Friday, April 04, 2008
“Too big to fail” means...
...someone else is too small to matter.
Government has three ways of paying for its current expenditures. It can tax. It can borrow. It can inflate, creating money and spending it.
Taxation is theft, but it is the most honest of the three methods. It is direct, and the payers usually have a fairly good idea that they are paying, and how much.
Borrowing is paid for, ultimately by either taxation or inflation. (Default is simply a messy way to tax the lenders.)
Inflation is arguably the worst method of financing government expenditures, from the standpoint of the citizen, since it is not uniform and is correctly anticipated only in blackboard models, and hence destructive of capital and the smooth functioning of money. Inflation is economic poison, because it distorts relative prices and confuses everyone's buying and selling decisions.
The U.S. federal government depends on all three methods of financing. Since taxes do not cover our "generous" spending programs, we borrow, primarily from abroad, and we inflate, via the easy money policies of the Federal Reserve. Keep this in mind when you contemplate the Fed’s many bailout programs - purchases of loans that are basically in default - and the federal government’s "stimulus" programs.
Martin Wolf at the Financial Times has a particularly clear account of what the U.S. bailouts mean: the mistakes and losses of private lenders and borrowers are socialized, and become public property. Those of us who did not take on ARMs, either as borrowers or lenders, will pay a substantial portion of the cleanup bill.
I'm thinking now of UC reader Jeff, who me told a number of years back that his co-workers were all taking out ARMs. He was telling them they were insane, that they were signing contracts that they'd never be able to fulfill. I agreed. Stupid us. Now we get to pay. Every politician in sight now has a scheme for us (me, Jeff, and the rest of America that stayed out of unmanagable debt) to bail these idiots out. Great...more federal debt, and inflation, inflation, inflation.
But what does "bailout" mean in a country where the government itself is also in the red? And where the average citizen has negative savings, on net? Brad Setser argues, correctly, that a substantial portion of the burden falls on lenders to the U.S. government, i.e. foreign central banks... which means ultimately upon the poor citizens of emerging economies, such as the Chinese lad pictured here.
Sorry kid. If it's any consolation, they're screwing me too.
Setser's caveat, that some others argue that central bank exchange rate losses on the dollar are irrelevant so long as the external (read U.S.) purchasing power of the dollar doesn't fall, is beside the point, in my view. Inflation Ben will see to that.
There's a good deal of irony in all this. Those who were irresponsible (borrowers and lenders) and therefore are responsible for the mess, and won't be held responsible. Those who behaved responsibly and hence aren't responsible, will be held responsible.
Nice symmetry here, yes?
The linked essays are worth reading.