Water flows uphill: a slippery analogy about how the government, despite the best of intentions, mismanages the economy.

Imagine that you have a plot of land with a long, gently sloping terrain. Someone has installed a water spigot right in the middle.

You decide that you want to put in a little garden, but the ideal spot is just a little above the spigot. “No problem,” you reason, “I’ll simply dig a trench to guide the water slightly uphill. There’s enough pressure coming out of the spigot that the water will flow up into my garden, so long as my trench doesn’t leak.” And it works. You dig the trench, open up the spigot, and the water eventually flows up to your garden.

Over time, you repeatedly expand the garden, each time extending the trench further up the hill. Though it becomes more and more difficult for the water to reach the right spot, it always manages to get there eventually. After a while, having become so accustomed to extending and maintaining these trenches, you just accept that water flows uphill. You forget that the only reason it does is because of the elaborate system which you yourself constructed and must continually maintain.

This is akin to what’s happening in our economy these days, especially as it relates to the housing sector. Decades of policies designed to “keep the economy growing” have convinced Americans that water flows uphill. What was once the earthen dike of regulation has become an elaborate system of market manipulation designed to keep prices flowing ever upward and plugging each leak as it develops.

The commonly held belief has become that, if home sales slow or prices fall, someone must intervene. If we experience a contraction of the market, people assume that the economy is being mismanaged. But the truth is, market corrections are a natural part of the economy, and are especially necessary when speculative bubbles cause prices to exceed the true value of an item.

Right now, home prices in the United States are too high. There are simply too many homes at prices too elevated for people to buy them on what they earn. That situation was brought about by the government repeatedly “stimulating” home buying, using tools like artificially low interest rates, the mortgage interest deduction, and lax regulatory oversight.

Yet even as many policy-makers now recognize these root causes, they’re prescribing the same medicine to solve the problem as created it. On December 1st, Treasury Secretary Paulson talked about the plans that his department has undertaken to address the financial crisis. Part of his statement included the promise that “…we continue to look for additional ways to make mortgage credit more affordable, which will stimulate purchases, help to stabilize prices and end this housing correction.”

If it’s really a “correction,” why do we want to end it? The housing market, now devoid of all the artificially cheap money, is doing what true markets do… correcting. The idea that we want to end that, and wind up with an incorrect, less correct, or manipulated market, doesn’t make any sense. It’s just going to put us back in this same place a few years down the line.

A correction, though painful, is exactly what is needed right now. At some point, water has to flow back downhill. It will eventually come to rest on level terrain.

President-elect Barack Obama gave a brief address to the Democratic Governors Association yesterday. Buried within it is one tiny statement which finally gives me hope about how his administration intends to address the nation’s long-term fiscal problems. In this era of monstrous bailouts and runaway deficits, barely one politician from either dominant party has broached the subject of fiscal discipline, until now:

“…we are not, as a nation, going to be able to just keep on printing money. So at some point, we’re also going to have to make some long-term decisions in terms of fiscal responsibility. And not all of those choices are going to be popular.”

Finally, someone who recognizes the problem and is not afraid to speak about it! The full transcript is here.