U.K. Prime Minister Gordon Brown and U.S. President Obama appear to have some rather peculiar ideas about the role of lending in the economy. Both men appear to believe that more lending (no matter how it is achieved) will be a source of wealth and prosperity. Thus they both tirelessly insist upon the importance of getting banks lending again.
However, this is rather to put the horse before the cart. If I lend someone money to dig a hole and fill it in again, has any additional wealth been created? Certainly not – at the end of the process we have nothing more than that which we started with (indeed we now have one slightly worn shovel and a pair of dirty overalls where before we had brand new ones). On the other hand, if I lend someone money to start the next Microsoft or the next Google – someone who could invest the money in a venture which was capable of turning a profit and thus repaying both the principal and the interest on the loan – then the loan would most certainly have given rise to the creation of wealth.
The origin of wealth is therefore not lending, per say, but profitable economic activity more generally. Lending is an important form of economic activity, to be sure. However the importance of lending in no way changes the fact that it can either be profitable or unprofitable. Lenders who consistently lend to entities that turn profits and are able to repay their loans clearly facilitate profitable economic activity and are therefore sources of wealth and prosperity in the economy (a fact which will be reflected by the overall profitability of such lenders). Lenders who consistently make poor judgments about the loans that they make and who’s loans thus go unpaid, to the point that these lenders themselves are no longer able to turn a profit, are not sources of wealth but engines of poverty. Such lenders merely serve to squander scarce resources.
Knowing then, that what we require is not just more lending (as Obama and Brown tend to suggest) but more accurately profitable lending, how might Obama and Brown be able to facilitate such a thing? Making profits is, after all, not exactly the strong suit of most governments and nor is it something they’ve ever been able to “force” on the broader public. Indeed even most private companies, risking shareholder funds and despite their best efforts, are unable to turn a profit. The only reason that the majority of companies running today are still profitable is that we constantly let the unprofitable businesses fail and thus attrition ensures that only the strong survive.
So how could Obama and Brown’s attempts to get money “flowing through the veins of the economy” possibly succeed? Where money flows as the result of loans, real economic wealth will only come about if the borrowers are profitable and thus, over the long term, if the lenders themselves are profitable. Profitable lending can only come about in a free market of lenders selected for their proven ability to make profits – a market where loss making entities are allowed to fail. All that governments can do is to frustrate free market profit and loss incentives by preventing the failure of loss making entities or by transferring money from profitable companies to unprofitable ones. Far from helping direct money to where it is needed, government interference forces it to somewhere that it plainly should not be. This is most certainly not “getting money flowing through the veins of the economy”. A better analogy would be that Brown and Obama are taking blood from the patient’s aorta and pumping it into the stomache instead.