An Economic Lesson from Carl

My friend Carl is back with a vengeance!  My mailbox is full of great stuff!  Here’s one about Ben Bernake and company selling you a sack of, well you know, about how the economy works.  Hey Ben, Ronald Reagan could have taught you a thing or two!

 

Steve

Credit Where Credit is Due

by Peter Schiff, Euro Pacific Capital | January 16, 2009

This week, in a speech before the London School of Economics, Fed
Chairman Ben Bernanke offered a perverse economic theory in his
quest to gather support for never-ending Wall Street bailouts; “This
disparate treatment, unappealing as it is, appears unavoidable. Our
economic system is critically dependent on the free flow of credit,
and the consequences for the broader economy of financial
instability are thus powerful and quickly felt.” In other words,
credit is the lifeblood of our economy, and the continued operation
of credit providers is an issue of national security.

In truth, not all economies run on credit. But over the last decade,
the United States became a bubble economy that needed unlimited
credit to keep from collapsing. In a legitimate economy, it is not
credit that fuels spending and investment, but simply income and
savings. It’s too bad our Fed chairman does not understand the
difference.

That American families now routinely rely on credit to make every-
day purchases is a habit that needs to be broken and not encouraged.
What we need in America is more restraint and less indulgence. For
example, Americans in the current economy should not go into debt to
buy new cars. Given the level of debt that weighs down the typical
family, Americans should defer such purchases until they have paid
down existing debt, or replenished their savings to the point where
they can afford to pay cash. Until that time, Americans should
continue driving their old cars. In the meantime, the untapped
savings could be made available to local businesses that would use
it to finance badly needed capital investments.

But such a drastic reversal in financial culture represents the kind
of change that no one in the outgoing or incoming Administrations
appears willing to consider. By providing perpetual support to
lenders who have bankrupted themselves through bad loans, the
government merely guarantees that bad economic behavior will
continue.

Credit is indeed vital to an economy, but it does not constitute an
economy within itself. The important thing to remember is that
credit is scarce, and is limited by the stock of savings. Savings
loaned to one individual is not available to be loaned to another
until it is repaid. If it is never repaid, the savings are lost.
Loans to consumers not only crowd out more productive loans that
might have been made to business, but they have a far greater
likelihood of ending in default.

In addition, while business loans increase our capital stock and
lead to greater productivity, loans made to consumers are merely
spent, and do not create conditions that will make repayment easier.
When businesses borrow to fund capital investments, the extra cash
flows that result are used to repay the loans. When individuals
borrow to spend, loans can only be repaid out of reduced future
consumption.

One of the reasons we are in such dire straits is that consumers
have already borrowed and spent too much. Many did so based on the
false belief that ever-appreciating real estate would ultimately
provide the means to repay their debts and finance their lifestyles.
Now that reality has finally set in, why should the spending spree
continue? The fact that a GDP comprised of 70 percent of consumption
is currently contracting should not surprise anyone. In fact, such a
contraction is long overdue and the government should not do
anything to interfere.

In trying to perpetuate the illusion, the government wants to revive
the spending spree that has led us to this disaster. But how can
such actions possibly help? How will more debt improve the economy?
Wouldn’t our circumstances be vastly improved if we paid off some of
our debts and replenished our savings? Wouldn’t we be in better
shape if instead of buying more stuff we concentrated on producing
it?

The unpleasant reality is that years of bad monetary and fiscal
policy have over encumbered our economy with debt and undermined our
industrial capacity. The sooner we can begin to repair the damages,
the sooner we can right the ship. If instead we merely administer
more of the same, the ship will sink in a sea of inflation.

Copyright © 2009 Peter Schiff