Conflicting Objectives
Do savers and borrowers have conflicting objectives? For one to gain, must the other lose.
I want to develop an easy-to-understand basis for people to comprehend the disruptive nature of government intervention in any market. Generally, people get a view of only one side of most economic issues. If a particular intervention helps a specific group of people, the idea seems good. In addition, I think that most people view the market as a process of winners and losers. In the interest of fairness, and based on this belief, they favor some degree of intervention.
These views do not, however, reflect the true nature of the market. As a result, they do not lead to accurate conclusions about the effect of market intervention. I will try to develop a model that provides a framework for discussing market interventions. The simple savings account provides a good model of market interaction to which most people can relate.
When a person seeks a place to invest savings, he wants to get the highest return he can, within a given level of risk. On the other hand, the person wishing to borrow money (the one who will pay the interest to the saver, either directly or through an intermediary) wants to borrow at the lowest possible interest rate. We have two people in the market who appear to have conflicting objectives.
If you have the viewpoint that a conflict exists between these parties and that one of them must lose for them to make a deal, then some sort of third-party intervention might seem appropriate. A free market, however, operates to resolve these apparent conflicts in a manner that allows both parties to win.
Before they enter into a transaction, the saver has a lower level below which he will not make a deal, and the borrower has an upper level above which he will not make a deal. If the saver sets his lower level higher than the borrower’s upper level, they simply cannot do a deal. They both win because they will turn to more favorable alternatives.
More commonly, these upper and lower limits set a range in which the saver and the borrower will settle on an interest rate through negotiation or shopping. (For the worshipers of the “law of supply and demand,” it simply does not work that way outside textbooks.) When they have completed the deal, the saver gets a return on his savings that he prefers to alternative uses for the funds—he wins. The borrower pays an amount of interest that he judges to satisfy his preferences—he also wins.
The savings example shows how the actors in a market represent their own interests better than anyone else could, and when they strike a deal, it always works to the benefit of both parties. Intervention can only disrupt this very effective, efficient, and adaptable process.
In an upcoming publication, I will provide a graphic explanation of the development of market pricing.