Vernon L. Smith
While on spring break from Chapman University, I am now “confined” by the pandemic to my home in Tucson where I live part of the year. The fourth of four COVID-19 cases in Pima County (population just over one million) was announced as I write this — a haven of safety indeed. But street traffic is heavy, the stores crowded, and people are busily surfing the empty shelves and buying from the shelves not yet empty.
Americans are selling securities and buying toilet paper as Donald Trump urges us all to socially distance ourselves at least six feet from each other and limit gatherings to no more than 10. Local stores have announced that oldsters like me will be allowed to shop their empty shelves for one hour before regular opening time.
There is a deep economic lesson hidden in this rush to stock up on ordinary consumer goods, coordinated spontaneously by common fears of supply shortages and stock-outs.
Prices guide economy
Why, throughout almost all our life of economic experiences, do none of us have the slightest concern that when we go to our local stores, everything we might desire will be waiting for us on the shelves? We never think on these things because we have no need or motivation to think on them. We operate deeply immersed in a world of prices and available goods and services, and never give it a thought. No central office, or person, or bureau is in charge. Yet vast supply chains encircling the globe and, coordinated by people governed by prices assure that your green tea, buttermilk, canned tuna and toilet paper will be waiting silently for you whenever you might decide to shop. Each of us oversees a fragment of this whole, and that is quite enough.
Welcome to the miracle of consumer markets, requiring only that sellers not falsely represent or advertise their products and that you must pay for anything you buy. Consequently, prices constantly adapt and change in response to events near and far that cause pork prices to fall, or poultry prices to rise. When your government thought it could improve air quality by mandating that ethanol be added to gasoline, you didn’t even notice that the price of tortillas increased, here and in Mexico.
Not everyone in the world is so graced by this economic freedom. Those living in dark-night North Korea, rich in coal and human potential, can barely feed themselves. In contrast, their historical language and cultural brothers and sisters to the south live in brightly lit abundance. Similarly, Venezuelan citizens live in the richest of all countries in oil reserves. The government instituted price controls intended to enable the poor to buy food more cheaply, and many Americans praised their compassion. The consequence was shortages and black markets. So, the compassionate government seized the supermarkets, and now Venezuela cannot feed its people.
True to this mode of thinking, many of our state governments have passed populist “anti-price-gouging” laws. Such price controls, by any name, can only exacerbate current shortages as consumers rush to buy, and producers, who need neither instruction nor police impediments, exhaust every avenue to increase output. The first motive for all savings and investment is to provide security against loss in current output and increase stores of potential consumption that can be drawn upon.
No economic free-fall
Not all markets, however, are born equal. Laboratory experiments for goods that cannot be re-traded easily converge to their predicted supply-and-demand equilibrium under conditions of strictly private dispersed information. Their counterpart in the economy, markets for nondurable consumer goods, are a rock of stability. Moreover, these markets are very large, constituting 75% of private product (gross domestic product less government expenditures).
In sharp contrast, laboratory studies of asset markets persistently yield price bubbles in environments with perfect information on fundamental value. Moreover, experiments prove that this propensity to bubble is precisely and only because the items are re-tradable. These studies helped us to understand why all market economic instability arises from durable goods markets, especially housing-mortgage markets, as we have seen in the Great Recession and in the Depression when house prices fell against mortgage debt, plunging households into negative equity. Homeowners, living in houses worth less than what they owe the bank do not feel buoyantly prosperous. The experiments also helped us to understand why security markets are so volatile, but are not a fundamental source of instability, like housing, because securities market loans are short-term callable loans, investor balance sheets are marked steadily to market as prices decline, and there is no build-up of negative equity to dampen long-term expectations.
I believe the economy today lives in suspense, not free-fall. The pandemic will pass; public health institutions have been a model of forthright dissemination of information on the spread of this disease and sanitary procedures to minimize its impact. It’s the citizenry that has been unruly for a time. Supply chains will refill and stabilize quickly, as the pandemic passes, securities markets will recover, and growth will continue to reduce poverty everywhere. Homes are more valuable than ever as a haven of safe and secure living. Provided that we continue to buy them with some of our own money, homes will be part of a secure future.
Stay healthy, well-fed, clothed, and warm in your home and in this suspended economy. Don’t take any “wooden nickels” either for your goods or from your politicians, and keep the faith.
Vernon L. Smith is the George L. Argyros endowed chair in finance and economics at Chapman University and member of the board of directors for the Mercatus Center at George Mason University. He is the 2002 Nobel laureate in economics.