Banks, Not the Federal Government, Are Distorting the Free Market


Advocates of free market economics often cite that government spending is the driving force behind a distortion of prices because of its massive spending and the elimination of risk. They are wrong. The U.S. Federal government injects mere chump change into the economy compared to the really big spenders. Who are these spendthrifts “destroying” our free market? They are the banks, insurance companies, and venture capitalists of the country.

In the religion of the “Invisible Hand,” the argument is that the free market will always create the best possible environment for the largest number of people if the government will just leave it alone. Governmental interference, in the form of guaranteed loans, government spending, and grants “distorts” the market by eliminating risk, injecting capital into enterprises that would otherwise fail, and choosing winners and losers against the wisdom of the “invisible hand” of the free market. But government does not have a chance to affect this kind of influence. They don’t have nearly enough money. Not by several orders of magnitude. They have competition that can, and does, spend more money in an hour than government can in a week.

First we’ll look at government spending. In 2008, the total expenditures for the entire federal budget were $2.66 trillion, not including the wars in Iraq and Afghanistan. Obviously, not all of this money went directly into the “free market” in distorting expenditures, but we can certainly assume that the $1.114 trillion in discretionary spending would be. The $1.114 trillion is a significant amount of money and on the face of it would certainly seem to be enough to distort markets. But now we’ll look at the capital injected into the market by banks in the form of debt. 

In 2008 America’s private sector debt increased by $3 trillion, new loans totaling more than the entire federal expenditures. But that isn’t the entire story. The total debt for the country’s private activities was $40.8 trillion. Total income across the nation in 2008 was only about $12 trillion and total GDP was $14.64 trillion.

Just what does this mean? We’ll start by looking at the increase in debt in 2008 compared to the federal budget. Discretionary spending totaled $1.114 trillion, just slightly less than a third of what the banks put into the economy. It should also be noted that $2.665 trillion is taken out of the economy through taxation, so the government effectively removes $1.551 trillion from the economy every year. According to the rules of the Invisible Hand, this should make capital a scarce commodity which would cause prices to fall. Unfortunately, the banks have put an extra $40.8 trillion into the economy, driving prices up because of the extreme excess of capital.

It would stand to reason that with all that money flowing into the economy, there would be income showing up to help pay off the loans. But no, it required $9 in loans to generate $1 in income.

The federal government has been criticized for making poor investment decisions, but would be hard-pressed to find a worse decision than those made by the banks, given that the possibility of repayment of the loans approached zero due to the loan to income generated ratio of 9 to 1.

I am forced to agree that there is a distorting influence operating in our economy, but that influence has nothing to do with the federal government. If anything, the taxes paid in are very slightly decreasing the effect of the distortion. The real problem is that the banks and the federal reserve corporation, a private entity over which the government has at best extremely limited influence, are printing money they don’t have and loaning it out in ridiculous amounts, and that is what is distorting the economy.

Photo Credit: emdot