There is a wealth and an income (work) economy. In my view they are categorically different and shouldn’t be confused. I explain the logic of the first.
Let’s say your friend Elon gets out of college and starts a business in real estate. His parents lend him money to build that first apartment building. He doesn’t get the rent expected.
His college friend, Barry (parents well off, but not wealthy enough to live off dividends), tells Elon his business will fail if he keeps building the same product with insufficient revenues.
Elon says it will work out. Barry expects that Elon’s parents will cut him off when the property doesn’t earn the income promised. Instead, Elon’s parents lend him money again. Elon builds again. And they lend again. Year after year.
Is Barry wrong that Elon’s business will fail?
Yes and no. Yes, Elon’s right in that his business is succeeding, even if only as a wealth-supported enterprise. He’s wrong in that it is failing in what he set out to do — create an income supported business.
My thinking is that Barry is right. But I’ll make the argument he isn’t.
People with money build what they want to build. It doesn’t matter what the renter will pay. All that matters is what the building is worth to other people with money to build (or buy) whatever they want.
Because Elon’s parents have dividend income from a stock portfolio they don’t need to sell any of their real estate. Indeed, they own tons of it in NYC where it sits empty, year after year.
Nonetheless, how can the parents with the money keep lending if the investments lose money? We’ll need to add some more detail to our story.
Elon gets out of college and starts a business in real estate. His parents give him $1 million against a bond that they hold. He must pay them 5% interest a year. Or he can buy back the bond if he returns the $1 million.
He doesn’t get the expected rent and has difficulty paying the interest on his parent’s bond. So they offer another bond for $2 million with 2% interest. He takes $1 million, pays off the first bond, and builds more apartment buildings with the remaining $1 million. Of course, he must come up with 2% to pay the interest. But once again, he can’t.
Do his parents default on him? No.
His parents say borrow as much as you want at 0% interest. All we want is our principle back at some point in the future.
How can Barry be right now? Elon can use part of the borrowed money to keep building, part to live on, and part to buy drinks for everyone at gloomy Barry’s birthday party. Where is the problem? There is none.
Many people live their whole lives on trust funds. Or live on borrowings against property. How can we argue that they’re failing? Elon and Barry live the same life. Sure, Elon has tons of debt but it’s only an abstract number in a bank statement.
For wealthy people there’s no higher authority who’s going to come down and say “stop doing that! It isn’t right”.
Hasn’t this always been, and always will be, the way things are? Sure, markets crash, debt goes bad, but the people with the money find ways to relend to each other so they can pick up where they left off. Sure, a few get left out in the cold, like Lehman Brothers, but, as my friend once said, “money always goes back to its rightful owner.” That’s a funny one, huh, “rightful owner!”
Assuming Elon’s parents have enough money, we’re going to have to side with Elon here.
Now that we have the basic mechanics outlined let’s look at a different lender than Elon’s parents — the U.S. Government (through the Federal Reserve Bank).
The difference between Elon’s Parents and the Fed is that the parents could only lend what cash they have in their checking account (that’s not quite the way it works, but keeping it simple). The Fed, backed by the U.S. Government, has the power to create bonds even if they don’t have cash in their checking account. You’re probably heard the euphemism, “creating money out of thin air”
Generally, a bond is created from money; or put another way, money is created by a bond. Only the Fed can do BOTH as the same time. Only the Fed can be both chicken and egg.
Let’s imagine that Elon’s parents lose a lawsuit and suddenly need $1 million. They go to Elon but he doesn’t have it. They’re about to declare bankruptcy when the Fed decides their business is too important to fail. So the Fed buys a $1 million bond off the parent’s bank’s balance sheet for $1 million and, with freed up capital, the bank lends the parents $1 million and creates a bond which the parents are expected to buy back.
After a year, the parents can’t pay it back so what does the Fed do?
It also buys the parents bond from the bank. But not so fast. Naturally, everyone who bought bonds from the Fed screams bloody murder. Why should the people who sued Elon’s parents get $1 million and the parents owe nothing? So the Fed must sit on the bonds until it can pay them back through taxes or destroy them slowly using various obtuse rationales. Remember, the U.S. Government and Fed decided certain businesses (“national interests”) get loans from new money.
Sure, it’s another level of unfairness. Elon gets to live his life on someone else’s money. “National Interests” live year after year (since 2008) from the U.S. Government.
What most people don’t realize is the “free money”, about $4 trillion worth, created following the 2007 financial meltdown has still not been paid back. Recently, the Fed has added another $4.8 trillion, totalling $8.4 trillion
The shell game being played is the Fed has created what I’ll call a shadow bank balance sheet. It uses it to free up capital that banks use to lend; that is, it takes dodgy loan assets off the bank’s balance sheet. The bank looks better for it while the Fed is given a pass because people view it with God like powers. It’s complicated stuff and I have trouble wrapping my head around it.
Yet life goes on. There’s no God that will come down and say the Fed can’t create $100 trillion worth of bonds. If Elon can live his life on his parents money, why can’t those “national interests” live out their lives on U.S. Government money?