Month: April 2023

In Part 38, we discussed how bad central bank digital currencies could be, and then we talked about the potential for cryptocurrencies to come into common use through market mechanisms.

I did my homework and, as I promised at the end of Part 38, read through my notes to see if any additional cleanup of scattered topics is necessary before moving on to discussing different ways to fix our monetary system.

One claim I hear people sometimes make and that is worth addressing is this: “All of our money is created through government debt, so if our government pays off its entire debt, then all of our money would disappear.” When smart and knowledgeable people make this claim, it feels pretty persuasive. But are they right? Will the federal government getting out of debt make all of our money disappear? This has important 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. At this time, if all of the gold coins were in the bank vault, then there would be 5,000 Goldnotes in circulation.

Then along came fractional reserve money, which, if the reserve ratio went down to 0.2, caused the amount of money to expand 5x, so then there were 25,000 Goldnotes circulating. But still there were only 5,000 actual gold coins in the bank vault.

Then, skipping a few steps that aren’t relevant to this example, the government decided to centralize the money into First Bank Notes, so now we have 25,000 First Bank Notes instead of Goldnotes. And, not long after, the government liberated all that money from its gold backing, which then allowed it to take the 5,000 gold coins and give it to foreign companies as compensation for war supplies.

Next, with the newfound freedom to print as many First Bank Notes as it wants, the government started printing more and more First Bank Notes using that accounting trick where an equal amount of government debt is created at the same time. Let’s say it printed 75,000 new First Bank Notes, so now there are a total of 100,000 First Bank Notes, and the government debt is worth 75,000 First Bank Notes.

We could now divide all of the country’s money into three categories according to how they were originally created: the commodity-created money (5,000 First Bank Notes), the fractional reserve-created money (20,000 First Bank Notes), and the fiat-created money (75,000 First Bank Notes).

So, if the government suddenly pays off all its debt, would all of the money disappear? Of course not. Only the fiat-created money would disappear.

The only way all of the money would disappear is if there was no commodity-created money or fractional reserve-created money in the society prior to the government starting to add fiat-created money to the money supply. But since no society ever jumps from no money (i.e., the barter system) straight to fiat money, that would never happen.

In the United States, we have a ton of fiat-created money, especially relative to the commodity-created money and fractional reserve-created money. But, regardless of how much more fiat-created money we have than the other two types, there will still be money if the U.S. federal government pays off all of its debt. True, not very much money would be left, but there’s no such thing as not having enough money for a society to function, as I explained in Part 5. The only challenge would be that the Wealth Unit:money exchange rate would change drastically, and that would make prices unreliable and hard to interpret until everything settles.

Obviously the pricing uncertainty would, in the short term at least, be a huge downside to the government paying off its debt (specifically, the debt owned by the Federal Reserve). But would there be a benefit to it as well?

Of course. I don’t like this intergenerational pyramid scheme the government is running, and I know my posterity will like it even less than me. I call it a pyramid scheme because government debt is future taxation (plus interest). So future generations are going to pay heavily for the deficit spending that the government is doing now. And the other benefit to paying off this debt is that it will free up a huge chunk of the government’s budget again so it doesn’t have to send 19+% of its revenue every year to creditors, most of whom are foreign.

To summarize: Yes, let’s pay off the entire U.S. federal debt!

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!

In Part 37, we discussed “too big to fail” and why it’s a terrible thing for our economy in the long run. It’s yet another example of how the government’s power over our 0% backed fiat money leads to them making policies that hurt us more in the long run.

This post, let’s see where money could go from here. And then finally dig into cryptocurrencies!

One intriguing idea to evolve money further, which is already being tried in many countries, is central bank digital currencies (CBDCs). A 0% backed fiat currency that gets converted to a CBDC is still a 0% backed fiat currency, 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.

I said the idea is intriguing because it almost seems like having a CBDC would be the same as having a country’s currency switch completely over to Bitcoin or some other popular cryptocurrency, especially if the CBDC uses blockchain technology.

But having a CBDC couldn’t be more diametrically opposed to having a private cryptocurrency. When a government and central bank run a 0% backed fiat currency that is purely digital, many new ways to take our wealth and control us arise.

For example, the government would be able to track every transaction, which opens up new taxation opportunities. It could even decide to tax every single transaction if it wanted. It could also disapprove certain transactions, so now it has direct control over what we can buy. Or it could cause money that hasn’t been spent in a certain amount of time to “expire,” which basically means it just disappears straight out of our bank account. (That would be even worse than inflation causing the money to lose its value–at least the money doesn’t completely disappear from your bank account!) So now it could force us to spend money when it wants to “stimulate the economy.” Or it could restrict money’s use to certain regions. And then there’s the risk of the government leveraging this power over money against its political rivals, which is analogous to (but more frightening than) what has already taken place in the United States when certain businesses have been “debanked,” except in this case the control would be even more direct.

And all of that doesn’t even consider the risk of the internet going down, which could completely prevent transactions from taking place. Hacking of the money is yet another risk, although that one is present any time you have digital money.

So, with everything I know about money, I believe CBDCs are only good for governments and banks furthering their selfish interests and that they create a terrible risk to the freedom and financial security of the people.

If we look at money again from an evolutionary perspective, I would say that CBDCs are actually the final possible stage of money’s evolution. Each evolutionary step past 100% backed receipt money has gotten worse, and CBDC is no exception; it is the worst possible form of money.

But what about private cryptocurrencies? Will any of them ever become a country’s official currency?

Originally, I wrote that I highly doubt it. But since then, further reflection has changed my mind. Now, my answer would be that it’s possible.

Not that I think any government would willingly give up its 0% backed fiat currency. Can you imagine any government willingly giving up its ability to create new money for spending whenever it wants? Suddenly politicians would become very unpopular when they have to raise taxes instead and people start to see the true cost of government actions. No more hidden taxation!

Governments would also not like switching over to a private cryptocurrency because much of a government’s power of taxation/tax law enforcement is dependent on transactions being reported. But if the two parties involved in a transaction choose to keep it anonymous (and nobody knows who the account owners are), then there’s no way for government to trace the transaction back to any individual. Which means there’s no one to send a tax bill to!

But, in spite of how much governments would oppose it, there are two factors that make a private cryptocurrency displacing a government’s 0% backed fiat money possible: (1) the strong and well-funded crypto lobby and (2) the private market.

The strong crypto lobby is obviously influential in shaping the crypto-related policies that get passed. But here’s something I bet most people don’t think of: The crypto experts dictating which policies the crypto lobby should support are more knowledgeable about that still-enigmatic industry than the politicians, so I think there’s a very real chance that some of the policies that are being advocated for by the crypto lobby (and that eventually will get passed) are policies that the politicians don’t fully understand the long-term implications of. This could lead to a sort of covert crypto takeover of the 0% backed fiat currency. At the very least, it will lead to the crypto owners making more money, which ultimately comes from increasing investment in their cryptocurrencies. And a huge way to increase interest and subsequent investment in crypto is by getting crypto to come into common use as a means of exchange and also as a store of wealth, as opposed to purely as a speculative financial instrument, which is mostly what cryptocurrencies are right now.

Now, how could the private market facilitate crypto taking over a 0% backed fiat money?

Remember what leads to the collapse of a fiat currency–a loss of trust in the money maintaining its value, which then causes it to no longer be a good means for storing or exchanging wealth. The value of fiat money is determined by its supply and its demand. Governments are already expanding the supply like crazy, which is devaluing their fiat currencies. But what governments don’t have direct control over is the demand for their money. Sure, they can institute legal tender laws to try to force people to accept their money, but what if an alternative to their money comes along and holds its value much better? People would increasingly turn to that alternative currency, and the demand for the fiat currency would drop.

So then you would have a fiat currency that already chronically has decreasing value due to ballooning supply, but on top of that you’d have decreasing demand, the combination of which would tank the fiat currency’s value. Then, the government, which is so reliant on funding itself through printing more money, would have to print even more money to be able to continue buying the same number of things. All of this would trigger a hyperinflation death spiral, and soon everyone would turn to using the alternative currency. Workers would start demanding to be paid in crypto by their employers, and stores would require they be paid in crypto as well.

I haven’t delved deep into what would happen to the government at this point. I think it might just implode. Services would just disappear, even though there’s still laws on the books requiring those services to continue. This could be the source of major political upheavals, with dire consequences. It could even lead to revolutionary attempts and civil war. I don’t doubt that at least one faction would be looking to establish a new constitution supporting a true socialist form of government, which is becoming increasingly popular among the younger generation who obviously haven’t read enough Friedrich Hayek or Milton Friedman or this blog. I really hope that the implosion of government that would likely happen as a result of it losing its power over the currency doesn’t lead to all of that. But, if there’s any major regime change, I hope they use my constitution (work in progress) the next time around instead.

So what kind of private cryptocurrency is most likely to win out when the competition kicks into high gear for general use?

Stablecoins pegged to the value of any other 0% backed fiat currencies are no good, especially if the fall of the USD starts a domino effect with other fiat currencies. Supply-limited 0% backed cryptocurrencies, such as Bitcoin, are better, but remember the goal isn’t to have a fixed supply currency; the goal is to have a stable value currency. And the only way to achieve that is to have one that is backed by specie, which makes its value always be regulated by supply and demand. The best would actually be to have one that is fully (100%) backed by specie, because then essentially what we have accomplished is getting back to a commodity money (with the perk of having digital receipt money as well), and there would be no way to create more digital coins without adding more specie to the vault, so no tampering with the value of money anymore.

Which commodity would be best? Take a look back at my characteristics of optimal money in Part 9. There’s a reason this blog has used gold as the example–because it’s a great option. Silver might be a better option though because it’s more plentiful and spread across different regions, which makes it less easily monopolized. But there’s a persistently strong historical interest in gold as money, so that may make it take precedence over silver when it comes to the market choosing between the two.

While the transition to cryptocurrencies is taking place, we will probably have different cryptocurrencies with different commodity backing competing for general use, but the downside of that (until everyone standardizes around a single commodity) is that you would have to track the value of the different commodities, which would change independently, so stores would constantly need to post and frequently adjust multiple distinct prices.

And we should expect big value swings in every cryptocurrency until the market settles on a single commodity and the speculation dies down. After that, the competition will be narrowed to being between the cryptocurrencies that are 100% backed by the market-selected commodity. I would love to see 4 or 5 different cryptocurrencies with that commodity as backing continue to compete with each other, each with policies that ensure efficiency/low cost, safe storage of the commodity, audit transparency, and easy exchangeability (so you walk in with your crypto wallet and exchange digital coins for physical coins). Then those cryptocurrencies could establish branches in every major city, where people could go to redeem their coins for the commodity. And I hope merchants start accepting either the digital coins or the physical coins because the continued use of the commodity itself as money would be important to help generations of people remember what they are actually using as money even when they’re making digital transactions.

Prices would be super turbulent in the market for a while, and that would hurt economic efficiency. But, as things settle, the new monetary system would unlock incredible economic growth, which would finally also start translating into continually rising purchasing power.

So that’s what I hope happens. I hope the private market comes in, with the help of some clever policies pushed through by the crypto lobby, and sets us free from the bondage of a 0% backed fiat currency.

Does that mean we should all start buying crypto?

Yes and no.

The more pressure that stores have to accept crypto in payment, the sooner this transition to a private cryptocurrency will happen. So getting set up with a crypto wallet and owning a few coins for the sake of experiencing transacting with crypto is a great idea! But, with cryptocurrencies still being so unstable in value, I don’t recommend anyone start storing too much of their cash wealth in any of them–at least, not until the USD starts down its hyperinflation spiral, and then at that point most crypto options would probably be better than keeping your cash wealth in the form of USD.

But, to be clear, cryptocurrencies should not be considered sound investments. Using them as investments is pure speculation, which you should understand by now (but, as a refresher, go back and read my definition of speculation in Part 20). I will not judge anyone for speculating in crypto, but I really hope that those who do are only allocating a small percentage of their portfolio to it and can stand to lose that money. Some people have a lot of fun with gambling, and if crypto is your game of choice, then go right ahead. I personally do not have any of my investments in crypto.

I will be interested to watch the crypto market over the next couple decades, and I hope it elevates quickly from a mere speculative financial instrument to an actual useful form of money that saves our economy and facilitates a drastic improvement in our quality of life.

Before writing Part 39, 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 discussing other solutions to help get us out of this 0% backed fiat currency mess.

In Part 36, I clarified a few random topics and also summarized the ways the government and central bank can control our money supply and how it hurts us.

Now that we have a thorough enough background in how modern governments control money, let’s look at what the government might (will) 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 increasing demand. 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 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 (by sinking an $800,000 loan into) 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 Independent 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.) This is the best case scenario for the bank.

Now let’s shift to a different scenario. 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 until the bank makes new loans all over again.

The $16 billion that was just lost was actual money. So the bank’s reserve has now dropped to $4 billion. And how much does the bank still have out in loans? Of the total $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 pool 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. Sure, it will induce a lot of inflation, but most people won’t know where that came from. 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 the politicians 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 the risk the bank took. 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 in Part 36.

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. And it’s one more example of how much benefit banks get from our 0% backed fiat money.

If we instead choose to let banks fail, regardless of their size, the economy would hurt in the short term, but we would avoid all the adverse effects of creating even more money and worsening incentives in the banking market, both of which would lead to greater wealth and financial security in the long run. But that’s a pretty nuanced explanation for a politician to make when they’re faced with supporting a bailout or not, so even a politician who understands these principles is unlikely to succeed at convincing their constituents that it’s the right choice and then be able to carry it out.

A reasonable counterargument is that you could have the best of both worlds if you bail out the bank but then institute banking regulations to try to prevent it from ever happening again. To which I would respond that this series documents thoroughly how damaging a bailout-induced period of inflation would be to an economy, and that’s hard to overcome with the benefit of saving a bank. Also, more regulation creates more complexity in an already overly complex banking system, which in and of itself decreases the efficiency and innovation in the industry, but also that new pile of regulations will probably lead to more loopholes and obfuscation-induced policies that benefit banks in other ways. So I’m not hopeful that a middle-ground solution would be better than simply letting banks fail when they go bankrupt just like every other business. The rigors of the market have so much to offer in weeding out imprudent risks.

Part 38 here.