What Can Government Do?

What are governments capable of doing? To answer that question, let us examine their sources of funding. At the state and local level, funding originates with taxes, Federal Government funds, and extensions of credit (bond issues). Unlike the Federal Government, they do not have the luxury of spending more than they have. When they do spend more than they have, they have to cut back on the services they provide, raise taxes, travel to Washington to ask for more funding, or all of the above. Presently, 46 of 50 states are experiencing budget shortfalls, implying those states may have to implement some of those measures.


The Federal Government’s funding primarily comes via taxes and tariffs (at one point in our history the Federal Government operated mostly on tariffs!). When they spend more than they have, funding comes from other sources. The Federal Government historically has the reputation as the best credit risk so investors (foreign and domestic) are willing to lend money through Treasury sales of Bonds, Notes, and Bills. Their credit base is even broader through a unique link to the Federal Reserve allowing Fed purchases of US Treasury debt. The Fed “lends” money to the US Treasury by creating bookkeeping entries. The “money” from these bookkeeping entries emerges out of thin air. The Federal Government has capabilities that other governmental entities or other market participants do not.


Now that we have established what governments can do, let us explore what the public’s capabilities are.
Economies are expressions of what people do. Participants in an economy act on their own behalf (what is best for them) in a manner that meets the satisfaction of others acting on their own behalf. The collective action of all of these participants is the Market. Therefore, the Market is a collection of many people acting on their own behalf for the benefit of others.
What is the government’s relationship to the Market? The government protects the market. Government protects the market by enacting laws or regulations along two main Principles:


1. Do onto others as they would do onto you – the basis of criminal law.
2. Do what you said you would do – the basis of contract law.


If you lived in a society where you had to worry about Principle #1 or Principle #2, it would be hard to have a market. There would be constant fear that someone was trying to inflict physical harm (Principle #1) or that you could not trust your market transactions with others (Principle #2). Government is responsible for creating an environment in which a market can operate safely.
As one can imagine, the Market is in a continual state of change. The Market changes due to changes in judgment on the part of its individual participants. A snapshot of the Market at any point in time reveals the “price” or exchange rate for something. The “price” or exchange rate is simply an agreement between two parties - nothing more, nothing less. Human actions create the Market.


Markets tell producers what to produce and in what quantities to produce them. Markets also tell consumers what to consume and in what quantities to consume them. What if the price of filet mignon were $0.10 per pound? How would consumers react? Similarly imagine the price of filet going to $1,000 per pound. How would consumers react then? In both cases, the Market dictates behavior.


In order for the government to protect the Market, it has to be a participant in the Market. Government inserts themselves in the Market buying raw materials, equipment, and labor. The government’s sources of revenue are tariffs and taxes. When more funding is needed, government borrows. The borrowing occurs in the Market alongside anyone else needing to borrow. They are also part of the Market when they sell their goods and services. Please understand this point. The Government, like anyone else, is a Market participant. The Government is not a supernatural or mystical being orbiting earth sprinkling magic dust on its inhabitants. Moreover, the Government is nothing more than the people allow it to be. The Government is the people.


The people allowed Government to expand well beyond their intended roles in the Market. The current economic crises gave Government an opportunity to expand its role further. Some call this expansion socialism. Socialism, in fact is a more comprehensive control of the economy. The Austrian economist Von Mises argued in Human Action, that an economy is either socialist or capitalist. If the economy is socialist, then government plans everything. If the economy is capitalist, then the Market dictates what happens. As large as government has become, it remains a minority player in comparison the rest of the economy.


That said, Government is consuming more of the Market’s resources (raw material, equipment, labor). Since its sources of revenue (tariffs and taxes) are considerably less now in this economic environment, it must borrow more. Unlike private enterprise who enacts austerity measures during times of greatly reduced revenue, our government has actually spent more. Market participants (you, me, and others) are marginalized when Government expands beyond its natural economic boundaries. The Market will ultimately judge Government’s performance.


Jim Mosquera is the author of The Sentinel financial newsletter www.TheSentinel.biz. Mr. Mosquera’s email address is jim@TheSentinel.biz