How to Fake Money, Government Edition

If you can't get it, fake it.

We recently explored a number of ways for governments to increase economic activity which also increases jobs and tax revenue.  Suppose a government tries all that and it isn't enough to satisfy the greed of the political classes - as is the case in modern America.

If we don't mind policies that will give us grief sooner or later, as our elites clearly don't, how can governments get money in other ways?

Sell Natural Resources

For nations that have resources to sell, there's a right way and a wrong way for the government to raise money by selling the resources.  Nations like the US and Australia traditionally leave the resources in private hands and tax the output.  This aligns the incentives properly: multiple private bidders for the resources will ensure the highest price, and the government can maximize the revenue without having to do any of the work.  Once the contracts are awarded, it's in the best interests of the private firm to extract the maximum amount of the resource by whatever means is most effective; that's also in the best interests of the government and the taxpayer, since royalties are usually paid based on amount of the resource mined and sold.

Unfortunately, many governments are so enthralled by opportunities for graft that they assume ownership of the resources, to "benefit all the people" of course.

Government-owned oil companies in Mexico, Nigeria, Venezuela, Russia, and many other countries are famously inefficient, overstaffed, and get out a lot less oil that a private company would.  In Saudi Arabia, government ownership means ownership by the "House of Saud," the princes who're descended from Abdul-Aziz, the warrior who more or less united the country in 1932.  The oil is managed very much as a family business, with dynastic quarrels taking precedence over maximizing value.

When government takes over ownership of the resources, the results are so bad that economists refer to the "curse of oil."  Resource extraction falls under the "Fake Money" category because resource-rich countries tend to grow more slowly than less well-endowed nations whose citizens work harder.

As the US government has gotten more and involved in regulating the oil business, we've pumped less and less oil.  The Indian and Chinese governments exercise heavy control over all resource extraction.  The Japanese government won't be tempted to get involved in owning natural resources because there aren't any natural resources left in Japan, but if there were, they'd be all over it.

The result of this change?  Fewer resources available for normal folks to purchase, and skyrocketing prices at the gas pump, electric meter, and anywhere else that natural resources are important.  But it does give politicians more power as they can award feather-bedded jobs or lucrative monopoly contracts to their supporters.

Print Money

This is the most tempting strategy of all because it's the easiest.  Governments already have or control a printing press used to produce paper currency, which costs far less to make than its face value.  If you want to help your friends or do something expensive without raising taxes, just print enough money to pay for it!  LBJ paid for the "Great Society" by printing money because he knew the citizens wouldn't stand for such huge tax increases.

Unfortunately, newly-printed money isn't actually free, it just robs from people who already have money.  As more and more money became available, the value of money dropped - we call this "inflation."  What used to be sold for a dollar, now costs two dollars.  Everyone has twice as much money but it buys half as much, not a helpful improvement.

A large economy can easily survive a little inflation.  Too much, though, and people demand wage increases in anticipation of more inflation to LBJ's inflation led to the "stagflation" of the Carter years when we had inflation and an stagnant economy at the same time.  It ended only when President Reagan wrung inflation out of the economy by letting interest rates get so high that many banks and other businesses failed.

That led to less money, which meant that the money around was worth more - very harsh in the short term, but it created a stable financial base to build on.  With inflation conquered, the economy could grow again, which it did for twenty years.

Having used paper money for centuries, the Chinese are aware of the dangers of inflation, but control of their monetary policy is spread across so many different factions that it's hard for them to make coherent inflation-fighting policy.  Japanese also know better than to set loose the forces of inflation, but the government will be sorely tempted to try it, just a little bit.  As our government is finding, but won't admit, having just a little bit of inflation is like being just a little bit pregnant - it might start small, but it tends to grow until it's large, awkward, and blatantly obvious, if not critically handicapping.

Borrow Money

Profitable governments like the Chinese needn't borrow much money.  The Asian tiger nations own so many US Treasury bonds and other debt from other nations that they could pay for just about any reasonable level of spending by cashing in what we owe them.  Mr. Obama wouldn't appreciate that because he wants to increase our debt, not reduce it, but the Asian governments may have no choice - their citizens are demanding construction and social-welfare projects from the government.

Even if the Chinese could borrow that much money in competition with our borrowing, they'd have to pay it back eventually.  It would probably be better for their taxpayers if they used some of their savings from past good years to pay for this disaster.  If their doing that made it harder for Mr. Obama to sell more debt to support his wasteful spending plans, the Asian governments would benefit our taxpayers as well as theirs.

The problem is that, in order to be able to borrow money, there has to be someone with spare money who's able to lend it to you.  Right now, the entire Western world is in hock up to their eyeballs, and the major emerging nations are making vast investments in improved infrastructure.

These investments will pay off enormously just as they did for America a century ago and England before that, but in the meantime there are more people needed cash than piling it up.  If everyone wants to borrow money, it quickly gets very costly to do so.

Raise Taxes

There are limits to taxation - if taxes get too high, revenue goes down, not up.  Alexander Hamilton, one of our Founders, pointed out this inconvenient truth a few centuries before Laffer rode to glory on Hamilton's insight:

If duties are too high, they lessen the consumption; the collection is eluded; and the product to the treasury is not so great as when they are confined within proper and moderate bounds. This forms a complete barrier against any material oppression of the citizens by taxes of this class, and is itself a natural limitation of the power of imposing them.

It is a singular advantage of taxes on articles of consumption that they contain in their own nature a security against excess. They prescribe their own limit, which cannot be exceeded without defeating the end purposed — that is, an extension of the revenue.

- Alexander Hamilton, Federalist No. 21, 1781

If taxes get too high, people quit doing things you're taxing such as working for a living or buying goods.  As the economy slows, tax revenue goes down even as the tax rates go up.  This has been shown time after time throughout history in all nations, times, places, and cultures, yet our media and government elites still refuse to admit its truth.

If you visit the house in which William Shakespeare was supposedly born around 1684, you'll find it has only one window.  At the time it was built, there was a high tax on windows - so people built poorly-lit, windowless houses.  Ours isn't the first government to want to keep its citizens in the dark.

One of the reasons the New York Times is printed on big pages that are inconvenient to read on the subway is that in years gone by, government levied a per-page tax on newspapers.  The bigger the pages, the lower the tax per word.  Once the industry had invested in printing presses and support equipment of a certain size, they were locked in for centuries to come.

Even some American politicians are beginning to recognize limits to tax rates.  Mayor Michael Bloomberg explained:

One percent of the households that file in this city [New York, NY] pay something like 50% of the taxes.  In the city, that's something like 40,000 people.  If a handful left, any raise would make it revenue neutral.  The question is what's fair.  If 1% are paying 50% of the taxes, you want to make it even more?

It's pretty much the same in the rest of the country.  The Economist reports:

In California the top 1% by income accounted for 43% of income-tax revenues in 2008 and the top 5% paid 64%. In America as a whole the top 1% paid 38% of federal income taxes and the top 5% paid 58%; their respective shares of national income were 20% and 38%.

We're reaching the Hamiltonian limit on taxing the rich.  Stephen Goldsmith, the deputy mayor of New York, pointed out that wealthy people are poised to leave if they think they're being treated unjustly - most of them already own homes in other states and in other countries.  The Indian, Japanese, and Chinese governments can't count on the rich to pay for new highways, rail lines, power lines, and other infrastructure.

When the Bough Breaks...

These strategies have the disconcerting habit of blowing up, but not for many years, long after the politicians at fault are honorably retired.  President Roosevelt started printing money during the Depression.  A cent in 1929 would buy almost what a dollar can today, but the politicians keep doing it because We the People haven't caught on.

Maybe, just maybe, the Tea Party will demand and enforce enough spending cuts to stave off our collapse.  Given all the hoopla it took to get what turned out to be not even a 1% cut, we'd not want bet the farm on it - but then again, we do still live in the US.

We can't afford to leave, so quite literally, we're betting the farm, the house, and everything we have that our government's urge to gamble with our future won't destroy our economy.  The rich can move away, but there's no way for us small people to get out of the game.

Let's hope the House of Representatives doesn't roll snake eyes.

Will Offensicht is a staff writer for and an internationally published author by a different name.  Read other articles by Will Offensicht or other articles on Economics.
Add Your Comment...
4000 characters remaining
Loading question...