Can you hear that sucking sound?

A week ago, I posted an article about Larry Burkett, who was a very sound Christian financial counselor who was criticised for going overboard on Y2K. This week I'm posting an article by economist Gary North, another Christian who many consider to be a little too preoccupied with the end of the world. North runs a website, garynorth.com, where he allows access to his daily articles for $14.95 a month. His site focuses on a few main areas of interest: 1) How world governments are royally screwing up the economy, 2) financial advice, 3) opinions in support of a generally more libertarian / free market government, 4) biblical defenses of the free market (ie freedom). While he has written in other venues about the end of the world, I don't see much of it on his site. Many Christians and non-Christians would find his ideas about the end of the world very controversial, but I have not read anything he has to say on the subject and I am not particularly interested in his theories on that subject, so I can't and won't comment on them. I will only say that I find his opinions on the economy and the free market to be very reasonable.

The quote I wanted to highlight in the linked article is this:

"The coordinated big bank bailout programs do not solve the carry trade problem. They are designed to get banks lending to businesses. But in a worldwide recession, why would banks want to lend money to businesses? They would prefer to lend money to governments. Politicians like this. They can spend more money this way.

This transfers liquid capital from the private sector to the public sector. It subsidizes government bureaucracies at the expense of productivity. But it is a rational response to recession when the government offers guarantees against bankruptcy. The guarantees are a major source of asset allocation from the private sector to the public sector."

The purpose of the bailout is to unfreeze the credit market and get banks lending to banks and businesses again. The method being used to acheive this goal is to borrow from the private market in order to lend to struggling businesses. This will necessarily drain the market of the very liquid capital that it needs to unfreeze itself. If the government really wanted to get banks to start lending again, it would dramatically reduce spending, and thereby decrease the number of government bonds that they sell. Drying up the supply of government bonds would force banks to put their money back into the free market in order to make a profit, by increasing spending we are increasing the amount of liquid capital that is being sucked out of the free market. "Ah-ha", you may say, "But by offering banks a guaranteed interest rate, we are encouraging them to lend the money that they would have otherwise tucked under the proverbial mattress so that the government can lend the money to the businesses that need it. The government acting as a broker of sorts, guaranteeing the investment, and facilitating the flow of money." At what cost? The government cannot guarantee results. No matter how powerful the government thinks it is, it cannot guarantee that the money that it lends out will turn any kind of profit. It can only guarantee that it will print money to pay back the lender if the venture fails. Ultimately, the government is lending money to unhealthy businesses at the expense of healthy ones. Solvent banks and solvent businesses will not receive support from the government. Troubled banks and investment firms will receive the lion's share of the bailout. This money is much more likely to be sunk into the same non-performing investments that are plaguing our economy that need to be liquidated.

By borrowing money we are draining the private market of it's accumulated wealth and making it more difficult for profitable businesses to borrow money needed for expansion. By putting this money into non-performing assets we are delaying the liquidation of these same assets which have locked up more of the much needed liquid capital needed by our economy to expand. By guaranteeing the ROI for lenders that buy bonds we will be forced to print money to pay back these loans which will lead to inflation.

Many economists have discouraged liquidation of capital because selling some asset at a loss puts downward pressure on all the other assets being held, which reduces the amount of capital in the economy. For example, if I'm a bank with a number of customers facing foreclosure, by selling these homes for a loss I am putting downward pressure on the market, which reduces the value of the rest of the houses in the community which reduces the value of the assets that my bank is holding. So, after selling off a dozen homes, my financial situation may be worse off than it was before, forcing me to sell more foreclosed homes at an even steeper discount. I contend that the latter (selling homes) is preferable to the former (holding onto homes), because our economy needs liquid capital, not homes that are worth $500K on paper but not in the real world. It's the difference between real capital and fake capital. We think that we can fix our economy with fake capital. We cannot. It will take the real stuff to get our economy moving again.