With the United States and much of Europe buried in public debt, many wonder how world governments will solve their impending budgetary crises. The economics profession has split into two camps: those who promote more spending; and their opponents, the “deficit hawks.” The spenders have been the more vocal, largely due to their dominance in mainstream academia.
Keynesian economists, like Paul Krugman, argue that growing debt will not be a problem given that large government debts are not unprecedented. For example, Krugman argues that the United States ran large debts during the Second World War and was able to pay them off after the war ended. This Princeton professor and Nobel laureate also argues that, because the United States is one of many countries piling up debt, its public debt is justifiable and tenable.
Paul Krugman conveniently leaves out, or fails to apply, some key details. Regarding the Second World War, he notes that the debt was paid off largely because of a cut in government spending. He fails to account for the fact that the most dangerous factors behind the current debt are “unfunded liabilities” — the future costs of welfare and social-insurance programs. As for those other countries building debt, they are also looking at political uncertainty and almost-certain economic collapse.[1]
Most onlookers have been able to see past these elementary flaws and realize the potential danger of growing public debt. Dismissing the Keynesian argument, however, leaves the layman with few other accessible explanations. For most, the biggest threat seems to be an increase in taxes. Although worrisome, high taxes should be the least of one’s worries. The worst to come is sovereign default, a scenario which the mainstream has declared unrealistic.
Fortunately, the Austrian School’s Garet Garrett chronicled the threat of accumulated public debt in The Bubble That Broke the World. Unfortunately, Garrett is the bearer of bad news.
The current fiscal situation is not unprecedented. High public and private debt has been the bane of large governments for the entirety of written history. It is what Ludwig von Mises described as the “crisis of interventionism.”
Intervention aims at confiscating the “surplus” of one part of the population and at giving it to the other part. Once this surplus is exhausted by total confiscation, a further continuation of this policy is impossible.[2]
Put in simpler terms, the crisis of interventionism is summed up by the adage, “the problem with socialism is that eventually you run out of other people’s money.”[3]
While Mises laid down the theoretical foundations for the argument against big government and socialism, Garet Garrett provided the empirical evidence. In 1931, amidst a global economic crisis, Garrett published The Bubble That Broke the World. This relatively short book, largely forgotten today, provides one of the best and clearest arguments against the accumulation of public debt, and applies Mises’s theory of the crisis of interventionism to the crisis in Central Europe during the Great Depression.
Garet Garrett’s Lesson Restated
Garet Garrett remains an unsung hero of liberalism.[4] Although he is probably best known for his novels,[5] he was also a great economist. He worked to discredit the New Deal[6] and Franklin Roosevelt,[7] while crusading for small government.[8]
The Bubble That Broke the World remains one of his most important works on economics and the Great Depression. Garrett placed the blame for the worldwide economic collapse of the 1930s on the Federal Reserve System’s program of extending credit to bail out its European friends. He branded the entire process a Ponzi scheme.
Garrett described the bubble as a product of three factors:
First, the idea that the panacea for debt is credit.…
The burden of Europe’s private debt to [the United States] now is greater than the burden of her war debt; and the war debt, with arrears of interest, is greater than it was the day the peace was signed.…[9]
Second, a social and political doctrine, now widely accepted, beginning with the premise that people are entitled to certain betterments of life. If they cannot immediately afford them, that is, if out of their own resources these betterments cannot be provided, nevertheless people are entitled to them, and credit must provide them.…
Third, the argument that prosperity is a product of credit, whereas from the beginning of economic thought it had been supposed that prosperity was from the increase and exchange of wealth, and credit was its product.[10]
The late 1920s and early 1930s was a period of fear throughout Europe. Currencies were losing value, governments were building debt, and animosity was again quickly spreading between governments. European central banks were having issues remaining solvent while still providing liquidity to their governments. As a result, they often looked to the New York Fed and a host of private banks in the United States for credit to provide this liquidity.
Ultimately, the solvency of the Bank of England and the Reichsbank depended entirely on the solvency of the US Federal Reserve System. The Fed could only remain solvent as long as the Europeans repaid their debts, and by 1930 it was becoming obvious that these countries were borrowing far more than they could afford to repay.
“The cost of social-insurance and welfare programs can increase with general price inflation. Government cannot print its way out of a debt that adjusts itself to the rise in the supply of money.”Germany was the weakest link. Her government, scrambling for funds to pay for war reparations and social programs, borrowed copiously from English and American creditors. Unsurprisingly, the Germans began to borrow to pay for debts owed to the same creditors. Garet Garrett described this as a method by which Americans were repaying themselves for debts owed by others. The long-run consequence was even greater German debt. The principal losers were the American creditors who had lent far too much credit to the Europeans.
The overall consequences were easy to predict. As European central banks became insolvent, they began to default on their debts, catalyzing the collapse of the giant pyramid of credit funded largely through the Federal Reserve Bank of New York.
The lesson of The Bubble That Broke the World is not the eventual collapse, per se. Although Garrett does argue that an accumulation of debt will end in insolvency, his focus is on the accumulation of debt itself. Garrett’s lesson is that government expenditure funded through debt and credit expansion creates an addiction to credit. Credit is considered a panacea, and is used to keep government programs afloat. Building debt, fueled by addiction, leads to ruin.
Credit can serve as a panacea for debt only as long as there is credit available to borrow. When the source of credit has been depleted, and governments find it impossible to repay their bloated accounts, the house of cards collapses. This is what occurred in the early 1930s, and it is what will occur in the present day.
The Lesson Reapplied
Although crises of interventionism have occurred between the 1930s and the present — including in Argentina and Zimbabwe — the majority of First World citizens remain distant from the concept. Apart from those few veterans of the Great Depression, the majority have lived in an era of abundant resources and unparalleled wealth. Despite the reoccurring booms and busts, there have been few serious periods of general poverty in the United States, nor in most of Western Europe.
Garet Garrett’s The Bubble That Broke the World was forgotten soon after it was published. Even Murray Rothbard’s America’s Great Depression, which in many ways brought Garet Garrett’s insights out from obscurity, remains unheeded.
But the era of growing bureaucracy, of the welfare/warfare state, and of illusionary wealth cannot last forever. Today, we are witnessing the symptoms of an impending “crisis of interventionism.” Garrett’s lesson is as relevant and valuable as ever.
The West has undermined its own security by allowing its governments to quickly grow beyond the fiscal means of their people. The United States and Western Europe have built up a mountain of debt. Deficit spending as a countercyclical fiscal policy is the least of the world’s worries. The collapse of today’s credit-based Ponzi scheme is mainly due to the multitude of social-insurance programs that are becoming far too costly to sustain. In other words, the crumbling keystone is not short-term expenditure but long-term debt.
Given the political unpopularity of cutting these untenable programs, it is unlikely that governments will purposefully reverse their growth.[11] There is a fast-growing addiction to credit. Western governments can be compared to drug addicts. While a drug addict can overdose, however, the government can remain high as long as credit continues to be supplied at an exponentially rising rate. But, as with any addict, the day the supply cuts short is the day that marks the beginning of a severe depression.
“There is only one long-term solution, and that is the reduction of government.”But wait, if government can just print money, would it not be able to pay off its debt, even if at the expense of everybody else? This is why unfunded liabilities are so important. The cost of these social-insurance and welfare programs can increase with general price inflation. Government cannot print its way out of a debt that adjusts itself to the rise in the supply of money.
There is only one long-term solution, and that is the reduction of government. Large government is unsustainable. For better or for worse, as Garet Garrett beautifully explains in The Bubble That Broke the World, the market corrects itself. The lengthening of the period of interventionism only increases the painfulness of the inevitable reallocation of resources.
The world already has the Great Depression as a warning. But governments and the bureaucrats who run them have decided to ignore the lesson. The new crisis of interventionism is fast approaching, and the market will not wait for governments to realize their errors.
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Notes
[1] Paul Krugman has seemingly lost all common sense. He recently suggested that if Spain still used the peseta, his suggestion would be to devaluate it in order to pay off public debt.
[2] Mises, Ludwig von, Human Action: A Treatise on Economics (The Scholar’s Edition). Ludwig von Mises Institute, Auburn, Alabama: 1998. Pp. 854–855.
[3] This saying is commonly attributed to Margaret Thatcher. What she actually said is, “Socialist governments traditionally do make a financial mess. They [socialists] always run out of other people’s money. It’s quite a characteristic of them.” She said this during a television interview for Thames TV This Week.
[4] For a biography of Garet Garret, see: Tucker, Jeffrey, “Who is Garet Garrett?“ Mises Daily: 25 October, 2007.
[5] Ramsey, Bruce, “The Capitalist Fiction of Garet Garrett“ Mises Daily: 26 December 2008.
[6] Garrett, Garet, Salvos Against the New Deal. Caxton Press: March 2002.
[7] Garrett, Garet, “The Myth that Is FDR,” Mises Daily: 19 January 2010.
[8] Ramsey, Bruce, “Garet Garrett: Far Forward of the Trenches,” Mises Daily: 27 March 2008.
[9] The war being referred to is World War I, and the peace referred to is the Treaty of Versailles.
[10] Garrett, Garet, The Bubble That Broke the World. Ludwig von Mises Institute, Auburn, Alabama: 2007. Pp. 3–7.
[11] The mere suggestion that Greek prime minister, George Papandreou, will cut deficit spending sparked mass protests in Greece. “Greece’s PM vows to slash huge government deficit,” BBC, February 10, 2010. Also, see Higgs, Robert, Crisis and Leviathan.
