Transactions: Nov. 3, 2008

One (of many) definitions of a conservative is someone who embodies a general skepticism toward the populi, the booboisie, the peeps. The human lot is fragile, frail, prone to error. This kind of small "c" conservatism believes in the inevitability of sin -- even original sin; there's a touch of Puritanism here. Given a choice, it edges toward pessimism, particularly over the ability of crowds of well-meaning peeps to avoid fooling each other. In a democratic context, it's Madisonian in its interest in checks and balances, Burkean in its belief in tradition: two cheers for democracy, perhaps, but not "American Idol" democracy. In economic terms, it's skeptical about self-regulation. Markets are normally excellent machines for pricing risk, but they consist of, aargh, people. And homo sapiens, whether investors, traders, speculators, politicians or regulators, are oh so human and prone to tell each other tales and dream of free lunches and no-money-down mortgages.

These days, as we face lurching markets and a much-anticipated election, we are a bit more small "c" conservative than a few minutes ago. Counterbalancing the financial collapse, the economic state has inflated into something larger and more intrusive than any we've seen before in peacetime. The paradox here undercuts the facile notion that, shaken to our toenails, we've suddenly grown to adore a giant, activist state. We don't have much choice; and beneath the surface, skepticism about our fellow man's -- including our own -- ability to manage complex financial affairs is on a bull run. After all, there sat the maestro himself, Alan Greenspan, admitting that he -- the man who bestrode our markets for so long -- was wrong, that there was a "flaw" in his reasoning about the ability of banks, firms and markets to self-regulate, not to say self-medicate.

Well, hold on, Al, you're not so unique: We've been making that mistake since the earliest markets in clay pots and cheap necklaces. Economic complexity regularly outruns human (or computer) comprehension; we regularly fail at, as Greenspan said, "self-regulation." Indeed, the theme that runs through so much of the talk about what to do is exactly that: Given our tendency to delude ourselves, how do we effectively supervise markets? One answer, which is the option on the table, is to create a "better" system of regulation. Reform, brother, reform. But who do you trust? Mere men want to regulate last year's problems, tend to be gulled by self-interest and the conventional wisdom. The alternative, which has boomed over the past decades, is to let markets regulate themselves: the famous invisible hand, which, alas, occasionally fails to show up for work. Markets can process oceans of information and produce efficient pricing. However, markets can also crap out big time.

At times like this, dreams of an automatic market regulator revive. Market dislocations represent a separation of value from price -- the kind of break a mechanism like the gold standard was designed to restrain. Gold is tangible, not abstract, a valuation beyond mortal control, and it represents a return to "reality" after an era of immoral excess -- excess always being immoral when things crap out. Some argue we've been wandering in the wilderness since the developed economies abandoned gold in the '30s (Nixon finished the job in 1971), building ever-higher houses of leverage and liquidity. That said, the academic literature lays considerable blame for the Great Depression on the re-imposition of the gold standard after World War I, which mechanically locked fast-changing economies into deflationary fetters. And, indeed, from a historical perspective, the rise and fall of gold marks the shift of Wall Street and central banking from hard money to soft, from scarcity to abundance, from Malthus to Keynes. The historical record is mixed, however. The gold standard era of the 19th century brought prosperity right up to World War I, advances that can't be dismissed because the mechanism finally stalled. Likewise, the past 60 years of accommodation and Keynesian management generated growth too, which can't be waved off as illusion because it finally broke down. Who do you trust?

So we're all addled by sin, crippled by imperfections, prone to fantasy and foolishness. The fact is, accepting that -- keeping that reality always before us -- is probably a better insurance policy for self-regulation than some unblinking deus ex machina, from gold standards to manipulation of monetary aggregates to Keynesian fiscal management. Mechanisms fail to adjust, spawn an unthinking complacency and -- like risk management -- provide tools to game the system. Keynes understood that. Economics is an art, not a science; finance is a skill, not a math problem. Still, psychologically speaking, dreaming of an automatic decider is a lot easier than dwelling eternally on our imperfections. And that's why small "c" conservatism in our exuberant wonderland is always a sect, never the state religion.