Clear Thinking on Healthcare

The project to read through and summarize all the posts in my Theory of Money series is actually pretty huge, so it’s taking most of my blogging time, but I at least wanted to share a short post about a thought I had this week.

I’m reading a great book by Peter Attia, M.D. (who also, it turns out, is a Canadian-American physician!). It’s called Outlive. He’s pretty popular in the podcastosphere, among other areas, and I really appreciate his rigorous approach to looking at the science of medicine and recognizing its weaknesses. His big focus is on figuring out how to increase our “healthspan” (as opposed to lifespan, which ignores quality of life). And finally he wrote a book about the topic.

Staving off the main four causes of death and disability is a big part of his focus: metabolic disease (as in metabolic syndrome, lipid disorders, diabetes, etc.), heart disease, neurodegenerative disease, and cancer. The crazy thing is that medicine, as it is today, is totally unequipped to prevent those things.

Why?

The issue is both cultural and financial.

Culturally, there just isn’t a big focus on trying to prevent things that might happen 30 years from now. Most physicians don’t spend a lot of time talking about that stuff, which I’m guessing is because (1) the evidence is not plentiful when you’re trying to look further than 10 years down the road, (2) we as physicians don’t learn about it enough, and (3) we get tired of being ignored when we tell patients over and over to make lifestyle changes that go against everything our culture is pushing on them. I can’t blame patients for this–will power can only take you so far when you’re surrounded by a modern industrialized culture that does everything it can to make us eat a lot and move very little. Case in point: Why is it that every person who encounters my children has to give them a treat (even without asking me)? Because it’s our culture’s way of being friendly. And driving kids from house to house when they’re Trick-or-Treating? Abominable.

Financially, if insurance companies stand to save a lot of money down the road for giving a little prevention upfront, wouldn’t they be all over pushing preventive things on us? Well, yes, but that assumes their upfront investments will save more money in the long run. They might, but if you’re on a different insurance plan by then, they don’t get to reap the savings from their investment.

But even if this kind of prevention is not cost-saving, wouldn’t the patient be motivated to save all that money and have a great quality of life up until they keel over at 100 years old? Yes, but this is far too long of a time horizon for us to be strongly motivated by it, especially when our culture pushes us so hard the other direction.

A better healthcare system is not going to be enough to fix this. Sure, it will help when the culture of our healthcare system changes and doctors start talking more about how to avoid those dwindle years where you’re alive but not very functional. But the primary solution here is a culture change. And I’m thankful that Peter Attia is pushing that change forward!

In 2019, I committed to a weekly blog post on Tuesdays. Since then, I have almost always achieved that. This week will be a little bit of an update on my plans with this blog and then a rant about academic writing.

I am spending a lot of time creating an index post for the Theory of Money series. This involves me reading each post and figuring out how to summarize it in a single paragraph, which is not easy. I hope to have that ready by next week so it can be my next Tuesday post.

After that, I will get back to healthcare. Like I was saying before I started the Theory of Money series, I have been wanting for quite a while to start over reading different foundational healthcare economics and policy writings and sharing what I’m learning from them.

This will help me build a database in my reference manager of all the topics that interest me, so I’ll have ready access to lots of articles that support anything I’m writing about. And I hope it will be instructional for you guys as well.

But I don’t think doing that will solve my primary ongoing challenge related to referencing primary sources in a lot of my posts: Much of what I write about does not lend itself to citing studies.

If, for example, I’m talking about the different levers that determine profit, what am I supposed to cite? A Business 101 textbook? Or if I’m writing about my synthesis of the different building blocks that make up every payment reform program (shared savings, quality-contingent bonuses, etc.), what am I supposed to cite as evidence for that? How about when I write about the evolution of pharmacy benefit managers? There aren’t any academic works that talk about that, or if they do it’s based on the same information I’m using–educated inference and some interviews.

I had a medical student reach out once, asking for more evidence on a post I wrote, and I had to just send her the names of my favourite writers and thinkers on healthcare and tell her that they were my inspiration but that the synthesis was my own.

This sort of writing is looked down upon in academic circles, even when it’s information that is not amenable to citations. So what is a rational person to do? Just find something, anything, to cite anyway. I see this whenever I get notified that my Rewarding Value Instead of Volume article gets cited. I’ll go and read the section of the paper that cited my article, and I’ve never actually felt like my article was supporting what they were saying.

Here are a the most common citation-adding tricks I have seen academic writers use in my field to give their writing the illusion of academic rigor:

1. Throw in a citation to something that is at least somewhat relevant, even though you haven’t read it and it doesn’t actually support what you’re saying. Nobody will notice unless they actually go and read the whole article you cited. You think reviewers are going to question those citations? Maybe only rarely.

2. Say a whole bunch of unproven stuff, but then make it look like it’s evidence based by finding an example of hard evidence that’s at least obliquely related to a small part of what you just said.

3. Similar to the last one, say a bunch of unproven stuff and then find a random evidence-based statistic that at least establishes the truth of a peripheral aspect of your argument.

4. Possibly the most comical one, this is a two-step tactic. Step 1: Publish a paper with lots of citations and make sure to mix in some of your unproven or not-amenable-to-citations ideas. Step 2: Publish another paper, write those same unproven or not-amenable-to-citations ideas, and then cite your first paper as evidence of them. Mark Pauly, one of my favourite healthcare thinkers, does this all the time–and I absolutely can’t blame him because so often he’s writing about the same not-amenable-to-citation ideas that I do.

There are many others. This article does an awesome job of going through this issue in much more depth, and it lists 13 different tactics.

So what’s my point?

I am annoyed at the state of scientific writing with its overemphasis on citations. It dilutes the usefulness of any citation. It encourages deception about the reliability of things written. And it underappreciates any not-amenable-to-citation ideas (unless bogus citations are padded around it), including many of the things I write about.

Moving forward, as I acquire more and more legitimate citations, I will start including them. And for things that are not amenable to citations, I’m not going to add bogus ones.

This is it! The final post of this series. I promised to share my ideas of how we could shift to a sound monetary policy in a more gradual way. And, by sound monetary policy, I mean only using commodity money and 100% backed receipt money. I have tried to show in the prior 42 posts (Part 42 here, Part 1 here) why this is the only truly sound monetary policy.

Last week, I described the catastrophic method to get there, and I said the gradual method would be more realistic, although I am second guessing myself–I worry that a government will only give up its power to create money if a catastrophe forces it to do so. Regardless, the following is my proposal for how to achieve the gradual method.

Just to provide a little structure to this discussion, there are four tasks we need to achieve to get back to commodity money and 100% backed receipt money:

1. Get rid of the government debt that the government owns
2. Get rid of the government debt that the government doesn’t own
3. Get rid of fractional reserve banking
4. Trade out the 0% backed fiat dollars for actual commodity money

The first issue is a simple one. Just so you remember what this part is all about, recall that any time the Federal Reserve creates new money for the government to use, the government gives the Federal Reserve an IOU in exchange. Those IOUs can be destroyed without creating any deflation or angry investors. Boom, 40% of the debt is gone. Along with this, there would need to be a new law created that abolishes the Federal Reserve, and a constitutional amendment preventing the country from having any kind of money-creating central bank would also probably be necessary.

There are all sorts of international monetary issues I’m totally skipping over with all this, but the essence of those is that the U.S. government would also have to stop trying to manipulate the price of various things, including the price of the U.S. Dollar (USD).

The second of the four tasks is not so simple. The government has to actually pay back that debt or else repudiate it and have its credit rating be downgraded and a lot of very angry investors on its hands, neither of which be healthy for our country.

Fortunately, paying back this money also does not create any deflation–the money lent to the government was already real money that real people owned–so gradual payback of this $18 trillion will not create any direct pricing turmoil. I think it would be reasonable for the government to give up the idea of deficit spending and start putting 1% of its annual tax revenues into the debt. This percentage could be increased slowly to give the government time to either increase taxes (assuming it can be done in a way that would increase total tax revenues) or phase out programs that are no longer worthwhile now that the government cannot create money or borrow more money. As discussed in Part 41, the exception to the rule about no longer borrowing any money would be if there is an existential emergency.

Some quick basic math for how long this would take to pay off that debt: If the government gets around $5 trillion in tax revenue each year, and it puts 5% of that ($0.25 trillion) into its loans, plus the ramp-up period, it will take around 80 years to pay off this debt. Except that it will probably be shorter than that because the amount of tax revenue going to paying interest on all those loans will be decreasing over time, which could free up increased loan payments if the political will is there. Either way, wow that’s a long time! But at least it spreads the payback burden over multiple generations.

The third of four tasks is to eliminate fractional reserve banking. We don’t want to touch this until the government has paid off its debt; otherwise, deflation will cause the effective loan size to be even bigger.

One option is for the government to wait to make a new law prohibiting all exploitative loans by all financial institutions until its loan is all paid off. Prohibiting exploitative loans would allow fractional reserve banking to be slowly phased out as each exploitative loan matures and a new one to replace it is not issued. So if the total supply of all USD (including cash and demand deposits) in the world is $8 trillion, and if the average reserve ratio is 0.1 (money multiplier 10), then after all the exploitative loans are gone, there would only be $0.8 trillion.

The problem with that plan, though, is that it will cause significant and unpredictable depreciation over several years. I’ve already talked about the detrimental effects of pricing uncertainty, so I won’t re-explain that here, but the goal is to avoid as much pricing uncertainty as possible during this transition.

Unfortunately, there’s no way of getting around the fact that because the introduction of fractional reserve banking caused a bunch of inflation, getting rid of it will cause a bunch of reflex deflation.

My solution, then, will be founded upon the principle that slow, predictable, stable inflation or deflation is much less detrimental to the economy than fast/unpredictable/erratic inflation or deflation. I would have the government slowly increase the required reserve ratio each day, maybe by 0.008% per day, so that it takes exactly 30 years to go from a reserve ratio of 0.1 to a reserve ratio of 1.0. We have to do it this slowly because some loans (like mortgages) are 30 years long.

And once we are back to 100% reserve ratios, fractional reserve banking will be gone for good!

The final of the four steps can only take place after that. We have to trade out our fiat dollars for gold. (Really, we can use whatever commodity we want, but I’ll use gold for this example.)

Unfortunately, this is where the piper gets paid, so to speak. Generations ago, when the government liberated the country’s money from its gold backing, it was free to spend all that gold however it wanted. And I talked about how it appeared that all those Labor Units the government was free to spend appeared to have been created out of nothing. But really the issue was that those apparent new Labor Units would disappear again if the country ever shifts back to commodity money. Well, now is the time for that to happen.

Fortunately, the real-world U.S. government didn’t spend all of the gold it took so long ago! Estimates are that it still owns about 18,000,000 lb of gold. So, for example, if 18,000,000 lb is a quarter of what it originally took, then the shift back to gold would only result in a 75% loss of all Labor Units that are stored in cash. This assumes the value of gold (in Labor Units) is the same as it was back then.

How many people can tolerate losing 75% of their cash overnight? I suspect a large percentage of the population would be in dire straits if this happened. Many loans would go unpaid. It could be enough to trigger a full-blown societal default, which is what we have been trying to avoid with the gradual method I’m describing in this post!

Not to mention the economic havoc that would be wreaked when people know that suddenly their cash will be worth 75% less overnight. Rational people will be doing everything they can to get rid of their cash by buying investments or other assets–anything they can get their hands on that isn’t already sold out by everyone else rushing to do the same thing. So the majority of the cash will probably be in the hands of businesses by the time the switch is made, which would mean that businesses will get a lot of sudden sales and then will suddenly be a quarter as wealthy (in cash) as a result.

None of these things are good. So, again, we’re going to have to do this the super slow way. The government will have to accumulate enough gold to be able to trade in all USD for gold without causing anyone to lose any Labor Units in the process.

The math for how to do this would be fairly simple. First, find out the current market cost of gold in USD. Then, accumulate enough gold to do an equal trade for the total USD in existence. So if there are $1 trillion USD out there, and each pound of gold costs $1,000 at that time, then the U.S. government will have to acquire 1 billion pounds of gold.

If it dedicates 5% of its annual tax revenues to buying gold, then, according to rough guesses of current tax revenues and the price of gold per pound, it could buy another 11 million pounds of gold each year. That means it will be able to acquire the required 1 billion pounds of gold in another 90 years.

Then, on that fateful day when the U.S. government determines that it owns enough gold to trade out for USD without causing anyone to lose any LUs in the process, there can be a giant USD buyback day. Your demand deposits will suddenly change to be quantified in grams of gold (yes, the U.S. will just have to shift to the metric system at the same time). And as for your physical cash, you will take it to some predetermined location (probably a local bank because it will be able to store the gold in a vault) and they will give you the appropriate amount of gold in return. And that will be the day that the U.S. finally officially achieves its goal to get back to a sound monetary policy.

In total, the gradual method would take about 80 years to pay off its debt, 30 years to eliminate fractional reserve banking, and 90 years to get back all the gold it took from us and spent. That’s 200 years! I didn’t plan it that way, but it sure worked out to a nice round number.

Maybe we could be more aggressive and do it faster. Maybe in the meantime some incredible technologies like AI-controlled robots will enable us to glean a lot more wealth from the earth and will decrease the cost of fulfilling many of our other needs, so society will be so wealthy that we will be able to afford to put 10% or 20% or even 50% of annual tax revenues into this effort and condense the timeline. We can hope.

I am struck right now by the extent to which we have been royally screwed by governments and their modern monetary policies. Think about it–to be able to pay back all the wealth they (and banks) have taken from us, plus the wealth that they’ve spent prior to taking from us, it will take them 200 years! This is ludicrous. And that doesn’t even include all the inefficiencies they have cost us along the way, which are impossible for me to quantify right now but probably amount to even more than the measurable wealth they’ve cost us.

And that’s probably an appropriate way to end this entire series. The final conclusion: We’ve gotten screwed. And, even crazier, almost no one in our modern society has the faintest idea that it has happened.

We really can’t even blame the politicians for this. I’ve shown how every decision they made along the way to get us here has been perfectly reasonable.

I guess the default path of some things in this universe tends toward bad outcomes. And the economics of money is one of them.

But I hope that, with the information I have shared in these 43 posts, you not only can understand how modern government monetary policies have cost us so much wealth, but also you can see that a few well-designed constitutional provisions are all we would need to prevent that default path with all its inefficiencies and injustices. Unfortunately, that only applies to new countries. For all those countries that have already traveled that default path and landed at 0% backed fiat money, there is a connecting path that can get them back to the sound monetary policy path, but it is an arduous and long path. Yet, like any other worthwhile major investment, it will be a big short-term cost for a long-term much larger benefit.

Thank you to everyone who has followed along for almost a year of money blogging (on a healthcare policy blog no less!) as I sated my desire to make this information accessible to the world. I dream that it will have some impact on improving monetary policy in this world, sooner or later. Maybe one day I will turn it into an audiobook so that it can be easier to share. But that sounds like a lot of additional work and research for someone who is still trying to devote a lot of time to fixing the healthcare system first. If you know anyone who would want to direct that effort for me, please reach out! But, until then, I will leave this series here on the internet with the hope that the people who need it will find it and share it.

Last week, I described what I believe to be an optimal monetary system, which is based on commodity money and 100% backed receipt money. It was simple and did not allow for manipulations of the money supply with all their associated costs.

At the end of last week’s post, I said my ideal money system is totally not realistic in the near future in the U.S. But that doesn’t stop us from imagining, just for fun, how we could get there anyway!

There are two different methods: the catastrophic method and the gradual method. I’ll describe the former this week.

The catastrophic method is pretty straightforward. For whatever reason, the government loses all restraint with how much new money it’s creating and kills the goose that’s laying the golden eggs (which is its 0% backed fiat monetary system). By creating too much new money, they induce hyperinflation.

People, seeing the rapid rate of inflation, realize that if they don’t spend their money this week, it could be worth half as much next week, so they start spending like crazy. Short-term demand skyrockets, which increases prices.

Businesses are also realizing that they need to price things to take into account how much less the money they’re getting will be worth next week, so they are pricing with an anticipation of further rapid inflation.

All these factors combine to cause prices to launch up so fast that people are soon paying with wheelbarrows of money. We’ve seen this many different times in history.

When the value of money drops so rapidly like this, it soon becomes completely worthless, which means people lose all their cash assets. Luckily, most people probably have more assets stored in non-cash assets, so many people do okay in this situation. But not everyone. Many people who had long-term contracts with money owed to them suddenly have no claim anymore because their debtor just paid off their entire loan with worthless money. And others who didn’t have much in the way of food storage or other non-cash assets go hungry.

And then there’s the effect on the economy as a whole. When an economy loses its monetary system, which acts as the grease that helps the gears of the economy continue turning, economic activity grinds almost to a halt. Very quickly you discover the incredible utility of having a common medium of exchange when you see an economy without one.

This catastrophic method of eliminating a monetary system can have an upside though. When there’s no official money anymore, what do people do when they want to make trades? They barter. And, soon enough, generally accepted commodities to facilitate exchange start to naturally arise, which is called commodity money. Basically, a society in this situation starts over with the progression of money that we just went through in the first 40 posts of this series.

And that is the prime opportunity to lay the foundation for a new, permanent, sound monetary system by enacting some constitutional amendments to prevent money from ever again going down the same road again, which is the road that always terminates in 0% backed fiat money.

I don’t know of a country that has capitalized on that situation to achieve this, but maybe one day it will happen. It would be an interesting case study to see how such a system fares in the modern world.

As I learn more about different issues related to government, I have been realizing lately that my learnings always seem to consolidate into clauses that I would put into a constitution. A well-crafted constitution is the holy grail of setting up an optimal government, and I think getting to be involved in writing one would be a pretty incredible opportunity. Maybe one day I will put the thought and research into writing an optimal constitution. But, in the meantime, I will accumulate my recommended clauses, which already include insights from studying money, lots of things about how government should and should not get involved in markets (including healthcare), how to structure checks and balances in a way that prevents would-be dictators from killing the democracy (I learned about this in How Democracies Die by Levitsky and Ziblatt), and structuring the voting system to allow for greater cooperation and freedom of ideas than our American system allows (I learned about this in The Politics Industry by Gehl and Porter).

Anyway, I’ll describe my suggested gradual (and more realistic) process to getting back to a sound monetary policy next week.

Over the course of 40 installments in this series (Part 40 here), I have tried to explain the theory of money as clearly as I can. Writing is a big part of my learning process, and before I started this series of posts I didn’t think that I would end up believing that the best monetary system is actually the most rudimentary one–commodity money and 100% backed receipt money. But I understand (and tried to demonstrate) why every major modern economy has gone down the path they have to 0% backed fiat money.

And now, let’s suppose I could design a monetary system from scratch. (I like designing systems from scratch–it’s an opportunity to imagine the idealized version of a system.) The from-scratch monetary system I outline in this post is based on the theory of money I have explained in the last 40 posts, and it’s also mixed with my personal biases toward simplicity and market-based solutions (for reasons I’ve described elsewhere). So I’m not claiming it’s the only form an optimal system could take. But, with the understanding I have now, it would be my preferred optimal system. If you’ve come on this journey with me, I hope you will easily be able to understand the rationale behind these choices.

Ok, where to start? The first important thing to recognize is that if a country’s monetary system is left to its own devices, it will sooner or later go down the path that terminates in 0% backed fiat money. Thus, to prevent that, some rules need to be outlined up front. And these rules also need to apply to the government so that it doesn’t succumb to the lure of manipulating the money supply to get more Labor Units for spending. Therefore, these rules need to be codified into the country’s constitution.

Here is my list of constitutional rules that would shape a country’s monetary system:

1. No national currency. This does not mean there will be no common medium of exchange–it just means the government will not give a special name to a specific weight of a specific precious metal. Instead of a national currency, prices will be dictated in weight of whatever precious metal is being used as the common medium of exchange. On this point, I don’t know if it’s best for the government to help solve a collective action problem and specify a preferred (but not required) precious metal, or if this could be left up to the market as well. I suspect people would end up using gold and/or silver, but other precious metals may work just as well or better.

On this topic of selecting the best precious metal to be used as a common medium of exchange, I didn’t mention this before, but if the demand for a precious metal is determined by its industrial use plus its monetary use, I suspect that the price of a precious metal that has a very large industrial demand will be fairly stable even if you add a monetary demand component to it (by starting to use that metal as money in your country). So, if other countries also start or stop using that precious metal for money, the price won’t be as significantly affected. And stability in price is one of the most important features of an optimal money.

The reason I don’t want the country even defining a specific weight of a specific precious metal as its national currency is because it adds conversion factors and complexity to the world market (which creates inefficiencies in the international market), and it may lock a country into a specific precious metal or a specific amount of a precious metal that ends up being less useful in the future.

Also, if people start thinking of money as anything other than a quantity of the commodity they are using to help facilitate exchange, it is the very first step down the path toward 0% backed fiat money. In other words, once you think of money as this specific thing that the government has defined, it is much easier for you to apply that same name to a piece of paper that represents the original money, and, given enough time exclusively using those pieces of paper, a society can eventually forget that those pieces of paper are not actual money. I demonstrated all of this already in this series.

2. No government involvement in coinage. If people want to use precious metals in the form of coins as opposed to lumps that need to be weighed, then businesses will form to provide that need to the market. This means different weights of coins will be produced by different companies, and it means any number of coins can exist in the market. Standardization will naturally arise around certain weights according to what people end up finding the most useful and therefore preferring. And those will be free to change (no pun intended) over time as the situation dictates.

3. Receipt money is allowed. This means people can pay for things using bank notes. A bank note will state its value in terms of the weight of a precious metal that it can be redeemed for. To get a bank note from that bank, it will be a simple process of giving the bank the appropriate quantity of precious metal, and they will give you a bank note in return. There would probably be a small fee associated with this exchange.

However, rather than using bank notes, people will probably actually just deposit their precious metal into their bank account (which would state the total weight of precious metal they have stored there) and then pay electronically, which would direct their bank to send the specified amount of metal to the payee’s bank and deduct that amount from the person’s account.

The risk here is that people start using bank notes and electronic forms of payment so much that they forget that they’re actually using a commodity to facilitate their exchanges. I suspect that coins would still be used regularly enough that that is unlikely to happen. Plus, all the accounts and bank notes will continue to be quantified in terms of weight of the precious metal being used as money.

4. No fractional reserve banking. In fact, no form of exploitative loans (i.e., where the person loaning some money doesn’t have the assent of the owner of that money to loan it out) will be allowed at all. This means that if a financial institution is overseeing someone else’s money, they will have to get the assent of the owner of the money before loaning it out. And this means that the owner of the money will expect the financial institution to tell them when they will have access to their money again and how much the institution will be compensating them for allowing it to be loaned out like that.

The implication of this is that fractional reserve banking is not allowed. All money substitutes will be required to be 100% backed, which will prevent those monetary expansions and contractions that are so harmful.

And to ensure banks are being honest and keeping 100% of the total demand deposits (i.e., deposits that someone can go and withdraw immediately, whenever they want) on hand, they would be audited randomly multiple times per year to make sure the amount of precious metal in the vault matches up with the total amount of demand deposits.

5. The government will be required to save up an emergency fund as I described last week. The specific details of the saving method and rate (such as a required 5% annual savings until the emergency fund is filled up) and what constitutes an emergency are important to define. But the important point here is that we have to acknowledge that if a government doesn’t have the ability to create money whenever it likes, it needs another way to reliably access more money in the event of an emergency, and saving up for the future makes the most sense here.

The government will also need to be allowed to borrow money in case a second emergency follows closely on the heels of the first emergency and the emergency fund is not yet replenished. This ability of a government to go into debt is undesirable, but it can be restricted to emergencies only, and I think it would be necessary because, for example, if an enemy country sees that the emergency fund is depleted and decides to attack, not being able to borrow any money to fund a defense in that war would be a huge problem.

6. No bank bailouts. This may be mostly a non-issue if there’s no fractional reserve banking, but it’s worth adding in here to make it clear that banks, like every other business, have a risk of failing. And if we don’t let the natural consequences of the market weed out the imprudent banks, the industry will be filled with imprudent financial decisions.

So, for an individual deciding where to store their money, they will also have to consider how risky a bank is before choosing to store their money in it. This forces banks to be prudent in their financial decisions because they know that nobody will want to choose them if they are overly risky. Standardized financial reporting requirements will be important so that everyone can compare the risk of different banks apples to apples.

Banks can go out and buy deposit insurance if they want to especially reassure potential customers, but this would not be government-sponsored deposit insurance, so the insurance company would have every right to deny the request for insurance, and they will probably want to analyze the bank’s level of risk very thoroughly and also employ risk management strategies prior to agreeing to insure the bank’s deposits. In this way, the price of the deposit insurance that the bank pays will be based on the bank’s true actuarial risk.

7. No government bank. To avoid various conflicts of interest, the government will not own any share in any bank. And, of course, the other rules above already make it clear that there will be no money-creating central bank either.

All right, I think that covers the main things that would be needed in a constitution to permanently establish my idealized version of a financial system. Let me talk about the expected effects of those rules.

First, they would force the government to get all its money through taxation and, in very rare emergency cases as discussed above, borrowing. But, ultimately, since the government would have to use taxes to pay back those loans, all money that the government receives ultimately comes from taxation. The overall effect of this is that government spending will be much more transparent because it will almost always be coming directly out of taxation instead of out of the hidden tax of inflation or the future tax of debt. And this is very important because only when citizens know the full cost of something (and are required to pay it in the near term) can they more rationally weigh the true costs of any policy against its benefits.

Second, these rules will make the financial sector much simpler and more stable. A lot of benefits come from those two characteristics. Simplicity keeps administrative expenses to a minimum and allows investments to be more comprehensible, so investors will be able to make more rational investment decisions. Stability encourages more investment, so domestic and international capital would flow in.

Third, the benefits to the economy as a whole would be even more significant. Booms and busts would be minimized, and societal defaults would be done away with entirely; think of all the shattered lives and lost fortunes and ruined retirements that that benefit alone would prevent. The economy overall would also be more efficient and would facilitate the generation of greater wealth. And there wouldn’t be so many forms of incidental and destructive wealth redistribution.

It’s hard to adequately describe the protean benefits, large and small, that people would experience on a day-to-day basis if we could get to a monetary system like this, but I hope that gives you a glimpse of it at least.

And to close this post, I want to emphasize that maximizing the generation of wealth is not the only goal an economy has. There are many reasons that policies can be enacted that decrease the generation of wealth in favor of other priorities, whether it be to secure various human rights that the culture has agreed upon or to promote ecological sustainability or others. And those priorities are perfectly compatible with a monetary system like this. In fact, I believe this monetary system would secure a more firm foundation for pursuing other non-wealth-increasing purposes than any monetary system currently existing on earth.

And now is probably a good time to say that I don’t believe this monetary system is realistic at all–at least not in the U.S. in the near future. So, next week, in what may be the final installment in this series, I’ll describe the simplest course I can imagine that could at least get us close to a system like this.

Ok I’m still doing clean up of the other principles and questions to be discussed that didn’t arise using the fictitious society narrative. Last week, I explained what would happen to our money if the government paid off all its debt.

This week, I’ll address two last things.

First, a question that arises as a result of the discussion last week: What will happen if the government suddenly has a large expenditure need and can’t create money at will anymore?

In this case, I think of how individuals prepare for an unexpected financial challenge. For the largest unpredictable and potentially financially catastrophic expenses, they buy insurance. I don’t think that’s an option for a government. Can you imagine a huge insurance company being willing to sell war insurance to a government? Absolutely not, especially because governments usually (but not always) have a fair amount of control over whether they get into a war, so war insurance would almost act like an incentive to for the government to go to war because now their insurance company would be paying for it.

So, aside from getting insurance, how else do people prepare for large unpredictable financial challenges? The individuals with foresight and motivation usually do this crazy thing called saving up an emergency fund. Usually that means saving 3-6 months’ worth of expenses. That way, if the primary breadwinner of the family suddenly loses their job, or if their house burns down, or whatever, they already have enough money to cover the gap in income or the large unexpected expense.

What I’m suggesting, then, is that governments save up for an emergency.

What I think would be amazing is if a government could save up enough that they could continue spending indefinitely by only spending the interest. It would be like a university with a huge endowment. There would be no more taxes!

But, realistically, maybe saving up something like 50% of annual expenditures (equivalent to a family’s 6-month emergency fund) would be a good solution. No politician would be able to convince enough people to forego all their urgent funding requests to ever make this happen, so a requirement to do this would probably have to be written into the country’s constitution. Maybe it would say that the government is required to save 5% of all income every year until it has built up an emergency fund that is equal to 50% of the most recent year’s spending. And the tricky part would be figuring out how to define an emergency that would allow that money to be used and not abused. But when any of that money ever gets used, then the 5% savings requirement goes back into effect immediately once the emergency is over.

But having a fund like that also may incentivize governments to go to war, so maybe there should also be a required war tax implemented any time the country goes to war. That way, the cost of it is felt directly and immediately by the people, so politicians would be more likely to take the unpopular cost of a war tax into consideration when they are deciding whether to enter or start a war.

These ideas probably sound crazy, but that’s only because we’re so used to governments creating money whenever they want. And the two main problems that creates are (1) their spending choices are insulated from public opinion because they’re not directly seen and (2) we pay for the emergency through inflation instead with all its associated costs.

Overall, spending for an emergency through inflation is just such a worse way of doing it, but we’re used to it, so it seems more normal than a government actually saving up an emergency fund.

Second, I want to list a few of the other ways that inflation hurts the economy and slows wealth building:

• It messes up calculations of the profitability of companies, especially companies that have asset depreciation as a major portion of their costs. Here’s an example. Let’s say a small factory owns a single machine that makes bolts. They bought the machine for $300,000 and expect it to be used for 30 years, making 20,000 bolts per year. They will depreciate the machine by $10,000/year so that it will be fully depreciated at the end of its 30 years. They have other costs of about $5,000/year. If they are selling bolts for $1 each and selling all of them, their revenues are $20,000/year, and their costs are only $15,000/year ($10,000 of which they are putting into their business account because they’re slowly saving up that money they’re counting toward depreciation for a new machine that they’ll eventually need to buy). Pretty profitable! Then serious inflation strikes–100% over a very short period of time–and they are able to raise their prices to $2/bolt. Their other costs also double from $5,000/year to $10,000/year. So their revenues are now $40,000/year, and their costs, assuming they stick with the same depreciation plan for their machine, are now $20,000/year. Now they look even more profitable! Their stock price soars, and tons of other investors start bolt-making companies because of how profitable of an industry it appears to be. But then, at the end of the 30 years when that machine is fully worn out and they go to buy a new one with the $300,000 they saved up (by putting $10,000 in their account every year for 30 years, remember), they find that the cost of a new machine is $600,000 due to inflation. Suddenly everyone realizes that the profitability of the bolt companies are super overvalued because they hadn’t been adjusting their depreciation for inflation! Investors’ decisions were also totally skewed because of the complexities inflation caused in accurately evaluating the profitability of different industries. Which means investments were not going to the highest-potential projects.
• Long-term fixed contracts become much more risky when the risk of inflation is larger. Businesses usually need large investments to get going or to try new things, so long-term contracts are the foundation of most innovations. But when those contracts are more risky, more of them fail simply because of the impossible-to-predict changes in the value of the money they borrowed.
• Inflation suspends the market’s punishment of unprofitable firms because everybody seems to be profiting until prices finally adjust.
• Inflation encourages people to buy sooner than later because they believe things are cheaper now than they’ll be tomorrow. Thus, inflation encourages going into more debt than would otherwise be prudent.
• It contributes to business cycles, as I have shown already in this series.

All right, I did it. I got through those last two things I wanted to address before moving on (next week) to a few thoughts about how to fix all this.

There are, of course, so many other things about the theory of money that I haven’t even touched. For example, there are theories out there about bankers and their control over governments (especially when it comes to decisions about war) because of their power over money and how much they stand to gain when they finance those wars. And I haven’t covered the different stages in the modern international history of money, including the stepwise abolition of the gold standard, fixing exchange rates, the Bretton Woods Conference, sneaky ways governments have transferred wealth to other governments, etc. And don’t forget about the curious and questionable things the International Monetary Fund and World Bank are doing!

But I can’t. I have to stop somewhere. This isn’t a money blog (believe it or not). The things I’ve talked about were the things I felt like needed to be explained because I wasn’t satisfied with how other writers have explained them. I hope it has been illuminating and that it provides a launchpad for understanding any other money issue out there.

My plan is to write one or two posts on my ideas of how to fix our money issues, and then I’ll get back to healthcare. Part 41 here.

In Part 38, I discussed the (very low) likelihood of cryptocurrency being co-opted as a nation’s official currency. And I also talked about my hopes for at least one cryptocurrency to eventually stabilize its price enough and become widely used enough to be elevated from the status of a speculative investment to an alternative common medium of exchange.

I ended Part 38 by promising to do a little clean up to make sure I’ve discussed all the main insights that I believe are needed to understand modern money, after which I will propose a method to get us back to commodity money. So that cleanup effort starts now.

One thing I didn’t mention last time was that even if a cryptocurrency does become a common medium of exchange (as an alternative to the country’s official currency), the value of it is not likely to be as stable as any actual commodity money. I explained how market forces will tend to push commodity money back to a default value way back in Part 9.

Another question that has arisen over the last few months of writing about 0% backed fiat money: What would happen to our money if the government pays off all its debt? Will all of it disappear? This has implications on whether it would even be fiscally safe for the government to pay off its debt!

To answer that question, let’s very briefly trace the origins of all the money we have.

First, people were using various commodities to facilitate trade. Ultimately, they landed on using gold because it was the most convenient commodity (again, check out Part 9 for details on the optimal form of money). Eventually, gold was being stamped into coins that were a standardized weight and were difficult to counterfeit. As individuals got wealthier, they were able to store any newly acquired wealth by buying more gold and having it stamped into coins. Let’s say there were a total of 5,000 gold coins at this time. And even when people started using receipt money instead of the coins themselves, the receipt money was 100% backed by gold coins, so the only difference was one of convenience by switching to receipt money.

Then along came fractional reserve money, which, if the reserve ratio was 0.2, caused the amount of money to expand 5x, so then there were 25,000 gold coin receipts floating around but still only 5,000 actual gold coins.

Then the government decided to liberate all that money from its gold backing, so it took the gold and gave it to overseas companies for war supplies. And the government started printing out IOUs to back the printing of new gold coin receipts. Let’s say it prints 75,000 gold coin receipts and also has a debt of 75,000 IOUs to match that.

That’s basically the state we’re in today. There are 100,000 total gold coin receipts, 75,000 of which are created with counterbalancing government IOUs, and 20,000 of which are created through fractional reserve banking, and 5,000 of which are the original money.

So, if the government suddenly pays off its entire debt, then the only money left over will be the fractional reserve money and the original money.

And if we eliminate fractional reserve money and get back to only the original money, then we’ve eliminated 95% of all the money. We’ll never eliminate all of it, because we had money before implementing fractional reserve banking and government money-and-debt creation.

But remember that the big difference here is that this original money is actually different than how it started because, when it started, every gold coin receipt had a gold coin backing it. And now none of them do.

Would there be a benefit to doing all this?

Well, there’s a benefit to the government getting out of debt so that we can break the intergenerational pyramid scheme of one generation overspending and sending the bill to the next generation. And there’s a benefit to getting rid of fractional reserve banking to avoid all the expansions and contractions and bank runs and their associated detriments (explained especially in Part 15). But even with those two major changes, we’ll still have gold coin receipts that are 0% backed fiat money; we’ll just have fewer of them than before.

Does this mean we’d be broke?

Absolutely not. I explained this in Part 12, but I think explaining it again here using details from the example above will be easy. And it’s always nice to understand a principle in a new context.

Let’s say, in the beginning before shifting to fractional reserve money, there were 5,000 total LUs worth of wealth stored in the 5,000 gold coins. 1 gold coin was therefore worth 1 LU.

Then, over the ensuing decades as the money was slowly diluted more and more, people were still earning greater wealth and storing it in the form of money. So even though the total amount of money was increasing a lot faster than wealth was aggregating, there was still wealth aggregating. Maybe, by the time we were up to 100,000 0% backed gold coin receipts, there were actually 15,000 LUs worth of wealth stored in the aggregate money supply. This increasing wealth was tempering the inflationary effect (money-devaluing effect) of creating so much new money.

And then, if we got rid of all the newly created 95,000 gold coin receipts and were back down to only 5,000 of them, we’d still have 15,000 LUs worth of wealth stored in our aggregate cash supply, it’s just that they would no longer be diluted over such a large supply. So now each gold coin receipt would be worth 3 LUs.

In other words, we haven’t destroyed any wealth by getting rid of the government debt-backed money and the fractional reserve money, we’ve just concentrated the wealth into a smaller number of gold coin receipts (plus gotten a bunch of other benefits by eliminating the government debt and fractional reserve banking).

Thus, the answer to my question earlier about whether it would even be safe for the government to pay off its debt is YES. It would be completely safe. It will cause some deflation, which can mess with prices, and it can also mess with international trade (which we haven’t gotten into), but these are short-term effects. Once the supply of money and prices stabilize, there are much greater benefits because now prices can be more predictable, so long-term contracts will be safer and wealth will more effectively be achieved. Part 40 here.

Pardon the brief interruption in my Theory of Money series. This isn’t a money blog anyway, but it IS a healthcare and economics blog, and the modern money and banking system is one of the most interesting applications of economics outside of healthcare! So I will be completing that series, I just wanted to share a timely something else this week.

For the longest time, I’ve just been blogging my way through my passion for healthcare policy as I’ve worked on figuring out how to fix the healthcare system. I have advertised the blog a little bit here and there simply by syndicating on a handful of other healthcare blogs plus sharing the link to posts on LinkedIn and Twitter, but that’s about all I’ve done to expand my reach. This has mostly been because I didn’t want to spend time on that kind of project–I wanted to instead spend my limited health policy time each week reading and writing, which strengthens my understanding of and ability to explain the healthcare system. But, with a recent job change (still working as a full-time hospitalist, just at a different hospital), I now have a little more health policy time each week.

That is why, over the last few months, I have gotten some help to plan how to broaden my reach. Initially this will be through sharing health policy content on Instagram, and the first post was yesterday! I’ll be posting about 4 times per week, including a weekly video (with the help of my wife’s filming equipment and skills) on Wednesdays that will feature me explaining healthcare policy principles in under 1 minute. I’ll be cross-posting those videos to YouTube for people who want to watch them there instead, but so far I haven’t planned to do any YouTube-specific (longer) videos. That may change as I learn and adapt to what seems will be most effective.

So, I hope you’ll engage with me on those platforms! I recently added the links to my Instagram page and YouTube channel to the sidebar of this blog: @DoctorTaylorJay.

(I’m working on getting that handle for Twitter as well, but some guy named Taylor Jeff McDonald created a Twitter account in 2016 with that handle and hasn’t used it once, which is probably why he hasn’t responded to my message on there. If any of you have insights into how to solve that little quandary, please let me know.)

As always, I encourage feedback to help me improve the usefulness of my content. I also love getting to talk to others interested in this space to connect over ideas and to hear your unique backgrounds. So I hope you’ll reach out to me sometime on social media or directly via email (see my About Me page for that). Talk to you all soon!

Last week, I discussed “too big to fail” and how that predisposes to bank bailouts by governments, which is yet another example of how the government’s power over our 0% backed fiat money leads to them making policies that hurt us in the long run more than they help us in the short run.

This week, let’s see where money could go from here.

One intriguing idea that is already being tried in many countries is central bank digital currencies. This is basically just the same as 0% backed fiat money, but now the money would be only digital–there would be no more physical cash. There are lots of ways to accomplish this, but every application of it involves people having to use a card or phone-based digital payment method for every single transaction. We already do that for nearly every transaction in many industrialized countries, even when we are sending money to friends, so it’s not too huge of a jump to move us to this kind of digital-only cash.

The big downsides of this, though, are that we would be completely dependent on the internet being up and running to enable every transaction, and it also allows the government to track every transaction, which interferes with privacy and also gives the government greater taxation power (or maybe I should say greater tax law enforcement power–no more under-the-table transactions!). There’s also been talk of central banks finding ways to reclaim money by simply having it “expire” (i.e., disappear). With the background already discussed in this series, you can see how that would be an attractive option to enable the government to make money disappear, which would allow the government to create more new money without as much of an inflationary effect.

And what about cryptocurrencies? Will any of these private currencies ever become a country’s official currency?

I highly doubt it. Sure, you could put a central bank digital currency on a blockchain, but that’s probably the only way any form of crypto will be an official currency.

But as for a government co-opting one of the private cryptocurrencies as their country’s official currency, can you imagine any country’s government willingly giving up their power over money? If they did so, they would instantly lose their ability to create new money for spending. And suddenly the true cost of so many of their policies would become known when taxes have to be increased significantly to account for the loss of their means of “hidden taxation” (through inflation).

Switching over to a private cryptocurrency may also take away much of a government’s power of taxation/tax law enforcement because so many more transactions would be completely anonymous. Remember, for a government to be able to tax a transaction, they need to know about its occurrence and know who was spending the money. But if a transaction is anonymous, there’s no one to send a tax bill to!

So is there a point to investing speculating in cryptocurrency? (Please refer back to my definition of speculation in Part 20.) Now that we’re all the way to Part 38, I hope you have a more complete understanding of why I said that cryptocurrency ownership is solidly in the realm of speculation. So, sure, if you want to gamble with your money, that’s an exciting way to do it. And if your goal is to have some fun, which I think is the only rational goal of gambling, then go right ahead and speculate in cryptocurrency. But if your goal is to invest money for the future with the hope that it will grow over time, cryptocurrencies are a terrible investment from a risk-reward perspective.

By the way, I’m not trying to argue that no private cryptocurrency will ever stabilize in its value and become more widely accepted. I hope at least one does! And I think it’s very likely this will happen sometime in the next decade, although take that prediction with a grain of salt because I am not a crypto expert. But if we get at least one private cryptocurrency to accomplish those two feats, that would elevate it from being a speculative instrument to an actual form of money, which would offer us a great alternative to transacting in our country’s 0% backed fiat money. So, until one like that emerges from the pack, I have no interest in owning crypto of any form.

Overall, then, I guess I’m saying that I think our money has pretty much reached its final stage of evolution at 0% backed fiat money (whether that includes physical cash or not).

Next week, I’ll look over my notes from some of the books I’ve read on this subject of money and banking to see if there are any other important topics to cover. And once I’ve done that cleanup effort, I’ll move on to the final topic of this series: how we could possibly get back to commodity money.

Last week, I summarized the control a government has over its country’s money when the money is 0% backed fiat money. And we saw that governments tend to leverage that control to try to help the country, but these efforts probably help us in the short term but harm us even more in the long term.

Now that we have a thorough enough background in how modern governments control money, let’s look at what the government might do when a bank is about to fail. This situation may be somewhat reminiscent of the U.S. in 2008 . . .

Let’s say that a bank is looking for the most lucrative places to lend money, and it finds that there is a particularly high demand for mortgages at that time. Maybe demand went up up as a result of some new government policies that are encouraging people to buy a house . . . they loosened the financial requirements for people to qualify for a mortgage, for instance. The bank sees this spiking demand for mortgages and recognizes it as a potentially lucrative investment opportunity.

Unfortunately, the new prospective borrowers were not allowed to get a mortgage before due to bad credit or too much debt, so even though now they can qualify for a mortgage, that doesn’t change the fact that they’re risky borrowers. But the bank is okay with this because higher risk means it will be able to charge higher interest rates. And, at this time, the economy is booming. Housing prices have been going up consistently for many years, and now they’re going up even faster due to the new policy. And with the booming economy, loan defaults are relatively low, and the few who are defaulting are able to sell their house for a higher price than what they originally bought it for even months before, meaning banks will most likely get their money back even in cases of default.

Taking all these factors into account, the bank feels like it can charge high interest rates and not have the default rate that such risky loans typically have. It’s a perfect opportunity to earn a ton of easy profit!

I hope by now you can see where this is going. These days with 0% backed fiat money, if there’s a relatively sudden abundance of wealth, you know it’s usually going to be from new money being created and injected into the economy, which means the perceived wealth is higher than the actual wealth. And in this perceived abundance, everyone jumps onto the speculation bandwagon to make some easy money. And then there’s an eventual correction as prices adjust to the new lower value of money.

As long as housing prices continue to rise like this, everything’s fine. All the parties–including the ones building houses, the ones getting mortgages, the ones doling out those mortgages, the ones flipping houses, the ones investing in repackaged mortgage investments from other banks, etc.–are counting on prices continuing to rise like this. And they are making investments accordingly, pushing their leverage as far as they can to earn as much as they can while there is still easy money to be made.

And then something changes. Maybe the influx of newly created money slows down, so prices finally start to adjust to this new lower value of money. The illusion of abundant wealth starts disappearing. The real price of a house starts to become clear as people realize their money isn’t worth as much as they thought. Demand starts to erode. Prices no longer look like they’ll keep increasing forever. Many businesses in the housing market were making big investments predicting continued rapid growth and big profits, but these investments no longer make sense given the slowdown, and many of them end up being lost. This puts some companies in financial trouble, and they start laying off workers. Things spiral from there, and soon the trickle of people losing jobs and being unable to pay their mortgage increases to a deluge. The tipping point has been reached, and tons of houses start going on the market as people are trying to get out before prices drop further.

Banks start having to foreclose on houses, and it’s them who are forced to absorb all the losses. How? Well, if they gave a borrower $800,000 to buy a house and then the market drops 50% and they foreclose on the house (becoming the new owner of the house), now they own a house that basically they bought for $800,000 and is now worth $400,000.

The banks all knew it was a risky market to invest in based on the risk evaluation of the people who were getting those mortgages, but they downplayed the risks based on the illusion of wealth and because of historical trends that they expected to continue. And who can resist investing in something that everyone else seems to be making huge profits investing in?

Part of the challenge here is the difficulty in pricing things like the land the houses are sitting on, which makes it easier for the prices in markets like this to lose touch with reality because there isn’t as reliable of an anchor to say what the things are actually worth.

Getting back to our bank, let’s say the required reserve is 0.2 and the bank has $20 billion in reserves, which means it is allowed to lend out $100 billion. This is a big bank! And of the $100 billion, it was pretty aggressive and invested (loaned) $40 billion of that money in the housing market.

We are back to the same situation Indie Bank was in way back in Part 17, except now it’s not a shortage of gold in a vault that is triggering panic. Let’s see how it works with modern banking in a 0% backed fiat money situation.

This can get confusing if I don’t make some simplifying assumptions, so I’m going to do that in the hope that it helps clearly illustrate the principle.

Let’s say the bank originated all $40 billion of its loans in the housing market at the same time, and immediately the bank had to foreclose all of those loans and then sell the houses. As long as it sells the houses for a total of $40 billion, it’s not a problem. The bank hasn’t lost any money. (Sure sure, there will be delays between loaning the money and getting it back after selling a foreclosed house, plus there will be a lot of bank employee time spent on all this stuff, but let’s ignore all that for now and say the bank breaks even.)

Now let’s say the bank makes the $40 billion in loans all at once and then it has to foreclose on all of them after 10% of the principal has been paid back. If the bank can at least sell those houses for 90% of the original purchase price, then it’s gotten 100% of the loans back (10% from the original borrower, 90% from the sale of the house), plus it earned interest while the loans were being paid on. This, too, is no problemo assuming inflation in the interim was 0%.

But what if the bank has to foreclose when only 10% has been paid back on the mortgages and then they can only sell those foreclosed houses for 50% of their original purchase price? The bank will only get a total of 60% of their loaned money back (10% from the original borrower, 50% from the sale of the house). So, of the $40 billion it loaned out, it got back $24 billion and lost the other $16 billion.

Where do you subtract this lost money? Does it come straight from the reserves?

Yes. Think about it this way. Before all this happened, the bank only had $20 billion of actual money. And this isn’t the bank’s money, remember. It’s customers’ money stored in the bank. Sure, the bank was lending out $100 billion, but that was money temporarily invented to exist until the loans get paid off, and then it disappears again.

The $16 billion that was just lost was actual money. So the bank’s reserve has now dropped to $4 billion. And remember that of the $100 billion in loans, $40 billion of that was in the housing market, none of which exists anymore, so it now only has $60 billion in outstanding loans.

Doing the math ($4 billion / $60 billion), this means that the bank’s reserve ratio just dropped to 0.07. To get its reserves back up to the 0.20 requirement, it’s going to need to borrow $8 billion. I doubt in this economic situation that the reserve-sharing central bank will have any excess reserves for sharing, so it’s getting all this money from the the discount window. Depending on what the discount rate is, the bank will very likely owe a ton of interest every single day until it gets back up to the minimum reserve requirement. So much interest, in fact, that its other revenues cannot cover this interest cost. And now we have a bank that is going down the drain quickly. It will have to declare bankruptcy.

And now it’s decision time for the government. Do they step in to help?

Remember, this bank is huge. It has an enormous effect on the economy. If it fails, this will hurt everyone in one way or another. And politicians don’t like to be seen as just standing by idly watching as things go bad. The public clamor will be for them to “do something!”

The government definitely has the means to bail out this bank with newly created money. So what is a rational politician to do? They know that actively working to help during a crisis will be very popular, and they can easily justify any bailout as being beneficial for the economy by deeming the bank to be “too big to fail.”

So of course that’s what they do. They end up creating a whole bunch more money, some of which will be a gift to this bank and some of which will be a loan to this bank with a very low interest rate (which is also a gift because it means the government is paying for the rest of the interest in one way or another).

As a result of this bailout, there has been a huge transfer of wealth. Wealth came from all people owning cash and it went to this bank (or, really, its owners). The cash-owning people just unwillingly and probably unwittingly had some of their wealth taken from them and given to this bank for the sake of helping the economy.

Just to make sure this is clear, the bank took a huge risk and initially made a lot of money. So they received the upside of this risk. But then, when things went bad, they got bailed out, so they experienced very little of the downside, and instead all the cash-owning people bore the downside of their risk. From a bank perspective, this is an amazing deal!

I don’t have the means of calculating how much this bailout would benefit the economy. But I suspect, based on all my other comparisons of similar situations (like in Part 15), the long-term cost of lost wealth to individuals and to the country as a whole will be much greater than the short-term economic benefit.

And this doesn’t even take into account the effects a bailout has on the future behaviour of competitors within the banking market. For every large bank, the incentives were just changed as soon as they saw that the government will bail out any bank that is big enough to hurt the overall economy if it fails. Large banks now know that they can make risky investments and not worry so much about major losses. This skews investment behaviour. It also skews bank merger decisions (“We gotta get too big to fail!”). Basically the government has incentivized mergers and is subsidizing risky investments, which leads to overinvestment in those risky investments and underinvestment in more solid investments.

And even if one bank wants to play it safe, they will be earning a lot less profit, and sooner or later their investment strategy will be changed to put them more in line with other banks.

I have a strong preference toward free markets, but I also believe government assistance to help markets run efficiently is important. Unfortunately, intervention in a market in this way does not help the market run efficiently; instead, it skews incentives and leads resources to being dedicated to different purposes than the market would otherwise direct them to, which leads to inefficiencies in ways that are often impossible to calculate. It’s the same principle as administrative pricing that I discussed last week.

So, for this reason, bank bailouts represent yet another way that the government leverages its control over our monetary policy in an attempt to help but that harms us financially. If we let banks fail, regardless of their size, the economy will hurt in the short term, but we will avoid all the adverse effects of creating even more money, and we will also foster the right incentives in the market, both of which will lead to greater wealth and financial security in the long run. Part 38 here.