Once, When You Were Free

Are you better off than you were four years ago?” Will some political candidate in 2012 be repeating presidential candidate Ronald Reagan’s query of 32 years earlier? If the consequences of vastly increased national government spending today are mitigated by a temporary economic recovery in time for the campaign season, the question may not get asked. People have short attention spans when it comes to interpreting the results—both short and long term, seen and unseen—of government actions. This flaw is a result of the failure to think in terms of principles, which enables you to make current value judgments and reasoned speculations about the future. If you consider the consequences of the massive government spending set in motion by the combination of the profligate years of the Bush administration and the statist ambitions of Barack Obama, the opening question of this essay may very well be as rhetorical as it was when asked of the American people by Reagan in his 1980 debate with then President Carter. Inflation and unemployment were high and Americans had suffered humiliation at the hands of Islamic radicals in Iran as well as at home by having to wait in lines—Soviet style—for gasoline in short supply due to price controls. One need only consider the multi-trillion dollar magnitude of today’s deficits to see how far things have deteriorated, and to be concerned about future consequences.

Consequences of Deficits

If you care to look there is a correlation between big deficits and various economic ills, among them general price inflation, rising unemployment levels, higher taxes, and reduced capital formation. Of course, correlation is not proof of a causal relationship. Only dishonest collectivists and government fundamentalists make such leaps of logic. They attribute systemic economic ills to non-existent capitalism and free markets while ignoring the growing role of government in the US economy over the last 100 years. So let’s try to explain why the correlation exists.

A deficit must be covered in the short term either by tax revenues, borrowing, or inflation of the money supply. In the end, of course, payment for any government expenditures must always be made by taxation. An immediate tax hike to cover a deficit would accomplish two things. First, it would obviously balance the government budget. As desirable as this is, you can easily see why an unusually large deficit would require an enormous tax grab to accomplish balancing. That action takes wealth and capital from its owners and directs it to current consumption, the nature of which is determined not by individual investors but by politicians granting government favors. This is capital that might have gone to investment, creating jobs in the process. If taxes are raised permanently to a higher level this will further inhibit the formation of capital, because it will be harder to accumulate savings, the source of capital. Therefore, the second consequence is that capital is misdirected to political purposes rather than economic ones determined by investors.

 

The Special Case of Recessions

If the economy is in recession, by which I mean a period of economic readjustment in which bad investments are liquidated, wages and prices reconfigured, and capital re-formed, intervention by government can postpone the liquidation of bad investments, distort the price and wage information system and cause mal-investment of capital. The ways this can happen are too many to imagine but examples would include bailouts of failed businesses, which likely postpones failure for an even greater impact in the future. Minimum wage laws or other forms of price controls would prevent economic actors from communicating through the price system their individual preferences. Some workers and employers would “go underground” or “work off the books” in order to survive. In a free economy, anyone who is unwilling to work at prevailing wage rates (not rates established by decree) will remain unemployed.

If taxes are raised in a recession and/or the recession is prolonged by other interventionist actions the distortions will impact both the utilization of existing capital and formation of new capital. Increased money and credit availability may delude investors into investing in politically favored enterprise. The “injection” of money and credit by government monetary policy, whether using “quantitative easing” or simply printing fiat currency and increasing bank reserves, can only proceed for a limited time. Deciding when to pull back is one of the great challenges for the tinkering bureaucrats at Treasury and the Federal Reserve.

There is a problem of inequity in this particular government fraud however. New money and credit is not dispensed evenly over all actors in the economy. Necessarily, since it is created essentially out of thin air, it is plunked first into the hands of favored players. It could be government employees in newly created high-paying jobs, “rebates” to individual taxpayers, loans to capital intensive industry, or bailout money to financial institutions, which may in turn go to new mortgagors and related brokers, contractors and others. The impact of the new money competing in the economy is for the prices of certain goods and services to be pushed up because of the new demand. The result is that non-recipients, those outside the favored group will now have to pay higher prices for goods and services driven up in price by the favored group. That means they must give up something else they normally enjoyed in economic terms. This is an injustice delivered at the hands of the state.

The above description is only one version of the sort of distortions and injustices that can occur. The fundamental point is that perhaps well-intentioned interventions by government have unpredictable and unintended consequences. Interventions by government not only distort economic decision-making criteria but may even paralyze the ability of players to act due to fear and uncertainty about what the central government will do next.

Inflation

Now for the biggest fraud of all: when government finds it can no longer tax or simply finds it not politically expedient, but the massive debt it has incurred must be repaid, there is only one avenue left open. Regular inflation of the money supply is the stealth destroyer of societies and has been over the centuries. (Even Keynes knew this.) Someone once wrote or said that inflation is like sin, denounced and practiced by all. By all governments, that is. When government has the monopoly on printing fiat money there are no economic constraints, no hard base money and certainly no honest currency. Only government monopoly money has been created.

So why do they do it? The parties to contracts or obligations payable in dollars are impacted in two distinct ways by inflation. A debtor pays off his obligations in dollars that have less purchasing power than when he made the contract. This is a benefit to him. Conversely, the creditor receives dollars that are worth less than what he expected to receive in value when he made the contract. In effect, wealth is being transferred from creditor to debtor by virtue of government policy. And, the biggest debtor of all is, guess who? Inflation is the central government’s way out of paying off part of its debt.

In 10 years you may be paying $5.00 for a Snickers candy bar, which may be your only affordable indulgence because the central government will have orchestrated one of the biggest wealth transfers in history. This is not the kind of historic wealth transfer that T. Boone Pickens means when he describes trading of exports for imported oil, which is actually an exchange. This inflation-based transfer is de facto confiscation of wealth and is in essence, a hidden tax. The impact will be an economy largely destroyed by government policy. To add insult to the injury, the massive taxation and intervention in daily life will be so onerous you will wonder what political freedom means, if you ever knew or understood it. All you will know for certain is that you will not feel better off than you do today.

©Copyright 2009 Edward Podritske

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