Government Borrowing and Money Printing - The Road to Ruin

I have found an interesting quote in the Telegraph as follows:

'The latest data from the World Gold Council shows that demand for coins, bars, and exchange traded funds (ETFs) doubled in the third quarter to 382 tonnes compared to a year earlier. This matches the entire set of gold auctions by the Bank of England between 1999 and 2002.

Peter Hambro, head Peter Hambro Gold, said the data reflects a "remarkable" shift in the structure of the market. The rush to safety reflects a mix of fears about the fragility of world finance and concerns that the move towards zero interest rates could set off an inflationary surge further down the road, and possibly call into question the worth of some paper currencies.'

When reading this analysis, we need to exercise some caution, as a surge in gold demand is in the interest of the person making the analysis. However, I am not sure that he needs to create any further boost to gold prices or demand. The same article reports:

The gold markets have also been in turmoil. Traders say it has become extremely hard to buy the physical metal in the form of bars or coins. The market has moved into "backwardation" for the first time, meaning that futures contracts are now priced more cheaply than actual bullion prices.

It appears that hedge funds in distress are being forced to cash in profits on gold futures to cover losses elsewhere or to meet redemptions by clients. But smaller retail investors – and perhaps some big players – are buying bullion in record volumes to store in vaults.

The important point here is that, when governments abandon all restraints on borrowing, and either start (or contemplate) printing money, it is certain that all will go horribly wrong. We are now in a very, very serious situation. On the one hand we have governments hoovering up huge amounts of capital in competition with investment in private businesses. On the other hand we have the extreme bears, who see gold as the only store of value going into the future. The combination of these two trends will leave very little capital to be invested in business....

Again from the same article:

'"It is sheer unmitigated fear: even institutions are looking for mattresses to put their money until the end of the year," said Marc Ostwald, a bond expert at Insinger de Beaufort.

The rush for the safety of US Treasury debt is playing havoc with America's $7 trillion "repo" market used to manage liquidity. Fund managers are hoovering up any safe asset they can find because they do not know what the world will look like in January when normal business picks up again. Three-month bills fell to minus 0.01pc on Tuesday, implying that funds are paying the US government for protection.'

The fundamental principle underlying all of this is complete lack of confidence in the wider economy (buying bonds), and in many cases complete loss of belief in the value of paper money (buying gold). These two trends sit in opposition to one another. On the one hand, there is a belief that the government is a safe place to put money, and in the other there is complete loss of confidence in the ability of government, and a belief that government is going to destroy the value of currency. As regular readers are aware, the government of the UK is finding it increasingly difficult to borrow, but the US still has the confidence of investors, however misplaced that confidence might be. However, as long as governments are able to continue to borrow, the problems caused by government borrowing remain.

We are in central contradiction that, the more the government borrows, the more the economy rests on the ability of governments to borrow, and the more government borrows, the greater the fear for government ability to repay the debt will be. The contradiction will be resolved with a complete collapse. I will explain further.

The move into gold has been steadily increasing, but is now starting to look like a surge. It seems that many now believe that buying bonds is the equivalent of buying pyrite (fool's gold). To say that all of this is very worrying is an understatement. Perhaps the worst part is that government borrowing is hoovering up capital despite negative yields (in the US). In so doing, there is a destruction of wealth, combined with increasing certainty of wider collapse in the economy. By denying businesses capital, it becomes ever more certain that business will collapse, including good businesses.

To give an example of what this government borrowing means in the real world, we can take the example of the bailout of the US car manufacturers. For the moment we will ignore the printing of money, and will view the bailout of the car manufacturers as being funded by borrowing. In so doing, the government is going to the market, borrowing money in competition with investment in private enterprise. Some of that private enterprise will be well managed companies, with genuine future prospects. However, they are now in competition with the (illusory) safety of investing the money in government borrowing. As such, instead of the money going to a good company, it is instead funnelled into companies that will quite literally destroy the value of that capital. When we read stories about the car companies, they talk of the automotive companies 'burning' through their cash, and this is a rather apt metaphor.

However, most of the government borrowing will not be going to support manufacturing. Most will be going either into spending, or to support the banks.

If we take the case of supporting the banks, what is happening is that the government is a direct competitor to the banks in raising capital. If the government raises $1 billion, there is $1billion less available elsewhere. It is that simple. What you have is a vicious circle in which governments are hoovering up the capital, leaving no capital, meaning that the only source of capital is the government. In other words, the more the government borrows, the less the available capital, meaning that the government must borrow more, so that they can then provide more capital injections into the banks to support the market from collapse.

In the case of government spending, this spending is denying investment into productive businesses. The more that government spends, the less available capital for productive businesses. It is that simple. $1 billion of lending to the government means $1billion less for business. Once again, we hit a vicious circle. The more the government spends, the more it will need to spend, as the competition for capital away from private business into government borrowing will lead to further contraction of the productive private business sector, leading to ever more need for government spending.

Quite simply, all of the government borrowing assures that the government is just going to have to keep on borrowing more and more, until the whole insane edifice collapses in on itself. In these circumstances, it is not surprising that governments are now either thinking of, or actually starting to print money. Governments, in flooding markets with government debt, are sucking the life out of investment into productive business, and redistributing that money into spending which will not create wealth, but is the spending of future wealth.

Governments are quite literally crushing private enterprise.

As that private enterprise contracts, the finances of governments will just go into ever steeper decline, as tax receipts fall, and government costs soar. As this happens, governments will just have to keep borrowing more and more, thereby exacerbating the problem.....

Or they print money.....

It is quite possible to see the insane logic in this 'solution'. Governments can not just keep on borrowing ever larger amounts of money forever. How much capital can they continue to divert from real investment and redirect into spending? How much capital is out there to hoover up, and how much will there be as business contracts? Faced with the consequences of their actions, their solution is to magic capital into existence with the use of the printing press.

The trouble is that, as fast as the money pours off the press, it will destroy the value of capital. What you then have is government hoovering up capital, whilst deploying that capital into unproductive spending, all the while slowly but surely destroying the value of capital. The more that the value of capital is destroyed, the more that government will need to print more money...

The current action of governments is to engage in the most self-destructive action that is possible, short of dropping bombs on their own cities. They are quite literally destroying their economies.

I have argued consistently on this blog that governments should not be able to borrow money, excepting in the case of crises such as war. My reason for this view is becoming ever more apparent, as we see the economies of the UK and US coming ever more under the control of governments. The more the government borrows, the greater the shift towards government spending and 'investment' as the centre of the economy. Perhaps this is most apparent in the UK, where yet another story of government control of banks has appeared:

'The Chancellor has said that ministers were studying a range of options to boost bank lending, including underwriting loans to businesses.

"I am prepared to look at a number of things that would make it more likely that banks will lend," Mr Darling said. "However, from the banks' point of view they have to understand that with billions of pounds of taxpayers' money, either invested in shares, or being made available as a guarantee, the general public and businesses are looking for something in return.

"So, yes, if we do something I think that will be welcomed by people but we've also got to make sure that is passed through."'

When the bank bailouts were proposed, this is exactly what I said would happen. The government is now taking ever more control of the economy. As money has moved from private sector investment into government borrowing, the government has become the most important source of capital. In becoming so central to the allocation of capital, the economy is now dominated by the government, and the government is seeking to 'command' the economy to do its bidding. In this case, the government is borrowing money to lend into banks, and wants to achieve a consumer spending led recovery.....

All on borrowed money....

The only way to reverse the cycle is to stop the borrowing, and switch off the printing presses. This will leave the holders of capital with no choice but to put their money somewhere else. Yes, the surge into gold will increase, and this is not a productive use of capital. However, it will not soak up as much capital as government borrowing, and investment into productive activity will commence. In particular, with government finances back under control, and the printing presses shut down, the flight to gold due to fears of currency collapse will diminish demand for gold.

I am not proposing a complete immediate stop to government borrowing, which would be impossible in practice, but an immediate return to pre-crisis borrowing levels. However, there should also be a commitment and firm plan to reduce borrowing very quickly, until the point is reached where the borrowing can start to be repaid. The only way to achieve this is to start the process of cutting government expenditure. As a ballpark, governments should be in a position where they are returning to surplus in about five years time. This is long enough to allow a transition from the current government domination of the economy, to an economy that will be based upon enterprise. Each year that government reduces borrowing, it will free up capital to be invested in enterprise, and by having a progressive reduction, it will allow business to safely absorb the new streams of available capital into productive investments. This time period would allow a smooth, but painful, readjustment. It is also not such a long period of time that it allows for government to wriggle out of the commitments and delay.

It is not a comfortable solution, and would be painful to implement. However, it is the only solution that makes sense for the future.

So there you have it, government borrowing and money printing as a solution. As I have said earlier, the only thing they could do that would be more destructive is governments bombing their own cities.

Note 1: I have not responded to some of the comments on my previous post, as I need to try to put some time into finishing the post on taxation. Hopefully I will come back to them, time allowing.