How Corporate Bailouts Inflate the Money Supply
Lennart Wagemans

Many claim that the problem with fractional reserve banking is that it loans money into existence. This is true, but under normal circumstances the money loaned by commercial banks disappears when loans are repaid or defaulted on, and this, therefore, doesn’t create a permanent inflation in the money supply.

Government intervention, however, converts temporary money into permanent money through bailouts like the Troubled Asset Relief Program. They purchase loans that would have been defaulted on, preventing the evaporation of credit.

When banks hold assets that are at risk of default, they face having to write them off and making a loss, which would evaporate them as part of the money supply. Bailouts turn such disappearing assets into permanent ones.

Without government bailouts, banks would be unwilling to make loans that are unlikely to be repaid, thus limiting their willingness to loan large amounts of credit into existence, keeping the money supply more stable. At any time, some proportion of money supply would still be temporary. This proportion would somewhat fluctuate with economic conditions, and the temporary money would be functionally indistinguishable from permanent money until a loan is repaid. But there would not be continual net inflation of the money supply.

The symbiotic relationship between the government and financial institutions ensures that when high-risk assets inevitably fail, the state steps in to purchase them. This arrangement incentivizes banks to continue producing worthless assets, knowing they will be able to sell them. However, seeing this creation of toxic assets as just excessive risk-taking in reaction to having a safety net of bailouts misses the larger dynamic. Praxeologically, the production of toxic assets is the rational supply of a good in high demand. These financial instruments can be sold for a higher value than it costs to make them, making their production profitable.

Banks thereby perform the function of government contractors, producing a “worthless financial asset.” Similar to how defense contractors produce fighter jets or fish farms produce caviar for state banquets, banks create toxic assets knowing the government will purchase them. This demand ensures that banks continue to produce high-risk financial instruments. The financial sector profits from creating these products despite knowing they may become worthless. It is their worthlessness that causes them to be valued as a purchase, since that rationalizes the bailout.

In praxeological terms, the financial sector and government participate in a cooperation that perpetuates this cycle. Financial institutions create high-risk assets, knowing they will be bought by the government because of the need to prevent economic collapse. This crisis theater maintains a façade of urgent necessity, masking the underlying relationship that benefits both the financial elites and political actors. It ensures continuous profit for the financial sector and retains power for those who appear to be responding to crises they help perpetuate.

By continually handing free money to the rich, the government facilitates a transfer of purchasing power from the population to the elites. This economic structure skews wealth distribution. The entities that receive the free money have the opportunity to invest in assets like tech stocks and real estate, which is where such new money usually lands first.

In a true free market, wealth accumulation would rely more on productive enterprise and value creation rather than financial engineering and rent seeking, resulting in a more equitable distribution of wealth based on merit and productivity. Thus, the current system perpetuates inequality where state policies and inflationary practices favor the rich at the expense of the broader population.

Karl Marx and the Left misdiagnose the root cause of economic inequality. It’s not the ownership of the means of production that gives capitalists an unfair advantage but continuously doling out free money to the rich. Through bailouts and other inflation, the state funnels new money to the wealthy, while everyone else has to work for it. This interventionist policy ironically perpetuates the very inequality they decry. In a truly free market, absent of state interference, wealth distribution would align more closely with individual productivity and innovation, reducing artificial inequality and creating a fairer economic system based on merit. Thus, their support for state intervention sustains the economic disparities they aim to eliminate, inverting the reality of how inequality arises.

Many businesses today, especially in the tech sector, function more as inflation-capturing devices than traditional profit-generating enterprises. They prioritize attracting fiat investment from the recipients of new money to tap into the vast pools of money created by banks. After that come the second layer of inflation capturers, who get the money that trickles down from the first layer. The closer to the inflation fan you are, the better you do. Today the success of businesses largely depends on how close to the inflation source they are. Overall, the economy is largely skewed to growth toward the money spigot rather than fulfilling real peoples’ needs.

Investors are those with early access to newly created money starting to buy up assets in the economy. This dynamic explains why tech giants grow disproportionately large — they happen to excel at positioning themselves within the flow of newly created money, benefiting from inflated asset prices and speculative investment environments. Productivity and traditional value creation take a back seat to capturing and capitalizing on inflation-driven investment, reinforcing wealth disparities fostered by state monetary intervention. This process distorts market signals, misallocates resources, and perpetuates an economic environment where success ties more to financial maneuvering than genuine productive output.

Via inflation, big players continually receive free money. This allows them to generate vast sums of money with minimal effort, whereas ordinary people must work and produce tangible goods or services for the money to trickle down to them, being paid at reduced purchasing power as earned money is just a small part of the money gained in the system. In a truly free market, purchasing power would directly correspond to productive labor, ensuring a more equitable distribution of wealth. Work would be more highly rewarded, and even modest employment would provide substantial purchasing power, reducing the need for a welfare state. The current system fosters a parasitic class benefiting from monetary manipulation rather than productive contribution. Marx’s analysis, focusing on the ownership of the means of production and advocating for state intervention, inadvertently exacerbates the problem. State mechanisms intended to reduce inequality instead perpetuate it by maintaining an economic environment where financial elites thrive on inflationary policies and bailouts, further widening the wealth gap and entrenching systemic inequality.

The problem is not insufficient regulation of the financial sector. All the banks need to create toxic assets is something to bet on. If you ban one way to bet, they just bet on something else or create a derivative of it. You can’t ban it all. A normal market would be self-correcting. Faced with losses when a bet goes sour, they would be unwilling to make an unsafe bet. Thus, the real problem is that government intervention makes that temporary money permanent.

During the era of industrial capitalism, power resided with industrial capitalists who created tangible products and infrastructure, driving progress and lifting society. In contrast, the current financial elite manipulate the allocation mechanisms themselves without producing real value, resembling medieval palace elites. This financial parasitism undermines the productive economy, concentrating wealth and power among those who excel at gaming the system rather than creating real economic value. This dynamic reflects a regression to exploitative, feudal-like power structures under the guise of modern financial capitalism, perpetuating inequality and economic instability.

 

 

 

Lennart Wagemans is a multi-decade Austrian economics thinker with an engineering degree from Denmark. If he gets around to writing it, his book will be called Grain Age.

 

 

 

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