Great fortunes are built on the proper use of credit. Improper use of credit leads to mal-investment and wealth destruction.
We
cannot understand our fundamental financial problems if we do not understand the
proper use of credit. Credit has a key role in capitalism; credit-starved
economies are underdeveloped economies, as economist Hernando De Soto explained
in his masterwork, The Mystery of Capital: Why Capitalism Triumphs in the West and
Fails Everywhere Else.
In
the chronically underdeveloped economies De Soto describes, households have
assets--land, dwellings, small businesses--but since the assets do not have
legally recognized status as "property" (because the system for recognizing and
registering property is both cumbersome and corrupt), they cannot act as
collateral for borrowed capital, i.e. loans.
As
a result, the majority of the assets are "dead capital," difficult to sell, pass
on to future generations or use as collateral.
Great
fortunes are built on the proper use of credit. The borrower needs capital
to expand his/her enterprise, and the lender needs a fast-growing enterprise
with collateral and an income stream to support a low-risk, high-yield
loan.
We
can profitably look to Colonial America as an example of a credit-starved
economy. In the wake of the Revolutionary war and the ratification of the
Constitution (1789), the U.S. financial system was a mess: debts left by the war
burdened the new government, which historian Thomas McCaw noted "started on a
shoestring and almost immediately went bankrupt."
Differing
views on the role of the central government, central bank and credit splintered
the political elite, with Hamilton squaring off against Madison and Jefferson
(though Madison's views were by no means identical to Jefferson's).
Meanwhile,
in the real economy, ordinary farmers and entrepreneurs were desperate for
long-term credit to fuel their rapidly growing enterprises. Though states were
banned by the Constitution from issuing their own currency, states got around
this prohibition by granting bank charters. The banks promptly issued the credit
that an entrepreneurial economy needed.
The
political elite, regardless of their differences, were appalled by this
explosion of privately issued and essentially unregulated credit, but this
access to credit--turning "dead capital" into collateral--fueled the astonishing
growth of the U.S. economy in the 1790s and early 1800s.
The
American economy in this phase was anything but orderly or
well-regulated.Wild and risky better describe the financial and commercial
chaos of the era, but this untamed capitalism led to more successes than
failures, and the bankrupt enterprises and busted banks were absorbed by the
fast growth of the real economy.
This
chaotic explosion of credit and entrepreneurial drive was the opposite of
central planning. Risk was everywhere; security in today's meaning did not
exist.
The
key to the proper use of credit is that it is invested in productive enterprises
at a high rate of return. Risk cannot be eliminated, it can only be
suppressed or transferred to others. This is the lesson of Benoit Mandlebrot's
masterpiece, The Misbehavior of Markets: A Fractal View of Financial
Turbulence.
All
the complex machinations of the financial magicians in the 2000s to eliminate
risk failed, for the profound reasons Mandlebrot explains.
A
high rate of return (i.e. a high interest rate) leads lenders to transparently
accept risk, and entrepreneurs to only borrow for the highest-return
enterprises. A low-yield, high-risk investment is not worth funding. We call
these mal-investments or unproductive uses of capital.
In
our era, the Federal Reserve and Federal policies have massively incentivized
mal-investment and unproductive uses of capital. Low interest rates destroy
the needed discipline on both lenders and borrowers to only risk capital in the
highest-return, lowest risk uses.
The
Keynesian Cargo Cult's blind spot is they do not distinguish between productive
and unproductive uses of capital. A bridge to nowhere is equally as worthy
as a truly productive investment to Keynesians, because their cult believes that
any borrowed-and-spent money is equally good at boosting their false idol,
"aggregate demand."
But
a truly productive investment of capital has a multiplier effect; it
stimulates not just consumption but increased output and productivity.
Mal-investments (duplicate MRI tests, McMansions built in the middle of nowhere,
etc.) have no multiplier effect because they are simply forms of
consumption--they are not even investments, though they are presented as
investments by those feeding at the Federal/Federal Reserve trough of
zero-interest credit and "free money" distributed by the government.
For
credit to be productive, there must first be productive uses for the
capital. In an economy with over-capacity in virtually every sector, a
massive surplus of labor, a predatory financial sector and a grossly inefficient
government in thrall to crony-capitalist cartels, truly productive investments
are few and far between.
Fonte