Today’s economic crisis is fueling a significant increase of policy and regulation aimed at controlling markets for safety and stability. These actions, combined with legacy programs and regulation, are setting the stage for an even bigger economic challenge in the not too distant future. Before you support the government’s actions, please take a look at the following information that may not otherwise be readily available to you.
- False Claims of Government and Mass Media
- The Current Crisis was not a Failure of Capitalism
- Government Solutions to the Crisis Exacerbate Our Problems
- Government Bailouts of Private Business Create Hazards
- Fed Policy Provides More of the Original Cause
- Economic Stimulus Stimulates Economic Stagnation
- Our Current Solutions Have Been Tried and Failed Before
- Our Risk Is Greater Than Ever
- Doing Nothing Should Be An Option
False Claims of Government and Mass Media
The claims perpetuated by the government and mass media around today’s economic crisis are:
- The current economic crisis is the result of a failure of capitalism and lack of regulation
- Government intervention is needed to escape and prevent the deepening of the current economic crisis
- More government regulation and economic involvement is needed to deter future market failures
The Current Crisis was not a Failure of Capitalism
There is much debate about the causes of our current economic crisis. The overriding theme communicated by mainstream media and the government is that market failures, or the failures of capitalism, are at the core of the economy’s problems. However, looking beyond what mainstream media and the government tells us, you will find that over time the government created an environment to make this crisis highly probable.
There are many causes and aggravators of the current crisis, most of which stemmed from the following four:
- Federal Reserve and fiat money (underlying, core cause)
- Government Subsidized Enterprises (GSE)
- Community Reinvestment Act (CRA)
- Government regulation of the financial sector
These interventions made up the illness that created an environment in which the side effects of greed and bad decision-making could thrive among businesses and consumers.
Below is an outline of how these government interventions caused the crisis:
Core Cause: Federal Reserve and Fiat Money
The U.S. and the world has a fiat money system run through the Federal Reserve (Fed) which has caused problems throughout its history, but has been running in full force since Nixon completely abandoned the gold standard in 1971. This system causes boom-bust business cycles, the most recent of which brings us to our current crisis.
- The Fed’s pre-dot-com monetary policy fueled the dot-com boom and subsequent bust.
- The Fed artificially lowered interest rates from 2001 to 2004 to attempt to bring us out of the dot-com bust.
- This “easy money” spurred spending and a surge in imports, which dramatically increased capital inflows through our trade deficit.
- Lower interest rates and large capital inflows distorted our economic system while allowing for easier, low-interest loans, which contributed heavily to the fueling of over-investment in real estate and related activity, inflated property values, and subprime mortgage lending.
- Because of the resulting increased competition for what became scarcer resources, the Fed was forced to then ratchet up interest rates until mid-2006, which triggered the default of mortgages and the failure of related financial instruments.
- This was not a natural market process – Interest rates are naturally adjusted to their most optimal levels in stable fashion within a free market system without the need of the Fed.
The Boom-Bust Cycle of Our Economy Illustrated:
In the graph above, notice that during recessions (shaded areas) since the late 1950s the Fed usually drops interest rates in an attempt to pull the economy out of recession. Also notice that after raising interest rates for no longer than a ten year period, the next recession hits and the Fed is forced to lower rates again to start the cycle once more. This is the high-level story of the boom-bust business cycle that our Federal Reserve system perpetuates.
Take a closer look at the Fed’s interest rate moves prior to both recessions in the last decade. It is arguable that the 2001 recession would have occurred sooner had it not been for the exceptional unexpected productivity increase of the dot-com revolution in the mid to late nineties.
Additionally, because of an inability to know all variables, Alan Greenspan (the Fed Chairman of the time) did not understand the actual productivity gains made as a result of the internet and other new technologies. He could not accurately compare productivity gains with the induced growth of the money supply. This lack of unknowable real-time information led him to raise interest rates to defend against inflation when it was actually not a threat.
One scary thing to note for our current crisis unlike ever before is that the Fed has no more room to move interest rates downward.
Synchronized Boom, Synchronized Bust – The Wall Street Journal (2009)
Evidence that the Fed Caused the Housing Boom – The Mises Institute (2008)
Money, Bank Credit, and Economic Cycles – The Mises Institute (2006)
Understanding the Crisis – The Mises Institute (2008)
Yes, Greenspan Did It – The Mises Institute (2008)
The Link Between “Fiat Money” and Boom and Bust Cycles – Institute of Economic Affairs (2008)
Fiat Currency: Using the Past to See into the Future – The Daily Reckoning (2008)
The Federal Reserve Monopoly Over Money – LewRockwell.com (2007)
Money in the American Colonies – Economic History Service (2003)
Our Financial House of Cards – The Mises Institute (2008)
There are inherent flaws to the concept of a central bank (in the U.S, the Federal Reserve).
Aggravator #1: Government Subsidized Enterprises (GSE)
- Fannie Mae and Freddie Mac are GSEs, which are government-backed organizations formed through the New Deal in the 1930s.
- These organizations do not have to abide by all of the laws private corporations must abide by – such as Sarbanes-Oxley
- These organizations were mandated to provide subprime loans to the needy.
- These organizations finance 40% of U.S. mortgages and 20% of delinquent loans.
- The offering of these loans caused non-government backed (private) firms to adjust their loan products to remain competitive making them likely to experience the same failure.
- This was not a natural market process.
Are Fannie and Freddie Too Big to Fail? – The Mises Institute (2008)
Freddie, Fannie, and Curses on FDR – The Mises Institute (2008)
Fannie Mae: Another New Deal Monstrosity – The Mises Institute (2007)
Aggravator #2: Community Reinvestment Act (CRA)
- The CRA was designed to encourage commercial banks and savings associations to provide loans to borrowers in all segments of the community, including low and moderate income neighborhoods.
- This caused pressure to offer low-income loans
- Those lenders that were not under the CRA needed to adjust their offerings to remain competitive with those that were under this law.
One key argument against the accusation of the CRA is that independent mortgage companies made more high priced loans to borrowers with bad credit than CRA-regulated banks. It is easy to refute this when you realize that independent mortgage companies are middlemen who arrange mortgage loans for borrowers (including subprime borrowers and through CRA-regulated banks).
The CRA Scam and its Defenders – The Mises Institute (2008)
The Government-created Subprime Mortgage Meltdown and its Defenders – LewRockwell.com (2007)
A Banker on the Evils of the Community Reinvestment Act – Thomas DiLorenzo (2008)
Aggravator #3: Government Regulation of the Financial Sector
In addition to the government activities described above, government regulation of the financial system (largely through the SEC) offered the loopholes and illusion of security that enabled the corruption and frivolous investment activity that was a final nail in the coffin.
It is not surprising that the inherent flaws of the concept of government regulation would contribute to such a crisis.
The following actions led to the failures and subsequent bailouts of many banking institutions:
- The Securities and Exchange Commission (SEC) allowed investment banks to take on abnormally high levels of leverage (use money they didn’t have) to make investments; in many case over 30 to 1.
- This enabled banks to take extreme risk with their investments – such as with mortgage -backed securities. In essence they were able to play with money they didn’t have. If the risk was successful, they would receive very large rewards, and many did make large amounts of money for awhile.
- If the risky investments did not pan out (which was the case in many of the major bank failures), or if even a small market downturn were to take place, the bank would be insolvent and fail.
- Because of historically based presumption of a Federal Reserve bailout safety net, many banks were comfortable with taking such risk.
Notice the two places where the government intervened to enable the current extreme situation:
- The SEC allowed investment banks to take on abnormally high levels of leverage.
- Through Fed organized bailouts, the Fed would not allow insolvent banks to fail (go out of business)
In a free market, leverage levels would be defined naturally. Banks that take too much leveraged risk will be punished by going out of business, and other banks will adjust to safer levels (if they weren’t already there) to avoid such fate. This natural market process was blocked by the SEC and Federal Reserve. They enabled banks to overleverage while not allowing those that became insolvent to fail.
Another shining example is government intervention in the market of credit rating agencies. Part of the public blame around the formation and collapse of the housing bubble was the lack of integrity of the privately run credit rating agencies that rate financial products, such as mortgage-backed securities.
When you look closer, you will see that competition in the credit rating market is limited by the SEC through its assignment of certain firms as Nationally Recognized Statistical Rating Organizations (NRSROs). Also, certain funds, insurers, etc were required by Federal and State laws to hold NRSRO-rated securities. This limits the free flow of ratings agencies entering the credit-rating market to compete toward offering the best possible ratings services. Simultaneously, the lack of competition allows the monopolized agencies to become complacent in their practices.
The SEC has since developed revisions to the rules around NRSRO ratings integrity, particularly for mortgage related securities. Unfortunately, because of the inherent problems with government regulation, these changes are not likely to have lasting, if successful, impact.
Additionally, the pressure the ratings agencies likely felt from the SEC to not ignore such a politically popular initiative (i.e. easier low-income mortgages) should not be discounted.
AAA Oligopoly – The Wall Street Journal (2008)
SEC Adopts Credit Rating Agency Reforms Including Differentiation of Asset-backed Securities Products – Jim Hamilton’s World of Securities Regulation (2009)
Amendments to Rules for Nationally Recognized Statistical Rating Organizations – Securities and Exchange Commission (2009)
Anatomy of a Train Wreck: Causes of the Mortgage Meltdown – The Independent Institute (2008)
The Myth that Laissez Faire is Responsible for our Present Crisis – The Mises Institute (2008)
The Economics of Housing Bubbles – The Mises Institute
Government Solutions to the Crisis Exacerbate Our Problems
The government’s proposed and current solutions to the resulting problems do not allow the self-regulating market to do its work.
The following are the government’s core solutions to the economic crisis:
- Government bailouts of private business
- Fed monetary policy
- Economic stimulus
Below is an outline of how these solutions do not solve the problems, and instead exacerbate them.
Government Bailouts of Private Business Create Hazard
For the current crisis the government has incorrectly adopted and promoted the belief that businesses can be “too big to fail” because of their potential negative systemic economic impact in the event of failure. This has been the justification for the myriad bailouts of financial institutions and automotive companies.
Financial Institution Bailouts: $8.8 Trillion Committed So Far
As of late November 2008, estimates of bailout money spent ranged from $2 to $3.2 trillion with overall commitments ranging from approximately $8 to $8.8 trillion.
In addition to fostering the environment of financial institution failures, by bailing out these organizations (AIG, Bear Sterns, Washington Mutual, Freddie Mac, Fannie Mae, Citigroup, and many other banks/financial institutions across the country) the government has:It is important to understand where this money comes from. It is either borrowed or printed. For example, within the last four and a half months of 2008, the Fed expanded its balance sheet from $900 billion to $2.2 trillion. This is essentially money created from nothing and increases the U.S. money supply, which leads to inflation, especially when there is not enough new production to warrant the new money.
- Not allowed a natural market correction to take place, which delays an inevitable and larger correction.
- Created a moral hazard which distorts the market for the future – Companies will act less responsibly given the security of a government bailout if they are considered systemically important.
- Created a stagnating economic environment as companies will sit on the sidelines waiting to see if they, their competitors, suppliers, or customers, are going to get bailed out. Additionally, their decisions are less informed as even if they think they know the answer of the government’s whims and assessments, they likely do not.
- Created an economic environment where resources are diverted from productive business activities to activities related to justifying and attaining bailout dollars.
- Created inefficiencies given the government’s inability to know or understand all variables (including market and consumer demand-related variables) in its regulatory decisions.
- Created inefficiencies where government has ownership or management control of industry given the inherent inability of a government to run an organization.
- Inflated the money supply and increased the country’s debt by printing new money and borrowing from other countries to fund the bailouts. This activity can lead to a significant devaluation of the dollar.
Term Asset Relief Program
For analysis of the TARP’s ($700 billion of the $8.5 trillion) philosophy and results, take a look at:
Treasury overpaid $78 bn for bank assets – The Swamp of the Chicago Tribune (2009)
Watchdog: Treasury Overpaying for Banking Assets – The Wall Street Journal (2009)
The TARP is Dead, Long Live the TARP – The Mises Institute (2008)
Bank Share Collapse Points to the Failure of TARP – RealClearMarkets (2008)
The Rescue Package Will Delay Recovery – The Mises Institute (2008)
Additional Money to Failed GSEs
The original $200 billion backstop bailout of GSEs Fannie Mae and Freddie Mac has now been doubled to $400 billion. This will further empower these failed organizations to bail out failed borrowers while perpetuating moral hazard without eliminating the likelihood of future failure by the organizations and the borrowers – all with taxpayer dollars that could have gone to more productive use.
Housing Bailout at $275 billion – The Wall Street Journal (2009)
Additional Money to Failed American International Group (AIG)
After originally giving AIG $85 billion, the total bailouts to the business reached $150 billion within a few short months. Now AIG is about to report their largest loss ever – $60 billion. What’s more is that they are expected to request more funding from the government (a.k.a. money from your pockets).
AIG seeking more U.S. funding, sources say – MSNBC (2009)
Like the current economic crisis itself, the downfall of GM, Chrysler, and Ford was not due to a failure of capitalism. Take a look at the significance of government regulation to the demise of the big 3:
- National Labor Relations Act: gives powers to unions, in essence taking rights away from private businesses
- Environmental Laws: fuel efficiency standards and pollution free factories
- State Franchise Laws: restricts the ability for auto manufacturers to sell directly to consumers
- Other general business targeted laws: minimum wage, corporate and sales taxation, and workplace safety laws
All of these laws, and the business adjustments required to abide by them, significantly added to production costs making the auto businesses less profitable, which led to price increases, compromised quality, and less ability to compete with emerging markets around the world.
Where Would General Motors be Without The United Automobile Workers Union? – The Mises Institute (2006)
Who Killed Detroit? – MSNBC (2008)
Without these government interventions, it is possible that these companies may have failed anyway, and it would be ok to allow the failure in that case as well as in the current case. Poorly run companies or companies with low demand products should fail. Poorly run industries or industries with low demand should fail as well. This enables the shifting of finite economic resources (labor and material) to new companies and industries that will be much more economically productive.
The industry as a whole is not a failure. Foreign auto companies have taken the lead in the U.S. because they have been able to innovate effectively and did not have to contend with higher costs due to overreaching laws.
Auto Bailout Justification
The government’s key reasons for the bailout are the potential loss of millions of jobs and the weakening of the U.S. world position in the auto industry. However, what they do not understand or explain is that:
- The loss of jobs is an inherent part of an economic correction.
- Resources (dollars, labor, materials) need to be shifted to more productive uses. Bailing out dysfunctional businesses delays this process from taking place.
- The $17.3 billion will now lead to a lot more money spent and eventual job losses anyway because the underlying problems of the businesses still exist. They are already requesting an additional $21.6 billion and we are entertaining giving it to them while recognizing that their chances for bankruptcy have increased.
- A bailout of these businesses will not save or strengthen U.S. manufacturing. The only way manufacturing will again become an economic strength for the U.S. is if we reduce the cost of doing business in that sector by removing many of the government-imposed restrictions that increased costs.
Yet Another GM Bailout – The Mises Institute (2008)
Chrysler Comparison of 1979
Frequently government officials argued for the potential success of providing this bailout because of the results of the last bailout of Chrysler in 1979.
At that time, Chrysler was a more poorly run business than Ford and GM, which made it more susceptible to the economic troubles of that period.
The results were not what the government makes them out to be. There underlying problems obviously still existed since that bailout, which have led them to their most recent request. However, aside from this point, success was not the appropriate word to use. Take a look at this detailed Heritage Foundation analysis published in 1983 to understand why – and to gain more clarity on likely results of today’s bailout:
The Chrysler Bail-Out Bust – The Heritage Foundation (1983)
Lessons from the 1979 Chrysler Bailout – Carpe Diem (2008)
The Chrysler Bailout [Flashback to 1979] – Free Republic
Government-directed Restructuring Ignores Consumer Demand
The focus of the reasoning for this bailout has been all on the production side. The government presumes to know what the companies should do operationally to be successful. They largely ignore the importance of consumer demand. Will consumers purchase the vehicles of GM and Chrysler to give them the profitability they need to survive? The government has no way of knowing this as it is up to each free individual to decide.
The government does presume to know one consumer demand. However, the idea of mandating the production of “greener” vehicles is based on a desired government result and not on the market’s demand. A lot of dollars will get thrown at this initiative and it will likely not draw the customer base required for profitability.
An example of GM’s move to accommodate this desire is a $40,000 hybrid electric/gas vehicle that they claim to be extremely important to their success/survival. Will this vehicle be warranted by high consumer demand when:
- Gas prices have dropped significantly
- Aside from gas prices, the cost is quite high even for a luxury vehicle
- The real cost is even higher given the current economic conditions
Additionally, the car has already garnered a government subsidy of $7,500. This not only proves the lack of marketability of the car, but also unfairly provides GM with a competitive advantage. It also acknowledges that GM continues to fail to produce profitable vehicles.
Last Thought on Bailouts
The bailouts of the financial and auto industries open the door for a line-up of other struggling industries to request and receive help from the government, ultimately continuing to perpetuate moral hazard and socialism while wreaking havoc in the U.S. economy.
The Importance of Failure – The Mises Institute (2009)
Delays In Bank Aid Spur Frustration – The Washington Post (2009)
After Auto Rescue: Bailout Fund Is Under Fire Again – CNBC (2008)
The Political Economy of Moral Hazard – The Mises Institute (2008)
Beware the Moral Hazard Trivializers – The Mises Institute (2008)
Mr. Moral Hazard – The Mises Institute (1998)
An excellent index of references for understanding the bailouts and crisis: The Bailout Reader
A blog that tracks the bailouts on an ongoing basis: http://bailoutsleuth.com/
Fed Policy Provides More of the Original Cause
For similar reasons as to why the Fed was a significant cause of the current crisis, the Fed’s actions are going to exacerbate the problem. The Fed’s key methods for combating the crisis are:
- Lowered interest rate target to 0% – .25%: offers cheap money to banks (through the Fed) that can then lend to others more cheaply, which is expected to increase overall lending.
- Quantitative easing: providing cash infusions (through increasing the money supply) to financial institutions to make them more likely to lend.
Both of these methods tamper with the U.S. money supply, can lead to dangerous inflation, and perpetuate the boom-bust cycle of our economy.
Additionally, both methods were tried in Japan during their crisis beginning in the 1990s. They were ineffective and only assisted in prolonging their problems during their “lost decade”.
The Insolvency of the Fed – The Mises Institute (2009)
Economic Stimulus Stimulates Economic Stagnation
2008 Stimulus – $152 billion
Remember the $152 billion stimulus package passed in February of 2008 and paid in the summertime as tax rebates to taxpayers? There is little said about the results of this economic rescue as it seems to have had an unnoticeable effect.
A blog posting from economists of the Federal Reserve Bank of Atlanta can help you get an idea of the results: Did the stimulus package actually stimulate?
Obviously those that recommended and crafted the bill did not understand the magnitude of the problems ahead. Even if the approach was founded on sound economic principals (which it was not) the dollar value for potential spending from the rebate was a small blip compared to what those same principals would have required had they seen the future more clearly.
Not only is the 2008 package failing to reach its goal, but the bigger point is that the government shouldn’t be trying to stimulate spending in the first place. Additionally, the government has again added to the inflation queue for us to pay for in the future.
2009 Stimulus – $789 billion
So will the 2009 $789 billion stimulus package work? This one takes a different approach…
The majority of the $789 billion is geared toward non-tax related activities. The majority of the activities are not even considered economically stimulative by those that believe in the use of stimulus packages to stimulate the economy. None of the activities on the list offer economic benefits beyond the economic costs, and many are meant for long-term economic improvements rather than the short-term recovery reasoning promoted.
One of the most jolting aspects of this stimulus bill is the “Buy American” clause touted as “economic patriotism”, which requires all public construction projects to only utilize U.S. made steel and iron. This is protectionism and hurts our economy and international relations as it has when used throughout history.
U.S. Protectionism in the Stimulus Bill – American Enterprise Institute for Public Policy Research (2009)
Fed’s Fisher: Protectionism Equals Economic Death – CNBC (2009)
Protectionist Rhetoric Will Accelerate the Dollar’s Slide – The Mises Institute (2007)
Take an itemized look at most of the initiatives included within this stimulus bill and judge their potential for yourself through Daylight Network’s breakdown.
Highlights of the Stimulus Bill – CBS News (2009)
A 40 Year Wish List: You won’t believe what’s in that stimulus bill – The Wall Street Journal (2009)
The use of stimulus packages to spur economic recovery is not a wise strategy because:
- No one can know all economic variables (both current and future) that would have taken place with or without the stimulus. You cannot control an economy.
- Even if short term effects are positive, long-term negative effects of inflation, debt, and a misallocation of economic resources will outweigh them.
Economic Recovery Requires Capital Accumulation, Not Government “Stimulus Packages” – The Mises Institute (2009)
Stimulus, Savings, and Stocks – The Mises Institute (2009)
CBO: Obama stimulus harmful over the long haul – Washington Times (2009)
Can Fiscal Stimulus Revive the US Economy? The Mises Institute (2009)
Does “Depression Economics” Change the Rules? – The Mises Institute (2009)
Government Spending Is No Free Lunch – The Wall Street Journal (2009)
The following section offers additional relevant historical examples of the failures of financial stimulus.
Our Current Solutions Have Been Tried and Failed Before
In recent history, and because of the influence of Keynesian economics, the U.S. government believes that throwing more and more money at the problem is the way to solve the problem – money that it does not have, either by printing or borrowing it. What’s more is that it throws money at the very things that caused the problems in the first place.
The last time the U.S. went through an extreme economic crisis was the Great Depression. Because politicians felt compelled to do something proactive instead of allowing the market to work, the New Deal was created. The New Deal was a series of economic programs geared toward recovery from the Great Depression requiring large sums of money (current and committed future money) to fund it.
To further explore the likelihood of success with our current strategy of bailouts, money pumping, and economic stimulus packages, take a look at:
- The impact of New Deal legacy programs on today’s economic crisis
- The similarities of our solutions to the current crisis to those of the Great Depression and Japan’s “lost decade”
Legacy of the New Deal
Below are a few of the New deals legacy programs that are relevant to today’s crisis:
- National Labor Relations Act (1935) – Enhanced power of unions, hence the UAW’s impact on the big 3
- Fannie Mae & Freddie Mac (1938) – Significant contributor to today’s housing crisis
- Securities and Exchange Commission (SEC)(1935) – Reliance on their inefficient regulatory abilities has enabled many loopholes for corruption
- Federal Housing Association (1934) – Predicted to possibly cause another wave of foreclosures in the current crisis
- Social Security Act (1935) – A portion of the $43 trillion entitlement shortfall for which the U.S. is not ready
- Medicare, Medicaid (1965 – amendments to the Social Security Act) – The majority of the $43 trillion entitlement shortfall for which the U.S. is not ready
- The New Deal also influenced changes in Fed policy philosophy that have endured
The actions of Hoover, FDR, and The New Deal prolonged the Great Depression. Take a look at the history yourself:
The New Deal Debunked – The Mises Institute (2004)
FDR’s policies prolonged the Depression by 7 years, UCLA economists calculate – UCLA Newsroom (2004)
How FDR’s New Deal Harmed Millions of Poor People – CATO Institute (2003)
The Disaster Called the New Deal – The Mises Institute (2008)
The New Deal and the Great Duratio – The Mises Institute (2008)
The New Deal in One Lesson – The Mises Institute (2005)
America’s Great Depression – Murray N. Rothbard (1963 – 2000)
Book for purchase – The Forgotten Man: A New History of the Great Depression
Similarities to the New Deal
Take a look at the similarities of current solutions to those of the New Deal:
- Attempts to prop up prices (housing prices)
- Expanded unemployment benefits
- Expanded welfare
- Financial institution intervention
- Wage controls
- Public works
How Government Prolonged the Depression – The Wall Street Journal (2009)
Don’t Repeat Errors of New Deal – The New York Post (2008)
Same Old New Deal? – The Washington Post (2008)
The New New Deal – LewRockwell.com (2009)
Analysis: Critics Warn Obama’s New ‘New Deal’ Is Not an Economic Silver Bullet – Fox News (2008)
Another New Deal is a Bad Deal – SFGate (2008)
Obama’s New Deal No Better Than Old One – RealClearPolitics (2008)
KHUNER: Obama’s New Deal – The Washington Times (2008)
Obama’s Wealth Destruction – The Mises Institute (2009)
Similarities to Japan’s Lost Decade
Comparisons have been made of our crisis and remedies to those of Japan in their “lost decade”:
Barack Obama-san – The Wall Street Journal (2008)
We’re All Keynesian’s Again – The Wall Street Journal (2009)
A Japanese Lesson – The Mises Institute (2002)
We are doing again what has been done before and has not worked.
Our Risk is Greater Than Ever
There are many factors that are unique to the U.S. and this moment in time that combine to create an extremely fragile situation for our economy and society. Outlined below are several of the most significant conditions to be aware of in evaluating America’s potential for collapse:
- U.S. existing debt of over $11.1 trillion is the deepest ever with no decrease in spending
- U.S. has indefinite ongoing huge debt from entitlements projected as low as $43 trillion and as high as $102 trillion. To put these debt levels in context, total U.S. Gross Domestic Product (GDP) is about $13.8 trillion and falling.
- A growing generation of retirees that are no longer productive
- U.S. citizens’ personal savings rates are low while personal debt is high
- Tax support of the government and its debt (local, state, and federal) is declining from rising unemployment, the decline of real estate (residential and commercial), bankruptcies, and less general productivity while spending continues to increase
- CALPERS (the largest U.S. pension fund, and 4th largest in the world) and California (the 9th largest economy in the world) are each on the brink of bankruptcy. California’s recent budget fixes are short term and their high tax strategy drives business away from their state, which hurts the recovery plan’s cause. Other state governments are struggling as well.
- Continued growth of health care costs which are projected to double in the next 8 years reaching 20% of U.S. GDP (16% as of 2008)
- The new administration uses depressive economic policy (unionism, auto bailout/eventual tariffs, protectionism, nationalization,price/wage controls, public works, welfare and entitlement expansion, excessive focus on the environment, capital gains and other tax increases, etc) – all inhibit economic productivity and recovery
- U.S. spending is exorbitant: most spending is going toward economic crisis recovery, military activities around the world, and funding existing and new government programs. None of this spending offers the prospect of profit and will add to our future debt.
- The International Monetary Fund’s (IMF) managing director has stated that it is likely to run out of money to fight the global crisis in 6 months (from 2/8/09) – This removes a critical backstop (though not one founded under sound economic principals) for international economies.
- Eastern Europe is on the brink of collapse which would start a wave of additional bank defaults across Western Europe and likely have significant contagion outside of Europe. The Euro is extremely susceptible to a collapse of even one EU member country.
- Continued U.S. monetary policy which fueled the current crisis and makes any short-term recovery an illusion waiting to be painfully exposed when interest rates are pushed back up again.
- Fed monetary policy that inflates the money supply through the purchase of long-term assets (not a usual practice), which decreases the ability to easily rein in the money supply to halt inflation as inflation kicks in (banks will eventually want to use the abnormally large reserves they have been accumulating, which increases the money supply and inflation)
- Because of the U.S. debt situation, U.S. spending is enabled mostly through money printing and foreign lenders (China, Japan, U.K., etc); printing hurts the value of the dollar – extreme borrowing risks default and dollar devaluation
- U.S. and world currencies are based on fiat money and fractional reserve banking. This translates into an extremely fragile money system that is especially vulnerable to full collapse during economic crisis.
While much of our foreign trading partners and lenders pains are tied to our own, over time these supporters could become less supportive of the U.S. because:
- Foreign lenders have their own economic problems and are applying scarcer funds to their own economic stimulus
- Foreign lenders can diversify funds to their own economies which have tangible productive assets
- Foreign lenders can diversify funds into other growing countries’ tangibles (mining, commodities, etc)
- Foreign lenders do not like protectionist policy, which is on the rise in the U.S.
- Foreign lenders may cut back or abandon lending to the U.S. when they believe their loan will not get paid back or will be diluted because of U.S. money printing
An important question to ask is where is all of the money going to come from. How will we fund the extreme circumstances of:
- Over $10.7 trillion dollars of current debt
- $43 trillion to over $100 trillion of debt over the coming decades
- A government that thinks additional debt will guide us out of the crisis
- A government that thinks additional costly government programs are required to accommodate society
- A population that is producing less and spending less, which translates into less tax revenue to fund the debt
One possibility is that it will not get funded (i.e. in a direct payment sense) – because all of the money printing and potential abandonment by foreign lenders could lead to inflation spiraling out of control (hyperinflation) and our currency losing all of its value. This would mean complete economic collapse.
That is the less likely scenario given that the Fed will likely be forced to raise interest rates to unprecedented levels to keep this from happening. The raising of interest rates will bring a whole new batch of heavy short- and long-term economic problems with it. In this case the money is going to come from the taxing of younger generations and their children and grandchildren. This financial burden will make their lives far less productive and prosperous than their recent ancestors.
Hyperinflation USA – LewRockwell.com (2009)
Government Debt Has No Upside – The Mises Institute (2006)
Madoff as Metaphor – The Mises Institute (2008)
Doing Nothing Should Be An Option
As described above, all of the government’s current and planned actions to spur economic recovery are going to lengthen and deepen the crisis. We never hear any serious talk about the option of doing nothing and allowing the economic correction to take place. The government believes that it must do something, because if it does nothing and pain continues, it will receive the blame, lose support of the population, and thus power.
One question that arises is: does the government know it should do nothing, but take action anyway, or does it just not understand fundamental economics?
Market corrections are a natural part of growth and progress. Capitalism is based on human action, and thus is susceptible to human mistakes. When a mistake is made, you pay the consequences, learn from it, and adjust. If you don’t, you do not survive. Through its actions, the government attempts to provide quick fixes and remedies believing it can avert this natural process. What’s worse is that it won’t learn from its mistakes that caused the problem in the first place.
The only potentially effective action the government should take in this situation is to knock down the walls of government intervention that delay and worsen the inevitable correction and inhibit our eventual recovery.
Economic Recovery Requires Capital Accumulation, Not Government “Stimulus Packages” – The Mises Institute (2009)
Beating Back Obamanomics – The Mises Institute (2009)
“Do You Austrians Have a Better Idea?” – The Mises Institute (2009)
Synchronized Boom, Synchronized Bust – The Wall Street Journal (2009)
Cures for Our Economic Disease – LewRockwell.com (2009)
Financial Crisis and Recession – The Mises Institute (2008)
Economic Depressions: Their Cause and Cure – The Mises Institute
Business Cycle Primer – The Mises Institute (2001)
The Causes of The Economic Crisis – The Mises Institute (1978 & 2006)
The Subprime Mortgage Crisis Will Fix Itself – The Mises Institute (2007)