Week in The Beacon

Below are the past week’s offerings from The Beacon, the web log of the Independent Institute. As always, readers are encouraged to share their comments at the bottom of any blog item.

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