Douglas French

The Philly Fed manufacturers survey for February plunged from negative 5.8 to negative 12.5, the worst reading in eight months. A big miss from the +1 reading that was expected. Ouch!

Our friends at ZeroHedge point out that hope springs eternal:

“Oddly enough survey participants have been hoping for a brighter future for 4 years now. Expect the sellside penguins to say that this number too should be ignored, just like the initial claims earlier, and the new housing starts yesterday. After all one should ignore all data that does not fit the goalseeked script of a centrally-mandated ‘recovery.’”

Evidently consumers haven’t received the recovery memo from Washington either. “Well, we just had one of those weeks here at Wal-Mart U.S. Where are all the customers? And where’s their money?” February was the retail giant’s worst month in 7 years. Wal-Mart may not be the entire economy, but what goes on (or doesn’t go on) in those big blue boxes, tells us a lot about the economy.

America’s economy just can’t get going despite trillions in stimulus from the Federal Reserve and Washington D.C. President Obama said in his State of the Union address, “After years of grueling recession, our businesses have created over 6 million new jobs.” Of course fact checkers have torn this assertion to shreds. The number is really, maybe 1.2 million.

But let’s take the President at his word. Four years of zero interest and a $2.1 trillion increase in the Fed’s balance sheet hasn’t provided much bang for the buck. That $2.1 trillion divided by 6 million jobs is $350,000 per job. The federal government has run deficits of $1.4 trillion, $1.3 trillion, $1.3 trillion, and $1.1 trillion the last four years. The total of the deficits — $5.1 trillion — divided by the 6 million jobs is $850,000 per job. All this stimulus hasn’t been so stimulating.

Surely Ben Bernanke is scratching his head. However, a couple of “smaller fries” in the Fed food chain put their fingers on part of the problem a decade ago, in a paper published in, of all places, the Cato Journal. It’s important to remember that along with all that liquidity came government bailouts, guarantees, and finance support.

John R. Walter and John A. Weinberg, who toil for the Federal Reserve Bank of Richmond, wrote an article in 2002 entitled “How Large Is The Federal Financial Safety Net?”

Walter and Weinberg state right away why size matters when it comes to safety nets. “It matters because actual or perceived guarantees can impair the efficiency of the financial system,” declare the two economists. “Guarantees alter economic behavior by increasing people’s willingness to take risks. Further, risk taking can become concentrated in those sectors of the economy enjoying the greatest protection. More broadly, resources tend to flow away from parts of the economy with few or no guarantees toward those with substantial coverage.”

Well no kidding. That’s why we have cash piling up in bank accounts while banks play the derivatives market to scratch out earnings in the Fed’s zero interest environment. Or they take the free deposits and buy long term debt for the yield, gambling that rates will never go up. But that’s not all. Weinberg and Winkler also point out, “The ultimate effect can be to limit the growth of income and wealth, and the larger the safety net the greater the effect. Our estimate of the safety net’s magnitude suggests that such an effect is a real possibility.”

The authors make the case that competitive markets allocate goods and services more efficiently. Markets do the same for risk and moral hazard. Government interference upsets this efficiency, distorting resource allocation and reducing economic efficiency.

Even if government guarantees are priced fairly, distortions occur if the guarantee is greater than what could be obtained without government interference. But most government guarantees are underpriced. The authors write that government guarantees are similar to direct subsidies, but different in the way it affects risk. “By assigning to the government part of the risk in the activities being financed, the safety net reduces market participants’ willingness to control risk.”

Much of what is guaranteed people know about: deposits at banks, S&Ls, and credit unions, and the liabilities of Government Sponsored Enterprises (GSE) like Fannie Mae and Freddie Mac.

However, the pension liabilities of most U.S. businesses are guaranteed by a government agency. There are loans backed by the Small Business Administration (SBA) and the Farm Service Agency (FSA). Plenty of mortgage debt is guaranteed by the Federal Housing Administration (FHA) and the Veterans Affairs (VA). Many student loans are also backed by Uncle Sam.

Using numbers from 1999, the authors calculated that in that year federal government guarantees totaled $9.2 trillion, “or more than one-fourth of all private liabilities.” Walter and Weinberg write that the distortions to the economy were apparent. “Approximately 61 percent of commercial bank and savings institution liabilities and 90 percent of credit union liabilities are protected by government guarantees.” These guarantees led to the excessive risk taking that manifested as the S&L crisis and the less-developed-country loan crisis.

Since then, as you would expect in “bailout nation” (see Vancouver favorite Barry Ritholz’s book) the size of the federal safety net has only become larger. In fact, it has more than quadrupled. The folks at the Richmond Fed have updated their data and have come to a new number as of yearend 2011. Their most inclusive estimate of the federal safety net is $44.5 trillion, or over 57 percent of total liabilities.

No wonder that while the Fed keeps forecasting GDP growth of 3.5 to 4 percent, the actual results come in at less than half that. If the Richmond Fed economists were worried about the magnitude of the financial safety net in 2002, they can’t be enjoying a wink of sleep these days.

Capitalism only works its magic with honest risk taking, with the results being profits, or, just as important, losses. As government protects more and more of those who invest capital, that capital is being misallocated to the detriment of the overall economy. Risk taking is increasingly being subsidized and funneled into politically correct avenues. The result is that instead of poor entrepreneurs being weeded out, they are being propped up by government to waste capital again and again.

The results trickle all the way down to those shopping at Wal-Mart.

Regards,

Doug French
for The Daily Reckoning

Douglas French

Douglas French is a Senior Editor for Agora Financial. He received his master's degree under the direction of Murray N. Rothbard at the University of Nevada, Las Vegas, after many years in the business of banking. He is the author of two books, Early Speculative Bubbles & Increases in the Money Supply, the first major empirical study of the relationship between early bubbles and the money supply, and Walk Away, a monograph assessing the philosophy and morality of strategic default. He is founder and editor of LibertyWatch magazine.

Recent Articles

In the Downdraft of Hormegeddon

Bill Bonner

The economist Milton Friedman didn’t go far enough when he said, “Concentrated power is not rendered harmless by the good intentions of those who create it.” Oftentimes, that power is rendered more harmful -- to the point of Hormegeddon -- the better the intentions behind it. In today's essay, Bill Bonner highlights the conditions necessary for popular delusions and the disasters they lead to. Read on...


Addison Wiggin
Health Care Costs: Still the Pig in the Federal Python

Addison Wiggin

Right now, health care makes up about 25% of the federal budget. A scary statistic to be sure... But here's an even scarier one: health care's portion of the federal budget doubles roughly every 20 years. Yikes! Addison Wiggin explains why this is and what needs to change to prevent health care from taking up half the federal budget. Read on...


Six Signs Your Government’s Too Big

Chris Campbell

Is your government too big? Find out in today’s Laissez Faire Today with six “red flags” to look out for. Chris Campbell covers everything from one ObamaCare whistleblower to the strange case of our new Ebola czar. Read on…


McDisaster: Fast Food Is Dying – Make a Killing From It…

Greg Guenthner

McDonalds stock is getting crushed right now. Shares have been in a tailspin since June. But it’s not just Mickey Dee’s. Coca Cola shares are in freefall, too. Bad news for them. But if you want to rake in a pile of easy money, it could be great news for you. See, Americans just aren’t choking down this junk like they used to. The fast food burger, fries and a Coke are just down payments on an early coronary - and Type II diabetes. And everyone’s finally gotten the message. So how can you play the trend? Greg Guenthner explains…


In the Year 2024

James Rickards

Panopticon goggles? Severe market panic in 2018? Gold confiscation by 2020? Jim Rickards' shocking thought-piece in the spirit of A Brave New World or 1984. Click to see how markets, economics, your money, gold, privacy, wealth building and more look a decade from now in the year 2024...