When the penalty for the marginal bit of immoral behavior is low, it increases the hazard of immorality – i.e., the likelihood that it will occur. In the wilderness, with only a knife and your wits to keep you, intense and relentless virtue is the only option. The constraints on your behavior are inescapably, painfully apparent. When you are wealthy, the hedonic penalty of imprudence is lessened. This is why prosperity – the situation that obtains when we control enough wealth that the marginal imprudence is apparently not at all threatening to our basic welfare – can be the seedbed of moral disaster.
Prosperity is a reliable sequela of virtue. So the discipline of the wilderness, or of hard times, can engender great wealth. Yet such wealth does not then necessarily result in improvidence, or a tendency toward moral corruption. Where the rewards to virtue and the penalties to vice are not obscured by noise in the system of the economy – when failure is not coddled, or success derogated – rational agents can more readily guide their acts toward appropriate ends. And since the most rational and intelligent agents always end up controlling most of the resources, and therefore making the most consequential economic decisions, a preponderance of virtue and knowledge among them can guide the whole system in such a way as to keep it predominantly within the constraints of prudence.
But when noise is introduced to the economic system, it misguides even rational intelligent agents, inclining them to vicious ways. Catastrophe then ensues.
For example, when the ECB and the EMU intervened in the natural cultures of Europe in such a way as artificially to depress the interest rates they were paying, it increased their moral hazard. Take Greece. The Greeks had an inveterate habit of inflating the drachma to monetize their imprudent borrowing. They therefore suffered higher interest rates than they otherwise would have. In 1993, the cost of capital for Greek borrowers was about 25% per year. Over the course of the 90’s, as Europe was moving toward monetary union, and thanks to the boom of the 80’s and 90’s, Greece improved her credit-worthiness so that by 1999, when the Euro was born, her cost of capital was close to those of other European countries. It fell to about 5% per year when she adopted the Euro in 2000.
Loosed from the constraints imposed by high interest rates, the Greeks proceeded to spend money like sailors on shore leave. Nevertheless their interest rates stayed low and stable through most of the next ten years. Why? Because at the lower interest rates engendered by the Euro, their economy could service more debt. So they borrowed up to and then beyond the limit of what their real production of economic goods could service. They became insolvent. Other European nations did the same. The United States is now a juggernaut moving faster and faster in the same direction.
The global crisis of 2008 was the recognition by markets that they had been misled about the true risks posed by debtors via massive state distortions to nominal interest rates. As soon as the real risks became apparent, investors instantly translated the cost of capital to Greeks to about 16% per year. This translation was an effectual, massive devaluation of the already existing corpus of Greek debt, denominated in Euros, and with nominal interest rates wildly lower than what would be required to compensate investors for the true risk of loaning money to Greece. The holders of those Greek bonds saw their balance sheets turn upside down as their bond holdings went down the toilet. They realized that they had less money than they had thought, stopped investing money (i.e., reduced their risk exposures), and economic ruin loomed. Ever since, the Europeans have been engaged in desperate measures to stave off the inevitable day of reckoning.
The amazing chart below tells the story. It displays cost of capital (long term interest rates) in the Eurozone. Its data come from the European Central Bank [ECB], which is to the Euro as the Fed is to the US dollar. There is an important difference between the two banks. The Fed has two contradictory missions: to maintain full employment, whatever that is, and to maintain a stable currency. The ECB does not (yet) have to worry about maintaining full employment in the Eurozone. Markets therefore seemed to feel for a long time that the Euro was unlikely to suffer much inflation. So far they have been right. And this kept interest rates in Euro-denominated loans relatively low, as compared with loans denominated in drachma. If the drachma is inflating at 10%/annum, a lender must charge at least that much just to stay even.
Before the intervention, the market constrained notorious Greek impecunity by charging Greeks higher interest than Germans. One result was a constraint on the economic development of Greece; but another was a constraint on the amount of trouble Greece might generate.
When U.S. banking authorities did the same thing with mortgages, the same thing happened in the real estate market.
The noise introduced to the economic system by these state interventions prevented it from responding appropriately to reality. They prevented economic agents from understanding the true consequences of their actions, so that they became more likely to behave imprudently. The noise obscured the truth, and that increased moral hazard. Behavior pushed toward its proper limit; thanks to the noise, it pushed beyond.
There is a principle at work here that is a type of a general principle in nature. We all refer to a different type of that same archetypal principle when we say, “work expands to exceed the available time.” Its financial version is, “the schedule of apparently important expenditures expands to exceed the available funds/economic resources.” The Second Law of Thermodynamics is perhaps the most pervasive type of the archetypal principle (except that with the Second Law, the budget of the system under consideration cannot ever exceed the supply of available energy – cannot borrow, or give, or cheat – the way that it can in human affairs).
What is the archetypal principle? Things seek their proper limit, and do not rest until they find it.
I saw this with my own kids. When I was a new and tentative father, my kids misbehaved more and were less happy. When I made the behavioral limits clear, and enforced them sternly, they settled down and were, not just well-behaved, but happier, less anxious about where they truly stood in the world. And this liberated their energies for creative work: for playing, learning, and developing. Fortunately for all of us, my wife and I figured this out when our eldest was only about two. [I note for the record that my wife was the one who mostly figured this out, and came up with most of the sensible ideas about what the limits should be. My contribution consisted mostly in looming with immense and imponderable power to destroy or to save, to condemn or to bless. A rumble from my direction, and the young nomads of my household trembled: if of thunder, with terror; if of laughter, with joy.]
Here’s a question: if a thing has not reached its proper limit, can it rest? Is that really possible? I am reminded of Augustine: “Our hearts are restless, Lord, until they find their rest in thee.”
“Lead us not into temptation,” then, can be understood to mean simply, “help us apprehend the Limit.” Thus the Psalmist’s endlessly reiterated prayer that YHWH show us his Way, and write his Law in our hearts.