- Facing the end of the modern economy, or
- Just going through a normal recession and our biggest fear is fear itself.
First, the bad news. Credit has been extended to people and institutions who are not credit-worthy. In the old days, this would have led to debtor's prison for the borrowers and financial ruin for the lender. Everyone would have observed the misery of those who ignored Shakespeare's maxim "neither a borrower nor a lender be" and prudence would presumably have guided their steps. A harsh system with built-in consequences has its benefits.
When credit that flowed out past where it should have flowed is cut off, and the parties are called to account, pain happens. People lose "their" houses, and investors lose money. Leveraged investors lose someone else's money, which creates its own amplified problems. There is nothing like a newspaper story of someone being evicted, or a financially powerful political lobby group, to influence politicians to intervene so that they can be seen to be doing something.
The intervention will inevitably take the form of insulating both borrower and lender from the natural consequences of their action. Who should pay instead? Why, the government will help people and institutions out, of course. If the politicians and special interest groups were honest enough to say "individual taxpayers" instead of "the government", perhaps the debate would take a different turn. Would that it were so.
Taxpayers will suffer in two ways: tax money will flow to undeserving recipients, and the currency of the debtor nation will be debased as governments try desperately to stave off the deflation that follows the collapse of an asset bubble. This will be good for no one other than investors in inflation-proof assets that generate inflation-adjusted returns.
Now the good news.
First, the economy is a big, inevitable, non-concentrated amorphous thing that is hard to knock off its feet. A financial crisis does not stop food from being grown and sold, kids from going to school, refineries from running, cars getting into accidents and so forth. At least in economies where freedom reigns, the system self-adjusts and carries on. I can not conceive of a credit crisis ruining the corn crop and causing mass starvation, for example. So the system will grind along, and we will muddle through, murmuring over the headlines but surviving nevertheless.
Second, just as the fear of the Lord is the beginning of wisdom (Proverbs 1:7) then surely a secular equivalent could take root, ie the fear of financial ruin is the beginning of prudence. Once beleaguered taxpayers see that THEY are being asked to insulate others from the consequences of decisions that the taxpayer had no part in, and they realize that their depreciating dollar already buys only 20% of what it bought a generation ago, is it too much of a stretch to expect the world to want to return to something real behind its monetary system?
Fiat currency systems fail because humans run them. Some fail faster than others, but the outcome is always the same, devaluation. The political benefits of devaluation of currency, and the individual benefits of repaying debt using diminished dollars, are irresistible in the short term. But it is like wetting the bed to warm yourself. Sooner or later cold reality asserts itself.
The world will be a better place when we live within our means, when we lend and borrow only to acquire productive assets instead of consumer goods, and when our monetary system is based on substance rather than empty promises. We may have to go through some wrenching re-adjustments to get there. I can only hope that a politician has the testicular fortitude to stand up soon, state what is going on in layman's terms, and get us started in a healthier direction.