Guest Post: Why The Full Faith And Credit Of Governments Is Inferior To Real Assets And How We Can Fix It Once And For All

Tyler Durden's picture

Submitted by Robert Paulson

Title: How the USA got to where it finds itself, why the full faith and credit of governments is inferior to real assets and how we can fix it once and for all

I used to think like a statist, and I used to agree with them. It's appealing to redistribute wealth, especially when it's not fairly achieved.

But what I've realized is that the solution to creating distortions in the market is not to create more distortions by attacking the symptoms. What ends up happening when you do that is that you create a hugely complex set of rules and regulations that hinder the market, make it inefficient and most importantly makes it ripe for abuse via regulation in favor of those who make the right campaign donations to the right politicians. This is the situation we find ourselves in now: A very broken market setup to benefit those who've made the right political moves.

On the other hand, you can simply end the sole cause of the problem to begin with. That sole problem is bad monetary policy. You might say that we should replace everyone in charge of the Federal Reserve with the "right" people. But even if you were able to do that, it's really a temporary fix. The issue isn't just having the wrong people in charge, but having so few people in charge of controlling the levers to begin with. Not only does it create a situation ripe for corruption and collusion, but it puts the value of money in the hands of people who are thereby expected to perform satisfactorily. They execute insane policies at the behest of a government and people who cry "DO SOMETHING!"

It is because of this monetary system that our government and the public at large have been able to amass such humongous debts. Because our system is based upon continual growth, its very lifeblood and continued existence hinges upon consistent expansion of GDP and inflationary monetary policy. The continually bad policy experienced off and on since the Nixon administration has a reason: It was masking declining economic factors.

The stagflation the US experienced in the 70s came about for two reasons: The final end to the gold standard and ensuing monetary policy attempting to stimulate the economy in lieu of actual economic activity. The badly implemented normalization of relations with China by Nixon began the trend of sending manufacturing jobs overseas.

All of this combined with the explosion of consumer credit and the financial industry. People were being squeezed by real declines in jobs and wages. With credit, they could afford to get by "until things got better." This paradigm shift from saving to spending created the consumer culture, yuppies and the decade of greed that was the 80s. As a people, we bought into this idea that we could spend our way into prosperity, and it worked for a while. Actually, up until 2007.

Stagflation was ended in the early 1980s when we finally put someone responsible in charge of the Federal Reserve: Paul Volker. He jacked interest rates up to the high teens until he tamed inflation, but an inevitable and deep recession ensued as a result. In the process, bad businesses (and some good ones) went out of business, many people lost their jobs, but in the end that creative destruction brought us back to reality and put the market in position to spring back forward, especially combined with heavy use of consumer credit as well as deep government deficits and increasing debt.

Throughout the 90s, monetary policy was relatively restrained but ever too loose near the end. It ended up assisting the dot-com bubble by allowing it to blow up far further than it ever could've by itself, ending in an unavoidable recession that was a long time coming. Further, during this time period, China began to become a bigger and bigger factor in supplying inexpensive goods to the market at the cost of American jobs and paid for partially with debt. This time, however, the debt explosion was in the private sector as government spending was restrained and the budget balanced by the end of the decade. In effect, the stagnant income and rising costs of the American people were being masked by continually growing private debt.

So what did the Fed do in the early 00s? In the wake up the dot-com bust and resultant recession, the Fed opened the monetary floodgates wide and never looked back. When the recession ended, it didn't tighten policy as it should've, and did so for two reasons. First, housing was becoming the new hot sector and they didn't want to stop the gravy train in the middle of war time. Second, the government had not only implemented hundreds of billions in war spending and failed to pay for it, but it also cut taxes and held them there. These massive deficits and and increasing debt could only be maintained with low interest rates. Basically, the Fed and the government made a bet that the deficits and debt wouldn't matter because they would be matched by a growing economy and inflation.

Unfortunately, the housing market couldn't keep growing with just loose monetary policy. That could only do so much. So what did they do? They deregulated the mortgage market and allowed lenders to go hog wild with cheap money and low lending standards. In a free market, this wouldn't have been such a problem. However, through a combination of fraud and ineptness, the banks were able to make terrible loans, package them up into securities and falsely rate them as AAA when they were really junk. This is the key factor that allowed them to continually make horrible loans with cheap money and reap massive profits in the process. They were able to build a ticking time bomb of epic proportions because there was no one able or willing to stop them. No one wanted to be the party pooper.

The ratings agencies failed or were complicit specifically because their continued existence was not dependent upon performance but by the fact that they were deemed by the government as the agencies of choice. They had government endorsements and had zero incentive to rate much of anything properly. As you can plainly see, all 3 of the official ratings agencies are still the official ratings agencies despite their horrendous performance. Why would we expect such a system to work in our favor?

Meanwhile, the American people were high. There were two wars on they didn't want to think about. Their houses were increasingly growing in value. They bought new and bigger houses with cheap loans. The "flipping" phenomenon went into full swing. People took out huge loans against their already paid down or paid off homes to pay for consumer goods. Jobs were growing on trees. Everyone was living the high life on borrowed prosperity. It was doomed to fail and began doing so in 2007, culminating with the credit crisis in the Fall of 2008 in the midst of a terrible recession. All the way along, the government and the people became as indebted as they'd ever been (the government's exception being during WW2, though that debt was largely held by the American people). As things got worse, the debt levels only increased in the face of declining housing values. Even worse, due to bankruptcy reforms made in the mid-00s at the behest of the major banks, many people became essentially trapped in their debt with no way out.

The most important factor that so few people understand is that this approximately 40-year long process of consumerism based on expanding consumer and government debt hid a very big problem: Decline of true wealth production and rising real energy costs.

The overall loose economic policies during those 4 decades fostered the rise of consumerism and the financial industry's increasing share of the market. In a normal economic environment with sound money, the efficient market allocates wealth towards activities which create wealth. This includes manufacturing, mining and energy production. Instead, because the market was distorted by easy credit, we began a 40-year long bubble of consumption and the financial services to make it possible.

For 40 years, our monetary policy enabled our ignorance of a very real and pressing problem: Other countries were catching up to us in technology and we were no longer in the front of the pack by a mile. Instead of doubling down on education and allowing the market to guide the future, we passed the buck. We decided that a continually rising standard of living without interruption was preferable to tightening our belt and delaying gratification.

Now we find ourselves saddled with ginormous debts and no economic infrastructure with which to grow our way out. We are a late-stage kidney failure patient on dialysis, and we are in terrible need of a transplant.

So how do we fix this?

Sound money, debt forgiveness and a truly free market that isn't guided by the hand of the government and is instead determined by what the aggregate investor pool thinks is the right direction. Gordon Gecko was wrong overall, but he was right that greed is good. The profit motive is the key to good decisions and long-term thinking. That doesn't mean we need to be miserly dickheads who only care about ourselves, but self-enrichment and the unfettered ability to be as successful as possible is the only route to a truly higher standard of living.

You might think gold is a barbarous relic, and I would agree that money based upon a single asset is a terrible idea. Putting all the eggs in one basket is too high a risk. However, a currency based on a multitude of assets, especially complimented by commodities that are the lifeblood of wealth creation (oil for instance, and perhaps corn in America's case), is a superior system in comparison to fiat currency backed by full faith and credit of the government. By using multiple assets, we can even out the distortions that will occur from time to time, essentially making our currency as stable as a rock. Those who produce the assets backing the currency will be induced to find the equilibrium which maximizes profit without over-extending. When we have that foundation, we can move forward with a market free of excessive and cronyism-based regulations and maintain a focus on only those regulations which are necessary to prevent harm that we find unacceptable. In other words, instead of using regulation to guide the economy in a specific direction, we can use regulation to make certain things off limits. It's the difference between steering towards something and steering away. It's far preferable to steer a ship away from an iceberg than to presume that you can steer it through the iceberg.

Most importantly of all, we need to take money out of politics. None of this will matter unless we prevent our politicians from being beholden to campaign contributors. Our current system engenders corruption of even our best, brightest and well-intentioned representatives. They begrudgingly accept the standard which says they must compromise their principles in order to get reelected. My solution is a constitutional amendment which requires all electoral campaigns to be paid for with public funds and prohibits any advocacy of a candidate which extends further than displays of support by private individuals, and a requirement that all such displays be transparent by way of indicating who is responsible for them.

I humbly give you these words and suggestions in the hopes that together we can build an America which is stronger, better and freer. I believe that only through freedom can we accomplish what our hearts desire. Thank you for reading this.