Let's consider a hypothetical scenario. Suppose you earn $50,000 annually and know of five individuals who each earn $2,000 per year. In this scenario, the six of you are the only inhabitants of the world. How would you strive to create a fairer world?
After posting this question in my Reengineering Politics Facebook group, I received numerous excellent responses suggesting that individuals must have worked for their wealth and did not feel obligated to share it with the less fortunate in their community. One response even mentioned providing employment opportunities for the poor to help them improve their standard of living.
Income Inequality = Crime
Let's extend this hypothetical scenario a bit more. Suppose the five underprivileged individuals, feeling discontent about the significant income gap, decide to rob you. Would it be ethically justifiable for them to resort to theft in order to obtain what they consider to be their rightful portion?
Every single member of my Facebook group expressed outrage. Not a single person thought that the less fortunate deserved the riches of the wealthy individuals in this situation. The idea of theft goes against our moral compass, especially when confronted with an income disparity similar to the one illustrated in my hypothetical scenario.
Direct Democracy
Most people consider robbery unacceptable. It's evident that wealthy individuals are unlikely to voluntarily relinquish their wealth. What if our impoverished citizens opt to establish a democracy?
A group of five impoverished individuals collectively decided to form a democracy. The decision was unanimous, resulting in a 5-1 outcome. They selected one of their own as their leader, and their government imposed a $15,000 tax on you. This money was then redistributed to the poor through government employment and welfare.
You still hold significantly more wealth than the rest, and the impoverished individuals continue to perceive this economic system as unfair. Two roles were established (1 politician and 1 government worker). Democracy is truly remarkable, isn't it?
The Free Market
Some of you have noticed the flaws in my thought experiment. How can the wealthy individual earn $50,000 per year in an economy that is so small? Why were the poor people poor? Why is no one working in this weird economy?
The reality is that a free market is the thing that creates wealth without government intervention. Everyone in a free market will earn more money as they gain skills and education that create benefits in their marketplace. There are still poor people in the free market. However, their poverty is often a result of low skills or laziness. In a free market, low-income earners are motivated to improve their skills to earn more and improve their lifestyle.
The indigent cannot thrive in a free market. For whatever reason, they are unable to improve their skills, or participate in earning a living for themselves. They may be too old, too young, disabled, or handicapped in some way.
The Mixed Market
While the free market is pretty good, there are gaps. The indigent will not survive unless they are given charity by others in this marketplace. There are public services that do not lend themselves to a free market. Such services as public education, roads, judicial systems, police, fire departments, etc. In addition, if the free market is allowed to run unregulated, unfair business practices will go unchecked and environmentally damaging practices can harm others.
When the government provides public services and taxes the private sector a few things happen.
Welfare Trap: Welfare programs eliminate the ambition of the poor to seek great skills because it is easier for them to receive welfare than to work. This creates what is called the “welfare trap”.
Reduce Human Resources: Since people are needed to work in government services, the government is now competing with the private sector for workers. Private sector companies must increase salaries or do with fewer workers in this scenario.
Indigent Don’t Go Broke: In this scenario, the government provides basic sustenance for people who cannot provide for themselves.
Lower Income: Those in the private sector who earn income will be paid less in order to give portions of their income to the government.
Less Ambition: In a progressive taxing environment, the wealthy pay most of the taxes. This slightly reduced the ambition by lower income earners to increase their earning potential as they will experience a slight penalty in paying higher tax rates.
The Debt Solution
There is a tension that is felt in the mixed economy. In the private sector economy, people want to purchase items that they cannot afford with their annual income. If the bank lends them money, they can pay back bank loans and live the lifestyle that they want. In the government sector economy, people want the government to provide more services. The government knows that people in the private sector don’t want to pay more in taxes. The solution? The government can borrow money from the bank. These two desires to live beyond current income create a debt-based economy.
As the government grows, it continues to pull human resources out of the private sector. Middle class and lower-class workers are drawn into direct service for the government or are employed by government contractors as debt fuels the government’s economic prowess.
Debt does something else with the economy. In the private sector, borrowing and repayment create debt cycles. When people are borrowing money, they inject more money into the economy. However, when those same people repay their loans, money is pulled out of the economy. In some cases, added borrowing improves the economy. For instance, if a business builds a factory with a loan from a bank and that factory creates new goods and more jobs. This is a way that money and wealth is created from nothing. On the other hand, economic harm results if a business borrows money and defaults on its loan.
In the government sector, debt acts differently. There are two primary different forms of debt creation for the federal government:
Selling bonds to investors. This is the same as the private sector. The government borrows money from private investors who expect to be repaid their principle plus interest. No different than private sector debt.
Money printing. The Federal Reserve buys government bonds. The interest paid on these bonds goes back to the U.S. Treasury. This is called “money printing” when money is created out of nothing.
In both cases, when the government borrows, it is increasing the money supply. Since the government doesn’t repay this debt, it is avoiding the traditional debt cycle experienced in the private sector.
While it seems like the government can get an infinite amount of debt, there are two problems that result from government borrowing:
Inflation. Inflation is the increasing of the price of goods and services. When the government spends too much money into existence through excessive borrowing, there is more money than there are goods and services. This forces the prices of those goods and services to rise. This has been a major problem with hyperinflation in countries around the world who printed more money than was reasonable.
Interest payments. Our government is required to pay interest on all of its debt. This cost of interest must come out of the yearly budget. In 2024, this interest cost is expected to be as large as the U.S. military budget. When money is allocated to interest costs, it cannot be allocated to government services.
The best thing to know about debt is that it can be used to invest in a new factory or something that will improve the economy. However, in many cases, debt creates a false sense of prosperity.
The Oligarchs
In a free market, it is inevitable that a few people become very rich and powerful. Their wealth is often the result of creating a beneficial product or service that is wanted and needed by many people. A few that exist in the U.S. include Elon Musk (space, electric cars, and X), Bill Gates (computers and software), Jeff Bezos (online retailer), Warren Buffet (investor), and Mark Zuckerberg (social media). These folks tend to earn more money than they can spend in a lifetime. They often reinvest their wealth into private sector businesses.
Wealthy people become oligarchs when they start influencing the government and the free market. Wealthy people cannot help but influence both the government and the free market. They influence the free market because this is where they gained much of their wealth. Many people in the free market have also benefited as a result, so they are loved in the free market. Politicians who need campaign donations will urge wealthy individuals to donate to their campaigns. This often results in a trade for favors that the government may grant such individuals.
The Politics of Money
In the original thought experiment, I showed how the democratic process allowed the five poor people to override the will of the one wealthy individual. We are in a similar situation in 2024. However, the large group in 2024 is not just the poor. The U.S. has become highly polarized between the left and the right. Here is how our current debt-hungry society is divided.
The red signifies conservatives; or those on the right. The blue signifies liberals or those on the left. While this division is the divide between conservatives and liberals, it is not the division between Republicans and Democrats. Both Republicans and Democrats are attempting to win within the context of our current economic model.
Oligarchs had typically aligned themselves with the right. They wanted low taxes and low amounts of regulation in their businesses. In today’s world oligarchs are leaning more heavily left. Why? Because they’ve learned that they can move their money if taxes get too high, so high taxes don’t bother them. Oligarchs can use regulation to prevent competition from smaller companies who struggle under higher levels of regulation by the government.
With the advent of ESG (Environment Social Governance), many oligarchs are transforming their large companies to cater to more liberal causes.
Banks love the higher debt climate as they earn profits by loaning money. Banks also know that they will get bailed out by a bank-friendly government if they make too many bad loans.
Lower income earners like a larger government to provide a safety net to prevent them from being poor. Many lower-middle class income earners are employed by the government. They enjoy high job security and a decent paycheck.
The middle class and small business owners are the few remnants who are firm believers in the free market. They have even been tempted by small business loans and grants being offered by the government to switch sides. The middle class are struggling to pay higher taxes and the full price for all services while their lower income counterparts are receiving discounts. Small business owners have few resources to dodge higher taxes.
The Problem
Our economy is what it is. However, where it is going IS a problem. In all these images, you may have lost track of the arrows that were labeled “AMBITION”. These arrows are less and less present in each graphic. Why? There is a hope by most in a free market that they can improve their income by increasing their skill. There are two emotions that drive this ambition, “fear” and “hope”. Free market participants fear that they will lose what they have or not be able to pay for their current lifestyle. Free market participants are hopeful that investments in their skill or their business will give them a better lifestyle. These emotions are absent in most government jobs.
There is a reason why the U.S. has attained its place as an economic power in the world. This reason is centered around valuing free market principles with a reasonable investment in government services. The debt cycle is causing damage in our government and has increased the shortage of workers in the private sector.
By flooding our country with impoverished immigrants from foreign countries, we are destroying the economy that made our country great. By welcoming in legal migrants who can fill vacant roles in our economy, we are fueling a vibrant free market and improving the lifestyles of several who are fleeing violence and oppression.
The Federal Reserve
I have labeled the Federal Reserve as the bank in the graphics above. The Federal Reserve is a central bank that was intended to smooth out economic cycles. It was started in 1913. Sadly, the FED seems to have created more, not less, volatility in our economy. I’m not blaming the FED. The FED is simply doing what they were ordered to do. They are tasked with targeting annual inflation of 2%, and relatively full employment (unemployment below 5%).
Rather than expounding on the entire history of the Federal Reserve, I think it is important to highlight their most recent actions.
Early in 2020, the COVID19 virus spread to the rest of the world causing a worldwide pandemic. The U.S. stock market plunged 20% and most governments reacted with what they believed were prudent lock down measures. Lock downs meant that any activity where people would encounter other people would cease. The only exclusions were first-responders, liquor stores, marijuana stores, big-box stores, grocery stores, and online retailers.
The FED responded by dropping interest rate from 1.55% to 0.00%. The government spent trillions of dollars into the economy by writing checks to individuals, giving 0% interest loans to companies, and improving unemployment compensation to displaced workers.
This flood of cash into the economy combined with low work output and broken supply chains resulted in inflationary pressures that resulted in an average increase of 5.5% per year for four years (2020 to 2024). Inflation peaked in March 2022 at a rate of 19.2%. These high rates of inflation prompted the FED to increase the FED rate from 0.0% to 5.5%. The unemployment rate jumped to 14.5% when businesses shut down in April 2020. Two years later in May 2022, the unemployment rate had returned to its pre-pandemic level of 3.6%.
The FED uses their FED Funds Rate to control the economy. The FED decreases the FED Funds Rate to stimulate the economy (as in the time of a pandemic). The FED increases interest rates to reduce inflation (March 2022 to October 2023). All the while, the FED attempts to keep unemployment around 5%.
The problem is obvious. If the controller (FED) doesn’t properly anticipate the variable being controlled (inflation, unemployment), the control variable will oscillate out of control. Likewise, if the controller is not 100% in command of the variable being controlled, its efforts will have no effect.
In the case of the FED, they reacted to the pandemic with extreme measures trying to inject money into the economy as fast as possible. No one can blame the FED for not anticipating this pandemic. The variables that were out of the FED’s control were the massive lockdowns implemented by the government in addition to trillions of dollars of economic relief paid by the government.
A smart controller would anticipate what would happen next… inflation. The FED denied this reality until inflation was entrenched. It then reacted harshly with a large interest rate increase in the shortest amount of time. This large increase caused a few hardships:
Bank Failures – Banks invest spare cash in safe investments like low-risk treasury bonds. When interest rates rise, and people want to withdraw cash from the bank in a declining economy, banks must sell their bonds at a loss. When this loss is too great, the bank has failed and cannot honor depositor withdrawals. Five large banks failed in 2023 in the U.S.
Housing Market Slowdown – The drop in the FED Funds rate caused mortgages rates to hit an all-time low in 2021. This caused a huge increase in home buying that drove home prices up and rents higher. When the FED Funds rate rose in March 2022, home buying and selling slowed to a crawl. Many in the housing industry (realtors, developers, builders, homeowners, renters, etc.) are experiencing financial stress. Buyers are faced with mortgage payments that are double what they had hoped. This housing flip created winners and losers who had no control over the timing of their home purchase or sale.
Personal Debt Crisis – Low-income earners often use credit card debt to fund basic living expenses. The interest rate on credit card balances rose from 16% in 2021 to 30% in 2023. Interest costs for this debt will bankrupt many low-income earners.
Stock Market Volatility – There used to be a time when stocks were valued based on the profitability of a company. Today, stocks are valued based on the cost of money. This is the nature of a debt-based economy. When the FED lowers rates, stocks increase in value. When the FED raises interest rates, stocks decrease in value. Ironically, during an inflationary period, profits tend to rise. In 2022-23, investors were in conflict. Rising profits vs rising cost of money… This caused high up and down swings in the general stock market.
As I write this article, the FED has announced that they are considering reducing the FED Funds rate in 2024. This is causing another mini-rally in the stock market.
The Road Back to Fiscal Responsibility
By reading this article, you may believe that I favor the red portion (political right) of the economic chart above. You’d be wrong. I value both sides. As I described in the problem section, I believe we are abusing debt, and we are destroying the ambition that can be present in a free market economy. However, we do need many of the services provided by the government, and we need to care for those who are unable to work.
Government’s role in a healthy economy is to be an objective arbiter and provide reasonable regulation of all businesses regardless of the wealth of the business owner.
All debt is not bad. However, debt that is used to perpetually fund expenses that exceed revenues is foolish. Debt that is invested in infrastructure that will benefit younger generations who will reap the benefits of that infrastructure is wise.
Taxation must match expenditures. The only time that we should spend more money than we earn in the government is during times of emergency. A natural devastation, or a war can be justifications for times when we spend more than we can tax.
About the Author
Jeff Schuster is an accomplished businessman, engineer, and writer. Three of Jeff's books are attempts at helping people understand and solve political problems made worse by political partisanship. His first book, Trial & Error, is a collection of 14 short stories. Reengineering Education is a story of innovative education reform amid political corruption. Engineering Unity is Jeff's most recent book, published in August 2023, addressing political polarization on wedge issues that politicians use to divide us. You are welcome to join our private Facebook group called Reengineering Politics, where we discuss politically polarizing topics in a civil manner.
Comments