David J. Bean

David J. Bean is a freelance writer living in California.

There is much in the media these days about the government adding capital to the accounts of banks and other companies from the $700+ billion bailout money and subsequent authorizations. Is this really what they are doing? Most economists agree that a nation's wealth is only the goods and services that it produces and that to produce wealth you need land, capital and labor. One of Webster's dictionary definitions states that capital is "accumulated goods devoted to the production of other goods." In short, capital is previous production, saved.

Take out a dollar bill and look at it. It is not just a piece of paper; it is legal tender. But, it is only an IOU for current or future production! It is a government promise that you can trade that IOU now or in the future for an equivalent value good or service. In short, long-range federal debt is a lien on future production. At one time the dollar also had a commodity value that it could be converted to, like silver or gold. No more though. Today no country in the world backs its currency with anything except faith.

So, when the government claims it is adding to the capital of a company by giving that company fiat money that adds to the federal debt, it is doing no such thing. Every dollar they hand out is a lien on current or future production. What the government is doing is adding to the national debt that is, in total, a lien on future production. Some economists think that since the annual increase in federal debt is not a large percentage of our yearly production, that it is not too worrisome. But remember; it has to be paid by the amount of production in excess of our own consumption. And that debt is getting so burdensome that the only way it can ever be paid off is through a very heavy bout of inflation. Of course inflation is ultimately just a repudiation of debt manifested by an increase in prices. That means that for any debt paid off in the future the receiver will not be getting the same purchasing value that was loaned originally.

The economic situation within our country can be visualized by considering it like a fox hunt. Our productive capability is the horse, the horse's rider is the government and the national debt is the fox. Thirty years ago the gap between the horse and rider and the fox was fairly narrow but for the last number of years the gap has been widening dramatically. Visualize the government whipping the horse to catch up (passing out fiat money), the horse doing his very best to produce (speed) but the fox widening the gap and gradually disappearing on the horizon. Finally, when the gap gets so large that the fox can't even be seen and identified, the horse gives up and collapses. The government is left with a dead horse.

Pouring more fiat money into the economy is not likely to fix our problems; it only adds to the total of future production that must be produced in excess of what we produce for our own needs. For the past decades we have been consuming more goods and services each year than are being produced (deficit spending). The only way we can come out of this slump is by increasing production, and flooding the economy with more dollars won't do it.

Of course the government is aware of this but it doesn't know any new tricks to try. So, it is using the tools it has used in the past to get production going again. But our past productive efforts have been largely financed by credit, and a sound credit system is based on a fair return. Today, loaners are not confident that they will be lending to a person or company that will be able to pay it back. Nor with the potential inflation, investors are not confident that they will be receiving money in return that is worth anything close to present value. The Federal Reserve has a dilemma; the deflation going on right now calls for a reduction in the interest rates; the inflation potential caused by the huge influx of fiat dollars calls for an increase in interest rates. Since deflation panics politicians, the emphasis today is on that aspect, but looming in the future is a gigantic inflation era.

The root cause of the present dilemma was that the Federal Reserve kept the discount rate too low for far too long, producing a flood of fiat dollars that were so plentiful that they were put to work in very risky ways. This was discussed in previous St. Croix Review articles (June, Oct, & Dec.) at length and was described as " the wrong cure." The correct cure is now going to be very, very painful, but until the government can assure investors that we have a sound dollar (which is the Fed's basic charter), and that lenders have a good chance of receiving a fair return, nothing good will happen and productivity will stagnate. *

"There is a degree of depravity in mankind which requires a certain degree of circumspection and distrust." --James Madison