Other peoples’ money

“The trouble with socialism,” Margaret Thatcher once famously said, “is that sooner or later you run out of other peoples’ money. This observation is the key to understanding the wave of government bankruptcies that has already begun to break over us.

The state of California was a leading indicator in the U.S., so broke that it has started issuing IOUs to its suppliers in lieu of cash. The state governments of Illinois, New York and New Jersey are in straits almost as dire. Before I checked, I thought 39 of 50 states were running deficits, but according to this visualization of 2010 estimates, 46 states are now in deficit. A massive selloff of U.S. municipal and state bonds is getting underway as investors run for the exits.

From overseas, we hear endlessly of the threat of sovereign default in Portugal, Italy, Ireland, Greece and Spain – the so-called PIIGS countries. The financially stronger EU countries (by which I mean, basically, Germany) have organized bailouts designed to give bond investors confidence that the PIIGS merely have a temporary cash-flow problem, but the markets aren’t buying it; the rush to unload Irish paper wasn’t even slowed down by the loan to Ireland. Analysts are now wondering if Belgium might be next.

What’s actually happening here is that bond investors are catching wise about the largest political truth of the post-Cold-War era: government is bankrupt. It’s not just individual governments that are headed for financial collapse, but the entire model of ever-expanding statism that began with Otto von Bismarck’s Prussian state-pension system in the late 1800s.

This bankruptcy was inevitable from the moment governments got on the treadmill of buying their legitimacy with entitlement spending. As I observed in Some Iron Laws of Political Economics, in any democracy political demand for income transfers, entitlements and subsidies always rises faster than the economy can generate increased wealth to supply them from; this is backed up by a recent study showing that each additional dollar of tax revenue collected in the United States has produced $1.17 in additional government spending.

Thus, raising taxes never helps. All it does is increase the system’s run rate towards collapse, and increase government appetites for borrowing to cover the ever-widening gap between revenues and political commitments. This is why EU governments are trying to bail out their weaker members – what they fear most is that they’ll lose the ability to paper over that gap using the bond markets, at which point the entire edifice of Eurosocialism will irretrievably crash.

American conservatives who want to blame pet villains like the public-employee unions for the insolvency wave in the U.S. are missing the forest for the trees. Those unions are doing nothing but rational minimaxing within a system where the incentives are broken at a much deeper level. And it’s no coincidence that the same problems are becoming acute simultaneously nearly worldwide, because the underlying problem transcends all details of any individual democracy’s history or particular political arrangements.

Between 1880 and 1943, beginning with Bismarck and ending with Roosevelt’s New Deal, the modern West abandoned the classical-liberal model of a minimal, night-watchman state. But the redistributionist monster that replaced it was unsustainable, and it’s now running out of other peoples’ money. We are living in the beginning of its end.

UPDATE: From the day after I wrote this Europe Debt Fears Hit More Secure Countries. Mene, mene, tekel, upharsin!

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