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The non-neutrality of government intervention

By Eddie Willers
web posted August 23, 2004

No form of positive government intervention is ever truly market neutral. Government cannot positively intervnee in such a way as to help everyone and hurt no one. Inflation of money and credit is no exception to this rule. Inflation is a form of positive government intervention in the otherwise peaceful affairs of the marketplace. Inflation tends to benefit debtors at the forced expense of creditors, at least for a time, since borrowed money is paid back with money having less purchasing power. It robs savers, many of whom may be locked in for a period of time into a rate of return which is lower than the rate at which other prices are being bid up. The people who get the new money first benefit at the forced expense of the rest of us who get the money after it has circulated around and has bid prices up. The people who get the new money first can buy at yesterday's prices; the rest of us have to buy at tomorrow's higher prices. Thus, real wealth is transfered to those who get the new money before it gets to everyone else.

Most of all, the process of inflation benefits the government itself -- and those favored entities with which it deals directly or which it subsidizes. The government can pay its IOUs with this new fiat money -- but if you or I tried to pay our debts with money we created out of nothing but ink and special paper, we could be sent to prison for the crime of counterfeiting because it is a fraudulent claim on the wealth of others (a form of theft). The government's deliberate policy of inflation is no less a fraudulent claim on real wealth. It is no less a form of thievery, though subtle. It is "legal" only because it is done by the government and its central banking mechanism -- and it is against the law for anyone else to do.

Whenever government and/or its central banking monopoly (the Federal Reserve System in the United States) inflate credit or money substitutes, this tends to cause interest rates to dip in the short run as the new money enters the economy initially, but later, as the new money circulates throughout the economy, interest rates are bid up higher than ever. Beyond not being "market neutral," this process sets in motion artificial incentives toward malinvestment which sooner or later are liquidated through economic recession or depression. In other words, inflatioin disrupts the usual market signals on which investors and others rely to make their decisions, and this results in unsettling instabilities in the economy. It is no accident that, as Milton Friedman and Anna Schwartz have carefully demonstrated, the U.S. economy was more unstable after the creation by Congress of the Federal Reserve than before its creation.

It does not matter how good a "money manager" the Fed chairman is or how careful he is in trying to control the nation's money supply; any inflation at all, no matter how gradually it is administered, tends to disrupt the economy with artificial booms based on malinvestments to be followed by painful busts in which those unsound investments are liquidated. The "monetary authorities" may try to avoid the recession phase of the cycle by stepping up the rate of their inflation -- "a little hair of the dog that bit us" in the first place. But this can threaten an inflationary spiral in prices as people begin to anticipate a certain routine level of monetary debauchery in their lives. If the brakes to monetary inflation are not applied, it is possible that this spiral could get out of control entirely and lead to a hyperinflationary depression as took place in Germany in the 1920s and in Hungary after World War II.

Just as inflation does not hit everyone with equal force, so too there is probably no such thing as a perfectly "market-neutral tax" -- a tax which helps everyone and hurts no one, or which falls on everyone with equal impact. There will always be some "winners" and "losers" in the game of legal plunder. (This does not mean that I am here suggesting that all taxes are equally bad necessarily, only that they all involve some degree of coercive violence on peaceful people and that there is probably no tax which hurts everyone equally. Some forms of taxation may be less bad than others. It has been suggested by some that if government could be reined in to its proper functions -- of using its coercive powers only negatively by defending against and justly retaliating against those who initiate or threaten the use of violent force and fraud -- that all the necessary funding to run such a proper republic could be generated wholly by non-coercive revenue devices instead of by the economically unhealthy and immoral practice of taxation, but that is a topic for another occasion. For the time being, alas, we seem to be stuck with taxes -- given the gargantuan size and appetite of our current government establishments, and especially the demands of the various welfare state programs. In the meantime, lower taxes and less positive government intervention is to be preferred, whenever possible, over higher taxes and more government spending, regulations, and controls over our peaceful lives and businesses.)

Again, no form of positive government intervention is ever truly market neutral. Government cannot give anything to anybody unless it takes it away from others. And then, don't forget, there is the government's own "cut" of the "take" as the administrative overhead. Society as a whole always loses, on net, when government is allowed to positively intervene. Think about that the next time you hear a community redevelopment official or local politician claim that the alleged benefits of a proposed taxpayer-subsidized project will outweigh the costs in the "long run." The estimates which are trotted out in the cost/benefit analyses for such schemes are usually merely wishful thinking on the part of the planners and schemers who want to sell the idea of a tax hike (aka a "bond issue") to the politicians or the voters. In a true free-market society, which the United States was supposed to be, if there is sufficient market demand for a project or development, let private capital build it instead of forcing the taxpayers to pick up the tab.

Eddie Willers can be reached at ewillers@Laissez-FaireRepublic.com. (c) 2004 Eddie Willers.

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