Why Government Deficits and Debt Do Matter, Richard Ebeling

The Congressional Budget Office (CBO) reported in early May that for the month of April 2015 the Federal government ran a budget surplus, taking in more in taxes than it laid out in expenditures. Don’t be fooled by one month, especially when it was a month when people filed and pay their taxes. Government deficits and growing debt are on the horizon for as far as the human eye can predict.

Yes, for right now the trillion-dollar-a year budget deficits that marked the first years of the Obama Administration have abated. For 2015 through 2017, the CBO projects that Washington’s budgetdeficits will be “only” in the range of $468 billion and $489 billion per year.

But after that, given current “entitlement” legislation for such programs as Social Security, Medicare and ObamaCare, the annual budget deficits will start rising again after 2017, and will be over a trillion dollars once more in 2025.

The CBO calculates that by 2025 these more “modest” annual budget deficits will cumulatively add over $7.5 trillion to the existing $18.3 trillion of Federal government debt, for a total a decade from now of almost $26 trillion. This will be more than a 40 percent increase in the Federal government’sdebt over the coming ten year period.

The per capita government debt burden for every American in 2015 is estimated to be about $58,000. In ten years, in 2025, based on demographic estimates of U.S. population growth, that per capita debt burden will have increased to nearly $78,000, for an almost 35 percent increase, while the U.S. population will have only increased by around 8 percent over the decade.

The Government’s Burden Equals What is Taxed and What is Borrowed

Does it matter that the government funds part of its expenses through deficit financing instead of simply raising taxes to cover all of its expenditures? Noble prize-winning free market economist, Milton Friedman (1912-2006), was adamant that what mattered was what government spent, not how it raised the money to pay for it:

“Keep you eye on one thing and one thing only, how much government is spending, because that’s the true tax . . . If you’re not paying for it in the form of explicit taxes, you’re paying for it indirectly in the form of inflation or in the form of borrowing. The thing you should keep your eye on is whatgovernment spends, and the real problem is to how down government spending as a fraction of your income, and if you do that, you can stop worrying about the debt.”

If the government taxes the citizenry, the dollars collected and the real resources those dollars have buying power over in the marketplace are transferred from private sector hands to the hands of Uncle Sam, who then decides for what they will be used.

But this is no less the case when the government borrows dollars in financial markets to cover part of its expenses in excess of collected taxes. Instead of a private borrower borrowing those dollars and using the real resources those dollars can buy in the marketplace for investment, capital formation or other purposes, the government borrows them and uses the real resources that can be bought with them for its own political-oriented goals and ends.

Either way, the total amount of the income and resources of the society transferred out of private hands and into the hands of the government is represented by the total spending by thatgovernment, even if part has been taxed and part has been borrowed.

Friedman once asked the question: Which is preferable, a situation under which the governmenttaxes and spends $800 billion with a balanced budget; or a situation in which it taxes $400 billion and borrows $100 billion for a total of spending of $500 billion, with a budget deficit?

In terms of the total extraction of wealth and income from the members of society by government, clearly its siphoning off $500 billion is preferable to it taking and using $800 billion of the resources and products produced through the peaceful and productive efforts of the citizen-taxpayers, Friedman reasoned.

America’s Former Balanced Budget Fiscal Rule, and Its Benefits

However, while it may be true that whether the government taxes or borrows the taxpayer-citizens are poorer by that total amount, it is nonetheless the case that government following a balanced budget rule versus a budget deficit expedient has a huge political difference on the institutional ease or difficulty of government growing over time.

Many years ago, Noble Prize economist, James M. Buchanan (1919-2013), and his colleague, Richard Wagner, wrote a book on Democracy in Deficit (1977). They pointed out that during the first 150 years of the United States, the Federal government followed what they referred to as an “unwritten fiscal constitution.”

There is nothing in the U.S. Constitution that requires the government to annually balance its budget. Such a balanced budget “rule” for managing the government’s spending and taxing was considered a way to assure transparency and greater responsibility in the financial affairs ofgovernment.

It was argued that a balanced budget made it easier and clearer for the citizen and the taxpayer to compare the “costs” and “benefits” from government spending activities.

Since each dollar spent by the government required a dollar collected in taxes to pay for whatever the government was doing, the citizen and taxpayer could make a more reasonable judgment whether they considered any government spending proposal to be “worth it” in terms of what had to be given up to gain the supposed “benefit” from it.

The trade-off, was explicit and clear: any additional dollar of government spending on some program or activity required an additional dollar of taxes, and therefore, the “cost” of one dollar less in the taxpayer’s pocket to spend on some desired private-sector use, instead.

Or if taxes were not to be increased to pay for a new or expanded government program, the supporter of this increased spending had to explain what other existing government program or activity would have to be reduced or eliminated to transfer the funds to pay for the new proposed spending.

There was an exception to this balanced budget rule, and that was a “national emergency such as a war, when government might needed large amount of extra funds more quickly than they could be raised through higher taxes.

But it was also argued that once the national emergency had passed, the government was expected to manage its finances to run budget surpluses, taking in more than it spent each year. The surplus was to be used to pay off the accumulated debt as quickly as possible to relieve current and future taxpayers from an unnecessary and undesirable burden.

Amazingly, in retrospect, this actually was the fiscal rule and pattern followed by the United Statesgovernment throughout the nineteenth century and into the twentieth century until the Great Depression in the 1930s.

CBO deficits

The Keynesian Call for Budget Deficits to “Stimulate” the Economy

However, starting with the 1930s, this unwritten fiscal constitutional was permanently overturned as part of the Keynesian Revolution. It was argued that the government should not balance its budget on a yearly basis. Instead, the government should balance its budget “over the business cycle.”Government should run budget deficits in “bad” years (recession or depression) and run budget surpluses in “good” years (periods of “full employment” and rising Gross Domestic Product).

This new “rule” of a balanced budget over the business cycle became a generally accepted idea for fiscal policy among many economists and government policy makers.

However, there has been one major problem with this alternative conception of the role and method of managing government spending and taxing: During the 70 years since the end of the Second World War in 1945, the U.S. government has run budget deficits in 58 of those years and had budget surpluses in only 12 years.

Hence, as Buchanan and Wagner referred to it, “democracy in deficit.”

With the elimination of the balanced budget “rule” as the guide for fiscal policy, it has been possible for politicians to create the economic illusion that is it possible to give voters “something for nothing” – a “free lunch.”

The Fiscal Illusion of Giving Voters Partly “Something for Nothing”

Politicians have been able to offer more and more government spending to special interest groups to obtain campaign contributions and votes in the attempt to be elected and re-elected to political office.

They can offer benefits in the present in the form of new or additional government spending, but they no longer have to explain where all the money will come from to pay for it. The “costs” of that deficit spending is be paid for by some unknown future taxpayers in some amount that can be put off discussing until that “some time” in the future.

Thus, politicians can supply benefits in the present – “now” – to targeted groups whose votes are wanted on election day, and avoid answering how the money will be paid back (with interest) because that can be delayed until the future – a period later in time, years ahead, when someone else will hold political office and will have to deal with the problem.

It is not as if the danger from unrestrained government borrowing was never warned about before John Maynard Keynes (1883-1946) made deficit spending a “virtue” in the name of “stimulating” the economy in his famous book, The General Theory of Employment, Interest, and Money (1936).


The Deficit Monster Cartoon

 Warnings about Deficits and Government Debt from Long Ago

The famous Scottish philosopher, historian and economist, David Hume (1711-1776), expressed the danger in his essay, “Of Public Credit” (1741), over two hundred and fifty year ago:

“It is very tempting to a minister [in the government] to employ such an expediency, as enables him to make a great figure during his administration, without overburdening the people with taxes, or exciting any immediate clamors against himself. The practice, therefore, of contracting debt will almost infallibly be abused, in every government. It would scarcely be more imprudent to given a prodigal son a credit in every banker’s shop in London, than to empower a statesman to draw bills[borrow money], in this manner, upon posterity.”

And almost 150 years ago, the American economist, Dudley Baxter (1827-1875), very clearly contrasted the incentives at work on those running for and holding political office when the institutional rule is a balanced budget versus deficit spending and accumulated debt in his book, National Debts (1871):

“When money is raised by taxation within the year for which it is needed, the amount that can be raised is limited by the tax-enduring habits of the people, and must be as small as possible in order not to provide discontent [among the voters]. By the same reason it must be spent economically, and made to go as far as possible.

 “But when the money is raised by loans, it is limited only by the necessity of the interest [payment] not to be too large for the taxable endurance of the people, or provoking their discontent. Hence the limits of borrowing are about twenty times larger than the limits to taxation, and an amount that is monstrous as a tax, is (apparently) a very light burden as a loan. In consequence, borrowing is freed from the most powerful check that restrains taxation . . .

 “When a loan is obtained the reason for economical expenditure is equally wanting, and borrowed money is commonly expended with much greater profuseness, and even wastefulness, than would be the case with taxes.”

Keynesian Economics served as an additional and powerful rationale for politicians to do what they like to do: spend other people’s money. In the process, it pushed aside the warnings of those like David Hume and Dudley Baxter, and many other economists, who understood clearly the dangers of unrestricted government authority to both tax and borrow.


Children Pulling Big Government Cartoon

 The Moral Dimension of Government Debt Financing

There is an additional moral dimension to the issue of government deficit spending and its resulting accumulation of debt. This was a theme especially addressed by economist, James M. Buchanan.

Normally, when a private individual or enterprise undertakes debt financing of some portion of his current expenditures, the legal obligation to pay back the contracted principle and interest falls upon the borrower. If he defaults or passes away before repayment of all that had been borrowed, creditors have a lien on the borrower’s positively valued assets.

The “benefits” of having the use of a greater sum of money in the present than his own income would enable him to spend, imposes on the borrower a “cost” of an obligation to pay back the loan out of his future income and assets. The cost and the benefit are linked together within the same person.

It is not the same, Buchanan argued, with government deficit spending and repayment of accumulated debt:

“If I borrow $1,000 personally, I create a future obligation against myself or my estate in the present value of $1,000. Regardless of my usage of the funds, I cannot, by the act of borrowing, impose an external cost on others. Unless I leave positively valued assets against which my debts can be satisfied, my creditors cannot oblige my heirs to pay off their claims.

 “By contrast, suppose I ‘vote for’ an issue of public debt in the amount of $1,000 per person. I may recognize that this debt embodies a future tax liability on some persons, but I need not reckon on the full $1,000 liability being assigned to me. If I leave no positively valued assets, the government’s creditors can still enforce claims on my progeny as members of the future-period taxpaying group.

 “Further, the membership in the taxpaying group itself shifts over time. New entrants, and not only those who descend directly from those of us who make a borrowing-spending decision, are obligated to meet debt, interest and amortization charges.

“In sum, the institution of public debt introduces a unique problem that is usually absent with private debt; persons who are decision makers in one period are allowed to impose possible financial losses on persons in future generations. It follows that the institution [government] is liable to abuse this and overextend its borrowing practices. There are moral and ethical problems withgovernment deficit financing that simply are not present with the private counterpart.”

Government debt is a way to impose part of the cost of what special interest group voters and politicians want “today” on those who “tomorrow” will have to be taxed to pay back the borrowed money.

Even if a current recipient of such governmental deficit spending largess is, himself, one of the future taxpayers, he is usually likely to have received a greater benefit than his personal portion of the future tax burden. Suppose that he is a farmer, for instance, who receives “today” $100,000 from the government for not growing a crop. When “tomorrow” comes and taxes have to be raised to pay back that $100,000 to the creditors who lent that sum to the government, that particular farmer’s additional tax burden will be a small fraction of that total amount.

To continue with the same example, many farmers who may have benefited from agricultural price-support programs decades ago have passed away. The burden of paying back whatever portion of that farm price support spending originally financed by deficit spending now falls upon others who even may not have been born at the time the recipient received this special privilege from thegovernment.

What is the ethics, James Buchanan asked, of a fiscal system under which incentives exist and come into play that enable the current generation of taxpayers and recipients of government programs to shift part of the burden to pay for them to future generations? Is that a culturally and economically healthy legacy to leave to our children and grandchildren?


Bailing Out Before Debt is Due cartoon

 The Importance of Balanced Budgets and Debt Limits

This is why it would desirable to incorporate a balanced budget amendment into the U.S. Constitution. It would not guarantee that government did not tax and spend more. But it would impose a greater clarity and transparency to the fiscal dimension of government decision-making that would make it far more difficult for those offering other people’s money in exchange for votes to do so without having to also explain who would be paying for the favors and privilege given to some, and how much they would have to pay.

In lieu of adding such an amendment to the Constitution, it is imperative that the Congress does not give up its authority to raise the Federal debt limit. While raising the debt limit has become more or less a rubber stamp after a number of congressmen make some verbal objections to moregovernment borrowing, the fact is if Congress were to ever have sufficient pressure from voting constituents to say, “NO,” that very act would impose a balanced budget on the Federalgovernment. Since once Uncle Sam had reached the hard debt limit, he would only be able to spend what he had taken in taxes.

This, combined with a strong educational and political campaign to reawaken the principles and ideals of individual liberty and limited government can bring the seemingly the unlimited growth in the size and scope of government to a halt.

Once halted, then a repeal and retrenchment drive can begin to reverse that size and scope of Big Government so to restore a society of freedom grounded in individual rights and economic liberty.

America’s Endless War Over Money, K. Granville and B. Applembaum (via NYT, 08/04/2015)


The “Audit the Fed” debate is the latest manifestation of a conflict as old as the nation, between those who argue that a strong central bank improves economic stability, and those who see an overbearing government engaged in harmful meddling.

Some Background: Strong vs. Weak Currency

Battles over central banking have historically pitted financial elites who wanted to limit the availability ofmoney, thus preserving its value, against farmers, businessmen and other borrowers who wanted money to be plentiful — and cheap. Each side has sometimes regarded the central bank as its great ally in that fight, and sometimes as its bitter enemy.

Since the Great Recession the Fed has mostly sided with the borrowers, creating vast amounts of newmoney and holding short-term interest rates near zero. Inevitably, that has angered creditors, and sparked efforts to swing the pendulum in the other direction.


A cartoon satirizing Andrew Jackson, shown raising a cane labeled “veto,” and his battle against the Bank of the United States and its supporters among state banks.

1. A Philadelphia Story: The Banks of the United States

The nation’s first two central banks, both called the Bank of the United States, were private, for-profit organizations chartered by Congress. The first (1791-1811) was created to help the government pay its Revolutionary War debt, stabilize the country’s currency and raise money for the new government. It was the dream of Alexander Hamilton, secretary of the Treasury, who overcame resistance from Thomas Jefferson (who wrote “I believe that banking institutions are more dangerous to our liberties than standing armies”) and other Southern lawmakers. When its 20-year charter expired, Congress chose not to renew it.

The Second Bank of the United States was chartered a few years later, in the aftermath of the War of 1812, after Congress decided it had a mistake. But it lasted just 17 years. President Andrew Jackson said the bank concentrated too much economic power with a corrupt moneyed elite and vetoed a bill to extend its charter in 1832. Supporters of the the bank rallied around Henry Clay, Jackson’s opponent for reelection that year, but the “Bank War” ended when Jackson won easily. United States Treasury funds were withdrawn and deposited in state banks; the nation would be without a central bank for more than 70 years.

The headquarters of both banks still stand about a block apart in downtown Philadelphia.

“The bank is trying to kill me, but I will kill it!”—Andrew Jackson.



Crowds gather across the street from a failed New York bank in 1908. CreditGeorge Grantham Bain Collection/Library of Congress

2. Perpetual Panic: Life Without a Central Bank

A severe financial crisis drove the economy into a deep recession in 1837, just one year after the demise of the Second Bank. Such crises became a recurring event in American life and, as the economy grew, so did their size and the frequency. Banks created the New York Clearing House as a private-sector backstop, but it proved inadequate for the task. The government also was hamstrung. In the absence of a central bank, the United States regulated the value of its currency by guaranteeing that dollars could be exchanged for gold, and sometimes silver. This meant the government could not respond to financial crises, and the resulting economic downturns, by increasing the supply of money.

In 1907, yet another crisis was brought about by a failed attempt to corner the stock of the United Copper Company. Government officials and financial executives jerry-rigged a response: an emergency lending pool orchestrated by J. Pierpont Morgan. But the crisis proved to be a tipping point in the political debate about the need for a central bank. There was a growing political consensus that Wall Street needed a permanent fire department.

“Unless we have a central bank with adequate control of credit resources, this country is going to undergo the most severe and far reaching money panic in its history.”—Jacob Schiff, a prominent New York banker, in 1907



President Woodrow Wilson signing the Federal Reserve Act of 1913, in a painting by Wilbur G. Kurtz Sr. He is surrounded by members of his cabinet and Congressional leaders. CreditWoodrow Wilson Presidential Library, Staunton, Va.

3. Third Time’s the Charm: The Federal Reserve Act of 1913

In November 1910, Senator Nelson Aldrich met with a group of bankers at a resort on Georgia’s Jekyll Island and hammered out a plan for a new central bank. The idea touched on many of the great political battles of the age: The states against Washington; Wall Street financiers against smaller banks, particularly in the South and West; populists against the Gilded Age elite. The bill that emerged from several years of debate, signed by President Woodrow Wilson, was an awkward compromise: There would be 12 privately owned reserve banks in major cities across the country, preserving the power of financial elites. But the banks would be overseen by a board of presidential appointees, including the Treasury secretary, granting the public a new measure of control over the financial system.

Before the Fed was fully established, however, the old system took a final bow. A financial crisis struck in 1914, and roughly twice as many banks failed as in 1907.

“We shall deal with our economic system as it is and as it may be modified, not as it might be if we had a clean sheet of paper to write upon; and step by step we shall make it what it should be.”—Woodrow Wilson, from his first inaugural address



In 1933, after some banks limited withdrawals to 5 percent or less, customers waited to enter the National City Bank in Cleveland. CreditAssociated Press

4. Recession and Response

Instead of preventing crises, the Federal Reserve helped to cause the Great Depression. The Fed was supposed to manage the gold standard — to make sure the economy was not choked by a lack of moneyand a resulting spike in interest rates. Instead, the Fed was paralyzed by disagreements between regional banks and the central board. It let the money supply shrink by one-third. The result was the worst economic crisis in the nation’s history.

Congress responded to the Fed’s failure by greatly increasing its power and responsibilities. In 1934 it authorized the president to devalue the dollar, beginning the long process of replacing the gold standard with a currency whose value is managed by the Fed. In 1935 it gave the Fed responsibility for “the general credit situation of the country.” The act also removed the Treasury secretary from the Fed’s board and created a new policy-making committee where board members would outnumber reserve bank presidents.

“I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”—Ben Bernanke, then a Fed governor, in a 2002 speech addressing Milton Friedman and Anna Schwartz.



The Federal Open Market Committee in 1966, led by the Fed chairman, William McChesney Martin, seated center. CreditFabian Bachrach

5. The Long Road to Independence

The central bank now had the freedom to encourage growth by printing money, and the responsibility not to print too much. Politicians who were focused on short-term problems were quick to demand money and, for the next several decades, the Fed hesitated to say no.

In 1942, at the request of the Treasury Department, the Fed agreed to hold down interest rates on government bonds to help finance military spending for World War II. It kept rates low for almost a decade, through the beginning of the Korean War, until rising inflation finally induced the Treasury to sign a 1951 accord affirming the Fed’s autonomy to raise rates.

In the 1960s, Wright Patman, a populist Democrat congressman from Texas and chairman of the House banking committee, repeatedly introduced legislation to roll back the Federal Reserve Act of 1913, maintaining that, in the Fed, “a body of men exist who control one of the most powerful levers moving the economy and who are responsible to no one.”

And in 1965, President Lyndon B. Johnson, who wanted cheap credit to finance the Vietnam War and his Great Society, summoned Fed chairman William McChesney Martin to his Texas ranch. There, after asking other officials to leave the room, Johnson reportedly shoved Martin against the wall as he demanding that the Fed once again hold down interest rates. Martin caved, the Fed printed money, and inflation kept climbing until the early 1980s.

“I hope you have examined your conscience and you’re convinced you’re on the right track.”—Lady Bird Johnson, spoken to William McChesney Martin, on his arrival at the LBJ ranch.



Paul A. Volcker, shown in 2009. He was appointed Fed chairman in 1979 with the task of controlling galloping inflation. CreditBrian Snyder/Reuters


6. The Volcker Rule: An Independent Central Bank

Congress finally formalized its demands in 1978. A recession in the mid-1970s had pushed the unemployment rate as high as 9 percent, and Democrats, frustrated by what they saw as the Fed’s inadequate response, won passage of legislation establishing the so-called dual mandate. The Fed was instructed to pursue maximum employment and price stability.

It turned out to be a high-water mark for Congressional interference. Inflation rose by 11 percent the following year, and President Jimmy Carter agreed to appoint a new Fed chairman, the independent-minded Paul A. Volcker. Over the next several years, Mr. Volcker would raise interest rates sharply, driving the economy into a deep recession but ultimately bringing inflation under control. President Ronald Reagan, meanwhile, made a point of respecting the Fed’s independence. Volcker was still subjected to sharp Congressional pressure, but it was mostly political theater. The Fed had declared its independence.

“Every time he had a press conference somebody was urging him to take a slap at the Federal Reserve, but he never did.”—Paul Volcker, referring to President Reagan.



Ben Bernanke, the Fed chairman, takes questions from reporters at an April 2011 news conference. CreditJim Watson/Agence France-Presse — Getty Images


7. Smokescreens and Sunshine: The Fed Opens Up

Between the great inflation of the early 1980s and the Great Recession that began in 2008, the Fed and the economy enjoyed more than two decades of relative peace and quiet, a period that Fed officials sometimes call the Great Moderation. Inflation trended downward and, except for a few short recessions, unemployment stayed down too. And Fed officials came to see these trends as a validation of their newfound independence.

The Fed also began to change its secretive culture. The trend began reluctantly, under pressure from critics who argued that independence required transparency. In 1983, for example, the Fed promised Congress that it would begin to release its Beige Book, a summary of economic reports from its regional reserve banks, as a way of distracting attention from more important reports that it was determined to keep secret. But the Fed gradually concluded that transparency could increase the power of monetary policy. In 1994, it began to announce changes in policy at the end of each policy-making session. In 2004, it began to publish edited accounts of its discussions three weeks after each session. And in 2011, its chairman, Ben S. Bernanke, began to hold quarterly news conferences.

“Since I’ve become a central banker, I’ve learned to mumble with great coherence. If I seem unduly clear to you, you must have misunderstood what I said.”—Alan Greenspan, Fed chairman, in 1987, before the central bank’s communications revolution.

“The Federal Reserve is the most transparent central bank to my knowledge in the world. We have made clear how we interpret our mandate and our objectives and provide extensive commentary and guidance on how we go about making monetary policy decisions.”—Janet L. Yellen, Fed chairwoman, in 2014, after the communications revolution.



Protesters in April 2009, outside an event where Ben Bernanke, the Fed chairman, was speaking. CreditJason Miczek/Reuters


8. The Great Recession, and ‘Audit the Fed’

The Fed’s long run as a political darling came to a crashing end in 2008. Its lax oversight of the financial system was one reason for the severity of the crisis, and the smartest guys in Washington had failed to see it coming. The Fed’s response was also controversial: It provided expansive support for the financial system, preserving some of America’s least popular companies, not to mention foreign banks. And then it embarked on an expansive stimulus campaign to revive the economy.

In the aftermath of the crisis, Congress moved quickly to strengthen the Fed’s regulatory responsibilities. It also imposed some limits on the Fed’s ability to repeat its rescue of the financial system. But it is the stimulus campaign that has prompted the most controversy.

In an inversion of the historical pattern, congressional Republicans have criticized the Fed for printing too much money, arguing higher inflation will be the inevitable consequence. And they have put forward proposals to constrain the central bank. One bill, known as “Audit the Fed,” would authorize the General Accountability Office to review the Fed’s monetary policy decisions. Another approach, backed by the House Financial Services Committee, would require the Fed to publicly articulate a set of rules it intends to follow in making monetary policy, and then explain any deviations.

“The Federal Reserve System must be challenged. Ultimately, it must be eliminated. The government cannot and should not be trusted with a monopoly on money. No single institution in society should have power this immense.”—From End the Fed (2009) by Ron Paul.

The Greek Monetary Back-Story, Jim Grant  (17/02/2015)

Raging against its German creditors, the new Greek government is demanding reparations for Nazi-era depredations. Herewith—from the Grant’sarchives—some timely context both for the Greek negotiating position and the underlying monetary issues.

(Grant’s, February 24, 2012) “Statements and assurances from Greece are no longer taken at face value,” a German economics professor, Wolfram Schrettl, has remarked. “Who will ensure afterward that Greece continues to stand by what Greece is agreeing to now?” the German finance minister, Wolfgang Schäuble, has demanded.

Such expressions of German disdain ignite a special kind of fury in Greece. While 21st-century Greek fiscal and financial management may leave a little something to be desired, the record of German monetary stewardship in the Hellenic Republic is supremely worse. During Nazi occupation in World War II, Greece suffered famine, pestilence, wholesale killings and hyperinflation. The last-named plague is the topic at hand.

Let bygones be bygones, they say, and well they might say it in Europe, the land of ancient enmities. However, there can be no understanding the present-day Greek sensitivity to its high and mighty creditors without a rudimentary knowledge of the German-inflicted catastrophes of 1941-44. Nor can there be a full and proper appreciation of the risks inherent in paper money without a basic grounding in such abominations as the occupation-era Greek drachma or, for that matter, the post-occupation drachma—for the liberated Greek central bank took up where the German-corrupted central bank left off. Fiat currency can’t seem to help itself. The insubstantial monetary material sooner or later goes up in smoke, no matter whose hand cranks the presses. These days, of course, the cranking hand is a technocratic one. “Quantitative easing” is the anodyne phrase. Yet in peace as in war, gold is the preferred refuge from state-imposed paper currency.

According to Mark Mazower’s scholarly history, “Inside Hitler’s Greece: The Experience of Occupation, 1941-44,” between 250,000 and 300,000 Greeks died from famine at the hands of the German overlords. “In reality,” Mazower writes, “there was no deliberate German plan of extermination.” The extermination that did occur was rather the result of the calculated destruction of the Greek economy and the stripping of the Greek larder for the Axis armies, the German one in particular. “Who is Mr. Schäuble to revile Greece?” the 82-year-old president of Greece, Karolos Papoulias, demanded last week in response to the German finance minister’s slighting comments about the country for which a teenaged Papoulias fought in World War II.

Famine was a certain, if not deliberately sought, consequence of German occupation policy, but there was nothing accidental about the destruction of the drachma.The German-controlled Bank of Greece printed up the national currency as the need arose. In the opening months of 1941, before the Germans (and the Italians and Bulgarians) came to stay, a British sovereign was worth 1,200 drachmas. As the Germans cleared out, in November 1944, blowing up railroad tunnels, rolling stock, harbors and such as they left, a sovereign commanded 71 trillion drachmas.

A sovereign is a gold coin weighing not quite one-quarter ounce—to be exact, 0.23542 troy ounce. When Britain was on the gold standard, a sovereign was worth one pound sterling, and it circulated as the people’s money. It was a popular coin in Greece, too, as Britain and Greece had joined monetary forces in 1928. Three years later, Britain went off the gold standard, and in 1932, Greece and Britain ended their so-called stabilization relationship. Cut loose from gold, the paper pound began its long descent in purchasing power measured in gold. However, from the Greek vantage point, paper sterling was a better anchor for the drachma than no anchor at all, and in 1936 the Greeks re-lashed their currency to Britain’s, at the rate of 548 drachmas to the pound.

Fast-forward now to the outbreak of war in Europe in 1939. As the pound came under new inflationary pressure, so did the drachma. In Athens, the cost of living was accelerating well before Hitler mounted his attack on Greece in April 1941. In 14 months of neutrality, prices in the Greek capital had jumped by 15%.

Nowadays, Germany is the national face of monetary and fiscal rectitude. It wore a different face in wartime Greece, though the German army of occupation did observe some of the basic commercial forms. “Rather than requisition all required goods and facilities,” write Dimitrios Delivanis and William C. Cleveland in their “Greek Monetary Developments, 1939-1948,” “the occupation armies usually preferred to pay with newly created currency.”

The German visitation lasted for 3-1/2 years, but the real monetary damage was done in the first 18 months. In April 1941, an index of the cost of living in Athens registered 116. In October 1942, the same index stood at 15,192, a gain—if that’s the word—of almost 13,000%, or an average monthly rate of rise of 722%, according to Delivanis and Cleveland. It didn’t help the price picture that the Greek economy was crippled or that the Germans were making off with whatever wasn’t nailed down to aid the Axis war effort. What, especially, didn’t help the price picture was the breakneck growth in the local money supply, up roughly 10-fold between May 31, 1941, and Oct. 31, 1942, or the fact that, in 1942-43, newly printed drachmas financed 81% of public expenditures.

During this first act in the play of the death of the drachma, the currency’s domestic purchasing power fell by 99.34%, its external purchasing power—expressed in terms of the gold sovereign—by 99.73%. These facts we commend to the 21st-century gold bulls on those discouraging days when the eternal monetary metal seems to trade as a proxy for the euro. It isn’t the euro, after all, but almost the opposite. It is money, the genuine article.

“It must be concluded,” write Delivanis and Cleveland, “that the almost complete collapse of the value of the drachma, both internally and externally, was largely the result of enemy exploitation. The enemy occupation authority seized all stocks of commodities that were discovered, exploited for its own benefit the productive facilities and capital equipment of the country, confiscated and exported as much as possible of the current production, and extorted, as occupation costs, payments equivalent to 7,674 million prewar drachmas between May 1, 1941, and March 31, 1942, 2,287 million prewar drachmas between April 1, 1942, and Oct. 31, 1942.”

No bear market is complete without a trick rally, an Act II, and the terminal decline in the Greek currency was no exception. News of the Allied victory at El-Alamein in October-November 1942 caused a rush out of gold into scrip. A sovereign had fetched 37,144 drachmas before the battle that Churchill famously characterized as not the end of the war, nor even the beginning of the end of the war, but, “perhaps, the end of the beginning.” By February 1943, it took just 14,180 drachmas to buy a sovereign—as it turned out, not a bad entry point for the final move up to an average of 71 trillion.

Act III of the eradication of the drachma resembled Act I but with the addition of many more commas and zeros to all the significant currency and inflation data. Hopes of early deliverance from the Nazi occupation dashed, Greeks resigned themselves to the likelihood of a replay of the Weimar inflation of 1922-23, an earlier episode of German-directed monetary chaos. As noted, the Athens cost-of-living index stood at 116 on the eve of the German occupation. It registered 76,171 in November 1943 and 18,850,000,000,000 in the first 10 days of November 1944.

“During the final period of the enemy occupation of Greece,” the Delivanis and Cleveland account continues, “the index of note issue by the Bank of Greece rose to fantastic heights. During the period of 18 months and 10 days [i.e., May 1943 til Nov. 10, 1944], the index increased in magnitude 11,214,823 times, i.e., from 7,368 to the value of 82,630,830,289. The total increase in the period was 1,121,482,300%, representing an average monthly increase of more than 62 million percent as compared with the average monthly increase of 60% during the first period of enemy occupation from May 1941 to October 1942, and the average monthly increase of only 22.5% during the succeeding period from November 1942 to April 1943. The tremendous expansion of the note issue was caused by the growth of public expenditures, principally on account of the enemy occupation and by the cumulative, self-reinforcing effects of monetary inflation.” Toward the end of the German stewardship, the Bank of Greece printed 99% of the receipts of the Greek treasury.

Gold and foreign bank notes were the de facto coin of the realm. The British Middle Eastern forces funneled an estimated 700,000 sovereigns to Greek guerillas. And the Germans, in a vain attempt to tamp down the raging inflation rate, sold gold in exchange for drachmas—as many as 1,300,000 sovereigns in 1943 and 1944. It was the bright idea of the head of the German economic mission to Greece, Hermann Neubacher, to drop sovereigns on the Greek market to try to buck up the drachma. “Astonished Greek businessmen started to question, should we be buying gold, or selling it ourselves?” relates Michael Palairet in his history, “The Four Ends of the Greek Hyperinflation, 1941-1946.” “Buying gold” turned out to be the correct answer.

At a glance, the Greek hyperinflation would seem a pale copy of the Weimar episode. The size of the drachma money supply as the Germans scuttled home in 1944 was a mere 826,308,303-fold greater than the size of the money stock in the year before the outbreak of war in 1939. As for Weimar, marks in circulation in 1923 were 3,250,000,000-fold greater than the German money stock in the 12 months preceding the outbreak of war in 1914. However, note Delivanis and Cleveland, the Greek catastrophe was six years in the making as against nine for the German one. Besides, they say, as the curtain fell on the Greek tragedy, only one-third of Greeks were still transacting in the worthless national scrip, whereas, up to the bitter end, nine-tenths of the German population continued to use marks.

It can’t be said that Greek monetary management represented much of an improvement over the German kind. Having seen off the enemy, the Greek authorities proceeded to print money—new drachmas—with the note issue climbing to 25,762 million from 126 million. The gold bull market and the cost of living in Athens both resumed their upward course. As for the Greek treasury, now crippled by a ferocious civil war, it liberally availed itself of the fruits of the central bank’s printing press. (“Early during the occupation,” Palairet writes, “the German authorities tried to get the Greek government to reform its system of tax collection, but wrote off the effort, such as it was, as unavailing.”)

Sixty-odd years later, the monetary scenery is transformed. A peaceful Europe is united, more or less, under a single currency. A single central bank aims for a rate of inflation in the neighborhood of 2%—no scientific notation required to calculate the rate of currency debasement these days.

However, in the all-important realm of monetary ideas, not so much has changed. Today, as in the war, government-controlled central banks print up the money with which to finance, directly or indirectly, burgeoning fiscal deficits. Today, as in the war, governments have recourse to “financial repression,” e.g., zero-percent funding costs and QE. And today, as in the war, investors with eyes to see are busily exchanging fiat currencies for tangible stores of value. Plus ça change, as they say in Athens.

A predictable pathology, Benjamin M. Friedman (11/02/2015)

We meet at an unsettled time in the economic and political trajectory of many parts of the world, Europe certainly included. In Europe in particular, the setting is neither usual nor welcome. Germany’s finance minister Wolfgang Schäuble has called last month’s elections for the European Parliament “a disaster,” going on to conclude that “all of us in Europe have to ask ourselves what we can do better … we have to improve Europe.” To be sure, an election is a political event. But just as surely, here and now as in other times and places, what underlies the politics is to a large degree the economics. What is happening in many parts of Europe today is not just a pathology, but the predictable pathology that ensues whenever the majority of any country’s citizens suffer a protracted stagnation in their incomes and living standards.

The origins of this stagnation, in the parts of Europe where it is occurring, are broadly understood. More than half a decade ago, Europe imported the backwash of the financial crisis spawned in the American mortgage market and the US banking system more generally. Factors idiosyncratic to one European country or another – fiscal imbalance, eroded competitiveness, an American-style construction boom, an excess of impaired bank assets, and the like – rendered some parts of Europe especially vulnerable. In the familiar way, both monetary and fiscal policies likewise played a role (although in this context it is not clear what one means by a European fiscal policy). But a large part of the story too bears on the subject of today’s conference – “Debt” – and, in particular, the sovereign debt crisis that Europe has also now been confronting for more than half a decade.

The euro area constitutes a remarkable experiment in this regard. The fact that it is a monetary union without a fiscal union behind it is of course entirely familiar. But a seldom discussed implication of this anomaly is that the euro area economy has no government debt. By “government debt” I mean obligations issued by a public entity empowered to print the currency in which the obligations are payable. All other major economies we know – the United States, the United Kingdom, Japan, Sweden, Switzerland and many others – have government debt in this sense. In the euro area, by contrast, public sector debt is entirely what Americans call “municipals” – that is, obligations issued by public entities not authorised to print the currency owed. It is this feature that makes the bonds issued by Massachusetts, or New York, or Texas, subject to default in a way that US government debt is not. The bonds of all euro area states, even those currently regarded as most secure, like Germany’s, are likewise subject to default in the same sense. It would be difficult to exaggerate how unusual an experiment this situation represents. I am unable to think of another modern example of a major economy with no government debt to anchor its financial structure.

A further unusual aspect of Europe’s situation in this regard is that, following the various actions taken to date, what amounts to municipal debt issued by some of the entities whose fiscal condition is the weakest is, increasingly, owed not to market investors generally but to official lenders. This ownership matters because, unlike private market investors, official lenders in principle do not accept defaults. To a certain extent, of course, this is a fiction. But widely maintained fictions often guide actions, especially in public decision-making, and sometimes they do so with highly unfortunate consequences. This particular fiction also strengthens the commonplace European presumption – which strikes many Americans as bizarre – that sovereign default by a euro area member state would necessarily trigger the country’s exit from the currency union. From time to time in America’s history, US states have defaulted on their general-obligation bonds, and it may happen again. In the recent financial crisis, the two states whose bonds the market deemed most at risk were Illinois (because of unfunded pension obligations) and California (because of the state’s overall budget imbalance at the time). It would not have occurred to an American that if, say, Illinois defaulted on its GO bonds it would, on that account, have to exit the dollar currency union. But this principle seems to be the working assumption in much of the current European conversation.

The route by which Europe arrived at this situation is also well known. The governments of fiscally strong countries lent, or gave, funds to the governments of fiscally weak countries, allowing them to service their existing debt and to issue new debt. (This process also allowed the governments of the fiscally strong countries in effect to bail out their lending institutions without acknowledging that they were doing so, thereby maintaining yet another fiction that may or may not be useful.) The fiscally strong countries provided these transfers and new credits mostly in exchange for imposition of contractionary fiscal policies – and, supposedly, structural reforms – in the fiscally weak countries, in both cases with the goal of rendering them better able to manage their debt. But the problem with the former is that, despite economists’ ability to devise theoretical demonstrations to the contrary, contractionary fiscal policy actually is contractionary. The problem with the latter is not just that structural reforms are politically difficult to implement, but that even when implemented they take a long time to become expansionary. Moreover, even then they are often expansionary in a highly non-neutral way, exacerbating already unwelcome trends in income distribution.

In a group consisting mostly of economists, it is useful to recognise that this approach to Europe’s debt crisis, and even more so the underlying attitudes it reflects, are counterintuitive in yet another way. The standard presumption in economics, dating to the conception of “commerce” articulated by David Hume and Adam Smith and their contemporaries, is that market transactions involve two parties, each of whom acts voluntarily and with sufficient information to make a choice. In the case of credit transactions, this means presuming that both borrowers and lenders acted voluntarily. Among borrowers there are familiar exceptions such as the inherited debt of deceased parents, or the “odious debt” issued by a country’s prior regime, and for just this reason they are normally treated differently. Similarly, there is a stronger case for the presumption of informed voluntariness on the part of institutional lenders than individuals, and this difference in information and expertise provides a standard rationale (along with risk diversification) for financial intermediation. By contrast, today’s public discussion surrounding the European sovereign debt crisis mostly presumes that when a bond is in trouble, the lenders – especially institutional lenders – are victims. In parallel, there is an almost religious presumption of guilt among the borrowers.

From a historical perspective there probably is something religious about these presumptions. Although Jews and Christians and Muslims long regarded lending with suspicion (and Muslims still do), by the beginning of the 19th century evangelical Protestants had mostly come to regard borrowing as sinful, even when the debt was serviced and repaid on a timely basis. Non-payment, of course, elevated the negative moral connotation to  a  whole  different  plane.  As  the 19th century moved on, in one European country after another (and in America too) the active frontier of this debate was often the movement to introduce limited liability for what we now think of as corporate borrowers and equity investors: limited liability represented a retreat from what historians often refer to as the “retributive philosophy” of 19th century evangelicalism. By mid-century, public attitudes had begun to change, driven in large part by the new awareness of the possibilities for ongoing economic growth and waning ambivalence toward it. Even so, the lingering opprobrium attached to borrowing persisted, especially in the public sector context. As one long-ago historian of HM Treasury described this development, “An ethic transmuted into a cult, this ideal of economical and therefore virtuous government passed from the hands of prigs like Pitt into those of high priests like Gladstone. It became a religion of financial orthodoxy whose Trinity was Free Trade, Balanced Budgets and the Gold Standard, whose Original Sin was the National Debt. It seems no accident that ‘Conversion’ and ‘Redemption’ should be the operations most closely associated with the Debt’s reduction.”

Today a reversion to the “retributive philosophy” of the 19th century – to the view, in the words of another historian of that day, that “a just economy was more to be sought after than an expanding one” – is clearly in evidence in Europe’s approach to its  sovereign debt crisis. Whether  Europe’s  economy  has  thereby achieved justice is a matter for a different discussion. It has clearly foregone expansion. The imposition of contractionary policies in the most heavily indebted countries has reinforced a perverse feedback between weak economies and questionable sovereign debt, with a further feedback between both of those and troubled banks. Cross-border lending has significantly contracted, and some countries face what amounts to a credit crunch despite the ECB’s expansionary monetary policy. Nor are these simply isolated phenomena, with little bearing on the broader European economy. Back when I was first teaching economics, a plausible exam question was “Why is unemployment in Europe always so much greater than in the United States?” Then, for some years, asking the question in the opposite direction seemed more apt. Today, with the euro zone unemployment rate roughly double that in the United States, we can bring out the old exams again.

The more fundamental consequence is ongoing stagnation of incomes and living standards for the majority of the population in many European countries. The median household income in the United Kingdom, adjusted for what little inflation there has been, peaked in 2007 and has yet to regain that level. France, Italy and the Netherlands have not experienced complete stagnation by this measure, but the real median income in each has seen only a minimal increase. Ireland, Greece and Portugal have all experienced stagnation, or worse, in real median income over this period. Spain did too for half a decade, only last year finally enjoying a solid increase.

A parallel stagnation of incomes has taken place in the United States as well, but America’s federal fiscal structure provides at least some built-in cushioning mechanisms that Europe lacks. Further, in Europe’s fiscally weak countries the usual frustration over stagnant incomes and living standards is today compounded by the sense of being dictated to, in many citizens’ eyes perhaps even exploited, by foreigners. Twenty-five centuries or so ago, if another city-state had conquered the Athenians the then-conventional tribute would have required some hundreds of Athens’s finest youth to trek off to the victors’ lands, to do forced labour, and an equal number of Athens’s fairest virgins to go as well, for purposes best left unspecified. Today’s political conventions are sharply different, but the resulting youth labour flows are similar.

And, as Mr. Schäuble has highlighted, the all-too-familiar consequence of this economic stagnation, together with the widespread absence of employment opportunities, is a turn away from (small-L) liberal values toward xenophobic populism of either the right or the left. The same pathology has emerged before, again and again, in one country after another around the world, whenever the citizenry has lost its sense of forward progress in its material living standard, and lost too the optimism that that progress will resume any time soon. Europe today increasingly looks to be on the verge of repeating key elements of the experience of the years between the two World Wars, with not only the ascendency of extremist political movements but cross-border communication among them. There are differences, of course: in the 1930s the central node of that communication was the rising Nazi movement and then government in Germany, while today it looks as if the facilitating vehicle will instead be the European Parliament. But the effects are parallel, and so are parts of these groups’ programs, today including the campaign to roll back within-EU immigration and EU regulatory authority, not to mention the entire European Union project.

With European monetary policy already expansionary – with the introduction just last month of a negative redeposit rate, innovatively so – and since Europe as such has no fiscal policy, the urgent need today is for debt restructuring and relief for the fiscally weak European countries (and it is useful to recall that in real time it is often hard to tell the difference between the two). In a similar way, in the United States today there is need for relief for underwater homeowners whom the bail-out of US lenders a half-decade ago largely neglected. But the need in Europe is more acute.

Again looking back to the interwar period, there is ample precedent, within Europe, for both debt relief and debt restructuring. Indeed, that experience is also the origin of our host institution this evening. The reparations due from Germany under the Versailles treaty were quickly transformed into the obligation to service two series of bonds, scaled to reflect the recovering country’s ability to pay; but in the end neither bond was ever fully paid. Initially, the Weimar government serviced the bonds to foreign investors at the same time as German states and local governments were borrowing from abroad, so that on net the international flows were mostly recycling while within Germany there was substantial intergovernmental shifting of burdens. The 1924 Dawes Plan and then the 1929 Young Plan further reduced what Germany owed, and each arranged for yet a new foreign loan. The need to facilitate transactions under the Young loan is what led, in 1930, to the creation of the Bank for International Settlements.

The Lausanne Conference in 1932 ended all German reparations payments, in exchange for which Germany deposited with the BIS bonds representing a small fraction of what was originally due; the bonds were never issued, and some years later the BIS burned them. By then Germany had acquired other foreign debts, however. The Nazi government initially serviced the debt but blocked the conversion of the Reichsmarks paid into foreign currency. It then began making payment half in Reichsmarks and half in non-convertible Reichsbank scrip. After a series of further steps, in 1934 Germany defaulted on both the Dawes and the Young loans.

After the war, the 1953 London Debt Conference took up the matter of Germany’s unfulfilled commitments, including government debt, state and local debt, and even private debt. The London agreement reduced the amount due by at least half (most likely more, depending on the calculation) and rescheduled the remainder so that no principal payments were due for five years and the rest strung out over 30 years. A significant part of the debt was further deferred, with no interest due along the way, until such time as reunification might occur – which turned out to be nearly four decades later. The United States also converted into grants most of the loans extended under the Marshall Plan, in parallel with treatment of the other recipient countries, and did the same for loans under the Government and Relief in Occupied Areas programme.

As one historian summarized the approach taken to Germany’s post-war debt relief, “at the time of the London conference most observers had in mind long years of what they viewed as Germany’s irresponsible treatment of foreign debts and property owned by foreigners.” Nonetheless, “The entire agreement was crafted on the premise that Germany’s actual payments could not be so high as to endanger the short-term welfare of her people … reducing German consumption was not an acceptable way to ensure repayment of the debts.” The contrast to both the spirit and the implementation of the approach taken to today’s overly indebted European countries is stark.

There is no economic ground for Germany to be the only European country in modern times to be granted official debt restructuring and debt relief on a massive scale, and certainly no moral ground either. The supposed ability of today’s most heavily indebted European countries to reduce their obligations over time, even in relation to the scale of their economies, is likely yet another fiction – and in this case not a useful one. As the last decade’s financial crisis fades into the past, and market interest rates move up to a more normal configuration, these countries and others too will find their debt increasingly difficult to service. In the meanwhile, the contractionary policies imposed on them are depressing their output and employment, and their tax revenues. And the predictable pathology that follows from stagnant incomes and living standards is already evident.

James Tobin often remarked that there are worse things than three percent inflation, and from time to time we have them. Indeed, we just did. In the same vein, there are worse things than sovereign debt defaults, and from time to time we have them too. They are in progress as we meet.

The Cultural and Political Consequences of Fiat Money, Jörg Guido Hülsmann (30/11/2014), Mises




It may seem unusual that an economist would talk about culture. Usually, we talk about prices and production, quantities produced, employment, the structure of production, scarce resources, and entrepreneurship.

But there are certain things that economists can say about the culture, and more precisely, that economists can say about the transformation of the culture. So what is culture? Well, to put it simply, it is the way we do things. This can include the way we eat — whether or not we dine with family members on a regular basis, for example — how we sleep, and how we use automobiles or other modes of transportation. And of course, the way we produce, consume, or accumulate capital are important aspects of the culture as well.

Limiting Budget Is the Key to Limiting Governments

Now to understand the effects of fiat money on the culture, we must first look at the relationship between financial systems and the nature of government.

A number of economists have observed that fiat money is a prerequisite for tyrannical government, and the idea that monetary interventionism paves the way for tyrannical government is very old and goes back to Nicolas Oresme in the fourteenth century. It has not been emphasized in the twentieth century, but Ludwig von Mises is among the few who has stressed the importance of this relationship.

Mises said that when it comes to limiting government power, it is essential that the government is financially dependent on the citizens, and this addresses the fundamental political problem of controlling the people in office once they are there. We know that generally, once they are in office, elected politicians turn around and do very different things than they said they would do, with many acting contrary to the common good and interests of their constituents.

So how do we ensure that the people in power can be controlled?

Mises tells us the way we control government is through the budget, and this is necessary in a free society. In a democratic system, at least, we elect certain people to the government, and they often enter office believing that they have a mandate to do certain types of things while in office.

But it’s not sufficient that the people tell government officials what they should be doing. It is equally important, if not more important, to dictate how much money the government will have to achieve those ends. So, it is not enough to tell the government that it will only protect private property. This mandate could be pursued with $100,000 or a billion dollars depending on what the people are willing to pay. So if the budget it not controlled, a limited mandate in itself offers no limitation on taxation or how much money is spent.

Mises believed that those who paid the taxes would then need to specifically limit the size of the government budget. The mission of the government does not by itself deter- mine the amount of resources to be used in the mission.

In response, many will complain that if budgets are tightly controlled, then we’ll never have an increase in government services because people hate taxes. That might be so, but, of course, that is the point.

Now, if we abandon a strict connection between what the citizens pay and what government spends, then we find that we move away from rule by the citizens who are being taxed, and toward greater rule by the elites.

The first way this shift can happen is by the government going into debt. The financial relationships then shift toward the new group that is funding the government, namely those who are extending credit to the government. This then weakens the relationship to the citizens who are being taxed, and it also allows the government to spend more money than would have been possible with taxation alone.

Now of course fiat money allows government to take out loans to an unlimited extent because fiat money by definition can be produced without limitation, without commercial limitation or technological limitation, and can be produced in whatever amount is desired. In this way, the government benefits from the support of a central bank, which is to be expected because the central bank itself depends on the legal framework of monopoly provided by the government.

Through these means of finding government revenues outside of directly taxing the population, we see then that fiat money allows for an extension of government activities unconnected to the willingness of the population to actually support revenue increases. In turn, the government’s rule becomes rule by elites such as central bankers and financiers rather than rule by the taxpayers, and the government’s ability to spend becomes more dependent on the ability to access fiat money than the ability to convince the citizens to accept a higher tax burden.

The Cultural Features of a Debt Economy

Now we come to the many ways through which a fiat money system affects the behavior of ordinary citizens.

One of the central features of a fiat money system is that it tends to produce near-permanent price inflation. This contrasts with the workings of an economy based on natural monies such as gold and silver. Here the price levels tend to stay flat over the long run or decline, especially in the presence of vigorous economic growth. We saw this throughout the nineteenth century in both Europe and the US, where deflationary growth has been the rule.

The reality of price inflation shapes culture in a variety of ways and much of this is deliberate, as it has long been an idea among government planners and ideologues of all sorts, even before Keynes, that ordinary people should be prevented from “hoarding” money at their homes.

In a free economy with a natural monetary system, there is a strong incentive to save money in the form of cash held under one’s immediate control. Investments in savings accounts or other relatively safe investments also play a certain role, but cash hoarding is paramount, especially among low-income families.

By contrast, when there is constant price inflation, as in a fiat-money system, cash hoarding becomes suicidal. Other financial strategies now become more advisable. It becomes advisable to exchange one’s cash for “financial products,” thus offsetting the loss of purchasing power of money through the return on that financial investment. It also becomes advisable to go into debt and leverage one’s investments. In a word, it becomes rational to pursue riskier investments in order to find a rate of return that can match or exceed the rate of price inflation. This is true across all sectors, including households and productive operations.

Before the twentieth century and widespread access to fiat money, debt was far less common and there were cultural imperatives against going into debt for consumption. Credit for households, for example, was virtually unknown before the twentieth century, and only very poor households fell back on debt to finance consumption.

But in a fiat money system, as price inflation diminishes the value of one’s monetary savings, we are encouraged to adopt a short-term perspective. That is, we need to hurry up to obtain credit as soon as possible and obtain revenue from that debt as soon as possible, because savings lose value if we just hold on to cash.

It no longer makes sense to save up money for a decade to buy a house, for example. It is much more opportune to go into debt to buy a house immediately and to pay back the loan in devalued money. There is then a generalized rush into leverage in a fiat money system since debt- financed investment brings greater returns than savings in cash or equity-financed investments.

It needs to be stressed that this tendency has no natural stopping point. In other words, fiat-money systems tend to make people insatiable in their quest for ever higher monetary returns on their investments. In a natural monetary system, as savings increase, the return on investments of all sorts diminishes. It becomes ever less interesting to invest one’s savings in order to earn a return, and thus other motivations shift into the foreground. Savings will be used increasingly to finance personal projects including the acquisition of durable consumers’ goods, but also philanthropic activity. This is exactly what we saw in the West during the nineteenth century.

By contrast, in a fiat money society, you are more likely to increase your returns by remaining in debt and continuing to chase monetary revenue indefinitely by leveraging more and more funds.

You can imagine, then, how this inflation and debt- based system, over time, will begin to change the culture of a society and its behavior.

We become more materialistic than under a natural monetary system. We can’t just sit on our savings anymore, and we have to watch our investments constantly, and think about revenue constantly, because if it is not earning enough, we are actively getting poorer.

The fact that the fiat money system pushes us into riskier investments also increases dependency on others because one must depend on the good behavior of those on whom the value of our investments depend.

Similarly, the stronger the level of debt the stronger is the selfish concern about the behavior of others who may owe us money. So fiat money creates an attempt to control others through the political system.

But at the same time, no household and no firm individually has an interest in abolishing the fiat system and putting in its place a natural monetary system. The short-term costs of such a transition would be immense. In this, we see that we are in a “rationality trap” in which one is motivated to maintain the fiat money system in spite of all its downsides, and because the culture at this point is so transformed by more than a century of easy access to fiat money.


We can apply economic analysis to explain cultural transformation, and a particularly important example is fiat money. It has a very important impact on our culture. This is something we would not see unless we step back and take a longer-term historical perspective. Of course, there are many other factors that come into play, but fiat money is an important factor, and the system is perpetuated by the fact that everyone stands to lose in the short run if the current system ceases to function. Moreover, given how our modern culture has been so shaped by fiat money systems, it runs against the very cultural foundations of our current society. In spite of the many short-term costs, we should nonetheless dare to change this system, and it is ultimately a question of courage, and insight, and of the will.

El dilema de regular cuestiones morales

Una de las ventajas de viajar de manera frecuente es el hecho de mantener cierta perspectiva. Si bien cada rincón del globo tiene su música y sus colores, lo cierto es que los extremos del planeta se parecen más de lo que se diferencian. En una cena con economistas, juristas y científicos en Guatemala se me preguntó recientemente y en tanto en que liberal, sobre qué opinión tenía respecto al aborto y la eutanasia. Mi respuesta, que no me atrevería a etiquetar de ningún modo, fue más precisa y rápida de lo que yo hubiera podido pensar.

Como católico, dije, estoy en contra del aborto y de la eutanasia por creer que la vida es un don de Dios y ser decisiones que se extralimitan a la voluntad del hombre. Por eso, añadí, me cuesta imaginar supuestos en los que tomar una decisión en estos términos. Por eutanasia entiendo interrumpir la vida de una persona en condiciones deplorables, no intervenir para mantener las constantes vitales a toda costa de una persona a punto de morir, que aunque hay casos en donde la frontera es difusa desde un punto teórico la distinción es muy relevante. En todo caso, añadí como argumento central de mi respuesta, no me parece que sea un tema en el que los poderes públicos deban intervenir en ningún caso. Yo no abortaría nunca, pero no me parece justo prohibir el aborto a quién lo quiera practicar. De hecho, me parece una situación tan sumamente trágica y dura, que me pienso que el hecho de hacer esta situación punible es añadir más dolor a una situación ya de por si triste.

Ahora bien, las instituciones del derecho están concebidas para proteger la vida. Por eso mismo tampoco estoy a favor de cualquier disposición normativa con el objetivo de “legalizar” ninguna de estas dos prácticas bajo ningún listado de “supuestos” aprobados por un parlamento. Tratar de regular positivamente sobre cuestiones morales es un terreno muy pantanoso que solo sirve para polarizar las sociedades; tratar de poner normas con listados de supuestos legales y supuestos ilegales es pretender coger agua con las manos. Cualquier disposición normativa que se haga al respecto siempre será incompleta, sesgada, y generará agravios en unos u otros por querer imponer una moral determinada que, por definición, nunca será compartida por la totalidad del conjunto con lo que será tendremos una fuente de conflicto constante. Lo más razonable, argumenté, es despenalizar –como seguramente sería la mejor solución con el tema de las drogas– estas prácticas para no añadir sufrimiento a una situación, ya de por sí, dramática. Algo similar a lo que ha ido sucediendo con el suicidio. Durante siglos, y en muchos países, estuvo penalizado por ley, de manera que los familiares de la persona que se suicidaba –además del trance sufrido–, tenían que hacer frente a duras sanciones por ser este un acto punitivo. Este entramado legal cumplía con el objetivo de disuadir a las personas de este comportamiento y proteger la vida.

Sin embargo, mi oposición más firme a los postulados, tanto de la izquierda como de la derecha, que pretenden regular de manera positiva estos asuntos es porque detrás de estas reglas no se esconde una genuina voluntad de resolver un hipotético conflicto social (que por otro lado surge precisamente cuando se intenta desde algún extremo imponer un credo), sino por querer diluir la responsabilidad individual que implica tomar cualquiera de estas decisiones haciendo al conjunto de la sociedad “cómplice” de la misma. En efecto, estas leyes lo que buscan es legitimar comportamientos disfrazándolos de “legales” bajo disposiciones normativas arbitrarias. De esta forma, podemos tomar ciertas decisiones sin tener que asumir la totalidad de la responsabilidad y, de existir, de culpa y remordimiento por la decisión tomada ya que, esta quizás se encuadra en un supuesto legal. El coste de lo anterior es el debilitamiento institucional –hacemos depender la moral de la coyuntura y los equilibrios parlamentarios que puedan existir en un momento dado– y envilecemos el conjunto de la sociedad homogeneizando valores.

Cualquier sociedad que quiera considerarse moralmente tensionada y libre debería abstenerse, con independencia de su credo, fe o ideología, de imponer de manera arbitraria normas concernientes a la moral y la autonomía de las personas.

Por última, huelga recordar que únicamente las sociedades normativas, en contraposición al modelo positivo, son las que permiten que las personas se equivoquen (en el sentido más amplio de la palabra) lo que permite el aprendizaje y el avance del conjunto, también el ámbito moral donde, precisamente la evolución y el desarrollo de las sociedades ha tendido a traducirse en un cada vez mayor respeto por la vida y la autonomía personal. Legalizar lo que es una situación penosa no solventa ningún problema y tiene el gran costo de devaluar al conjunto: si alguien considera que ha de abortar que aborte, pero sin obligar al conjunto de la sociedad a legitimar sus actos. Solo así aprendemos, solo así una sociedad, con la multitud de principios morales que están en constante competencia, puede fortalecer aquellos que mejor funcionan, que nos hacen más libres y que nos hacen avanzar como civilización. Sin responsabilidad individual no hay civilización posible. Si queremos favorecer una convivencia pacífica, dejemos de colectivizar problemas y diluir responsabilidades.

La economía a la intemperie (Deusto), A. González y R. Orsi. Los economistas que dudan y los que no.

La ciencia económica es, o debería de ser, ante todo eso,  una ciencia. Lo que le otorga esta categoría no es la matemática, como pensaran algunos.  La matemática, en el mejor de los casos, añade a la economía un falso barniz de sofisticación del mismo modo que el maquillaje puede servir a la mujer poco agraciada. Como dejo escrito Popper, lo que hace que podamos decir que algo es científico es su falsabilidad. Es decir, algo es ciencia cuando es falsable. Probablemente, debido a la poca tolerancia del ser humano a la incertidumbre –somos de largo el mamífero que peor a tolera–, y de nuestras ansias por controlarlo todo (Hayek hablaba de “fatal arrogancia“), históricamente los modelos matemáticos han contribuido a generar una burbuja de falsa seguridad a la hora de trabajar con la que, por otra parte, es la ciencia más compleja de todas. Algo similar a lo que ocurre con la creación de la entelequia del Estado del Bienestar a traves del cual intentamos vivir evitando asumir riesgos y eluyendo un cada vez mayor número de responsabilidades.

Digo todo esto para encuadrar la reseña de La economía a la intemperie (Deusto, con la inconfundible firma de Roger Domingo) de Andrés González y Rocio Orsi (filósofa, como la mayoría de los grandes economistas), ya que no se trata de un ensayo más sobre la crisis, sino que estamos ante una obra más compleja, profunda y completa en la que se aborda de manera valiente y rigurosa multitud de temas con la gran ambición de tratar de dar respuestas con criterio al estado general de las cosas; no se si hablar de crisis o resulta más preciso hablar gran zozobra y confusión general y generalizada en muchos ámbitos. El libro tiene la gran cualidad de las grandes obras y ayuda a expandir los horizontes mentales del lector siendo su lectura aconsejable tanto para neófitos como doctos en la materia.

Desde 2008 se han sucedido múltiples libros sobre la crisis de calidad, digamos, muy diversa. Este libro no es, como decía, un libro sobre la crisis, sino más bien una reflexión sobre el estado de las cosas. La gran crisis financiera sirve de hilo conductor en algunas de las piezas que componen el variado mosaico que configura la obra, pero la obra llega mucho más lejos. Su lectura me ha evocado otros ensayos recientes verdaderamente notables como La gran degeneración de Niall Ferguson (también con sello Deusto) o Los años irresponsables del siempre agudo Valentí Puig. En parte también incorpora elementos de la sociología que podemos encontrar en otro gran libro, que contiene grandes dosis de autocrítica, Todo lo que era sólido de Antonio Muñoz Molina (versión española al “mundo líquido” que ha popularizado el ya nonagenario Zygmunt Bauman).

Me valgo de todas estas referencias por qué me es difícil poner adjetivos que describan con precisión la profundidad a la que quiero hacer referencia. Pese a su brevedad, tan solo 190 páginas, el texto aborda muchos temas y muy diversos siempre con la doble perspectiva histórica y global, y con el foco puesto en el grueso de las sociedades Occidentales. Esto no es óbice para que los autores buceen en la realidad específica de cada uno de los asuntos tratados y utilicen la muleta del caso español, también ejemplos en otros países, para ilustrar los argumentos y apoyar las tesis con las que los autores cierran cada capítulo.

Esta quizás sea una de sus muchas y grandes virtudes: saber combinar perfectamente lo global con lo local; lo actual con lo histórico; lo general con lo específico, y además hacerlo de manera que el lector no se pierda entre las páginas del libro, sino que también el lector participa del proceso de  reflexión y de relación de ideas que permiten una mejor comprensión de la realidad que nos rodea con cada página.


En un momento en el que la información abunda y el criterio es tan escaso, la lectura de González y Orsi resulta balsámica.

A veces se hace la broma de que existen dos grupos de economistas: los liberales y los malos. Una broma cruel (quizás por lo que pueda tener de cierto). Uno de los grandes problemas del mundo, decía mi abuela (DEP), es “que los inteligentes dudan mucho y los ignorantes hablan sentado catedra”. Me venían a la mente ahora estas palabras, porque quizás la bisectriz más importante dentro del mundo económico no sea la que separa –y simplifico– hayekianos de keynesianos, sino la línea que divide los economistas que dudan de los que no. De hecho, tanto Hayek como Keynes pertenecían al selecto grupo de pensadores económicos que sí dudaban (no es el objeto de este artículo, pero un servidor habiendo leído la biografía de Keynes está convencido de que hoy Keynes no sería keynesiano, pero de eso les hablaré otro día). Todo lo anterior quiere remarcar el hecho de que González y Orsi pertenecen a este primer grupo -selectísimo- de economistas que dudan en el sentido más científico de la palabra. Con esto quiero decir que el libro rehúye el típico guion en el que el homo economicus de turno nos dibuja cual es la realidad que percibe (sin ni siquiera preguntarse si esta definiendo bien el problema) para, acto seguido, proponer un ratalía de recetas (suelen ser mágicas) que, de ser aplicadas por el político de turno (recuerden el mantra de que “el problema es la política”), la tierra se convertiría en un paraíso terrenal (sic). Lleven este discurso al paroximo y tienen el fenómeno Podemos.

La economía a la intemperie  describe los hechos al tiempo que se nos invita a reflexionar sobre la teoría y la historia que hay detrás de ellos; todo sin usar trampas semánticas, más bien todo lo contrario, se nos invita a ser rigurosos con el lenguaje y romper muchos de los esquemas mentales que hoy en día encorsetan y limitan el debate. Esta manera didáctica, científica, de abordar los asuntos económicos permite al lector participar de forma activa de la reflexión y llegar a sus propias conclusiones. Esto es lo que hace que el libro de González y Orsi sea agradable de leer incluso cuando uno no comparte los puntos de vista de los autores.

Quién escribe se ha llegado a desesperar muchas veces por lo que lee, pero nunca por la opinión o por el corolario al que llega el autor, sino que la desesperación (entre comillas) siempre viene cuando uno observa con impotencia y frustración como el economista de turno esta edificando su argumentación con una falacia detrás de otra, haciendo uso de ideas ya obsoletas y probadas falsas. Por eso, para mí, la gran virtud del libro es ta sensación que transmite de genuina búsqueda de la verdad; algo que debería ser la brújula de cualquier economista o científico social y que, por desgracia, demasiado a menudo es la excepción, no la norma.

Se trata además de un texto culto lleno de erudición. No únicamente por el buen uso de las alegorías clásicas –la crisis de deuda en Grecia las ha vuelto a poner de moda–, sino por la variedad de fuentes y autores a los que  hace referencia. Los diversos temas se van sucediendo de manera rápida y ágil, pero el hilo del libro no se pierde; al igual que sucedee en un cesto de mimbre, la ciencia económica se compone de la infinidad de ámbitos y aspectos que se refieren al hombre, todos ellos complejos y con multitud de puntos de encuentro entre ellos que se entrelazan una vez tras otra. Pretender estudiarlos de forma aislada y compartimentada solo conduce al sesgo y al error.

Si un juez me pidiera una prueba irrefutable, científica valga la redundancia, de que se trata de un buen libro sobre economía, simplemente me limitaría a constatar que la obra menciona (y repetidas veces) palabras como ahorro y capital o hace mención a un tema tan vital como olvidado: la demografía.

Quizás (por ponerle algún pero al libro) he echado en falta la inclusión de forma explícita del concepto de “riesgo” (ineluctable en los procesos de “creación de riqueza”), y también el tema central que para mi tiene la propiedad privada y el imperio de la ley. Quizás sea mi sesgo hayekiano, pero para un servidor causa principal de todo lo que nos pasa deriva de una manera u otra de la erosión de los principios del “rule of law” y la propiedad privada. En cualquier caso ya sabemos que con respecto a las personas todo es subjetivo y, por definición, la perfección nos es inalcanzable en este mundo. Además, los autores compensan de sobras esta ausencia con la inclusión en el texto de la palabra “whig”.

Buena lectura.