Wisdom on Bailouts

Ron Paul recently spoke on the subject of bailouts:

We must remember that governments do not produce anything. Their only resources come from producers in the economy through such means as inflation and taxation. The government has an obligation to be good stewards of these resources. In bailing out failing companies, they are confiscating money from productive members of the economy and giving it to failing ones.

By sustaining companies with obsolete or unsustainable business models, the government prevents their resources from being liquidated and made available to other companies that can put them to better, more productive use. An essential element of a healthy free market, is that both success and failure must be permitted to happen when they are earned. But instead with a bailout, the rewards are reversed - the proceeds from successful entities are given to failing ones. How this is supposed to be good for our economy is beyond me.

Shooting in the Dark

Paul Krugman, a proponent of fiscal stimulus, recently published some of his thoughts on the subject:

Nearly every forecast now says that, in the absence of strong policy action, real GDP will fall far below potential output in the near future

...

we need a fiscal stimulus big enough to close a 7% output gap

These brief statements highlight a major problem with Keynesian economics, the assumption that there is one ideal "potential output", or worse, that the ideal level of output is that which is the greatest. What this fails to consider is that output based on debt is generally not good. To put it another way, growth based on debt and speculation is false growth. As we've seen recently, false economic growth eventually reverts, which can lead to quite severe crashes. So this leaves us with some questions: What sort of growth should we look to achieve? Is perpetual growth by any means possible the goal? Is contraction always bad, and if not, is there some magical level beyond which contraction becomes bad?

In the Keynesian view of the economy where consumer spending drives growth, merely stimulating consumer spending is the theoretical key to prosperity. But if this were so, why not take on unlimited amounts of debt, stimulating unlimited amounts of consumer spending in good times and bad? The fact that such a scenario would lead to disaster is not lost on Keynesians, which is why they instead look to achieve optimal growth, and stimulate spending if needed via the optimal amount of debt, whatever those things may be. If consumption can be stimulated just enough to increase output, but not so much that the cost of the stimulus outweighs the increase in production, then we've achieved something good. But how can we measure the result of our stimulus to know if it's been successful? How do we know if we've not simply created more false economic growth?

Keeping in mind that increased production based on consumption is the goal of fiscal stimulus, the success or failure of stimulus would clearly lie in what is or isn't consumed. This brings us to an important distinction, productive consumption versus nonproductive consumption. With productive consumption, a participant consumes based on what they produce. Their production not only enables them to maintain their well-being through consumption, their consumption sustains their ability to produce. Obviously not all consumption is productive though. While some economic participants are able to produce much more than they need to consume, which is clearly productive, other participants consume much more than they are able to produce, or they produce goods which are not useful for sustaining further economic production - this is clearly nonproductive. If the goal of fiscal stimulus is to grow production, we would certainly want to support the economic activities that produce the most useful production sustaining goods with the least amount of input. But herein lies the problem with stimulus policy, it makes no distinction between productive and nonproductive consumption, nor can it.

So what happens when we implement a fiscal stimulus? Realistically, it is impossible to measure and distinguish those economic activities which are productive from those which are nonproductive. Therefore, the result of stimulating consumption is a blanket subsidizing of both productive and nonproductive economic activities. Unfortunately, subsidizing those economic activities which are nonproductive results in false economic growth, which as always, will painfully revert at some point. Looking at recent history, we can clearly see that the growth of the housing and financial services sectors were beyond what was needed to sustain other economic participants. While their growth was measured as increased output, clearly it was false growth and has since receded.

Getting back to the original topic of implementing stimulus in order to achieve "potential output", two things are now clear: some portion of growth resulting from stimulated consumption will inevitably be false, and stimulating nonproductive activities is not only counter-productive, it is harmful to productive activities that are competing for the same resources.

Ultimately though, all that anyone is cares about is whether or not the end will justify the means. Do the benefits of fiscal stimulus outweigh the costs? Can we achieve potential output through fiscal stimulus, and more importantly, do we even know what an optimal output is? The problem with the calls for fiscal stimulus isn't the idea of stimulus itself, but with the fact that such calls fail to address the many inherent problems and questions raised here. For all of the very real costs that stimulus carries, we should hope for more from its proponents including Krugman. Anything less is shooting in the dark.

Innocence and Freedom

Consider a recent argument in favor of a housing bailout:

I know many, many innocent people who just wanted to buy a home...Now the innocent people have houses worth $200,000 less than their 2005 purchase price.

The innocence of a homeowner relative the innocence of an uninvolved taxpayer is arguable. But innocence isn't the key issue pertaining to bailouts. They key issue is personal responsibility, an idea that is closely tied to freedom.

If someone bought an overpriced home, that was their decision, just as if someone decided to invest in beanie babies or NASCAR collector plates, that too is their decision. They, and nobody else, are responsible for the outcome. Forcing that responsibility onto someone else who had no involvement is a most clear violation of the other person's freedom.

Is it sad that people make bad economic choices? Of course. But what is most sad is the idea that anyone thinks it is ok to force the outcome of their bad decisions onto others. In the same way that we would not sentence one man for another man's freely executed crime, we should not burden one man with another man's freely made economic decisions.

As I've shown before, government economic policies such as subsidies, bailouts, stimulus and inflation are counter-productive, but even more important to recognize is that they are also counter to individual freedom.

Freedom to make bad decisions is inherent in the freedom to make good ones. If we are only free to make good decisions, we are not really free.

- Ron Paul

Rationalizing Theft

A writer for the NYT recently called for something to be done about housing:

Yes, there were lots of Americans who were not greedy or foolish during the housing bubble, and many resent the idea that their neighbors might get a bailout they don’t deserve. They need to get over themselves. If housing prices keep falling, many millions of additional homeowners will find themselves, through no fault of their own, with underwater mortgages. Besides, foreclosures damage property values for everyone, not just those losing their homes.

It's interesting that certain parties should be protected from the harm brought on "through no fault of their own", but not others. In case you had trouble understanding this rationalization for a bailout, let me translate:

Wealth needs to be taken from party A (taxpayers) and given to party B (homeowners), because even though party B was foolish the outcome of their foolishness might hurt party C (other homeowners). And while party C might also have been foolish, though clearly not as foolish as party B, both parties are somehow more deserving of party A's wealth than party A itself. Allowing harm to come to parties B or C as a result of their foolishness is somehow worse than harming party A by stealing its wealth.

Since the government has nothing and produces nothing, all it can do is use its powers of coercion to redistribute wealth from one party to another with the hope that this redistribution will bring about the greatest overall benefit for society. This is the reason given for such intrusions, that the end will somehow justify the means. But how is it that the redistribution of capital from economic activities that are succeeding to those which have failed will some how bring about a better outcome? How do failing activities produce more wealth for society than those which are not? Perhaps it is important to look at who the activity is producing wealth for and for whom it is not.

A successful market economy depends on fairness and justice. These aren't just ideas that appeal to us as individuals, they are necessary in order for a market economy to function properly and to its full potential. A market economy that lacks fairness and discipline, where winners and losers are picked by the coercive power of the government, is an economy that disincentives participation, work ethic and innovation. It is the same problem that caused the failure of classical socialism - why work hard when the product of your labor may be taken away and given to someone else?

An economic system which allows for the forceful redistribution of wealth with the thought that it is for our own good, ultimately and ironically, disincentives economic productivity and brings about the very economic harm that it claims to protect us from, subsidizing activities that the economy cannot afford and that consumers do not want, violating freedoms all along the way.

Why did the gold standard fail?

If the classical gold standard worked so well, why did it break down? It broke down because governments were entrusted with the task of keeping their monetary promises, of seeing to it that pounds, dollars, francs, etc., were always redeemable in gold as they and their controlled banking system had pledged. It was not gold that failed; it was the folly of trusting government to keep its promises.

- Murray Rothbard

Behind Closed Doors

From Marketwatch:

Pelosi said the exact timing of the House vote would depend on the outcome of closed-door meetings currently underway on Capitol Hill.

Freedom is won on the field and lost behind closed doors.

$700,000,000,000.00

I wonder what $700,000,000,000.00 could buy, you know, if we were to actually put it to some constructive use as opposed to, you know, handing it over to Wall Street.

One can only imagine.