It’s hardly a secret that the 2012 election is shaping up as a contest between free markets and big government.  And while the choice seems clear in the current political environment, it’s important to recall that government does play a critical role in the development and maintenance of functioning markets.  Yet, as Tea Partiers, Occupiers, and Ron Paul acolytes all note, government has both abdicated that critical role and inserted itself where it does not belong.

If markets were magical places that flourished whenever government disappeared, Somalia would be the world’s leading economy.  Markets are sophisticated mechanisms that enable informed parties to exchange resources, voluntarily, to mutual benefit.  There’s a lot packed into that sentence.  For markets to work, participants must trust the system.  They must believe that they have—or least can access—the information they need to make informed decisions.  They must feel free from coercion—both explicit coercion and unacceptable take-it-or-leave-it offers.  They must trust the inherent fairness of the system, and they must believe that it is possible to enforce the rules of the marketplace by sanctioning cheaters.  The closer an actual market comes to meeting these needs, the better it will function.  The further a market drifts from these goals, the more likely it is to fail.  It is thus absolutely critical that someone—presumably the government—serve as the market referee and the guarantor of market enforcement.

First and foremost, market participants must believe that courts will honor contracts and property rights fairly, dispassionately, and smoothly.  Contracts allow strangers to exchange promises; property allows people to focus on matters in front of them without worrying about possessions that may be out of sight.  In the absence of enforceable contracts and property rights, people could never travel far from home, leverage their assets, or exchange current payment or performance for a promise of future delivery with anyone unfamiliar.  In short, a society that distrusts its courts cannot progress beyond a tribal or a village economy—even if it employs tribal or village markets.

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From CBSNews:

A bill to stop “insider trading” in Congress is gaining momentum with two new Senate sponsors.

Sens. Scott Brown, R-Mass., and Kirsten Gillibrand, D-N.Y., today are introducing the Stop Trading on Congressional Knowledge (STOCK) Act of 2011, which would prohibit members or employees of Congress, as well as executive branch employees, from using nonpublic information obtained through their public service for investing or any attempt at personal financial gain.

Like everyone else, members of Congress are subject to current insider trading laws. However, current insider trading laws do not apply to nonpublic information about current or upcoming congressional activity — that’s because members of Congress aren’t technically obligated to keep that information confidential.

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Stocks collapsed roughly 700 points over two days after the Federal Reserve launched its “Operation Twist.” The market correctly perceives that the central bank’s plan to swap $400 billion of short-term notes for long-term bonds adds no new reserves to the financial system. So it wasn’t QE3, that’s for sure. No stimulus. In fact, with the Treasury yield curve flattening, the Fed’s sterilized asset swap actually tightened financial markets.

The Fed should have listened to the GOP congressional leadership, which in a letter advocated no more stimulus and no more market-subverting interference.

But the real issue is the new FOMC forecast: “There are significant downside risks to the economic outlook, including strains in global financial markets.” That was the killer statement.

So let me repeat: We are on the front end of a recession. The profits picture is very much in doubt. More Obamanomics tax hikes are in the air. Europe is unsolved. U.S. finances are a mess. All this is being discounted by slumping stocks.

Corporate credit risk spreads have been widening, which is a negative for the profits picture, as economist Michael Darda has pointed out. Profits are the mother’s milk of stocks. And the European funding markets have tightened substantially, as their much-wider financial-stress spreads all indicate.

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From the Associated Press:

The U.S. Federal Reserve’s tacit acknowledgment that America’s economic slowdown is likely to persist for quite a while sent global stock markets skidding Thursday as investors brushed off the central bank’s efforts to spur growth and focused instead on its gloomy assessment.

Oil tumbled too but the dollar held its own against the euro, which has been weighed down in recent weeks over concerns that Greece might go bankrupt. Hong Kong’s Hang Seng led the retreat lower earlier during the Asian session with a near 5 percent dive.

The losses began Wednesday afternoon in the U.S. after the Fed announced a highly anticipated program to trade in $400 billion worth of short-term bonds for the same amount of longer-term bonds. The goal is to ensure low borrowing rates for a long period, thereby helping to stimulate the housing market and other economic activity.

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In today’s New York Post:

There was once a time when trouble in foreign markets, whether in Asia or as now in Europe, would be good for US stocks.

Sure, our markets can get hammered when news like the 1997 Asian currency crisis hits. But we often make a comeback as investors digest the news and come to the conclusion that the best place to bet for future growth is on the companies at the heart of the US economy.

No longer.

And it’s not just the zero-percent job growth and 9.1 percent unemployment we’ve got now.

The mainstream business media will tell you that the problem lies in the “dysfunction of Washington.” In other words, the economic slump and all the market turbulence, including yesterday’s 100-point drop in the Dow, stem from a bipartisan cause — lawmakers and President Obama can’t manage to craft a sensible plan to grow the economy.

But talk to enough investors, and they’ll tell you this isn’t really a bipartisan problem. Rather, it largely remains at the top, meaning with Obama and his economic advisers — who, when they aren’t threatening to raise the taxes of “millionaires and billionaires” who make just $200,000 a year, are offering up the leftovers of previously failed economic policies, such as this “infrastructure bank” gimmick that the president plans to unveil in what’s being billed as a major economic speech later in the week.

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From CNBC:

I just got off the phone with a source on Capitol Hill who has spent the past few days trying to convince Republicans to vote for a debt ceiling hike.

He told me that the biggest obstacle he faces has been “market complacency.”

“Frankly, a bit of panic would be very helpful right now,” he said.

As he explained it, lots of people in Washington, D.C. expected that this would be a week marked by panic in the markets. Stocks would tank. Bonds would get clobbered. The dollar would do something dramatic. And all of this would help convince reluctant lawmakers that they had to reach a compromise on the debt ceiling.

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A good friend of mine, David Jeffers of The Aletheia Group, sent out a message last night almost directly after President Obama finished his speech to the American public regarding the debt ceiling. His message was titled “Obamaocchio,” and, in light of what Mr. Obama and his Administration have been telling bankers behind closed doors about this issue, appropriate.

Even as President Obama and Treasury Secretary Tim Geithner take to the airwaves (as it were) to trumpet that the economic sky will fall if Congress does not reach a deal to raise the debt ceiling; to give the federal government the ability to amass more foreign debt, both Mr. Obama and Mr. Geithner – and their dispatches – have been reassuring the financial sector that they have no intention of allowing the United States government to “default” on its debt, regardless of whether Congress raises the debt ceiling or not.

A senior banking official admitted to receiving “guidance” from the Obama Administration insisting that “default is off the table.” This should be the catalyst for a great deal of anger; anger emanating from those who receive Social Security, Medicare and Medicaid payments, not to mention anyone whose investments have been held in limbo for all the uncertainty surrounding the debt ceiling issue.

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Ben Bernanke threw a curveball in his midterm report to Congress this week. The Fed view of the economy has been downgraded since it last reported in February. Although the official Fed forecast for 2010-11 is still 3 to 4 percent real growth, Bernanke sounded particularly gloomy when he characterized the economy as “unusually uncertain.” And he indicated that the majority view of the Fed Board of Governors and Reserve Bank presidents is that the risks to growth are “weighted to the downside.”

But here’s the disconnect. With no inflation and weaker growth, including stubbornly high unemployment, Bernanke mostly talked about an exit strategy that would shrink the Fed’s balance sheet by removing liquidity. This was the Fed’s bias last winter when the recovery looked stronger. Now that the recovery looks weaker, the stock market was hoping to hear Bernanke hint of an easier policy that would increase liquidity if necessary. Didn’t happen.

At the end of two days of testimony, Bernanke’s message seemed to be this: Expect the zero-interest-rate policy to be extended for another year. Futures markets now predict free money until September 2011.

Whether the economic outlook is as downbeat as Bernanke suggests is an interesting question. The vast majority of corporate profit reports for the second quarter show better-than-expected earnings and top-line revenues. In other words, the CEOs are a lot less pessimistic about the future economy than Wall Street or Main Street. And a combination of strong profits, a zero interest rate, and a positively sloped Treasury yield curve would certainly seem to rule out a double-dip recession.

However, one year into recovery, private jobs should be growing much faster and unemployment should be a lot lower. Following a deep recession, economic growth should be closer to 8 percent than 3 percent.

But there are limits to Fed fine-tuning. The central bank can produce more money, but that doesn’t mean it can produce more jobs.

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In August of 2005, Houston investment banker Matt Simmons predicted in a New York Times feature article that the price of oil, then $65/barrel, would soar.

Simmons, who had written a book arguing that the world is running out of oil, was predicting oil prices “in the high triple digits.”

After reading Simmons’ prediction, John Tierney, a libertarian, who was then an op-ed columnist for the New York Times, telephoned Simmons and called him on it.  He asked him if he’d be willing to put money on his prediction.

The two made a $10,000 bet.  If the average oil price five years hence in 2010, adjusted for inflation, exceeded $200, Simmons would win. If not, Tierney would pocket the ten grand.

We’re now into the second half of 2010, and the average oil price, in 2005 dollars, is $70.  Unless there is a remarkable explosion in the oil price for the remainder of 2010, driving it well above $300, Matt Simmons loses this bet.  It was not even close.

The point here is to try and learn something from this that is relevant to what is going on today.

Simmons is an energy specialist.  The company he founded advertises itself as “the only investment bank specializing in the entire spectrum of energy.”

It’s reasonable to assume that he knows a zillion times more about exploring for and producing oil than John Tierney.   But Tierney didn’t make the bet because he felt he knew more about drilling for oil.  He made the bet because he knows something about markets and change.

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Even though the Obama Administration claimed that squandering $800 billion on so-called stimulus would  keep the joblessness rate below 8 percent, the unemployment rate today is almost 10 percent. There are many reasons for the economy’s tepid performance, including a larger burden of government spending and the dampening effect of future tax rate increases (tax rates will jump significantly on January 1, 2011, when the 2003 tax cuts expire).

A closer look at the unemployment data, though , suggests that minimum wage laws also deserve a big share of the blame. In this Center for Freedom and Prosperity video, a former intern of mine at the Cato Institute (continuing a great tradition) explains that politicians destroyed jobs when they increased the minimum wage by more than 40 percent over a three-year period.

Mr. Divounguy is correct when he says businesses are not charities and that they only create jobs when they think a worker will generate net revenue. Higher minimum wages, needless to say, are especially destructive for people with poor work skills and limited work experience. This is why young people and minorities tend to suffer most – which is exactly what we see in the government data, with the teenage unemployment rates now at an astounding (and depressing) 26 percent level and blacks suffering from a joblessness rate of more than 15 percent.

Since the video is focused on economics, it does not examine why politicians would enact legislation that destroys jobs.

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In this week’s edition of Coffee and Markets, featuring The New Ledger’s Francis Cianfrocca, we’re talking about the BP spill, the right approach to tax policy, and why Obamacare won’t work. We’re brought to you as always by Andrew Breitbart’s BigGovernment.com and LibertyPundits.com.

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Related Links:

TNL: Dances With Bears
BigGovernment: Obamacare Isn’t Medicine for Deficit
Avik Roy: Orszag’s Weak Response
Barack Obama: Frat Boy in Chief?

It’s time for your weekly dose of markets and politics with Coffee and Markets, featuring The New Ledger’s Francis Cianfrocca, a podcast brought to you by the fine folks at Andrew Breitbart’s BigGovernment.com and LibertyPundits.com, your new home for Conservative podcasts. In this week’s edition, we hash out what’s happening in Greece and the global markets, President Obama’s broken promises on taxes, and what lies ahead for the big entitlement bomb.

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Related Links:

The Daily Caller: Showmanship is Not Leadership

Politico: Obama’s Bipartisan Health Summit

The Daily Beast: An Interview With Paul Ryan

Paul Ryan’s Roadmap

It’s time for your weekly dose of markets and politics with Coffee and Markets, our podcast from The New Ledger with Francis Cianfrocca, brought to you by BigGovernment.com.

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Yousefzadeh: A State of the Union in Contradiction

Domenech: The Speech Obama Didn’t Give

Morrissey: Ryan Reintroducing Health Care Reform

Samuelson: Bernanke Must Rebuild Confidence

In the wake of a stunning political result in Massachusetts, it’s time to assess the future Scott Brown dictates for health care, the market, the Democrats, and the country. It’s the third week of January 2010, and here’s the latest edition of Coffee and Markets, a weekly podcast from The New Ledger on politics, policy and the marketplace with Francis Cianfrocca, brought to you by BigGovernment.com.

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Related Links:

Dan McLaughlin: Seven Lessons of the Brown Bombshell

WSJ: Obama Scales Back Health Care Plans

Paul Krugman: Obama Wasn’t The One We’ve Been Waiting For

If there’s one thing we’ve learned over the past few years, it’s that we should never doubt the abilities of Joe Lieberman to get what he wants, and the willingness of Harry Reid to cave in the clutch. We’ll discuss where health care goes from here, the latest on the markets, and a disturbing trend in food prices on today’s edition of Coffee and Markets, a daily podcast from The New Ledger on politics, policy and the marketplace with Francis Cianfrocca, brought to you by BigGovernment.com.

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Related Links:

The Hill: Lieberman and Nelson Get What They Want
New Ledger: On Lieberman, How Reality Based Are Klein and Yglesias?
Business Insider: If You Thought The Economy Was Being Inflated By The Stimulus, You Ain’t Seen Nothing Yet
Bloomberg: Fastest Food Inflation Since Riots Means Milk Up 39%

Francis adds: Keep your eyes peeled on food prices, because it’s an explosive sleeper issue. For the first eight months of 2008, nobody except finance geeks was aware that we were in a financial crisis. The Lehman collapse took an ongoing situation and planted it into public consciousness.

But during those months before Lehman, commodity prices around the world were on an insane tear. Oil at $147 wasn’t the only thing affected by huge inflation. And it was starting to cause real social upheaval in places like the Philippines (which couldn’t beg borrow or steal enough rice) and West Africa (which couldn’t beg borrow or steal anything).

The acute financial crisis of late 2008 damped out the inflation, because it damped out all economic activity. But I never felt like I really understood the food-price inflation, and I don’t think anyone else did either. If it’s back, it’ll be a major story in 2010.

We’ve learned that Keynesianism does not make sense and that Obama’s so-called stimulus was misguided. In the final installment of this three-part series, let’s discuss the policies that actually would improve economic performance. As this video explains, both Economic Freedom of the World and the Index of Economic Freedom identify sound money, rule of law, property rights, small government, low tax rates, open markets, and laissez faire as the key conditions for prosperity.

The simple summary of the video is that economic liberalization and small government boost economic performance, not “jobs programs” or “stimulus packages.” But things are never as simple as they seem. Many Republicans, for instance, act as if any economic problem can be solved by cutting taxes. That’s a laundable instinct, to be sure, but fiscal policy only accounts for 20 percent of a nation’s economic performance and it is unreasonable to assume good tax policy can solve the problems caused by bad monetary policy or foolish regulatory interventions. Moreover, there is a big difference between good (supply-side) tax cuts that increase incentives for productive behavior and useless gimmicks such as tax credits and tax holidays. If Republicans want to rebuild their credibility on economic issues, they need to apologize for the reckless statism of the Bush years and rededicate themselves to shrinking the size and scope of the federal government.

What if a future President wants to go to war or ship more troops overseas to protect American interests, but can’t because China won’t let him? Could this actually happen? We’ll discuss the dangerous foreign policy ramifications of America’s current path on the latest edition of Coffee and Markets, a daily podcast from The New Ledger on politics, policy and the marketplace with Francis Cianfrocca, brought to you by BigGovernment.com.

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Related Links:

Ferguson on the Economy and Foreign Policy
Yousefzadeh on the Decline of American Foreign Policy
Wehner on Obama’s Unmasking

The dominant Democrat leadership in Washington is terrified that people will actually start blaming them for historically high unemployment levels, despite their best efforts to create or save jobs in Texas District 85 and elsewhere. We’ll talk about how the markets perceive their possible solutions — and why none of them are likely to work — on today’s Coffee and Markets, a daily podcast from The New Ledger on politics, policy and the marketplace with Francis Cianfrocca, brought to you by BigGovernment.com.

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Related Links:

WP: House Focus Shifts to Jobs
AP: Jobs Jobs Jobs
NYT: Jobs!
WSJ: Jobs?

Hu Jintao and Barack Obama sitting in a tree, K-I-S-S-I-N-G. Is America becoming more like China under President Obama? Or should we be upset that it isn’t? We’ll talk about the President’s jarring diplomatic trip to Asia and how the markets responded to Ben Bernanke’s New York speech on today’s Coffee and Markets, a daily podcast from The New Ledger on politics, policy and the marketplace with Francis Cianfrocca, brought to you by BigGovernment.com.

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You can subscribe to the podcast by following the links above, and if you’d like to email us, you can do so at coffee[at]newledger.com. We hope you enjoy the show.

Related Links:

WSJ: Common Ground With Obama and Jintao
AP: China and America, Working Together
WP: Obama, Hu vow to continue to strengthen partnership
Niall Ferguson: The Great Wallop
RCW: Asia and the West in the Age of Obama