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Simple examples can be used to explain
what seem at first glance to be complex economic principles. I'll use a
hypothetical yet commonplace experience to explain how money may be used for
only one of three purposes--it can be held/hoarded, saved/invested, or spent.
Furthermore, my example will show that foregoing consumption--i.e., either
holding or investing--is necessary for non-inflationary lending and that credit
decisions must always be made by the entity taking the risk and especially not
government. Here's the scenario:
Let's assume that my colleague and I go
to McDonalds for lunch. When my colleague reaches for his wallet to pay for his
five dollar Happy Meal, he finds that he left his wallet on his desk. I lend
him the money and we have an enjoyable lunch. When we return to work, he repays
the debt.
What economic lessons that can be
learned from this simple story?
1.
Expanding the money supply is NOT required in order to increase lending.
When I gave my colleague five dollars, total
loans in the economy expanded yet the money supply remained unchanged. Upon
returning to work, my colleague retrieved his wallet off his desk and repaid
his loan. At that point loans in the economy fell by five dollars yet the money
supply remained unchanged. Therefore it is a fallacy that expanding the money
supply is necessary in order to increase lending.
2.
A prior act of foregoing consumption IS required to expand loans.
Let's expand somewhat on our previous
example. Where did I get the five dollars that I lent to my colleague? I had to
have foregone previous consumption in order to have this amount available to
lend to my colleague. Fortunately for my colleague I did not consume all that I
could have.
3.
The holder or hoarder of money does not harm the economy.
The act of carrying that extra five
dollars in my wallet can be characterized as holding or hoarding. Hoarding is
not the same as investing. Had I invested my money I would not have had the
additional five dollars in my wallet. Instead the five dollars would have gone
into some production process that would yield increased benefits later in time.
Instead I desired the flexibility to spend the money for some unforeseen purpose.
Lucky for my colleague that I didn't spend it on some frivolity or invest it in
longer term production. Instead I hoarded five dollars and was able to lend it to
him in order to purchase his lunch. Although the term hoarding is often used disparagingly,
one can see that it serves a useful, economic and social purpose.
4.
Money cannot be used at the same time for more than one of three purposes.
I had a choice of what to do with my
unspent (unconsumed) five dollars. I could have carried it in my wallet, an act
of holding or hoarding in order to take advantage of unforeseen circumstances.
Or I could have invested in production, such as lend it to my son to buy gasoline
for his summer lawn mowing business. Or I could have spent it on consumption,
perhaps upgrading from a five dollar Happy Meal to a Big Mac, super sized
fries, and a milk shake. Of course had I invested it or spent it, I would not
have had money to lend to my colleague for lunch. The important point is that I
could not do both hoard the money and invest it and/or spent it. Furthermore, we
can see that there is no room in our simple example for a "multiplier
effect" that emanates from the lending process, as is claimed by those who
defend fractional reserve banking. I could lend the money only once.
5.
The lender of money assumes the risk of non-repayment.
There was little possibility that my
colleague would not repay his loan to me. However, I doubt that I would have
lent my five dollars to just anyone who happened to be in McDonalds at the same
time as we were. Let's assume that the person on front of me had been a
stranger and not my colleague. I probably would not have lent him the money,
despite the probability that he was a good credit risk. The important point is
that I would not have known him.
"Know your borrower" is rule number one in banking. The age
old truism is still valid that good character is the best trait in a borrower.
I would have known the character of my colleague but not that of a total
stranger.
Yet much borrowing (and resultant defalcations)
on loans today are made by giant firms based upon numerical credit scores. The
lender never meets his borrower. The loan production offices that generate the
loans applications do not know their applicants. Many of these loans are then
sold to a government owned entity, such as Fannie Mae or Freddie Mac.
Furthermore, lending also has become a
tinder box of political risk. For example, the infamous Community Reinvestment Act requires banks to make loans that do not meet their
lending criteria. If the borrower and his property reside in an arbitrarily and
ill-defined underserved area, the bank must lower its credit standards. The
result is higher loan losses. We would not desire a government mandate that I
be allowed to loan my colleague five dollars to pay for his lunch at McDonalds
only if I also lend five dollars to complete strangers.
We
must look askance also at outright loans by government or government loan
guarantees to politically connected borrowers. We taxpayers are the true
holders of the loan and will suffer if the loan is not repaid. The Export-Import Bank is a prime example. We taxpayers are on the hook for
non-payment of government loans to foreigners so that they can buy the products
of politically connected groups. It's simple corruption disguised as a
legitimate banking function. It would be absurd for the government to design a
program to lend money only to people who desired to buy lunch at McDonalds in
order to help the world's largest fast food chain maintain its sales in a
highly competitive environment. It is no different just because the program
helps foreigners buy American products. In both cases the real lender is the
American taxpayer.
Conclusion
Simple examples from everyday life help
us clarify our thinking about what at first appear to be highly complex
economic problems.
