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Inflating Government Bubble Can Only Lead to a Major Financial Hangover

During the 1990s, the inflationary policy of the U.S. Federal Reserve fueled a tech-stock bubble. When that bubble burst, the Fed inflated a larger one in real estate. Now that the real estate bubble has burst, the Fed is inflating the biggest bubble of them all – a bubble in government.

While the earlier booms provided at least the illusion of prosperity – as well as some fun while they lasted – the government bubble will cripple the economy and deliver widespread misery to the vast majority of Americans.

Of course, there will be winners in the government bubble – at least for a while. As was the case with the stock and real-estate bubbles, plenty of money will be made by the well-connected and parasitic classes. Government employees will continue to enjoy pay raises at our expense, as will anyone benefiting from the new wave of subsidies, such as Wall Street investment bankers, financial speculators, and those working in healthcare or education.

These gains will come at the expense of the taxpayers who foot the bill and the consumers who face higher prices. As government grows, it "crowds out" the private sector, depriving it of the resources it needs to survive and grow. 

The result is a lower overall standard of living.

Not only are government jobs less productive than private sector jobs, but bureaucratic interference actually makes the remaining private sector jobs less efficient, as well.
Our economy is being transformed from a mostly capitalistic one to a mostly socialistic one. More decisions are being made by politicians and lawyers in Washington and fewer by entrepreneurs. The motivation behind this shift is the mistaken belief that the financial crisis of 2008 was caused by too much capitalism and a lack of proper government oversight. 

This conclusion is self-serving for those in power, and couldn't be more economically misguided.

Through corruption or just plain ignorance, Congress and the Obama administration have embraced an ideology that has failed every time it has been tried.
Take the recent student loan reforms that were slipped into the healthcare bill. U.S. President Barack Obama wants to reduce the cost of providing student loans by taking the profits out of the industry. According to President Obama, student loans are too expensive because banks profit from making them. If the government nationalizes the function, we would apparently bring down costs by eliminating those pesky profits.
This is a Marxist argument, pure and simple. If true, it would apply to all industries, not just banking. States like Cuba and North Korea would be the envy of the world, as they prohibit profits across the board. The truth is that profits – earned from free-market competition – keep cost down. By taking the profits out and putting the bureaucrats in, any incentive to provide better service or lower costs is eliminated. It's not hard to predict that student-loan costs will now rise faster than ever.
That is clearly not the result we want. To solve the problem, people must understand that college tuitions are so expensive specifically because the government has guaranteed student loans. Guaranteed loans don't mean more access to education, but rather that universities are free to charge more per pupil than if their customers were paying out-of-pocket.
President Obama's plan only serves to remove more market forces and creates an even bigger moral hazard.  Under the new rules, students will be required to repay a much smaller portion of what they borrow. As a result, students will be willing to borrow even greater amounts of cash to pay inflated tuitions, making it that much easier for colleges and universities to raise them.

Also, since the government will actually be loaning the money directly – rather than simply guaranteeing private-sector loans – the U.S. Treasury will actually have to borrow the money itself before it can re-lend it to students. I suppose the irony of going into debt to loan money never registers in Washington. Further, as this bill will cause tuitions to rise even faster, it will necessitate even larger loans that will produce even greater taxpayer losses when the loans end in default or forbearance.
Whether it is in education, housing, healthcare, automobiles, insurance, or banking, greater government involvement in the economy means higher prices, lower productivity, more bailouts, bigger deficits, increased taxes, diminished industrial capacity, fewer private-sector jobs, less freedom, and a falling standard of living. 
In the end, when runaway inflation and skyrocketing interest rates burst the government bubble, there will be no more bubbles to replace it – just one hell of a hangover.

[Editor's Note: Peter D. Schiff, Euro Pacific Capital Inc.'s president and chief global strategist, is a well-known author and commentator, and is a periodic contributor to Money Morning. Schiff is the author of two New York Times best sellers: "Crash Proof: How to Profit from the Coming Economic Collapse," as well as "The Little Book of Bull Moves in Bear Markets." His latest book is "Crash Proof 2.0: How to Profit from the Economic Collapse." Schiff also publishes The Global Investor newsletter. For more information on that newsletter, please click here.]

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  1. Craigie | April 12, 2010

    Borrowing limits on federal student were not increased this year, and have barely been increased in 30 years. Yet the sticker price of a postsecondary education apparently continues to increase. Furthermore, a more flexible version of income contingent repayment has been offered for 15 years with only a microscopic interest from student loan borrowers, in part because of articles like this. Better to have someone repay a smaller portion of the loan for a couple of years than default. In addition, at a relatively low income level, the monthly payment owed by the borrower exceeds that under standard repayment. It is not the welfare "free ride" that those who haven't read the details are asserting.

    When the demands on government were small, and when very few Americans were over age 65, guaranteed loans was a reasonable, unaudited way to get the job done. However, it is far more expensive than direct lending, particularly when market interest rates return to normal (much higher) levels, because the government guarantees a quarterly rate of return to loan holders.

    Guaranteed student lending is about as far from market forces as can be imagined. Attempts to introduce market forces into the program were fiercely resisted by the participants in the program. These include auction bidding, loan sale bidding, interest rate bidding, and so on. Paying someone a flat rate (as the fed'l gov't does with the student loan guarantors as well), regardless of performance, is not the American way. Under the new system, they will now be paid based on performance

    • Tony | April 13, 2010

      Craigie – You're reply is interesting unfortunately I'm not savvy enough to understand your last sentence could you elaborate a little on how the loans 'under the new system, will now be paid based on performance'.

      • Tony | April 13, 2010

        Okay so after July 1 "all student federal loans will be direct loans, delivered and collected by private companies under performance-based contracts with the Department of Education," and with the direct lending the lender will never change for the student, unlike now where private lending companies can sell loans to consolidation companies and the students risk losing benefits they built by paying on time. This recently happened to me but in my case it worked out for the better because they not only lowered my rate but after 36 months I can get it down another percent to 1.25%. It sure made being a liberal arts student easy, fortunately I'm able to pay back the loan but just barely right now, because I'm having to retrain myself with skills that are actually worth something in the market place.

        Anyway the direct lender will be lending a performance based loan to student with funds guaranteed through the US Treasury. The student will only have to deal with the one lender until it's either paid off or defaulted upon, and I presume that the 'performance based' part will be the lender being creative in getting the money back. Well I wish them luck because it sounds like a whole lot of these loans will be completely shifted to the tax payer if the liberal arts departments keep sucking in the kids with their useless degrees (but it's a lot of fun on that side of the campus while it lasts).

        • Craigie | August 21, 2010

          The federal government pays loan holders and guarantors in the FFEL program an entitlement amount unrelated to performance. The performance based contracts are posted on the web and are publicly available. In addition, the contractors that perform better will get more new volume than the contractors that perform worse.

          DoD, as powerful as it is, has been politically unable to control its contractors. That said, contractors are a lot more controllable than recipients of no-strings-attached largesse. The FFELP lenders and guarantors got provisions into the Higher Ed Act stating that they could never be treated as contractors. They knew what they were doing there. There is still $400 billion or $500 billion out there in FFELP portfolios that will be receiving the old subsidies and will be ongoing as the loans pay down.

          The loans are not "shifted to the taxpayer." Direct loans, just like any loan made by a private bank, is an asset. In this case, instead of being an asset of a loan holder subsidized for 20 years by the taxpayer, it is actually an asset of the taxpayer. The subsidy rate for direct loans is negative, meaning there is never an appropriation, the program makes money for the budget. Loan defaults are just one of dozens of parameters that determine net gain and net loss of the portfolio, and the data show that, after the default, the loans are still collected, because the loan programs have some extremely tough collection methods baked in.

          The liberal arts students have super-low default rates anyway, compared to the students with the more "practical" majors, such as truck driving, cosmetology, hair dressing, business, court reporter, medical assistant, IT, and so on. And, as mentioned, default just delays the inevitable, with interest and fees tacked on as well. It is pay now, or pay later.

          Changing the postsec model in the USA would literally require the shut down of 95% of schools, at least during a brief transition period of 6 to 18 months. The schools are so powerful politically they will never allow it. The only thing that will force change is if the students from the wealthy suburbs band together and decided to boycott school for five years. That will force the schools to change their ways. Unfortunately they are likely too arrogant to make such a bold move.

  2. Dan C | April 12, 2010

    Think about why and how distributed risk ideas start out: to provide benefits to those in need during unintended catastrophes.
    An insurance company used to be a conduit for money to flow in from premiums and out to claimants, while skimming a little off the top. Now, they just burn the money and the executives get the energy from the burning money (landscaping, elaborate buildings, lobbyists, computers, advertising), while some soot might fall on the dying beneficiaries and be called “benefits”.
    Government has followed the same model. So have many rich people and it seems, all of the merged corporations (much of this I think is due to the income tax code).
    Where is the clean, simple usefulness of the original labors of people’s hands and minds? Buried in the ashes.
    “Unintentional catastophes” is a key term here, because I would say that our poor health, climate instabilities, and political indulgences in uselessness are actually semi-intentional catastrophic results that increase the flow of money to the fires of ‘economics’. Whether you burn the money or not, it adds to the GDP.

  3. whereisthe beef | April 12, 2010

    doom and gloom every soap box emits static noise .. neglecting the facts we all get old
    we all get senile we all get to die.. now what part we forget? or we do not get? .. It be
    challenging to focus on future derivatives, arm chair analysis forget we all are senile participants
    who follow missionary noisy predictiors, forecast of fear, guru predators feeding the senile..

    The senile elders ask can predators focus on stairways? promote real advice to senile elders retired old folks lost capital preservation..

    Begin preaching a one a two a three a real investor tragedy your index guides? We got Hollywood? what time start movie entitled doomsday? What senile people must do to preserve capital paid for wood coffin?…

    All you begin building a real stairway… replace your smoke and mirror fantasy.. get the elder
    senile folks to die in peace all paid from preservation of USD… Get real what when where to
    to put USD before death due part us

  4. Dave | April 13, 2010

    For those here that believe that we can change our course by voting for the "right" candidates,please get real.
    Our demise is securely locked on auto-pilot since there is roughly half of the population receiving funds from "the gubmint"(not including the hideous levels of debt).
    Even without Obama's victory our end would have been certain,with his ascendency it's just overkill.
    Most of you reading these words already have gold,so sit back & relax and watch the show.
    There 'aint nuthin that the libertarian minority can do about it.
    Just never,ever let them take your guns…

    • chris | April 13, 2010

      Dave and all….. become a tourist….. for 30 days here…. 90 days there….. 6 months over there…. or become a boat person….. and move your home to wherever most benefits you….. the human animal is adaptive….. put on your thinking caps and with a plan you can stay one step ahead…… would like to have like minded neighbors ….. anyone want to colaborate on finding a good bug out plan and retirement

    • Zeus | April 13, 2010

      Even your golden assets will not be beyond the reach of our nascent totalitarian governement .

  5. Jason Calley | April 13, 2010

    Dear Mr. Schiff, thanks for another great article! I have one disagreement though.

    You say: "Through corruption or just plain ignorance, Congress and the Obama administration have embraced an ideology that has failed every time it has been tried." On the contrary; once we realise that the purpose of the ideology is to benefit a small group of already powerful and wealthy, our only conclusion is that the ideology is very successful, even wonderfully successful.

    Because the average person thinks that our purposes are the same as our politician's purposes, we are continually disappointed and confused at governmental "ineffectiveness". We are mentally hamstrung by our belief that that our leaders are — at least in the important matters — trying to make a better life for us all. No. Not even maybe. Our leaders are sociopaths and parasites whose ONLY purpose is to prosper themselves by stealing from us. Until the average citizen understands just how evil our glibe and persuasive politicians, bankers and CEOs have become, we will never regain control over our own lives and property.

    Look in the mirror and repeat this: "Our leaders are sociopaths who are enslaving us."

  6. Bill Ross | April 13, 2010

    Inflating the government bubble equals more people dependent and thus beholden to government. Ie; more might in support of "might is right". It is clear that that the parasite has already outgrown the host (states, economy). Thus, if the state is to survive, it must get more aggressive in stealing private property, domestically and internationally.

  7. INVA$ION USA!! | April 14, 2010

    And the ongoing INVASION will only make things worse –

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