Bailing out with pick axes

Notes on Ch 6 - Credit Diverts Production

Government 'encouragement' to business is sometimes as much to be feared as government hostility. This supposed encouragement often takes the form of a direct grant of government credit or a guarentee of private loans.

Now all loans, in the eyes of honest borrowers, must eventually be repaid. All credit is debt.... ...They would seem considerably less inviting if they were habitually referred to by the second name instead of by the first. 

...there is a decisive difference between the loans supplied by private lenders and the loans supplied by a government agency. Each private lender risks his own funds. (A banker, it is true, risks the funds of others that have been entrusted to him; but if money is lost he must either make good out of his own funds or be forced out of business.) When people risk their own funds they are usually careful in their investigations to determine the adequacy of the assets pledged and the business acumen and honesty of the borrower.
If the government operated by the same strict standards, there would be no good argument for its entering the field at all....(so) the whole arguement for its entering the lending business, in fact, is that it will make loans to people who could not get them from private lenders. This is only another way of saying that the government lenders will take risks with other people's money (the taxpayers') that private lenders will not take with their own money (or other people's). 

Sometimes this point is conceded, even gloried in - you know, sometimes government should take the risks that private industry is unwilling to take.  The argument runs: the benefits to the economy through the sucess of those who do pay back their loans are even greater than the losses that occur through the higher than usual level of defaulting that happens. Mmmm.

Remember, we have to look at the whole picture. This might be all lovely for these sucessful famers or fisherman or 'small businesses'. But what about those who lose out through this? These are those people who don't get a farm or a tractor or the premises for a new building or whatever (there are limited resources - real capital - at any given moment). If A is lent the money to buy X then B can't buy it, or he buys it but at an increased cost (because demand has been spiked by all these A's wanting X). Trouble is, B is a guy with a proven track record of serving others well with what they want and A is not!

And what about the other factors that now creep in. Do the bureaucrats adminstering these loans have special friends they are keen to help (personal or political, or both)? Will they accept bribes? And how much are their salaries ... who is paying for the cost of the layer of administration that this 'credit' requires? And how is this fair, that an individual will profit when all his neighbours have born all the risks (as taxpayers)? Shouldn't they benefit from the profits? Taken to it's logical conclusion this should inevitably lead to an increase in the size of the state.

...the net result of government credit (will not be) to increase the amount of wealth produced by the community but to reduce it, because the available real capital (consiting of actual land, buildings, machines, labour etc.) has been placed in the hands of the less efficient borrowers rather than in the hands of the more efficient and trustworthy.

Another aspect of private loans is this, that repayment is expected with interest:

This is a sign that the persons to whom the money has been lent will be expected to produce things for the market that people actually want.

Government loans are more likey to be lent for vaguer purposes, such as 'job creation'. Well, the more inefficient it is, the greater the job creation and the greater success it has been! Oh, wait a minute, that doesn't sound right (wait for ch 7 I think).

The government can give no financial help to business that it does not first or finally take from business. The government's funds all come from taxes. Even the much vaunted 'government credit' rests on the assumption that its loans will ultimately be repaid out of the proceeds of taxes. When the government makes loans or subsidies to business, what it does is to tax sucessful private business in order to support unsuccessful private business.

Remember we have to look at it from the standpoint of the country as a whole.

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This is a great quote about the general concept of credit:

There is a strange idea abroad, held by all monetary cranks, that credit is something a bank gives to a man. Credit, on the contrary, is something a man already has. He has it, perhaps, because he already has marketable assets of a greater cash value than the loan for which he is asking. Or he has it because his character and past record have earned it. He brings it into the bank with him. That is why the banker makes him a loan. The banker is not giving him something for nothing. ... He is merely exchanging a more liquid form of asset or credit for a less liquid form.

I must remember this next time a credit card company phone me up. I'd love to know what they know about about me that makes them think that I am a good bet to lend money to.

Economics in One Lesson - Henry Hazlitt