Column by Cristian Gherasim.
Note: Cristian Gherasim partially plagiarized this column from here.
There are signs of another massive bailout coming Europe’s way. On Monday the European Central Bank intervened to prop up the eurozone bond markets as political leaders and bankers warned the debt crisis was deepening amid fears that Portugal was edging close to an international bailout. The European Central Bank had to buy the country’s government bonds to stop the market selling off steeply before important debt auction in Lisbon on Wednesday.
Whether we’re dealing with an international or national bailout, the principle stays the same: you socialize the losses, turning private debt into collective credit. They call it funding. But contrary to what Keynesian commentators say, funding is not about money but about real savings – final consumer goods. It is the flow of final consumer goods and services, and not printed money that maintains people’s lives and well-being. Money is just a medium of exchange. It’s worthless without the backing of the goods and services produced by each and every worker. You just can’t sustain an economy by simply injecting more printed money, just like you can’t consume your way back to economic prosperity. The increase in consumption must be in line with the increase in production; and the increase in production is in accordance with what the pool of real savings permits. The economy can only be supported by producers and not by central bankers. You need real savings to bring the economy back to health.
What these bailouts do is weaken the process of wealth formation. A massive fiscal stimulus, by generating inflation, acts like a wealth relocation agent taking resources and real savings from where they are most needed. This is exactly what the government-sponsored job creation programs accomplish. The artificial creation of employment is not going to be free. The unemployed individuals that will be employed in useless projects must be funded. Since the government doesn’t produce any real wealth, the funding will have to be diverted from wealth-generating activities. This, however, undermines wealth generators and weakens the real wealth-generation process.
The alternative is a free market, a self regulating mechanism where things can work and sort themselves out. The market economy is a profit and loss system, and its self-correcting properties offer the most important lesson of economic science. One of these self-regulating tools is bankruptcy. It ensures that, while profits ensure the survival of good investments, continued losses will end up driving bad investment out of the market. It’s a process of continual reevaluation and re-shuffling of resources among alternative users. Good businesses survive while the bad ones fail. This ensures a system of perpetual improvement. Bankruptcy is thus a necessary self-regulating element of the free market. It helps sustain the pool of real savings, which in turn drives production and generates wealth.
But once again we have another clear example of how a government, or in our case a union of states, by the use of small tweaks, can bring this system to a halt, and even put it in reverse. The US and many European governments have propped up bad businesses by redistributing wealth towards them from the rest of society, through what have been called The Bailouts. This, however, turned out to be not only immoral but harmful and highly inefficient. These bad investments made wasteful allocation of resources the norm, hampering the flow of good investments. If we succumb to the pressure of this new trend, of politicians and bureaucrats deciding which companies are worth preserving which should go bankrupt, we have outright replaced the market with a central planning system.
Bailouts also represent a combination between two incompatible ways of management: profit management and political management. In the first, organizations strive to make profits and to avoid losses, while in the latter, organizations must obey the dictates of government officials. The companies bailed out are expected to continue operating as private businesses, but funded by government money. That’s how bailouts were advertised. But that’s utterly impossible. From the very moment government money comes into play, the companies are in effect nationalized. And we all know what that means: gone are efficiency, entrepreneurial discovery and wealth-production. Even though these companies may seem to be acting on their own will, the government is the only one calling the shots. This is when decisions are no longer taken by consumers but by bureaucrats.
The market doesn’t need adjustments, it adjusts by itself. Poor decisions and malinvestments are sanctioned, in a free market, by bankruptcy, while the opportunities for wealth creation are exploited. Bailouts, employment programs, regulations and government-orchestrated wealth redistribution only hinder the market’s ability to self-correct.
Preventing the self-regulating process of bankruptcy from occurring not only distorts the economy, but also creates an unsustainable system that is bound to collapse. The only factor preventing an economic collapse is the buildup of real savings. This buildup can only be secured by wealth generators and not by arbitrary government spending, which only weakens the process of wealth formation.