[Editor's Note: This article was originally published in 2008 at the excellent on-line journal NthPostion. That it continues to be relevant is one of the reasons I've always confused the words "travesty" and "joke."]
Were the expence of war to be defrayed always by a revenue raised within the year, the taxes from which that extraordinary revenue was drawn would last no longer than the war. ... Wars would in general be more speedily concluded, and less wantonly undertaken. The people feeling, during the continuance of the war, the complete burden of it, would soon grow weary of it, and government, in order to humour them, would not be under the necessity of carrying it on longer than it was necessary to do so.
—Adam Smith, The Wealth of Nations, V.iii.50
The private sector got us into this mess. The government has to get us out of it.
—Barney Frank
It's the ekonomy, stoopid.
—James Carville
If you're reading this at some date significantly beyond October 2, 2008, you will know whether the events of the past weeks were catastrophic on the order of, say, Armageddon or the Great Depression, or just another Chinese fire drill for trained financial and economic "experts." But the orderly, slow motion market collapse of the week following provided a touch of melodrama to the show, more like a series episode in which someone forgot to write in the hero saving the world rather than an international event unfolding live in real-time on television. Whatever the outcome, an interesting aspect of the exercise is the language, particularly by politicians and media "gurus" and "savants." The phrase "simmering credit crisis" pointing at some ill-defined horror lurking on the horizon. The attendant hand wringing over this "unprecedented interference" in the Market, or Free Market, or the advance of Socialism into God's ordained land of pure Capitalism. One buffoon from the Senate actually implied the US was going down the road of France, though I had read somewhere that it's the French who are adopting our own predilection for tasteless prefab high-velocity food.
It leads one to recognize, first and foremost, that humans are not much changed since Neolithic times except they have developed fancier ways of expressing their fundamentally superstitious views of the world.
Perhaps the most amusing hue and cry regards the taxpayers, with this massive debt passed to their children. And grandchildren, and great-grandchildren, ad infinitum like one of those Old Testament curses of leprosy by the miffed Jehovah. That is as amusing as the fanciful notion that somehow all this money will be borrowed. Much like the illusion that money is borrowed to pay for the wars in Iraq and Afghanistan. Or that money is borrowed to pay for other government spending.
The word borrowed here is euphemism for printed. By which is meant creating money out of thin air, nowadays electronically. Sure, there may be some borrowing by foreigners who are drowning in greenbacks. They send it back to the US in exchange for slips of paper that promise to return it with interest, sometimes low enough that they lose principal to the falling value of the dollar against their own currencies. The taxpayers are not on the hook to repay that which is not really borrowed. So there is no taxpayer fallout, though there are other consequences to a nation willy-nilly printing money. David Hume, among others, had a thing or two to say in this regards. Anent more later.
Milton Friedman described the method by which money is created in the US in modern times. In a little book entitled Money Mischief which even a trained economist or MBA or "political scientist" might understand, he points out that government has only three ways to increase spending. It can raise taxes or borrow money, the first of which is unpopular as hell and the second of which is largely impossible given the amounts required. Both of these options reduce the supply of money in the hands of private citizens, and leave less for the "private sector" to invest. The only other option is to increase the money supply. That is done by borrowing in a very odd way. The Treasury sells bonds. And some of these indeed go to borrowers, of late often Asian nations. But the reality is that mostly the Treasury sells the bonds to the Federal Reserve System (Fed). According to Friedman the quantity of bonds in such transactions is legally limited, but there is a workaround. The bonds are sold to specialist intermediaries that in turn sell them to the Fed and collect a commission as payment for maintaining the fiction that the government is borrowing from the public.
So in essence one hand of the government borrows from another, with the Treasury inflating the supply of "high powered" money when the Fed credits the Treasury account. Friedman also points out that the Fed is a branch of the government despite the smoke screen of private ownership of district banks. He ought to know, having worked in the Treasury and having spent a lifetime studying the history of these arcane mechanisms.
Most people confuse fractional-reserve banking, which is controlled by the Fed within its own system, with printing money as described above. But banks do not create what is called high-powered money. They inflate it by lending all but some reserve they are required to hold, which does inflate demand accounts, for example. This isn't new, harking back to the days when money was supported by gold and silver, before the advent of purely fiat money. Goldsmith's notes were issued by goldsmiths who held deposits of gold and loaned against it on reserve in 17th century England. (See Herman van der Wee, Monetary, Credit and Banking Systems, in The Economic Organization of Early Modern Europe, edited by E. E. Rich and C. H. Wilson for goldsmith's notes and other history, and Karl Brunner, High-powered Money and the Monetary Base, in The New Palgrave Money, edited by John Eatwell, Murray Milgate, and Peter Newman, for a discussion of the concept of high-powered money.)
This wholesale creation of money out of thin air is the basis for Ronald Reagan's famous supply side economics, by which the rising tide raises all boats. But as David Hume might have remarked given his view on printing money, "Aye laddie, but the rising prices have swamped any trickle down to the wee folk, who are drowning in them." He would have been right, and the ensuing inflation can be seen as a form of clandestine taxation of the most recessive variety. Reagan's massive defense spending, ostensibly the reason for the Soviet disintegration (but as to the reality of that, see for example the discussion in Norman Davies' Europe: A History, wherein this US myth is effectively deflated), certainly raised a few boats much higher than others. A very few much higher than most, actually, which was perhaps the reason for the gift Reagan received upon leaving office. When Republicans talk cutting taxes via supply side economics as a means to increase the flow of revenue into government, the hidden assumption is that they will print money to augment that flow. Their schemes for balancing the budget have been based on this absurd idea, and the irony is that a Democratic regime eventually realized the balanced budget grail, only to be pissed away by another Republican "conservative."
Note that this monopoly money is not necessarily worthless. It is likely that whether or not you play the game is outside your control, and so the monopoly money is the only currency available. But read Friedman's little book to understand how commodities like cigarettes actually became money in post-WWII Germany when the inflation tax overwhelmed the currency.
Consider a recent historical example to put all this into some kind of perspective.
The Reagan regime inherited a situation called stagflation, high inflation and stagnation (slow growth of measured GDP, whatever that might actually mean), from the Carter regime, the reasons for which are not important here though they likely had something to do with oil and a cartel called OPEC and a recently lost war. Reagan's solution was to boost growth by printing money and distributing it through the Department of Defense (DOD) at record rates in the name of National Defense, though there was no war and little real threat. (Some people believe in a thing called the Cold War, a bogeyman of a few decades past that persisted from the end of WWII until recent times, though whether or not the specter has been laid to rest is an interesting topic for discussion. A study of history indicates that such problems in diplomacy have been common since at least the Greek times and don't merit the term war.) Reagan's Fed chief Paul Volker (also inherited from Carter but reappointed) knew that this money creation program of epic proportions would be inflationary, a dangerous problem given the persistent inflation already infesting the nation. (The Pentagon had so much money allocated to it for Reagan's Star Wars program that it could not spend it fast enough via the issuance of contracts; those were the days before wads of cash were simply handed out to contractors in grocery sacks.) So Volker got creative in extending the Fed's control over its member banks well beyond the silly overnight rates charged between the members. He increased margin requirements, for example, and effectively made it prohibitive to borrow money. This caused a slowdown outside the defense sector, but money flowed through defense contractors like the fuel it was meant to be. Volker saw to it that most of that ended bottled up in a few privileged hands from where some of it might eventually trickle down to the little people. And Reagan got his paper-growth.
Skipping the one term Bush the Elder for now, William Jefferson Clinton came into office and loosened things up again. His Fed chief, a hand-me-down from the end of the Reagan regime named Alan Greenspan, who had already begun easing up on Volker's tightfisted control, let more money flow out. The money Reagan had printed in such massive quantities that had been shoved out of sight by Volker popped out in a craze of lunatic proportions, handed out to all sorts of children like allowances and rewards for asinine ideas. This was later called the Internet Bubble and these dull children (many well into chronological adulthood) were called entrepreneurs.
The genius of the Clinton regime was recognizing that indeed a new mania had gained control of the populace (during Reagan's regime the craze was, not surprisingly, a round of the same sort of witch hunt that had afflicted Salem a few centuries earlier, with similar trials and similar outcomes) who believed that the New Economy had arrived and that they were all to become blessedly wealthy with 401ks. Taking advantage of this temporary insanity or faith, depending on your point of view, people were encouraged to switch their 401ks to ROTH accounts, paying taxes on the money they had on deposit. This would allow them to pay taxes in the present on money that would grow to huge fortunes in a few years without further tax burden, thereby exercising their propensity to avoid taxes while paying taxes. I personally found it amusing to talk to people who borrowed to pay those taxes on accounts that would soon be worth less than those taxes. I had to work to keep from laughing at their tears of chagrin. But Clinton used this trick to balance the budget, and he did it with the money Reagan had printed less than a scant decade earlier.
Contrast Reagan with Bush the Younger, who has also constructed a massive budget deficit and swollen government bureaucracy and who also prints copious quantities of money for "Defense." Money that is practically thrown in the streets to create easy credit and large debt to feed the propensity to consume of the average clown eschewed in the 80s by Volker. This has led, in part, to the crisis alluded to in the first paragraph. But there is more to that.
At any rate, the muddle-headed Market intoxicated "conservatives" in Congress who rail against the "bailout" of private sector banks as an incursion into the rightful role of the Market are a funny lot. (It is probably best to drop the term conservative here and replace it with Republican, for which it has become a synonym. Liberal is a synonym for Democrat. Neither word has any objective significance beyond these affiliations.) Jim Bunning, former jock and U. S. Senator, said "the free market for all intents and purposes is dead in America." Which is hilarious, since he is right. But this is not the death-knell, since the Free Market has been dead since at least WWII and probably longer. In fact, it isn't clear there has been such a thing anywhere ever. After all, Adam Smith only saw it in a vision.
Funny also is Republican candidate for President John McCain, expressing his ire at those greedy characters on Wall Street. He is supposedly an educated man who somehow missed Adam Smith's Revelation of Free Market Capitalism as driven by greed, invoking an invisible hand to direct something or other. For Smith, an ethicist, this utopian system produces good behavior from its citizens by combining free markets with greed. It is not clear what is meant by free markets, but so far as I can determine Smith meant by good behavior some sort of sheepish conformity to social norms.
In reality the US is not now a capitalist nation, at least not in the classical sense of the word capitalism. Since the time of Reagan (and perhaps nascent since WWII), the US has become a military-socialist nation, or as some call it to point out how this variant of socialism is mechanized, a military-Keynsian nation.
Yet the loudest cries of Market! Market! come from big-defense Republicans, not that they are a singularity in delusions. But their most public genuflecting and invoking of the Free Marketplace to save us all would certainly be a form of idolatry to the Old Testament prophets. Perhaps a visit by a modern prophet to these back-sliders along the lines of Elijah's dealing with the Baal priests in chapter 18 of 1 Kings would be appropriate. Certainly these Republicans have endorsed the prophet Adam Smith, and their religion of the Market is similar to Baal worship in that they think they are offering up their offspring to unbridled government intervention in the Marketplace. It's likely they know as little or less of Smith's work as they know of the Old or New Testament. They decry government spending even as they authorize massive spending projects in the name of National Defense, a perfect example of blind hypocrisy, an inability to see oneself (or to remove the rafter from one's own eye before removing the straw from one's neighbor's).
