Governments DO Create Markets

Its amazing how strongly some people will cling to the idea that well-functioning markets are a natural result of mankind's activity on earth. While its true trade results inherently from human activities, a well-functioning market requires many things.

It requires a system of currency, which most economists would agree should be controlled by a central bank (the monetary supply). It requires an exchange to allow people to trade their goods in a way that is not cumbersome. No one really wants to drag their physical good to market, and we certainly want to be able to trade futures (and obviously no one has a 'future good' in physical form, unless you want to count seeds...), so this means an exchange.

So now you've got instruments that represent physical goods to be delivered, pieces of paper that represent value backed by the government, an exchange that enforces various rules upon the participants, such as clearing, credit, and margin obligations. And we're still only trading commodities...

Now our exchanges our private companies, but they are governed by a comprehensive set of regulations to allow transparency in the markets, as well as to ensure that the market functions right. You know, things like insider trading rules, etc, that make the market a fair and equal place to transact. After all, every capitalist should understand that markets work best when there is ample liquidity, and participants have confidence their deals will settle with their counterparties and that all participants have relatively equal knowledge of the market.

The government brings credibility to a currency, as its generally the most credit-worthy counterparty in any given country. Modern capitalism, as Fareed Zakaria so elegantly put it, depends on credit, and credit depends on confidence. The ultimate source of confidence is that ultimate counterparty, the big bad government, and when confidence falls apart, as in a Minsky Moment, that source of confidence can provide a steading hand.

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