The Problem With Loan-based Stimulus

So, we've been giving loans to everyone who will take them on the theory that it will drive capital consumption by the masses. What that means in simpler terms is that people will buy houses and cars and other expensive things. This is considered a good thing because this will allow those who make those things to keep their jobs. It is, however, a slow poison in the long run.

In the near term, things seem grand. More things get bought, inventory drops, businesses sense a trend and hire more workers. This is always the first thing in an inflationary boom. The changes, however, are due to mispricing of the cost of money, something that cannot be sustained. The eventual end of such a 'crack-up boom' is inflationary ruin. But, that is not the point of this essay. The point of this essay is the near term results of such a policy.

On the first month after having bought a car or house, the owner's disposable income is reduced by the amount of the monthly payment. That is the rub. See, prior to having bought the thing, the owner had presumably more disposable income. This is, of course, assuming the owner traded up. Now, once having bought the thing, the owner has lost income and will thus reduce his purchasing of less expensive things.

The owner bought the thing on credit from a financier. The money backing that loan came from nowhere essentially, so any interest rate above zero will provide profit to the lending institution. In other words, if the Fed requires a 1/10th of a percent reserve on the loan, assuming simple interest, in a year the institution has gotten, say, 5% of $100,000, the principle, or $5,000. Reserve on such a loan is $100. The amount they have made is 5,000% on the loan, essentially.

Now, as appalling as it is that a financier can make that kind of profit for essentially zero risk, what is far more interesting is the fact that the house is bought. No more work will come out of it, despite money being paid. In other words, the work has been sunk, so in the near term at least, there's no more work to be done and no more money to be made by anyone else. That income from the purchaser is now officially in stasis.

You'd think that most of that money, being interest, would get spent by the financier, but this is seldom the case. Financiers are in the business of making money and building financial empires, so very little of their income is normally consumed. Thus, the replacement consumption from their spending does not even begin to match the loss of spending from the original transaction.

Now, once everyone has the widget on credit, spending simply stops. Nobody has any more negotiable income so nobody can assume any more credit. Until they're done paying something off, they're eating ramen and beans. Thus does the middle of the industrial pantheon commence to evaporate.

So, what is an economy to do? Well, according to 'helicopter Ben' Bernanke of the Federal Reserve Bank, one can simply drop cash from a helicopter. Far easier to limit the cost of extent loans, hence bankruptcy laws. However, the only way to reduce the cost to society of such a monstrous blunder is to reduce the comparative size of debt, which pretty much requires massive inflation such that the loan burden shrinks at an adequate rate compared to wages to help the average person increase negotiable funds.

Of course, the result of an inflationary boom has been thoroughly discussed. Almost to death. Still, a few salient points need mentioning: the wage earner gets replaced by cheaply-financed machines, the fixed-income people, such as the aged, eat cat food, the young become discouraged from saving. Pretty much what we see now.