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Source link: http://archive.mises.org/2485/impending-bankruptcy-of-the-welfare-state/

Impending Bankruptcy of the Welfare State

September 15, 2004 by

Laurence Kotlikoff, author of the recent book The Coming Generational Storm, is featured in an article Speeches ignore impending U.S. debt disaster: No mention of fiscal gap estimated as high as $72 trillion. Kotlikoff’s primary message is that the on-budget debt is only a small part of the total liabilities of the US government. The largest share is in unfunded promises to pay benefits for three programs: social security, medicare, and medicaid.

    “The country’s absolutely broke, and both Bush and Kerry are being irresponsible in not addressing this problem,” Kotlikoff said. “This administration and previous administrations have set us up for a major financial crisis on the order of what Argentina experienced a couple of years ago.”
A study by government economists Ghokale and Smetters produced an accounting measure of the total liabilities (called “net present value” which a way of adding together liabilities that occur at different points in time) of $51 trillion. In a radio interview, Kotlikoff said that the study used somewhat optimistic assumptions, and the problem has gotten worse since the study was completed. He offered a more pessimistic figure of around $71 trillion. To get some idea of the magnitude of this sum, the following comparisons are offered:
    – More than double the payroll tax, immediately and forever, from 15.3 percent of wages to nearly 32 percent;
    – Raise income taxes by two-thirds, immediately and forever;
    – Cut Social Security and Medicare benefits by 45 percent, immediately and forever;
    – Or eliminate forever all discretionary spending, which includes the military, homeland security, highways, courts, national parks and most of what the federal government does outside of the transfer of payments to the elderly.
In reality, none of these “solutions” would or could ever be adopted and the promises will result in some form of default, either through outright reduction in benefits, increased taxation of benefits, means-testing, or inflation to reduce the nominal value of the benefits.

{ 12 comments }

Al Grayson September 17, 2004 at 10:01 am

Why is there any limit to how large the units of phoney money? If the mental image is of the German overprints, remember that today actual paper money is rapidly becoming insignificant. Blips on computer memory are unlimited. If the number of zeros after the digits becomes cumbersome, just rename the unit to be equivalent to a billion or a trillion old units.
As long as the government has the power to create credit units with which to bless its minions who carry the guns, it will possess the power to rob the victi… um, citizens of as much of their earnings as the state needs to keep spending.

Today the bulk of taxes are extracted from the earth, not via human sweat. Today one man running a machine, which is itself extracted from the earth and fueled with extractions from the earth, can produce what it would have taken hundreds and even thousands of men to produce in past ages.

One percent income tax three hundred years ago was enough to incite insurrections. Today the state confiscates half, or according to some, three-quarters, of the earnings of the average worker and it only incites grumbling at most. The remaining half or quarter of the earnings of the worker is ample to provide him with a standard of living that emperors could not even dream of a few centuries ago.

With continuing quantum improvements in productivity, government’s take can increase without reducing the standard of living. If the thinkers of the state can figure out how to extract wealth directly from the earth without having to confiscate it from men who have sweated to dig it out and form it into useful things, governments of large nations will be in a position analogous those small nations in which the prince provides from his own estates government for the entire nation at no cost to the citizens.

I have been studying the Hutterian colony system. A voluntary (for adults) communistic system, each colony levies “taxes” at 100% of the produce of each inhabitant and provides 100% “welfare” to each. They need money only for dealing with the outside world to pay its tax demands and to buy those things they cannot produce or do not think worthwhile to produce for themselves or to obtain from other Hutterian colonies.

This system, of course, cannot work in society in general as even shooting and starving millions of people who did not want to be communists did not eradicate the human desire for self-determination. The Hutterian system works without force and violence (coercion) only because those who do not want to participate can, upon becoming of age, leave for the surrounding society. Even those who do not want to participate and who are in their mid-teens can leave if they are determined enough to seek legal emancipation.

Doug Smith September 18, 2004 at 10:45 pm

Why is there any limit to how large the units of phoney money? If the mental image is of the German overprints, remember that today actual paper money is rapidly becoming insignificant. Blips on computer memory are unlimited. If the number of zeros after the digits becomes cumbersome, just rename the unit to be equivalent to a billion or a trillion old units.

I suppose the only limitation is when creditors rebel against the central bank’s artificially low interest rates by refusing to purchase the dollar-denominated debt instruments.

The jig is supposedly up when someone else offers better returns and assures the creditors that the debt won’t be retired by inflation. But what nation on earth will do that? And what nation on earth other than the US is a better place to put your money?

Much as I’d like to believe otherwise, why can’t the fiat money system continue indefinitely? I would be thrilled if someone could demonstrate why this is not so.

Steven Kane September 19, 2004 at 1:37 am

Doug: I think the fiat money scam could continue indefinately, if it were not for technology. When people can move funds around the world at the speed of light(which they already can over the Internet), they will have no need for archaic methods such as bank wire transfers. There are inherent limitations to what banks can offer due to the fact that their whole scam depends on certain time lags in their system. When growth in global trade becomes severely limited by the banks, global firms will eventually reject banking, and the banks will crumble. In other words, I think that firms that do business all over the world will get fed up with the fiat money games. It is going to take a long time, but I think it will eventually happen. I don’t know how old you are, but I am optimistic that it will probably happen in my lifetime.

Robert Blumen September 19, 2004 at 11:27 am

Doug: Mises wrote: We can imagine the purchasing power of money getting continually lower without ever disappearing altogether, and prices getting continually higher without it ever becoming impossible to obtain commodities in exchange for notes. Eventually this would lead to a situation in which even retail transactions were in terms of millions and billions and even higher figures; but the monetary system itself would remain.

But he didn’t believe that this could possibly happen because somewhere before that, the masses would catch on to that the policy of inflation was t be endless and would stop using the currency. The point here is at that point, no money is better than money. If they have a better money alternative then they will use it, but there have been historical cases of hyperinflation in which a community reverted to barter.

The reason that the fiat money game is unsustainable is that the counterfeit money originates in the banking system as credit, so it misleads people about how much savings exists in the economy. The credit money gets invested in projects that cannot be completed because there are not enough real savings in the economy, or spent on things that people could not afford if they knew the real cost of paying back the loans. This means that the debtors do not have the ability to generate enough cash flows on their use of the money to service the debt.

Eventually there must begin a chain of defaults on the credit, which destroys credit money along the way and causes the whole system to contract back to a base of whatever the ultimate reserve is. It used to be gold but now??

The central bank can try to resist this process by inflating more. If they are successful, they only start the cycle anew but from a worse position. If they fail, they end up creating a hyperinflation.

mikey September 19, 2004 at 2:15 pm

Robert Regarding “it used to be gold but now? “Do you believe that governments have successfully
demonetized gold?

Robert Blumen September 19, 2004 at 4:08 pm

mikey: Ultimately I think that markets decide what is and is not money. So, no, central bankers cannot demonetize gold at least not just by saying so. The promise that was held out for central banking originally was that paper money was better than gold because it was more “elastic”, that is, permitted more inflation. This is still a widely held view, that there is “not enough gold”, that the gold standard would be “deflationary”, and deflations lead to depressions. Anyway, I disagree with all that too.

What I meant was that central banks are not using gold as the reserve asset for their monetary system, at least formally. We have gone through a period in which most central banks, including even the Swiss, have sold quite a lot of their gold. If you believe the folks at http://www.GATA.org, the western banks have sold about 1/2 of their reserves over the past 8-10 years. There are some signs that this lunacy may be coming to an end fairly soon, as a the Bank of England made a fool of themselves by selling at the absolute low of the gold market, around $250, costing the UK treasury billions of $. Other western CBs have issued statements to the effect that they have no plans for further sales.

While the Western CBs have been selling, individuals and probably middle and far-Eastern central banks have been buying. It is rumored that China has quite a lot more gold reserves than they let. The president of Indonesia is trying to form a gold-based currency block for the Islamic world for regional trade. And Argentina recently purchased 24 tons of gold as a resever asset, in defiance of the IMF.

So in the end, the central banks recognize some value in having some of the stuff around. The west has sold a lot of its gold to the middle and far east at what will prove in retrospect to be disastrously low prices.

In the ashes of the next monetary crisis, money will be a matter of what people accept. Whose to say that we could not return to an international monetary system based on gold?

Caley McKibbin September 19, 2004 at 10:30 pm

We will never be free of FIAT money for one reason: we are required to pay taxes in the form of it. In effect, its acceptance it legally mandatory. In order to abolish it, it’s use must no longer be mandated by law.

I look forward to the bankruptcy of the welfare state. It will teach a valuable lesson to those who remained ignorant to their own peril. The american people will suffer so that people elsewhere won’t need to. That’s the great thing about history. Some make all of the mistakes so that others don’t need to.

Name withheld by request September 20, 2004 at 10:42 am

We will never be free of FIAT money for one reason: we are required to pay taxes in the form of it. In effect, its acceptance it legally mandatory. In order to abolish it, it’s use must no longer be mandated by law.

True enough. However, there is nothing us from conducting private transactions in gold or any other form of money. Honestly, checks and credit card transactions are simply a private currency created for a single transaction. There is a continuum ranging from fiat money at one end to barter at the other. In between, we find foreign fiat currencies, checks, credit cards, private barter exchanges, and gold among other things. As most of us know, money is simply a commodity that facilitates liquidity. The only barrier to creating another form of money is to generate broad enough acceptance for it.

With that said, governments can accomplish several obvious things through legislation. First, they can demand payments to them be made in their fiat currency. Second, the can legislate that the fiat currency can be used to fulfill any other debt. Third, they can outlaw other fiat currencies within their jurisdiction. Fourth, they can outlaw private ownership of other monetary commodities such as gold.

How much whiskey would you accept for that used lawn mower? How many cartons of cigarettes for a bushel of corn?

Steven Kane September 20, 2004 at 3:47 pm

“We will never be free of FIAT money for one reason: we are required to pay taxes in the form of it. In effect, its acceptance it legally mandatory. In order to abolish it, it’s use must no longer be mandated by law.”

I tend to think that it is a myth that just because fiat is required to pay taxes, the economy will accept it for payment as well. Here we have a “chicken & egg” type problem. Did fiat become the standard form of currency in the free market before the government started requiring it to be used to pay taxes, or did the economy accept fiat AFTER it was required that fiat be used to pay taxes? Historically speaking I do not know which is the case.

However, ultimately I do not believe that payment of taxes influences whether or not people accept fiat. I think that people today accept fiat because they believe in rampant myths regarding commodity based currency. When it comes to currency people are looking mostly for stability, or what they perceive to be stability. Over a period of decades the fiat currency regime was able to get people to believe that commodity based currency was somehow “unstable” and that the management and production of currency in a modern economy was a function that only the government could be trusted with, or could successfully achieve. Hence, Keyenes, the world’s foremost statist calling gold a “barbarous relic.”

Kyran September 23, 2004 at 1:39 am

Monetary realists…

Could I borrow your brainpower for just a moment gentlemen? Suppose various small stores within an economy began pricing their goods and services in real money as well as fiat. If fiat inflates, demand for commodity currency could increase.

This is difficult to accomplish, but the only logical way to get a commodity currency back is to make it happen.

What would result from the existence of both currencies in a mixed economy?

To illustrate, let’s suppose X is the amount of fiat and C is the amount of commodities in. The balance of X and C in circulation will be B.

X + C = B

If fiat (X) is increased by 100 billion then…

X (+ 100 billion) + C = B (+ 100 billion)

…inflation appears on X. Our price signs show this over time very slowly, and ultimately are reacted to by the market; causing C to increase:

X + C (+ 1 billion) = B (+ 1 billion)

What happens at this point? The economy now has 101 billion more than it used to? Negative. In order to get that 1 billion of commodity in, we had to push something out…

Paper. =)

X (- 355 billion) + C (+ 1 billion) = B.

Oops. I thought we printed a 100 billion George Washingtons. Now this example is just a possibility; there are no guarantees what the market will actually do…but the mechanism is what’s important.

The market can obtain more C by trading goods, services, or legal tender. Currently, the market reacts by suffering the full assault of inflation on fiat. If it could take the path of least financial resistance, it would; it needs that choice first.

I don’t have the understanding to see how this could work out long-term or across economies. Does anyone have a clue?

Email me at your leisure.

Doug Smith September 23, 2004 at 11:22 pm

The reason that the fiat money game is unsustainable is that the counterfeit money originates in the banking system as credit, so it misleads people about how much savings exists in the economy. The credit money gets invested in projects that cannot be completed because there are not enough real savings in the economy, or spent on things that people could not afford if they knew the real cost of paying back the loans. This means that the debtors do not have the ability to generate enough cash flows on their use of the money to service the debt.

Robert: Thank you for your comments and timely article, Weimar and Wall Street. This makes sense.

I suppose theoretically, perhaps even practically, it is possible to issue fiat money “backed” by all goods and services available for exchange and keep the money supply stable over time. Human nature being what it is though, bankers are incentivized to inflate. Combine this with government and inflation is a certainty, and down the slippery slope we go.

One question though. How did the German economy recover from hyperinflation despite the fact that, so far as I know, it did not go back to hard currency?

Regards.

Steven Kane September 28, 2004 at 2:26 pm

“One question though. How did the German economy recover from hyperinflation despite the fact that, so far as I know, it did not go back to hard currency?”

The same way the U.S. recovered from the hyperinflation of the 1970s. The politicians just started printing less.

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