by Mark Goodson
2008 October 3

If the United States had a moral money and banking system, then we Americans would not be experiencing many of the problems that are seen today. The only moral (and economically sound) money and banking system so far devised is a gold or silver standard where fractional reserve banking is outlawed, the only way to bring additional money into the system is to mine gold or silver, and the only money available for lending purposes is derived through saving. There are sophisticated and beguiling arguments in favor of the economics often touted today which embraces fiat credit expansion (monetary inflation) and tends to deprecate saving (underconsumption). But the Keynesian fallacies, as Hazlitt referred to them, are precisely that... fallacious reasoning at its most dangerous. Economics present the student with inherent difficulties that alone would tend to cause fallacies to infect its structure. But Hazlitt wisely pointed out that "the special pleading of selfish interests" tend to multiply these fallacies many fold. We must be particularly cautious in remaining objective in our investigation of the cause of our current economic hardships. That said, here's my take on what this bailout means to us, and more importantly how we got into this mess in the first place.

Credit has been so plentiful for so many years now that many businesses have become dependent on it (much like a heroin addict). The market most severely affected most recently has been the housing market. But it's important to note that the expansion in the housing industry has resulted in the expansion of a whole host of complementary industries. Think about this for a moment... when a family buys a new home all sorts of additional purchases are made. Not only that, but with home prices rising so rapidly and to such absurdly high levels in some parts of the country because of the rapid credit expansion, many unwisely chose to tap into home equity by taking out equity lines of credit. Of course, all of this was not sustainable.

There is much talk in Washington D.C. and by the pundits on the radio about "lax lending standards", corruption, and "subprime loans". Unfortunately, what is not generally understood is the root of the cause. We can ultimately thank the lax lending standards and resulting subprime debacle to the credit expansion itself. You see, after everyone who could reasonably be expected to pay off a home mortgage loan had been serviced, the only other place to put all the new money made available by our inherently corrupt financial system was into loans made to those who cannot legitimately afford to own a home. So, starting in about 2003 the lending standards began to decline markedly... we saw zero down payments, interest only mortgage payments, "stated income" documentation, and adjustable rate mortgages. If you recall, it was about this time when home prices around the country really began to accelerate upward.

Now, all this credit expansion has a way of making its way through the economy and bidding up the prices of not only real estate, but all other resources. Naturally, general prices started to rise. People found during about 2005/2006 that it started to get a little harder to make ends meet. Home prices were approaching their peak meaning that fewer people were willing to risk taking on larger mortgage payments. But most relevant is that about this time interest rates started to rise. As expected, the home mortgage market collapsed shortly thereafter, and home prices began a precipitous decline. But attempting to grow an economy through a credit expansion that is not derived from savings (in this case it was derived from borrowing from abroad, and by expanding the money supply through fractional reserve banking) always sows the seeds of its own destruction. We simply cannot have our cake and eat it too. Saving by definition is UNDERCONSUMPTION, yet even professional economists today seem to deprecate this wise counsel. Today our financial system has become dependent on a continual high rate of credit expansion and the malinvestment it encourages. When business expansions are financed by this means, then the resulting expansion must be met with insufficient consumer demand. When one thinks about this for a moment it becomes obvious. You see, the only way to make additional scarce resources available for expanding an industry is to first reduce consumption of said resources elsewhere. If this is not done, then the result is entirely predictable. Trying to grow an economy through phony credit expansion (by not saving) must always hit a wall and result in a bust.

The business cycle caused by this process is a source of upheaval and misery to the average American. But this money and banking system in place will always work in the favor of its benefactors... namely, the banking industry and the federal government that protects it through force of law. They can never lose. The federal government needs the central bank (the Fed) to finance its expansion through deficit spending, and the Fed needs the federal government to give its currency (Federal Reserve Notes) legal tender status and to bailout the banks when they become insolvent.

The only rational course of action is to accept a severe and protracted recession gracefully. We have to collectively start saving again. We have to put a stop to the credit expansion. But that cannot be allowed to happen by the political class in D.C. Recessions are unpopular, and politicians tend to lose their jobs under these conditions. So the solution that is proposed is to make all of our bankrupt lending institutions (banks) whole again by buying up all of their bad paper. The U.S. gov't will effectively print 700 billion dollars and put it into the banking system in exchange for the bad paper (most of it mortgage securities). Don't fall for all the talk on the radio that the government can eventually sell these later and gain a profit.... you see, even IF they can the damage will already be done. What this bailout will do is delay the much needed recession by allowing banks to keep on loaning out the money that our distorted economy is now so dependent on (effectively warping the distortion further). The U.S. gov't is the enabler, the banks are the pushers, and the American people are the heroin addicts. This bailout will give us all only one thing in the long run, and that's the certainty that the value of the dollar will continue to fall.