Deficits, Debt and Interest on the Debt 1988-2012

Posted by PITHOCRATES - March 26th, 2013

History 101

Congress printed so much Money that the Continental Dollar became Worthless

The American Revolutionary War lasted eight years.  And eight years of war ain’t cheap.  It took money to buy arms.  It took money to buy uniforms.  It took money to pay soldiers.  And paying for these for eight years required a lot of money.  Which the Americans didn’t have.  They were at war with Great Britain.  Who was their major trading partner.  And pretty much their only trading partner.  As the Americans were a British colony in the days of mercantilism.  Which meant the Americans sent raw materials to the mother country.  On British ships.  Through British ports.  Britain then transformed those raw materials into finished goods.  And exported them.  On British ships.  Through British ports.  Throughout the world.  And back to America.  Before the Revolution, that is.

Thankfully for the Americans there was a nation that hated the British.  And had been in a near perpetual state of war with them since about forever.  And they had just recently lost their North American territories to the British.  Which they wanted back.  So the French had other interests than American Independence.  But American Independence was a good opportunity to settle the score with their old nemesis.  And when the Americans defeated a British Army at Saratoga the French thought that just maybe the Americans could pull this off.  And if so they wanted to be in on the spoils of a British defeat.

So the French financed a large part of the American Revolutionary War.  But it wasn’t enough.  The Continental Army was poorly fed and poorly clothed.  Even leaving bloody footprints in the snow as the Continental Congress couldn’t put boots on their feet.  Nor could they pay them.  So they turned to printing money.  Unleashing a brutal inflation.  No one wanted the currency.  The inflation was so bad that it lost its value before they could spend it.  So no one wanted to accept the Continental paper dollar.  Giving rise to the expression ‘not worth a Continental’.  Everything had two prices.  A low price if you paid with hard currency (gold and silver coins).  And a very high price if you paid in Continental dollars.  They printed so much money that the money became worthless.  So the Continental Army just took what they needed from the people to keep their men from starving to death.  Leaving the people with an IOU.  That Congress would redeem one day.  Maybe.

The Percentage of Tax Receipts going to Pay the Interest on the Debt has fallen as the Federal Debt Rose

Today hard currency is a thing of the past.  It’s pure un-backed paper these days.  This paper money has no intrinsic value.  And you can’t exchange it for gold or silver that does.  But you sure can print it.  Well, the government can.  And they do.  They borrow and print money like there’s no tomorrow.  Allowing them to spend money they don’t have easier than ever before.  And it’s not just for feeding and clothing our soldiers.  But just about everything under the sun.  Causing the federal debt to soar.

Think of the growing federal debt like a credit card with a growing balance.  And these balances grow fast because each month they charge you interest on your past purchases.  And on your past interest charges.  Which is why if you let that credit card balance get too high it’ll grow beyond your ability to pay it off.  A lot of people who do find themselves filing a personal bankruptcy.  Because the interest charges just balloon their monthly payment.  With the interest in their credit cards consuming an ever larger portion of their paycheck.  As should the interest on the federal debt consume an ever larger portion of federal tax receipts.

Debt and Interest as Percentage of Receipts

(Sources: A History of Debt In The United States; Interest Expense on the Debt Outstanding; Historical Amount of Revenue by Source)

Interestingly, the percentage of federal tax receipts going to pay the interest on the debt has in general fallen as the federal debt rose.  Odd.  The more debt one has the greater the interest one pays.  That’s how it works on our credit cards.  When the debt was approximately $6.2 trillion in 1991 the percentage of total tax receipts going to pay the interest on the debt was 27.1%.  But when the debt soared to $16.1 trillion in 2012 the percentage of tax receipts going to the interest on the debt fell to 15%.  The federal debt grew to be 2.6 times what it was in 1991.  Yet it appears we are paying less interest in 2012 than in 1991.  Something doesn’t seem right.

Interest Rates will Rise as the Purchasing Power of the Dollar Falls, Raising Prices and the Cost of Borrowing

A couple of things could explain this.  And the first thing that comes to mind is tax revenue.  The reason why interest on the debt as a percentage of tax receipts has fallen while the federal debt grew is, perhaps, that tax revenues grew even greater.  So even though interest on the debt could be soaring along with the soaring federal debt the government could be awash in tax revenue.  And if the number you’re dividing by is larger than the number you’re dividing into it than you get a smaller percentage.  Simple arithmetic.  The driver of the federal debt is the annual deficits.  So let’s compare interest on the debt to the deficit.  To see if the interest on the debt rises with the deficit.

Interest on the Debt and the Deficit

(Sources: Interest Expense on the Debt Outstanding; Table 1.1—SUMMARY OF RECEIPTS, OUTLAYS, AND SURPLUSES OR DEFICITS (–): 1789–2017)

And it doesn’t.  In fact, the interest on the debt almost held constant when the deficit plunged into a surplus.  And when the deficit soared to a record high.  It seems like there was some other factor involved here.  Something actually keeping the interest on the debt down.  Even when the deficit soared after 2007.  What could do this?  Well, there is only one other thing to look at.  Interest rates.

Interest on the Debt the Deficit 10 Year Treasury

(Sources: Interest Expense on the Debt Outstanding; Table 1.1—SUMMARY OF RECEIPTS, OUTLAYS, AND SURPLUSES OR DEFICITS (–): 1789–2017; Market yield on U.S. Treasury securities at 10-year constant maturity, quoted on investment basis)

And we have our answer.  Interest on the debt has not kept pace with the debt because of bad monetary policy.  Keynesian economic policies introduced permanent inflation into the economy.  The Keynesians in government kept interest rates artificially low to stimulate economic activity.  Those low interest rates stimulated so much economic activity in the Nineties that it created a dot-com bubble.  And when it burst it created a painful recession in the early 2000s.  Also, President Clinton’s Policy Statement on Discrimination in Lending lowered lending standards in the Nineties setting the stage for a great housing bubble that burst into the subprime mortgage crisis in 2007.  And the Great Recession.

The Keynesians have been increasing the money supply (i.e., printing money) in a desperate attempt to pull the economy out of recession.  Which is why the market yield on a 10-year treasury has fallen as the deficit soared in the early 2000s.  And fell even more as the deficit soared even further after 2007.  With the yield falling to as low as 1.8% in 2012.  Even though the demand for so much borrowing should have raised interest rates.  Which would have happened had the government not been increasing the money supply.

And this is why interest on the debt as a percentage of receipts has fallen.  Despite record debt.  Some may look at this and think it’s a good thing.  As it lets the government borrow more money.  So they can give us more stuff.  But printing money causes inflation.  Which has been kept at bay for now thanks in large part to the Eurozone sovereign debt crisis.  As investors everywhere are desperate to find a safe harbor for their money during these uncertain times.  But that won’t last forever.  Eventually those interest rates will rise as the purchasing power of the dollar falls.  Raising prices.  And the cost of borrowing.  A lot.  Because of that record debt.  And when they start selling new treasuries at higher interest rates than the ones they’re replacing a very large portion of our tax receipts will go to pay the interest on the debt.  Just like when people charge too much on their credit cards.  Pushing the country closer to bankruptcy.  Just like people with overextended credit cards.  And like countries in the Eurozone.

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Sixteenth Amendment, Revenue Act of 1913, Progressive Tax, Marginal Tax Rate, Tax Shelter, Tax Cuts and Decade of Greed

Posted by PITHOCRATES - July 10th, 2012

History 101

Americans find Taxes Repugnant and have a Long History of Making this Repugnance Known

American independence began with a tax revolt.  The ratification of the U.S. Constitution happened only with safeguards against the new federal government from growing too powerful.  And great efforts went to limiting the amount of money it could spend.  For a long time all federal tax revenue came from import tariffs.  Then from sales of federal lands as the population moved west.  It took a civil war for us to impose an income tax.  Our first income tax was 3% on incomes over $800 (or about $20,000 today).  The first income tax was a flat tax.  They passed this income tax to pay for the war.  They repealed the income tax following the war.  Americans wouldn’t see another federal income tax until 1913 when we ratified the Sixteenth Amendment.  And President Woodrow Wilson signed into law the Revenue Act of 1913.

Woodrow Wilson was a progressive.  The precursor to today’s liberals.  Who thought beyond the limited government of our Founding Fathers.  They wanted to expand government.  To make it a part of our everyday life.  Where the brilliant progressive politicians would make better decisions for us than we ever could.  And their changing of society included the funding of the federal government.  For their income tax was a progressive tax.  Everyone paid a flat tax of 1% on income of $3,000 or more.  About $66,100 today.  Then the progressive taxes came into play.   Adding another percentage to the income tax rate for increasing amounts of income.  The thresholds for these increases were as follows: $20,000 (roughly $440,400 today), $50,000 ($1,101,000 today), $75,000 ($1,651,600), $100,000 ($2,202,100), $250,000 ($5,505,300) and $500,000 ($11,010,700).  The top marginal tax rate on the super rich (earning $11,010,700) was 7%.

Our second income tax was quite controversial.  A lot of people hated it.  For Americans find taxes repugnant.  And have a long history of making this repugnance well known.  But thanks to the American Civil War a generation of men was lost.  And a generation of boys grew up without fathers.  Tended on by doting mothers.  Smothering them with love and affection.  And these boys grew up without knowing the manly hardships of life.  And they entered politics.  Becoming those early progressives.  Who wanted to change the government into a great doting mother.  And now they could.  For they had their income tax.

Few paid the Confiscatory Tax Rates of the Seventies by Hiding their Income in Tax Shelters

The rich paid our first federal income taxes after the Revenue Act of 1913.  And these were very small percentages we had them pay.  Back then the top marginal tax rate was lower than our lowest income tax rate today.  Think about that.  The richest of the rich paid only 7% of their income ($11,010,700 or more today) in federal income taxes.  While today single people earning the lowest bracket of taxable income (from $0 to $8,700) pay 10% of their income in federal income taxes.  Clearly the growth of government exploded thanks to the Sixteenth Amendment.  Much as our Founding Fathers feared it would if they had too much money to spend.

Of course, this is ancient history.  Few know about this today.  For few could even tell you why we fought for our independence.  Or even who we fought for our independence from.  (We fought for our independence from Great Britain because of their policies to tax us despite our having no representation in Parliament.  That’s where the phrase taxation without representation came from).  Today high taxes are sadly just an accepted part of life.  In fact, we have referred to our paychecks as take-home pay.  Our net pay.  Because gross pay is a myth.  No one sees their gross pay.  About a third or more of that disappears in withholding taxes.  So gross pay is a meaningless expression for us today.  (It wasn’t before the Sixteenth Amendment or before the progressives came to power).  Something that we sadly accept.  And we now fund our lives on the take-home pay the government allows us to keep.  All the while accepting these high tax rates.

Government spending took off in the Sixties and the Seventies.  As did our taxes.  If we had once thought that a 7% tax on incomes of $11,010,700 or more was an outrage, we didn’t see anything yet.  In 1978 the top marginal tax rate was 70% on incomes of $351,712 or more.  And there were 25 marginal tax rates.  As shown here adjusted for inflation (sources: Tax Rates, Tax Receipts, and Celebrity Incomes).

 In this example we calculated the average of some top celebrities.  And the top celebrities on average earned about $30,000,000 in 2010.  Using the 1978 tax brackets they would have owed $20,936,506 in federal income taxes.  Or approximately 69.8% of their total income.  Which is pretty much equal to the top marginal tax rate.  Of course, few paid these confiscatory tax rates.  They hid their income as best as they could in the Seventies.  In tax shelters.  And you know they did because despite these confiscatory tax rates the federal government still ran budget deficits.  Having to print money to pay for their explosion in government spending. 

The Low Tax Rates of the Eighties created so much Economic Activity the Opposition called it the Decade of Greed

The heyday of Keynesian economics was in the Seventies.  After Richard Nixon decoupled the dollar from gold the Keynesians were free to print money to stimulate the economy.  Which was their answer to ending a recession.  Stimulus spending.  Have the government print money to create economic activity that wasn’t happening in the private sector.  Their policy tool to end a recession was inflation.  By pouring money into the economy people would borrow it and buy cars and houses and furniture.  And everything else under the sun.  Creating a surge of economic activity.  And creating jobs in the process as businesses must hire new workers to meet that government stimulated demand.  With the dollar decoupled from the ‘cross of gold’ the Keynesians were finally able to prove their mettle.  And solve all the country’s economic problems.  It was the dawn of a brave new world.

And that world sucked.  For the implementation of Keynesian economic policy proved those policies did not work.  Instead of replacing high unemployment with inflation they just added high inflation to the high unemployment.  Something that was impossible to happen in Keynesian textbooks.  But it happened.  Stagnant economic activity.  And inflation.  What we called stagflation.  We added the unemployment rate to the inflation rate to come up with a new economic indicator.  The misery index.  The economy was so miserable during Jimmy Carter’s 4 years in office that he lost in a landslide to Ronald Reagan.  Who was a proponent not of Keynesian economics but of the Austrian school.  Or supply side economics.   And the Austrians believed in low tax rates.  For low tax rates would stimulate economic activity.  And the greater amount of economic activity would generate a greater amount of tax revenue even at lower tax rates.  Let’s look at that same celebrity paying taxes a decade later under Ronald Reagan.

 Much simpler.  And more in keeping with the Founding Fathers.  Instead of paying 70% of their earnings in federal income taxes they will only pay 28% (again, equal to the top marginal tax rate.  Which is pretty much the only tax rate the rich pay).  That’s still a lot of money to give to the federal government.  But it’s so much smaller that in many cases it was cheaper and easier to pay Uncle Sam than trying to hide that income.  So economic activity took off in the Eighties.  It was so great that the opposition called it the Decade of Greed.  Out of sour grapes because their policies could never produce anything like it.  But what about tax revenue?  Those on the Left say this economic activity came at a price.  Exploding deficits.  Well, the deficits did grow.  But it wasn’t because of the cuts in the tax rates.

Higher Tax Rates do not Necessarily Increase Tax Revenue 

In 1978 total tax revenue was $1,113.6 billion.  In 1988 total tax revenue was $1,421.1 billion.  So Reagan’s cuts in the tax rates produced $307.5 billion more in tax revenue.  An increase of about 27.6%.  Dropping the top marginal tax rate from 70% to 28% actually increased tax revenue.  So the cut in tax rates did not cause the deficits.  It wasn’t a revenue problem.  Revenue went up.  Spending just increased more.  And it was this excessive government spending that caused the deficits.  Not the tax cuts. 

The lesson here is that higher tax rates do not necessarily increase tax revenue.  Because changes in tax rates changes behavior.  Higher tax rates discourage people from investing in businesses.  They discourage businesses from expanding.  Or hiring new workers.  Higher tax rates may decrease the opportunity costs for hiding income.  The cost and inconvenience of hiding income in tax shelters and offshore accounts may become less that the cost of paying higher taxes.  Like it was during the Seventies.  Where despite confiscatory tax rates the government could not generate enough tax revenue to meet their spending obligations.

Income tax rates grew from a very small percentage on only the largest of incomes to high tax rates on very modest incomes.  And yet our deficits have never been larger.  Proving that our tax rates are either too high and dampen economic activity (as well as encouraging people to avoid paying their taxes).  Or that government spending has just grown too large.  More than likely it’s a combination of the two.  A fact that would shock and dismay the Founding Fathers were they alive to see what we did with the republic they gave us.

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Yorktown, North, Rockingham, Shelburne, Franco-Spanish Alliance, Vergennes, Adams, Franklin, Jay and the Treaty of Paris

Posted by PITHOCRATES - July 5th, 2012

Politics 101

For the British to Maintain the Balance of Power in Europe an Independent America actually Helped Them

The war wasn’t over with Cornwallis’ surrender at Yorktown.  But his surrender changed everything.  The continuing war was becoming more and more unpopular in Britain.  And costly.  Britain was fighting four wars.   One with the Americans.  One with the French.  One with the Spanish.  And one with the Dutch.  The debt was growing so great that there were discussions about suspending some interest payments.  The British wanted out of these wars.  The opposition blamed Lord North for the latest debacle at Yorktown.  The Prime Minister resigned.  His government fell.  And the opposition took power.

The new Prime Minister, Lord Rockingham, had favored American independence.  His foreign secretary, Charles James Fox, had favored American independence.  In fact, those who had favored American independence filled all cabinet positions.  Except for one.  The Secretary of Colonial Affairs.  Lord Shelburne.  Fox and Shelburne did not much care for each other.  They quarreled.  Each having their own idea of how they should conduct the peace.  Fox sent Thomas Green to France to begin negotiations with the French.  Shelburne sent Richard Oswald to France to begin negotiations with the Americans (Benjamin Franklin was in Paris).

The French had a debt problem of their own.  And they, too, were anxious for the war to end.  But on favorable terms.  They were looking to change the balance of power with their eternal enemy.  The British.  And therefore wanted to negotiate the peace for the Americans.  Get back some of their lost North American territories.  And elsewhere.  Meanwhile the Spanish were laying siege to the British in Gibraltar.  Anxious to retrieve that from the British.  They were greatly interested in blocking American westward expansion.  And they also wanted to keep them off the Mississippi River.  Which flowed to the Gulf of Mexico through their Louisiana Territory.  So the politics were quite complex in negotiating the peace.  For the British to maintain the balance of power they enjoyed an independent America actually helped them.  While an independent America actually harmed the French and the Spanish.

Shelburne negotiated Directly with the Americans to use them to gain Favorable Terms with their European Enemies

The original peace commission in Paris was just John Adams.  Few could be found that were more adamant on American independence than he.  And this was a problem for the French foreign minister.  Charles Gravier, comte de Vergennes.  He didn’t like Adams.  Who was not willing to compromise.  Vergennes wanted to end the war.  And stop the financial hemorrhaging.   And he was willing to compromise with the British to make that happen.  Willing to compromise away American independence.  American navigation of the Mississippi River.  American territorial ambitions beyond the Appalachians (leaving Maine, New York City, portions of the Northwest territories, Charleston and Savannah British).  And the American fishing rights off Newfoundland.  He was willing to give all that up to end the war with Britain.  He had only one problem.  John Adams.  Who refused to give up what the Americans were actually fighting for in the first place.

Vergennes instructed the French minister in America, the Chevalier de la Luzerne, to lobby the Continental Congress.  To have them order Adams to be less belligerent.  To be more willing to compromise.  And to accept the wise counsel of the King of France.  The most generous sovereign who made it possible for the Americans to bring the British to the negotiating table.  Luzerne was successful.  Perhaps with a little bribery.  The Congress sent Benjamin Franklin, John Jay and Henry Laurens to join Adams.  With the instructions to follow the advice of the French in the peace negotiations. 

Fox still favored granting American independence.  And he wanted to do it quickly.  To split the allies apart.  And make separate peace treaties to limit the damage.  For the French, Spanish and Dutch could hold out for a grander bargain.  Especially if the fortunes of war turned their way.  As the Spanish were hoping would soon happen at Gibraltar.  So the British warned that their allies could force the Americans to continue the war not for their own interests but that of these Europeans.  He told Green to tell Franklin that Britain was prepared to recognize American independence.  And that it was in America’s best interests to negotiate a separate peace.  Franklin suggested early that Britain may want to throw Canada into the deal.  To help pay for all the damage the British did to American property.  Shelburne wasn’t about to negotiate away Canada.  His answer was to bring up the debt owed to British creditors.  And reimbursing the Loyalists who lost their property in America.  Things that weren’t high on the American list of demands.  Then Rockingham died.  Shelburne became prime minister.  And Fox quit.  Pro-American independence ministers no longer filled the government.  Still, Shelburne continued to negotiate directly with the Americans.  So he could use them to gain favorable terms with their European enemies.

The American Negotiators were being Played by the Best of European Intrigue

In Franklin’s talks with Oswald he made it clear that independence was a prerequisite for peace.  Officially that was a problem for Oswald.  For his original commission from Shelburne directed him to negotiate with a commissioner from the colonies or plantations.  Not a commissioner from the United States of America.  Which, of course, would recognize American independence.  Vergennes urged Franklin and Jay to proceed anyway.  That official recognition could follow in the final peace treaty.  Jay suspected that the French were stalling.  He knew of the siege of Gibraltar.  And didn’t trust the Franco-Spanish alliance.  So he ignored Congress’ order.  And did not listen to the wise French counsel.  Joining Franklin and Adams in stating that independence was a prerequisite for peace.

The American commission had good reason to not trust their European allies.  The French wanted the British to agree to keep the Americans out of the fisheries along Newfoundland.  So they could fish these waters.  A bitter pill for a New Englander like Adams to swallow.  The French were also opposed to the Americans annexing Canada.  What they once called New France.  Before it became British.  While the Spanish were working hard behind the scenes to keep the Mississippi River away from the Americans.  Had they gotten their way the Mississippi south of the Ohio River would have been in Spanish hands.  As well as the states of Kentucky, Tennessee, Mississippi, Alabama and parts of Louisiana. 

The American negotiators were being played by the best of European intrigue.  But thanks to the principled men America sent to negotiate the peace the Americans bested the Europeans at their own game.  John Adams.  Benjamin Franklin.  And John Jay.  For the Americas got their independence.  Territory that stretched to the Mississippi River.  And navigation on the Mississippi to the Gulf of Mexico.  Even their fishing rights off of Newfoundland (though they would revisit that issue later).  It would be America’s greatest achievement in diplomacy.  The Treaty of Paris (1783).  And they made this treaty without consulting the French.  Who were miffed.  But thanks to Franklin America and France remained friends.  So the Americans won the Revolutionary War.  And the peace.  While avoiding any entangling alliances with the old European powers.  Not bad for a brand new nation on the world’s stage.

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Mercantilism

Posted by PITHOCRATES - May 14th, 2012

Economics 101

Wealth is the Stuff we use our Talent and Ability to Make

Mercantilism gave us the United States.  For it was because of these policies that the British established colonies in North America.  And it was those same policies that led to American Independence.  Because those polices pissed off the Americans. 

The mercantile system came into being as nation states arose from feudal estates.  Kings arose and consolidated these estates into larger kingdoms.  Then one king arose to consolidate the kingdoms into a nation.  Creating Spain, France, the Netherlands, England, etc.  Enlightened thinking and better technology created food surpluses.  With food surpluses a middle class of artisans arose.  And manufactured goods.  People met in markets to trade their food and goods.   These markets grew into cities.  All of this economic activity created wealth.  Food.  And manufactured goods.  That we bought with money.  Often silver and gold. 

There was wealth.  And there was money.  Two different things.  Wealth is the stuff we use our talent and ability to make.  Food and manufactured goods, for example.  And the more food and manufactured goods a nation has the wealthier that nation is.  This is a critical point.  And the mercantile policies ultimately failed because those policies mistook money for wealth.  But money is not wealth.  It’s a temporary storage of wealth.  To make our trading of food and manufactured goods easier.  By reducing the search costs to find people to trade with.  Which is why the barter system failed in a complex economy.  It just took too long to find people to trade with.  Money solved that problem.  Because you could trade what you had for money.  Then trade your money for what you wanted.

England used the Positive Flow of Bullion to Finance the Building of the Royal Navy

Mercantilism focused on the money.  And used wealth to accumulate it.  Instead of the other way around.  The way most advanced nations do today.  These European nations accumulated money with international trade.  Beginning in the 15th century they started looking at the balance of trade between nations.  And did everything they could to maintain a positive balance of trade.  Meaning they tried to export more than they imported.  Why?  Well, nations often did trade with each other.  So they owed each other money.  And when you settled your account if other nations owed you more than you owed them there was a net flow of money to you.  Bullion.  Silver and gold.  Which is what they wanted.

To maintain a positive balance of trade the government actively intervened into the economy.  It set up monopolies.  It provided subsidies for manufacturers who exported their goods for bullion.  It placed tariffs on imports.  Or simply blocked the importation of any goods that they produced domestically.  They set up colonies to harvest raw materials to ship back to the mother country.  Which would use those raw materials in their factories to produced higher valued finished goods.  That they would export.  Especially to their colonies.  Which were convenient captive markets for their finished goods.  On the mother country’s ships.  Through the mother country’s ports.  Where they, of course taxed it.  Guaranteeing that at every step of the way they added to the positive bullion flow back to the mother country.

And it worked.  To a certain extent.  England used that positive flow of bullion to finance the building of the Royal Navy.  Which proved invaluable in the wars that followed in the mercantile world.  For mercantilism is a zero-sum game.  For every winner there had to be a loser.  Which is why this era was an era of world war.  To wrest control of those colonies.  And those sea lanes.  Great Britain came out the victor.  Thanks to their Royal Navy.  But it wasn’t all good.  For Spain found gold in the New World.  And they took it.  Shipped it back to the Old World.  Just like a good mercantilist would.  Which caused problems in the Old World.  Because money is not wealth.  It’s a temporary storage of wealth.  And when they inflated their money supply it took more of it to hold the same amount of value it once did.  Because there was so much of it in circulation.  And what happens during inflation?  Prices rise.  Because the money is worth less it takes more of it to buy the same things as it did before.  So by hording bullion to create wealth they actually destroyed wealth.  With wealth-destroying inflation.

With the Boston Tea Party the Americans Renounced Mercantilism and Demanded Free Trade

Spain was one of the greatest mercantile nations of the era.  But they quickly became a shadow of their former self.  Even though they had more bullion than their European neighbors.  For it turned out that those mercantile policies hindered economic growth.  Which is the true source of wealth.  Economic growth.  Where people use their talent and ability to create things.  That’s where the true value lay.  Not the money that held that value temporarily.  All those mercantilist policies did was raise domestic prices.  And allocated scarce resources poorly. 

It turned out free trade was the secret to wealth.  For free trade can increase wealth.  For both nations.  Thanks to something we call comparative advantage.  Instead of both nations manufacturing all of their goods they should only manufacture those goods that they can manufacture best.  And trade for the goods they can’t manufacture best.  This more efficiently allocates those scarce resources.  And produces a greater total amount of wealth.  By allowing people to buy lower cost imports they have more money left over to buy other stuff.  Increasing the overall amount of economic activity.  Which is why when Great Britain adopted free trade in the 19th century the British Empire went on to rule the world for a century or so.  And led the Industrial Revolution.  By creating wealth.  Goods and services people created with their talent and ability.  That changed the world.  And ushered in the modern era.  Something no amount of bullion could do.

But before Britain adopted free trade they were struggling with one of their belligerent colonies.  Their British American colonies.  Who were unhappy over taxation without representation in Parliament.  And the mother country forcing them to buy only British tea shipped on British ships at higher prices than they could get from the Dutch.  The British thought they found a solution to their problem.  By permitting their British East India Company monopoly to ship their tea directly to America without passing through an English port.  The tea was cheaper because of this.  But it also would set a precedent for taxation without representation.  Something the Americans weren’t about to accept.  So they threw that tea into Boston Harbor.  What we affectionately call the Boston Tea Party.  Renouncing mercantilism.  And demanding the right to engage in free trade.  Which they got after winning their independence.  And the mother country would follow suit in a few decades.  Because they, too, would learn that free trade was better than mercantilism.

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