Social Democracies–A General Overview of Financing

A pyramid scheme is a fraudulent business which makes people poorer every year (wiki explanation here). It is inherently unsustainable, POINT. One of the biggest and latest world-wide pyramid scheme frauds went bust a few years ago. It was the sub-prime mortgage market in the US. CDS were in the end unsustainable and worked a bit like a pyramid scheme.

But there is still one of the biggest pyramid schemes on-going: Western Democracies idea of government financing. It actually rests on 3 pillars that all have to operate in between a specific boundary for it to at least partially work in the long run:

1. Inflation
2. Growth
3. Technology Advancement

If these three pillars do not work according to plan, the government is in deep trouble, but even if they work, we people get poorer every year. So it is a lose-lose for us citizens who participate in it by spending money and paying taxes.

Now, let’s get a bit more into the details. I will start with Inflation.

Inflation is necessary, because governments accumulate debt. The incentives of social participatory democracies are such that governments do spend a lot, in most cases and at most points in time they spend MORE than they take in (Spending > Tax Income). So, they accumulate debt on their own currencies (having a nationally controlled currencies is paramount as some European PIIGS just start to find out).

Inflation (especially targeted inflation) now does the job of reducing the debt-burden without actually REPAYING much of it. So, government still can spend more than it takes in, but it can reduce the relative value of its debt by inflating prices and money supply, which of course leaves the creditors paying for it.

Inflation, however, isn’t a precise instrument, which can be easily wielded. it has its drawbacks. One of them is the simple problem of targeting a specific value. If you miss or people lose confidence in your targeting abilities, inflation will either rise to Hyperinflation (meaning it devaluates too fast, the description of too fast comes later) or we get Deflation, which actually makes the debt bigger.

Now, how do states counter debt problems and do appear confident? This is the next point: Growth. Growth is very important to states, because it is analogues to health bar in computer games. Healthy states grow or at least that is the general assumption. The goal here is that Growth is always HIGHER than Inflation, so that tax income rises and Spending can be bigger than Tax Income without accumulating ever rising debt. Almost all modern states work on this principle. Of course, there are some exceptions, which are notably natural resource rich countries (Norway Oil, Arabic Emirates etc.) and emerging markets (China, India, Brasil etc.).

Now, even growth and inflation are not enough. They are necessary for the state to work properly, but they alone would make live miserable for its citizens, because they would get poorer due to inflation every year. The problem here is that especially agricultural goods will get more expensive every day and eat up to a considerable share in the balance sheets of a household. Here comes the last ever important point Technological Advancement. It is important that technology gets cheaper and better all the time, so that people don’t feel cheated and robbed to poverty by inflationary means. High tech equipment gets cheaper every decade and thus the every rising inflation poses not a big problem for most people.

The problem is that whenever there is a steep drop in the market, growth breaks down and inflation rises, if the state is imprudent and tries to generate more money or misses its inflationary target. This can and will lead at some point in the future to an implosion similar to the  CDS market and thus will restructure the world.

In the end it will become clear that you cannot endlessly spend more than you make. Every household in the world learns this lesson at some point in its life time. Why should governments be exempt? After all, it is just a bigger household of a few Million or Billion people.