Free Markets vs Intervention


“Everyone wants to live at the expense of the state. They forget that the state lives at the expense of everyone.” — Frederic Bastiat

In my last essay, “Debt and Social Contracts”, it was pointed out that Greece is headed for its “third bailout.” As I write this article, the Dow Industrials are up over 200 points, partially because of the following—”hopes of a Greece deal helped European equities turn higher and U.S. stock index futures extend gains. As soon as a bailout deal is agreed, Greek banks could receive an initial injection of as much as 10 billion euros,” a euro zone official familiar with the situation told Reuters. “The payout could come even before the European Central Bank completes a stress test, the report said.” (Reference: LINK) The question needs to be asked, “What makes this bailout different from the previous two?” Below is a quote from the German Finance Minister after the second Greek ‘bailout.’

“The worst is over in the euro crisis,” German Finance Minister Wolfgang Schäuble said on Friday, praising Greece and expressing confidence that France would master its problems. Asked if the euro crisis would continue to worsen in 2013, Schäuble told German daily Bild: “I think we have the worst behind us. Countries like Greece have recognized that they can only overcome the crisis with hard reforms. I hope the progress will continue. We are moving ahead step by step.”

Source: Spiegel

It was outlined in the last article how Greece’s economy has continued to shrink and its debts worsened since the initial “bailout” in 2010. Just who exactly is benefiting from these bailouts? It certainly is not the Greek economy or the Greek people. The argument could be made that it is the creditors who benefit, as they do not have to endure a write-down on Greek debt instruments. Citizens are stuck with austerity, high taxes, shrinking benefits, and a shrinking economy. What a DEAL! Do creditors, who purchased Greek bonds, not have some responsibility here for having made these loans to a bankrupt government,—or were these creditors banking on the European Union (EU), European Central Bank (ECB), and International Monetary Fund (IMF) backstopping their investment? I believe it is the latter, as interest rates on Greek Debt would normally have been higher, reflecting the real world risk, thus restricting the deficit spending of the Greek Government. The point being, we do not have free markets in operation here. Intervention by technocrats is occurring, preventing the free market from operating. This intervention has allowed Greek politicians to promise more than they could deliver leaving the average Greek citizen trapped in debt slavery.

Americans would be surprised to discover that on a per taxpayer basis, they are more indebted than the Greeks. The individual American taxpayer’s portion of the $18 trillion federal debt is $154,161. This figure has more than doubled since 2004, when it was $72,051. The ratio of U.S. federal debt to GDP, GDP (gross domestic product) being the total amount of goods and services created by the U.S. economy, has grown from 35.4% in 1980 to 102% today. (Reference: LINK) The United States is losing ground,—fast. In raw numbers, we have become the most indebted nation in the history of the world, yet we only comprise 4.4% of the world’s population. As our politicians legislate more social programs and benefits, they promote the U S as the richest nation on earth. I suppose, if you consider debt to be wealth, it would be true. Ironically, this may be the case. How have we gotten here, and is this sustainable?

A short explanation is that the United States Dollar’s (USD’s) dominate roll as a reserve currency has allowed the U.S. to run large and persistent trade deficits,—and as a result, fiscal deficits. When businesses enterprises in foreign countries sell products to the U.S., they are paid in USDs. As the U.S. dollar is not the legal tender of a foreign country, a business enterprise must exchange USDs for the local currency in order to conduct business in their country of origin. Foreign central banks that end up with these dollars use them to purchase the debt instruments (treasuries) of the U.S., thus helping finance our fiscal deficits. Foreign countries hold these debt instruments as reserve assets accumulating interest until such time as they mature, or are liquidated for their own purposes. In effect, large trade deficits help enable and fuel our fiscal deficits. This could be described as economic incest. This relationship is not sustainable over time. If it were, the U.S. could create debt to infinity to finance trade and fiscal deficits.

How did we start down this road? The fact is, a self-regulating mechanism, the Bretton Woods system, was suspended by fiat in 1971 by Richard Nixon. He had no choice, as there was a run on U.S. gold reserves. The U.S. was printing more currency than gold held in reserve. The money printing binge was being used to pay for the Vietnam War and a myriad of new social programs. This ended a partial gold standard governing world trade. In 1974, the dollar was —, again, — tied to a commodity,—oil. Henry Kissinger helped negotiate an arrangement with OPEC where the USD was required for all trade of oil, resulting in a huge demand for dollars,—the petrodollar was established. Since the USD was backed by nothing since ’71 and had been floundering, the 1974 agreement was a stroke of genius. Although, this was genius, it is not self-regulating, and has helped precipitate the debt crisis we face today.

What function did a gold standard serve? How the gold standard operated is best described in a book by Richard Duncan, “The Dollar Crisis — Causes, Consequences, Cures” — copyright 2003 — pages 8 & 9. “The gold standard prevented imbalances in countries’ trade accounts through a process that acted as an automatic adjustment mechanism. A county experiencing trade surpluses would accumulate more gold, since gold receipts from exports would exceed gold payments for imports. The banking system of the surplus country would create more credit, as more gold was deposited into the country’s commercial banks. Expanding credit would fuel an economic boom, which in turn, would provoke inflation. Rising prices would reduce that county’s trade competitiveness, exports would decline and imports rise, and gold would begin to flow out again. Conversely, counties with trade deficits would experience an outflow of gold. As gold left the banking system, credit would contract. Credit contracting would cause a recession, and prices would adjust downward. Falling prices would enhance the trade competitiveness of the deficit country and gold would begin to flow back in, until eventually, equilibrium on the balance of trade would be re-established.”—”Under the gold standard, trade imbalances were both unsustainable and self-correcting. They were unsustainable because of recessionary pressure they brought about in the deficit country. At the same time, they were self-correcting through changes in the relative prices of the two countries.”

The gold standard was a simple, yet elegant system that was immune to outside intervention when allowed to operate in a free market. It was a process that forced a balance in trade through the pricing mechanism, both for money (interest on capital) and goods & services between countries. At the same time, governments and politicians were constrained by the market place, had to remain cognizant of the ebb and flow of the business cycle, and understand that financial resources where limited,—meaning they could not print or borrow their way out of irresponsible decisions. But, of course, politicians do not wish to be fiscally constrained. They prefer control and intervention over free markets. The only problem is,—when the amount of money available is infinite, the demand for it will be infinite,—until a crisis arises,—then it is someone else’s fault. The following is a quote from EU President, Jean-Claude Juncker. Would you trust this individual in any financial negotiations? “When it becomes serious, you have to lie.” ― Jean-Claude Juncker (Reference: LINK)

We must add one more caveat. Foreigners own approximately 34.4% of U.S. debt, while 65.6% of our debt is domestic. The following is a breakdown of who owns domestic debt. “Social Security owns about 16% of the debt followed by other federal government entities (13%), and the Federal Reserve (12%).” (Reference: LINK)

How can government entities own their own debt? This brings us back to the question, “Is debt money?” Also, how long will foreign governments and central banks be content to buy and hold U.S. debt as their holdings are diluted via the digital printing press? It is an unsustainable cycle of debt.

Freedom, and economic freedom are inextricably tied together. There cannot be one without the other. Ask the Greeks. There has to be a change of course if we, as a people, are to remain free. Should we remain complacent, and accept the status quo, debt slavery will be our future. It is inevitable.