The CIA calls it “Blowback”. The unintended consequences of one’s actions will come back to bite you in the future.
Representative Ron Paul, the only Republican presidential candidate versed in Austrian economics, mentions it in his stump speeches (see www.RonPaul2008.com). George Washington and Dwight Eisenhower warned us about it.
In the political sphere it’s fairly obvious. Good deeds can quickly backfire. Support Osama bin Laden with money and weapons to kick the Soviets out of Afghanistan and you’ve created a monster which will rear up and attack the hand that fed it. Allow illegal immigrants to work off the books for low wages in America and you’ll create a potential underclass of law breakers and entitlement seekers. Break Iraq by overthrowing its maniacal dictator and his henchmen, and the vacuum created invites a new group of henchmen to surface.
Economists bemoan the fact that lawmakers at every governmental level are constantly passing laws which look good in the short term — which are great for reelection vote-getting — but have unexpected long-term negative effects.
In physics, Isaac Newton observed that for every action there is an equal and opposite reaction. When lawmakers spend the peoples’ money, the law of economics is much worse. Because of the entitlement effect, monetary expansion, and inflation indexing, the delayed reaction can compound to orders of magnitude.
Here are a few examples.
For nearly 100 years, the Federal Government accumulated a mountain hoard of silver. Over the next century, Washington proceeded to sell off this national treasure at a weekly fixed price which was under the real production cost. In the end, silver was artificially pegged at $1.29 per ounce. Then, one day in 1967 they ran out of silver and stopped selling. Almost overnight, the price of silver jumped to $5, as the market acknowledged that for years the cost of mining silver was far higher than the government’s selling price.
Soon, people discovered that their silver dimes, quarters, half-dollars and dollars were worth more melted down than as coins in their pockets. Within a few months, America ran out of species, and the government was forced to abandon the centuries-old tradition of providing real money for circulation.
The silver coins were replaced with base-metal clad coins, and the inviolate promise printed on the dollar bill (the old “silver certificate”) — to redeem the paper note for real silver money at the government bank — was eliminated. The price of silver briefly (over)shot, up to $50 per ounce, as the marketplace reacted to the release of the government control over the silver price. Gresham’s Law (bad money drives out the good) was proven true once again.
The principle at work is simple: whenever a government manipulates a market — in either direction — the market will be distorted. Eventually it will break free from its bonds, and a new market-based equilibrium price will be established. The longer the government distorts the marketplace, the greater the reaction will be.
Milk prices illustrate the opposite phenomena. Government price-fixing keeps the price of milk artificially high with minimum selling price regulations and support payments. Farmers, seeing they can make good money in this government-manipulated food industry, over-invest and over-produce milk.
The result? Excessive milk production is sometimes poured down the drain and mountains of milk power and milk products build up. To get rid of these, the government ships the milk overseas to African and other under-developed countries to help feed their starving citizens.
This, in turn, destroys the local dairy industries which can’t compete with the free milk being sent by the Americans, and countless local dairies are wiped out. This process was discussed in the Bible. Except, of course, the opposite course of action was recommended: don’t give the needy free fish but rather teach them how to become fishermen. A free ride always creates a “moral hazard” as they say in econospeak.
An initially virtuous circle created from innocent good intentions thus segues into a viciously destructive one.
And so it goes over and over again. A well-meaning effort which distorts the natural free market at work usually backfires down the road.
Take the government’s creation of Medicare Part D — the “free drugs” benefit. Originally conceived as a safety net for poorer people above 65, it was quickly expanded into an entitlement program for all older Americans, from Billionaires on down. The cost of the program? Perhaps trillions of dollars over the next century. Who really knows?
Of course, future Americans can’t pay this bill, any more than they can pay their looming Social Security bill. But Social Security is not counted “on the books” as an expense obligation of the US Government — the way any corporation must do under the law. Thus the staggering future liabilities remain invisible.
The solutions are obvious: either the government repudiates its debt, or it breaks its promise to pay in more subtle ways. It will raise the retirement age, tax Social Security payments, and stop SS indexing. It will inflate the money supply to pay for the future bill with more pieces of paper worth less and establish “means testing” for wealthier citizens. Eventually the problem will be fixed, but at a much higher cost in dollars and heartache.
Then there’s the process of shipping our hard-earned wealth overseas to buy oil and cheap commodities from mostly totalitarian regimes unfriendly to our American values of individual freedom and liberty.
Why? Because it is politically expedient to drill for oil anywhere else other than our own backyard. And it is politically expedient to destroy the old-line manufacturing industries in North America (including Mexico) to feed the consumer’s thirst for cheap goods, no questions asked.
But, once again, for every action there is a reaction — and usually unexpected. The mountain of overseas dollars are now washing back onto our shores. And they are buying real goods and commodities, real estate and company shares. They are not buying the Government’s T-bills and bonds they way they did just a few months ago.
The result? Bond prices have dropped sharply, interest rates are rising, and the FED is caught between a rock and a hard place as it rides the roller coaster over the next few years. And so are we. Everything should become a lot more expensive in the process as the glut of dollars drives up prices. This includes rare Picasso’s and publicly-traded stocks. Just don’t call this phenomena inflation.
The message should be simple — and obvious. Whenever any government tampers with the free market, there will be hell to pay — eventually.