Both liberals and conservatives have come to accept this statist box as a permanent feature of American life. Even worse, they have convinced themselves that life in this statist box is actually freedom.

What makes libertarians different from liberals and conservatives is that, although we too have been born and raised within the statist box, we have broken free of it, in an intellectual and moral sense. Moreover, unlike liberals and conservatives, we recognize that statism isn’t freedom at all. It’s the opposite of freedom. Genuine freedom, libertarians contend, entails a dismantling of the statist box in which we all live.

Let’s set aside, for the purposes of this discussion, the warfare state, and consider the welfare state, which is an economic system in which the federal government taxes people in order to transfer the money to other people, after deducting hefty administrative costs associated with making those transfers.

Welfare-state programs include Social Security, Medicare, Medicaid, grants, subsidies, foreign aid, and bank bailouts. Every one of those programs involves the federal government’s forcible taking of people’s money in order to give it to other people.

Most people living today have been raised with all or most of those programs. They are considered a core element of American life. While people often call for reforming the programs, hardly anyone other than libertarians questions the propriety of their existence. The attitude seems to be that the welfare state is here to stay and that we just need to continue devoting our efforts to trying to make it work and continue telling ourselves that it is equivalent to the free society.

It is not surprising that most people view the welfare state as freedom. From their earliest years, American children are taught that they live in a free country. The message that America is a free country is repeated and reinforced in school five days a week for 12 years. Those who are sent into government schools (i.e., public schools) receive an extra-strength dose of the freedom message, oftentimes beginning with the Pledge of Allegiance every morning. Those who resist the message are inevitably provided with such drugs as Ritalin or Adderall to make their minds more receptive to the official freedom message.

So by the time American children are 18 years old, the vast majority of them have no doubts that they live in a free country. They may even find themselves singing, “I’m proud to be an American where at least I know I’m free.” At some events, they stand to proudly recite the Pledge of Allegiance, which of course all of them will know by heart, even if they’re not aware that it was authored by an avowed socialist. Those who go to church on Sunday are exhorted by the minister to pray for the troops who are somewhere overseas protecting and defending the freedoms enjoyed by Americans.

In the mindset of the average American, freedom entails having the government take care of people, which it does by having the IRS take money from those who own it and giving it to others. Presumably, the more the government takes care of people (and, therefore, the more money it takes from people), the freer Americans are. In other words, the more people are taken care of with Social Security, Medicare, Medicaid, grants, subsidies, and aid, the freer the American people become.

North Korea, Venezuela, and America

Suppose we asked Americans whether, in their opinion, people living in North Korea are free. Most would say no. When asked why, most of them would respond, “Because North Korea is a communist dictatorship, not a democracy.”

Very few Americans would focus on North Korea’s socialist economic system in framing their answer.

Now, suppose Americans were asked the same question about people living in Venezuela. They might be tempted to say that Venezuelans are free because there are elections in Venezuela, ignoring the fact that a democratically elected ruler can be a dictator.

Again, few Americans would focus on Venezuela’s socialist economic system in responding to a question that asks whether Venezuelans are free. It simply would not enter their minds.

The fact is that North Korea and Venezuela have the same welfare-state programs as the United States: Social Security, Medicare, Medicaid, grants, subsidies, and aid. And people in those countries are as convinced that all that welfare-statism is freedom as the average American is.

This is one of the things that distinguish libertarians from statists. We oppose all welfare-state programs, including the crown jewels of the welfare state — Social Security, Medicare, and Medicaid. We favor the immediate termination of all those socialistic programs.

The Libertarian Concept of Freedom

Libertarians view freedom differently from statists. Our concept of freedom, in an economic sense, is as follows:

We believe that people should be free to engage in any occupation or profession without any government-issued license, permit, or other form of official permission. Let consumers, not the government, decide who engages in different lines of work.

We believe that people should be free to enter into mutually beneficial transactions with anyone else in the world, without interference by the government. That includes such things as hiring a housekeeper from Mexico and selling food to a Cuban.

We believe that people should be free to accumulate unlimited amounts of wealth and, equally important, to decide for themselves what to do with it — spend, save, invest, or donate it. Thus, we hold that people should be free to plan for their own retirement (or not), to donate to their church or other causes (or not), and to help out their elderly or ailing parents (or not).

For us libertarians, that is what genuine freedom is all about, in terms of economic activity.

Compare the statist interpretation of freedom, an interpretation that libertarians consider to be false, fraudulent, and counterfeit. The statist version of freedom holds that government, not the individual, is sovereign and supreme. If people want to engage in a line of work, they’ve got to ask the government for permission. The government restricts them from engaging in mutually beneficial transactions with others, through such devices as minimum-wage laws, trade restrictions, and immigration controls. Everybody’s income is subject to being taxed in any amount deemed proper by government officials and redistributed to others. People are forced to share their money with others, be it the elderly, the sick, or simply the politically privileged.

Thus, when libertarians are asked whether they live in a free country, our answer is opposite to that of liberals and conservatives. Our answer is “no,” because an essential aspect of freedom is economic liberty. If people in a society don’t have economic liberty, then they cannot truly be considered free. And statists are not free merely because they think they are. A denial of reality, no matter how severe, doesn’t affect reality itself.

It is how libertarians view freedom that befuddles and confuses, and sometimes even angers, American statists. They’re simply unable to comprehend how libertarians are able to honestly believe that Americans are not free. That’s because in the minds of American statists, it’s obvious that Americans are free. Everyone knows that the United States is a free country.

The reason for this phenomenon is, again, that, while all of us are living within a statist box, most Americans have not been able to break out of the box, mentally speaking, and question and challenge the legitimacy of the statist box itself. Undoubtedly, that is in large part because of the powerful indoctrination that takes place in people’s formative years — a period in which their minds are molded so that they believe that the welfare state is, in fact, freedom. Thus, when a statist encounters a libertarian, who wants to bring freedom to America, the statist becomes confused, befuddled, and even angry because in his mind he’s already free, thanks to the welfare state.

The Managed Economy

Here’s another example of how different libertarians are from statists in the realm of economics — the concept of the managed economy. What is the standard debate that takes place between liberals and conservatives in the political arena? It is that the party in power has “mismanaged the economy.” Most of the time, the accusation is directed at the president. When President George W. Bush was causing federal spending and debt to soar through the roof, what did the Democrats say? “He’s mismanaging the economy!” And what have Republicans been saying about President Obama’s exorbitant federal spending and borrowing ever since he took office? “He’s mismanaging the economy!”

The entire process is simply a game in which voters transfer power back and forth between the two wings of what is really just one big political party — the Statist Party.

Sometimes, liberals and conservatives will ask libertarians, “What’s your plan for managing the economy?” Our answer: “We don’t have a plan for managing the economy,” which causes statists to go ballistic. They respond, “Oh, you libertarians are so impractical. How do you expect to win elections if you don’t have a plan for managing the economy?”

Well, there is a very simple reason that libertarians don’t have a plan for managing the economy. We don’t believe that it’s a rightful role of government in a free society to manage the economy. We believe that people should be free to manage their own economic activity and that government should stay out of the process entirely.

Thus, there are fundamental differences between libertarians and statists over the concept of freedom and the role of government in a free society.

Statists hold that freedom entails the government’s having the power to seize money from people in order to take care of others and to manage and control economic activity.

Libertarians, on the other hand, hold that freedom entails people’s having the right to manage their own economic activity in any way they want, including engaging in enterprise free of government control, accumulating unlimited amounts of wealth, and deciding for themselves what to do with it.

Another big difference between libertarians and statists relates to morality. Liberals and conservatives see nothing wrong, in a moral sense, with government’s forcibly taking money from people in order to give it to other people. In fact, for both liberals and conservatives, the welfare state is the epitome of morality. The forcible seizure and redistribution of wealth, they say, actually reflects how good, caring, and compassionate the American people are.

Libertarians hold the contrary. We say that it’s wrong for government to forcibly take money that belongs to one person in order to give it to another person. We call that stealing. And we say that stealing is immoral even when the thief puts what he steals to good use, such as funding the education of a poor student, helping a destitute elderly couple, or paying for a medical operation for a sick person.

Interesting enough, statists would agree with libertarians when the stealing is done by a private thief. They would say that such theft is morally wrong, even when the money is used for some good purpose.

The difference arises when government enters the picture. For the statist, what would ordinarily be considered to be an immoral act is suddenly converted into a moral act when the government is doing it. In other words, if the thief is a private person, the statist joins the libertarian in condemning the act. If the thief is the government, the statist praises the act, while the libertarian condemns it.

Finally, we must consider the economic consequences of the welfare state and the managed economy. Imagine a spectrum that has libertarianism at one end and total statism at the other end. At the statist end, the government owns and controls everything, and everyone is working for the state. At the libertarian end, people engage in free enterprise (that is, enterprise free of government control or management), have the right to accumulate unlimited amounts of wealth (that is, no income taxation), and are free to decide what to do with their own money (that is, no Social Security, Medicare, Medicaid, grants, subsidies, or other welfare-state programs).

Drifting to Total Statism

What liberals and conservatives fail to realize is that the totally statist society will be one that is on the verge of starvation. At the other end of the spectrum — the libertarian end — people will be enjoying the benefits of a rapidly growing, prosperous economy, one in which people are using their resources in different ways — consumption, saving, donating, et cetera.

The reason for this economic outcome lies in savings and capital. When people are free to keep everything they earn, they inevitably save a part of it. Their savings provides the capital that businesses use to expand their operations. The expansion produces higher revenues and profits, enabling firms to pay higher wages. In that way, standards of living rise. In the totally statist society, where the state owns everything, private savings and capital are squeezed out of existence, thereby dooming everyone to a life of extreme impoverishment, possibly even starvation.

In the middle of the spectrum are the welfare state and the managed economy, whereby the state attempts to extract sufficient wealth from the private sector to sustain its ever-growing welfare sector. What inevitably happens, however, is that the welfare sector becomes so large and so voracious that the private sector shrinks to a point where it cannot sustain the burden. The result is an environment of crisis and chaos, one in which people in the parasitic sector are demanding that the government do something to save them.

Because statists are convinced they’re free, they inevitably blame the economic woes on freedom and free enterprise rather than on the government’s socialistic redistributive programs and its interventionist economic policies. Thus, statists call on the government to move further along the spectrum toward more government control over economic activity and wealth.

It comes as no surprise then, that libertarians have an entirely different diagnosis of the problem. It’s the welfare-state programs and the interventionism that are the root of the economic woes, libertarians hold. The solution lies not in more government control but rather in more freedom. The solution lies in repealing the welfare-state programs and separating economy from the state.

For decades, libertarians have been telling Americans that the welfare state is not freedom and that it would inevitably lead to economic hardship, maybe even destitution. Americans haven’t listened, in large part because their minds have been trapped within the statist mindset that was mostly molded during their 12 years of childhood schooling.

Today, an increasing number of Americans are asking questions and challenging out-of-control federal spending, debt, and even inflation. Time will tell whether they’re able to do what libertarians have done — recognize the statist box for what it is, break free of it, and call for its dismantling rather than for its reform. If so, we libertarians will have a much better chance of overcoming the decades of statism under which our nation has suffered and restore a free, prosperous, and harmonious economic system to our land

Regards,
Jacob G. Hornberger
Whiskey & Gunpowder

May 23, 2011

Libertarianism vs. Statism was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Okay, Mr. Vice President. Thanks for clearing that up for me. I see now that the executive office’s position on wealth is that it is not fair for some to have more wealth than others and the fair thing to do then is to redistribute what some people have to others even if it has to be done without their permission. Wow! Was my Kindergarten teacher Ms. Lund wrong. She taught us that that was called stealing. As you can probably imagine, I’m actually quite upset at her right now for not doing a better job of explaining this to us at age 5 since I see now that I have forgone countless opportunities since then to redistribute wealth my way.

Better late than never though; my neighbor has a smoking hot 1969 Mustang convertible that has been restored to near mint condition. I on the other hand drive a 2006 Ford Escort. I don’t know how my neighbor obtained such a cherry ride but as you said: redistribution of wealth is just being fair so I’m going to redistribute his car to my garage tonight after he goes to bed. I’d do it during the day but I don’t know if he’s read your article today or not, so he might get upset if he hasn’t. Better to just do what is fair and worry about the rest later. Honestly, I’ve wanted his car since the first day I saw it but was struggling with the morality of forcibly taking things that don’t belong to me, until I read your article that says it’s okay.

Your article has given me so many ideas: we are a single income household and most of my friends are two income households, so those guys are way wicked wealthier than me. I think I’ll go sit down with some of them and discuss how much money we have altogether and then suggest that we divide it up equally amongst us. If they insist on being unfair a**holes and not voluntarily redistributing their wealth to me and my family, then I’ll just quote you and take it without their permission. Unfortunately, some people in America are just selfish like that.

I can’t tell you what a profound impact this revelation is going to have on my life. Having just had an expensive surgical procedure and not having health insurance I was planning on paying for it out of my own pocket but now I see how un-fair that would be to me and my family when there are so many others in America with more money than us.

It would also seem that I am off the hook for my student loans now as well. I can simply keep putting them off until I die and let the government pay them off for me out of redistributed wealth.

This also changes my whole outlook on life and work. What a fool I’ve been for so long, taking personal responsibility for myself and busting my ass through school and my career in order to ensure that I’d always have the necessary marketable skills to earn a livelihood and provide for my family. When all along what I should have been doing is lobbying politicians like you to just do what is fair and give me more of other people’s money. It would seem all that college education didn’t make me very smart.

Also, I think this is a fantastic opportunity for you and your colleagues in Washington to prove to the electorate that you are a man of action. Considering the median household income in the U.S. last year was $67,000 and your annual income as vice president is almost $270,000 now is your chance to just do what is fair and redistribute three-quarters of your income to 3 other families so you 4 all make about the same income in 2010. What a great day for America. Could I also ask a favor: could you pass this letter along to the Clintons and John McCain for me? With their combined net worth of $100 million plus I think it would be beneficial to a number of American families for them to know how to make things in America more fair as well. I wish I could be there when those families get their money.

All kidding and sarcasm aside, all I can say in response to Mr. Biden’s comment is: I’m done. I am so done with this government. I am ashamed of this government. How ridiculous was that to say? How socially irresponsible? How socially destructive? How unconstitutional? How un-American? It ranks right up there with comments like: “Sarah Palin for president.” So it’s obvious that our vice-president advocates taking wealth from those that have it to “spare” — I guess Joey will be the one to decide what that means — and giving it to those that don’t have as much. I challenge anyone to try and convince me how that is in any reasonable way different from the communist manifesto: Karl Marx — “from each according to his ability, to each according to his need.”

I’m also tired of that lame old political rhetoric that there are “unfortunate” people in America who need help and it’s “American” to help those in need. If it’s so damn “American” then why aren’t American’s helping them voluntarily? Why must the government intervene and force Americans to do what they say is inherently “American”? I’ll tell you why: because the kind of help the government wants has nothing to do with being American. I think American’s are some of the most magnanimous people on the planet, but they also want the freedom to choose their own charitable endeavors. And with every dollar the government taxes us to “just do what is fair” is one more dollar that Americans don’t have to be charitable with. Furthermore, if the government doesn’t run a welfare state then they risk losing a large, dependent cross-section of voters come election time. Now we can’t have that now can we?

Certainly there are those in our society that have fallen upon hard times due to no fault of their own, but I say they are the minority of minorities. The majority of the “unfortunate” ones sat right next to me in public school and are in the economic situation that they are in due to the decisions they’ve made throughout the course of their lives. Some would call me an a**hole for expecting people to be responsible for their own lives and dealing with the consequences of their actions and in response I’d say that they are the a**holes for feeling entitled to the fruits of the hard work of others.

I can’t tell you how sad it is to me to realize how many socialists and borderline communist-thinking people there actually are in America in 2010. It’s only been 20 years since the fall of communism in Europe and people are talking here now as if it never happened. As if the volumes and volumes of historical evidence on socialism and communism don’t exist. As if a society of social programs, entitlements and redistribution of wealth from the haves to the have-nots is a just, moral and productive society.

The government blatantly and brazenly takes control of auto manufacturers, banks, insurance companies and now they want to control health care and millions of people don’t see anything wrong with that. So few are saying anything.

I don’t even recognize this country anymore, and I’m sure it doesn’t recognize me.

Regards,
Don Cooper
Whiskey & Gunpowder

October 4, 2010

Do You Recognize This Marxist Country? was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

“Good,” we replied.

“How can you say that? Aren’t you worried you’re going to upset your readers? They won’t become customers if they’re angry with you.”

“That’s true. But you probably misunderstand what our business is. I don’t want a customer who’s easily offended by ideas. It’s my job to provoke thought. And you do that by presenting ideas, challenging conventional wisdom, and just thinking harder about things.”

Warming up to our task, and perhaps inspired by a sip of Maker’s Mark, we continued, “When I see someone say something idiotic – or, if you prefer – something I think is totally wrong, I feel compelled to point it out. You have to challenge that stuff when you see it, or else people start to believe it. And once they start to believe it without really thinking about it, the game is up. You become a servile, passive, brain-dead whip dogged to be kicked around and cuffed about the ears by the Welfare State. You’ll be lucky to get a bone.”

The discussion came up because of this quote by the Prime Minister earlier in the week on the radio. He said:

The core element of conservative economic management, in which I believe, is expanding the role of government in the economy when the private sector is in retreat. Had we not done that we would have had a quarter of a million more Australians out of work, many small business [sic] collapsing. Now that the economy globally is on a pathway to recovery it’s time for the role of government to retreat. That’s what conservative economic management is all about. That’s what I believe in.

You have to give the Prime Minister credit. He says what he believes. But what he believes is all wrong. And we wish he’d stop using the phrase “the business of government.” It’s an insult to businesspeople. Government is not a business. It does not take risks with its own capital to create value and jobs. The Prime Minister is not an entrepreneur.

He is, however, by his own admission, a manager. And in that respect, his hubris and his error are revealed. It is not “conservative economic management” for the government to massively intervene in the private sector. It is Socialism.

You might agree with it or believe in the moral rightness of that intervention, mind you. But let’s at least call things by their right names. It’s one of the surrealities of the modern world that things are often given names that are in direct opposition to what they actually are. Examples include the Democratic People’s Republic of Korea, which is neither Democratic nor a Republic, and Britain’s Liberal Democratic Party, which is neither Liberal nor Democratic either. We would add to the list Kevin Rudd as a “conservative economic manager” of the economy.

In any case, the Prime Minister’s error (shared by many members of the opposition who fail to rebuke him), is that he does not understand the inherent impossibility of managing a complex system like the economy. The second order error is probably just a disagreement about the government’s role in the economy. But you can’t have the second error without the first. And the first one is a fundamental question about the limits of human knowledge.

No human being, economist, and philosopher made this point more clearly than Friedrich Hayek. One of Hayek’s great achievements – picked up today we think by Nassim Taleb – is forming a clearer picture about the quality of knowledge and what we can say that we really know. What does that mean?

Hayek simply pointed out that in a complex system like an economy, no single person can have enough information or even know what information is required to correctly allocate and direct the use of society’s resources. To believe otherwise is to have an exalted sense of your own abilities as a micro-manager.

Hmmn.

Hayek’s critique of central planning – what he called the fatal conceit of socialism – was, and remains, the most sensible criticism of centralised economic authority. It can’t work because human action is too complex and unpredictable and ultimately unknowable in a strict cognitive sense. You cannot plan and organise for what you do not know and cannot understand.

Market prices, on the other hand, are the sum total of human action. Those prices contain information and help maintain the relationship between supply and demand. That is the essential triumph of a free market: it allows people to be free and choose their own path and, at the same time, manages the most efficient allocation of resources.

It does this based on what people want as expressed through their own choices, not what government tells them they should or should not want. It produces this kind of peaceful and prosperous order – most of the time – without being organised by a smart man in an expensive suit serving on the public payroll.

But the basic idea simple. Individuals and firms know better how to plan their own future than the government. If you believe otherwise, you believe the government has the right and the obligation to make plans on behalf of people who are not fit to govern themselves. Proper names for that include: Nanny State, coercion, tyranny and more!

The Prime Minister is a planner and a world improver. That is the “business” he is in. And perhaps his motives are building a better world. But the way to do that is to sweep your own doorstep and tend your own garden, we’d submit. His belief about the proper role of government in the management in the economy is based on an overweening pride in the knowledge and skill of government ministers and career bureaucrats.

How else can you explain a piece of tax law like the Resource Rent Tax which effectively makes the government a silent partner in the profit and the losses of the resource industry without the consent of shareholders? Only a man who believed government had the right and the ability to insinuate itself into private business relationships would so pridefully propose a scheme like that.

That’s not to say that the government doesn’t have a role in civilised society. It most certainly does. Its role is to guarantee and enforce clear rules that establish and protect the ownership of private property and enforce contract, as well as punish people who take what is not theirs. The Law – transparent, providing equal justice, and impartially administered – is as important an institution to civilised society as the free market, which itself is could be described as a mechanism for communicating prices.

By those standards – which are, of course debatable – this government has done the exact opposite of conservative economic management. It has changed the rules in mid-stream, proposed to enforce them retroactively, and demanded equity in private enterprise without paying for it like the rest of us.

To be fair, that is “business” of a kind. Monkey business perhaps. Or “business” in the same way organising payments through the threat of violence is a “business.” Or less threateningly, it’s just meddlesome troublesome “business” that gets in the way of real people doing real business.

As the economist and thinker Henry George wrote, “It is not the business of government to make men virtuous or religious, or to preserve the fool from the consequences of his own folly. Government should be repressive no further than is necessary to secure liberty by protecting the equal rights of each from aggression on the part of others, and the moment governmental prohibitions extend beyond this line they are in danger of defeating the very ends they are intended to serve.”

The world is complicated enough. Europe’s sovereign debt crisis will eventually migrate its way to America and the super cycle in fiat money will end in either a debt deflation or massive inflation or both. Real wealth will be destroyed. Sound economic management would have been to leave well enough alone. But that is not what the government has done…and it’s going to reap the whirlwind…

Regards,
Dan Denning
The Daily Reckoning Australia
Whiskey & Gunpowder

May 20, 2010

Even a Little Government Intervention Is Destructive Socialism was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Up until Monday, we’ve seen the end of the super cycle in fiat money as a process that could take years to unfold. The piecemeal nationalisation of certain industries…the assumption of private sector liabilities on the public sector balance sheet…the abrogation of contract in the form of defaulted mortgages that are not foreclosed on…and higher-and-higher public debt-to-GDP ratios were all signs that the government everywhere was sucking the life out of the economy to preserve the status quo, and turning dozens of firms and institutions into zombies with no real productive economic future.

But Monday is the day that sent a bit of a chill down your editor’s spine. And it’s not because the €750 billion bailout package by the ECB caused a frisson here in St. Kilda. Granted, it did wonders everywhere else. The S&P 500 was up 4.4% in New York. Local stocks rallied. And most impressively, the spread between 10-year Greek debt and equivalent German bunds shrunk by a massive 570 basis points.

And if you’re a speculator — and especially a high-yield bond hunter — why not get on the gravy train? If the ECB is going to print money to buy public and private sector debts to “ensure depth and liquidity” in certain markets, it’s not a trend you want to fight. If the central banks are going to splurge on assets to support debt markets, bond yields will fall and asset prices will rise. For now.

But we reckon it is not for long. This really is Act V of the fiscal welfare state, in which monetary policy becomes the shameless handmaiden of fiscal policy in order to sustain an unsustainable kind of riskless society with massive benefits for everyone paid for by a few. That is an unaffordable illusion, the shattering of which leads to lower standards of living — a fact many in Europe find politically unacceptable (even if the fiscal facts speak for themselves).

To delay the day of reckoning, the ECB is offering European banks nearly unlimited amounts of cash for three and six month borrowing periods. You can imagine those banks — proud owners of heaps of sovereign debt from Greece, Spain, Italy, Ireland, and Portugal — are happy to sell that stuff to the ECB and borrow some short-term cash to lever up into an equity rebound. More privatised profits and socialised losses that favour the financial industry.

And why wouldn’t you play that game if you were playing with other people’s money? We’ll get to WHOSE money in just a moment.

The immediate question you might have is, “Will this work?” It depends on what you mean by “work”. By throwing wads of cash at stressed banks, the ECB alleviates the immediate threat in the market that bond yields spike and a liquidity crisis sets in. But enabling debt-laded countries to take on more debt hardly seems like a long term solution to the problem of living above your national means.

“You cannot make any nation that is unable to service its accumulated debts more creditworthy by extending more credit!” said Jeremy Batstone-Carr, analyst at Charles Stanley in today’s Wall Street Journal. “If the EU lends Greece money, the loan will increase that country’s public sector debt. The interest on the additional loan, whatever it eventually proves to be, will increase the public sector deficit. Total debt-servicing costs will rise, raising the burden on public sector cash flows. At some point in the future, the loan will have to be paid back.”

EU policy makers hope that by extending more credit now to sovereign governments, bond investors will just, you know, back off! It’s amazing to read how officials blame derivatives and a “wolf pack” of speculators for the crisis. As if it was the speculators who ran up huge debt-to-GDP ratios. As if the solution was to ban credit default swaps and remove the one market pricing mechanism which alerts investors to rising sovereign credit risk.

Incidentally, this is a minor trading point…but worth thinking about…who is on the other side of all the credit default swaps underwritten on European debt? Remember it was AIG that collected premia by writing default insurance against sub-prime mortgage backed securities and collateralized debt obligations. Goldman, among others, bought that insurance.

If you were a handy speculator right now, you’d find out who sold default insurance on Greek and Spanish debt. And then you might consider shorting the daylights out of them.

Of course maybe the ECB really has solved the problem by throwing a wall of fake money at it. But we reckon yesterday’s action gives you fair warning about what’s ahead and a bit of time to do something about it. A massive monetisation of debt and an increase in public sector liabilities has now been set in motion. The euro itself will soon, again, become a target of speculators once the next major tranche of sovereign debt must be rolled over and there’s no one but the ECB there to buy it.

How long can Europe pay its bills and creditors with money that doesn’t exist?

But the buried item in yesterday’s news reveals that the U.S. dollar might be on the hook too. The Fed re-opened its swap lines with major banks around the world. This means the Fed will be expanding its balance sheet again…and sending a flood of dollars out into the world to shore up banks that need them. The Fed had closed the swap line with the ECB in February, when everything was just fine.

To the barricades, dollar standard! But this really could be a kind of last stand for the dollar as the world’s reserve currency. Unbeknownst to the American taxpayer, the Bernanke Fed has now thrown the dollar once more into the breach of a liquidity and solvency crisis. It may not survive.

That’s what you should watch for, then: the expansion of the Fed’s balance sheet. It will be hard to keep your eyes on that target with so many green numbers on so many shares and indices. The ECB has invited the entire financial world to speculate on the house. The ECB’s monetisation — with the Fed’s cash — is going to lead to a quick reflation of some markets; that’s for sure.

The biggest inflation, though, could come in precious metals. In fact, as a hedge against the central bank monetisation strategy, precious metals are about the only sensible speculation in a market which has essentially been reduced to total speculation by the distortion of values from the flood of money.

Things that can’t be printed by a central bank and aren’t anybody else’s obligation to pay might be the best investments for the rest of this year. And beyond?

The Welfare State has met its great funding crisis with a fraud. And the fraud is going to cost a lot of people a lot of money. If you’re in markets now, be aware that markets no longer bear any relation to underlying risk or reality. It’s never been more dangerous. And given the last few years, that’s saying something.

Regards,
Dan Denning
Daily Reckoning Australia
Whiskey & Gunpowder

May 13, 2010

Debt to Break the Back of the Welfare State was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The Eurozone’s problem? In short, it’s history…precisely what the single currency was supposed to neuter, of course.

Greece’s still-pending €110bn bail-out has already cost three lives in Athens’ riots yesterday. More bloodshed inside Western Europe would make a horrific end for this grandest of grand post-war projects…the crowning achievement of Europe’s longest-ever period of peacetime.

But thanks to history — and the very same history that built the Euro, as well — Germany cannot inflate. The rest of Europe, however, cannot do anything else. Sharing one printing press was always unwise. Now it makes UK prime minister Gordon Brown look smart for staying outside. Which really is saying something.

No “single currency” could ever reconcile history, however, because Europe’s monetary politics over the last 100 years is cleft right in two. Germany suffered first hyper-inflation…and then madness…before banishing the shame of cattle-trucks packed full of people by promising “Never again!” to wheelbarrows overflowing with bank-notes.

The rest of Europe, in contrast, and especially the PIGS of the south (but also Great Britain, you’ll note), got things the other way round. Deflation came first, thanks to the interwar Gold Standard. Victory in Europe was then followed by the victory of soft money. Time and again, devaluation worked magic to rescue over-spent nations from ever settling their debts.

So, where Germans look back and see catastrophic inflation…followed by the sins of the Führer…and finally a five-decade boom built on sound money (not to mention cream-laden lunches)…Greek, Spanish and Italian civil servants fondly recall an insane scramble for cash, only redeemed — repeatedly, and for the next 50 years — by default through debasement.

The hyper-inflation of 1919-1923 is scorched onto Germany’s collective conscience and Germany’s alone. To the west of the Rhine and everywhere south of the Alps, a very different 20th century applies. Their only memory of tight money was the disaster of the Great Depression. Spared hyper-inflation in the 1920s, Europe outside of Deutschland slipped instead into chronic deflation the following decade. Come 1931, the world’s monetary anchor — the international gold-exchange standard — was cut loose from the Pound, forcing everyone else to do the same sooner or later.

Sooner was better, as well. Inflation worked. So did the war. Just ask Paul Krugman or Ben Bernanke.

“You owe us €70 billion for the ruins you left behind,” spits the mayor of Athens, Nikitas Kaklamanis.

Deputy prime minister Theodoros Pangalos cuts nearer the heart of the matter by adding how “The Nazis took away the Greek gold that was in the Bank of Greece. They took away the Greek money and they never gave it back.”

Germany should cough up, in short, for the sins of the Führer. Which is kind of correct, since Hitler’s greatest achievement today is a welfare state that neither the Allies or Axis could ever afford.

Compare and contrast with the crushing demands made after WWI. Denied a knock-out blow on the battlefield, the French and British sought victory at Versailles instead…squeezing the Hun for more money than yet existed in the form of gold bullion. Whereas today, “Greek civil servants are suffering because of a crisis they didn’t cause,” reports the BBC. Only they did cause it, of course — or rather, their parents did…like everyone else who survived or was born after WWII…by voting themselves a cradle-to-gravy-train welfare state that hasn’t stopped paying ever since.

The irony of Greek civil servants demanding 16 months’ wages each year from German taxpayers runs deeper than it seems at first glance. The inevitable response by central banks takes us straight back to Weimar, as well.

“What might therefore take place in the long term?” asks French economist Patrick Artus at Natixis of the single Eurozone project. The options he sets out are nigh-on impossible:

• the launch of a federal system (taxes, spending and central control), “which is highly unlikely given Germany’s stance”;

• a continued gap between permanently depressed member states and high-growth prosperity elsewhere — “difficult to accept both politically and socially”;

• withdrawal from the Euro, ignoring the costs, by “irrationally populist governments in the countries experiencing the greatest difficulty…”

Option 1 would force that political union which Helmut Kohl first sought, but the rest of Europe refused to accept. A pan-Eurozone council would hardly help German politicians cool tabloid demands to reinstate the Deutsche Mark, either.

Option 2 is also too ugly to bear, since ignoring the growth-gap only prolongs and worsens the anger, delaying the catastrophe that is Option 3. Watching the Eurozone project — the end of history, no less, for the people who built it — collapse into social unrest inside Western Europe would be just too ironic at best. It might end six decades of peace at worst.

So what about Option 4 — which Artus ignores — by re-opening Germany’s print-shop in Frankfurt?

To date, the plan for bailing out Greece, and thus preserving the Euro, means giving Athens enough money to save it asking the markets for funding until 2014. That sum, so far, is put somewhere near €120bn. But to date, Greece’s Eurozone partners have offered up diddly squat. Italy and Spain, in particular, have gone very quiet.

Wheeling out the printing press in Frankfurt, however…and getting the European Central Bank to do precisely what Havenstein did in 1920…means Europe can pay its pensioners the same way the Weimar Republic tried to pay Britain and France after Versailles, and with the same inevitable outcome, as well.

Just like British and French pride in 1919, today’s heroic welfare promises are just too expensive. Whether sooner or later…and with or without a hyperinflation to try and pay off the victorious pensioners and civil servants…these costs from the past cannot be paid from tomorrow’s money. They’re simply too big.

Regards,
Adrian Ash
BullionVault
for Whiskey & Gunpowder

May 6, 2010

Gold, the Euro, and German Hyperinflation was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

First, let’s check out the chart below from the 2008 annual budget audit by the U.S. Government Accountability Office. It shows that the U.S. government must roll over $3.4 trillion in debt over the next four years. This $3.4 trillion does not include any additional borrowing that may be required for other government programs (wars, healthcare, wars, school lunches).

What’s the big deal? $3.4 trillion is a small number by today’s standards, isn’t it? Not exactly.

The chart shows how incredibly interest-rate sensitive U.S. government borrowing now is. Not only is it a big ask to ask the world’s creditors to continue funding such large deficits (there are only so many savings available to borrow, after all), but the interest expense on that debt is likely to go up as the fiscal position of America deteriorates.

And if America can’t find anyone willing to finance its deficits, what then? Well, the luxury of issuing debts in the currency you also print is that you can print money to pay for them. Technically, you can never become insolvent when you enjoy this privilege. The Fed, for example, can create new money to buy debt issued by the Treasury, funding deficits ad infinitum.

But this monetisation of the debt is another way of saying that international creditors are no longer willing to pick up America’s spending tab. They will be betting against the American economy, not on it. Even if the Fed takes the unusual step of moving out further along on the yield curve to set interest rates (and keep the bond vigilantes from sending yields to the moon) this is a clear signal to owners of dollar-denominated assets and holders of dollar currency reserves to get out.

Another scenario to watch for is when creditors begin asking the U.S. to issue debts in currencies other than its own (Yuan, Euros). That would be something. In the meantime, they will look to lessen their dollar reserves.

That may not be such an orderly process. And the urgency to get out of the greenback and into something better will only pick up pace as it becomes clear the politicians in America (along with the Fed) are not likely to suddenly rediscover fiscal prudence.

You never know. The Fed may assert its independence and baulk at more quantitative easing. But we wouldn’t count on it. And we reckon tangible assets and possibly emerging market equities would be the biggest beneficiaries of capital flows out of the dollar…and into anything else.

The next chart is for you, Paul Krugman. Krugman, among others, continues to insist that larger public sector deficits are necessary if the Western world is to avoid a Japanese-style deflationary “Lost Decade.” He claims the government must increase spending as households and businesses deleverage and reduce debts.

Advocates of this idea claim that public sector deficits, as a percentage of GDP, have no real limits. And the example they cite is Japan. As you can see from the chart below, Japan’s debt to GDP ratio is nearing 200%. America’s isn’t even half of that yet (it’s about 98%, or $13 trillion). If Japan can finance a deficit at 200% of GDP, then why are we worried that U.S. deficits half that size would threaten interest rates or the dollar?

First off, it’s worth pointing out that high public sector-debt-to GDP ratios haven’t worked in Japan, if by work you mean pave the way to a stable recovery. Advocates might say-as advocates of the stimulus here in Australia often say-that the public spending made things less worse. But the opposite is true. It’s made things more bad!

Or just worse, if you prefer. We mean that the public spending has done two things, neither of which is productive, and both of which, in fact, waste capital and resources. First, public sector spending to prop up financial firms with dodgy assets prevents the needed reckoning in asset prices that would produce market clearing prices for commercial and residential real estate. You get zombie banks and a zombie economy and zombie house prices.

Secondly, there’s no indication that all the infrastructure spending in Japan has produced any kind of lasting growth for the economy. It may have built some great roads and bridges. But we wonder if it solved any of the underlying problems? What’s more, the capital and resources that went into those projects was directed by political considerations and not available for the private sector, which could have put them to some use at least designed to produce a return on the capital.

The underlying problem which deficit spending does not solve is compounded by demographics. Japan’s government is hoping that continued borrowing can be financed at low rates by pensioners who will be cashing out of their pensions but seeking safety. However, we suspect that Japanese pensioners will begin to consume their savings as they downsize their lives into their twilight years (which tend to last much longer in Japan, as the number of Japanese centenarians shows).

That means interest on Japanese bonds-which already one fifth of the Japanese budget-will consume even more of the nation’s resources, if the older population clams up with its money. And like in the U.S., you’ll see the government borrowing more and more of every new yen spent, with more of that borrowed yen going to pay a previous creditor. That’s bordering on Ponzidom.

Japan has been able to run a higher-than-average public debt-to-GDP ratio because it has had such a high personal savings rates. This kept borrowing costs low for the government. But we’d expect that to change soon. A debt-to-GDP ratio of 200% will be very difficult to finance in the world as it is-much less in a world where those rates begin to rise and when Japanese savers begin to consume their savings.

Finally, what about Europe? Our argument here is simple: Europe’s monetary union is going to come unstuck. Why? Europe has one interest rate for twelve different economies. That does not leave national governments with the flexibility to print money and inflate away political problems. This will be intolerable, the monetary union will break up.

The sign to watch for is a spike in the yields on euro-denominated debt. As the chart below (from Stratfor) shows, earlier this year bond yields did in fact begin to widen. Germany Bunds have the most stable rates, as Germany has traditionally the most stable fiscal and monetary policies in Europe (they did not go hog wild for stimulus).

But for Spain, Ireland, Greece, Portugal, Italy and Austria (whose banks lent large for real estate in Eastern Europe), another round of falling asset values really would show that the GFC has become a sovereign debt crisis. And will Germany bail out these nations? Can it afford to?

We don’t know the answer to those questions. But it is worth pointing out that by assuming or guaranteeing the liabilities of the financial sector, national governments have also assumed the risk. And the bond markets will be left to decide how to price this risk.

How it ends is anyone’s guess. But our take is that the Super Cycle in fiat money is at its peak. And as it unwinds, it’s going to take national governments and their financing model with it. They will be forced to adopt a new model and take a new form to survive.

This means a great deal of political and economic upheaval. It’s no coincidence that the last time the world faced such monetary upheaval was when it went off the gold standard and straight into essentially thirty-two years of military and economic conflict (1913-1945). If the world is about to become that disordered again, you’ll need a plan to deal with it.

Regards,
Dan Denning
Daily Reckoning Australia

November 5, 2009

Debt to GDP Ratios Indicate Governments Going Bankrupt was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.