It’s been a month of big surprises. And the biggest was saved until last night.
The US government, after a week of desperate wrangling, failed to pull a rabbit out of the hat to save the banking system, the economy, and the Western world in general. It seems that Republican senators decided that if they’re to have any chance of being voted back in come November, then they’d better start acting like fiscal conservatives. And they blocked Hank Paulson’s $700bn ‘bail-out’ of Wall Street.
It’s a fine time to get an attack of conscience. After all, under the Bush administration, the state has grown ever-more bloated, and ever-more intrusive, just like our own state here in the UK. But it’s never too late, as they say.
So what happens now? Well, you can expect a lot more editorials about the death of capitalism for one thing. And more bank failures for another. But I’m an optimist (believe it or not).
The economic fall-out from all this will be brutal – nothing can stop that. But if we’re lucky, this might just be a turning point. We might just be witnessing the death knell for big government…
All through this crisis, people have been screaming that markets don’t work any more. That capitalism has failed.
But while asset prices were rising, no one complained. Even though any one who dared look past the PR puff could see that house prices were hugely overvalued. Even though there was obviously something flawed about a housing market where most people could only afford to own their own home by racking up dangerously high levels of debt.
Markets are now working just fine. They’re tumbling fast, and turning overpriced dross back into what it should be – plain old worthless dross.
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What’s finally failed – and what the commentators are really wailing about when they talk about the end of capitalism – is government. In the West, the voters have made a little deal with the governments. We never wrote it down anywhere, but it went something like this.
“You, the government, can do pretty much what you want. You can spend our taxes on destructive social engineering programs. You can use our money to spread democracy to other countries. You can collect as much data as you like on us and allow it to be used and abused by every pen-pusher in the civil service.
“We’ll let you do all that, with barely a murmur of dissent. All we ask for in return, is that you make sure that house prices never stop rising and that there’s a constant supply of cheap credit.”
That’s perhaps a harsh way to look at it. But what it boils down to is this – if, as a government, you can maintain an illusion of economic prosperity, you can pretty much get away with anything, because people assume you must be doing something right. After all, it works for China every bit as well as it worked in the West.
But now voters are realising that governments can’t uphold its side of the bargain. It can’t make prices rise forever, regardless of how many independent central banks there are, or how much money is pumped back into the system.
And this $700bn bail-out package may have been big government’s last throw of the dice. Most of us had assumed the deal would simply go through, and that things would somehow just rumble onwards. Even though the deal in the end actually didn’t offer much that the Fed isn’t already doing (see here for more on what was on the table: Why hasn’t the bail-out plan lifted stock markets?), the sight of something being done would have at least calmed markets down, so the thinking went.
Now, as Congress retreats to the drawing board, with government effectively paralysed, we are seeing free markets at work. It’s not pretty. The Dow Jones plunged 7%, nearly 800 points. The FTSE 100 ended the day yesterday down more than 250 points, while the oil price plunged sharply too.
And deals thought done look as though they might be unravelling. HBOS shares have been sliding pretty much ever since Lloyds TSB agreed to buy them. Lloyds insists the deal is on track, but the markets are clearly concerned.
In fact, about the only things that went up yesterday were gold and government bonds. Marc Faber of the Gloom, Boom and Doom report said recently that he held gold as insurance because he expected the financial system to collapse one day. We expect most MoneyWeek readers probably already have some – goodness knows we’ve gone on about it enough. If you don’t – well, it’s never too late to buy some. You may not see the easy capital gains from here that we saw when it was trading at $250 an ounce all those years ago, but it’s reassuring to have some as a hedge against everything else in your portfolio.
So why might this be the end of big government? Well, big government relies on big spending. But tax revenues are going to go through the floor – the bigger the recession, the harder they’ll fall. That leaves borrowing – but there’s only so much money that other will be happy to lend to a country with no visible means of supporting itself.
The simple truth is that we can’t afford big government anymore. And if there’s one silver lining to the dirty great cloud hanging over our economy, that’s got to be it.
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