Home » Quick guides » Economics In One Lesson » VI/ Credit Diverts Production

Hazlitt begins,

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 guarantee of private loans.

Faith in these policies springs from two acts of shortsightedness. One is to look at the matter only from the standpoint of those who borrow. The other is to think only of the first half of the transaction. All credit is debt and all loans must be repaid, at least by honest borrowers. All proposals to increase credit are proposals to increase the burden of debt. They would be less appealing if referred to as such.

There is a decisive difference between loans provided by government and private loans. Private lenders risk their own funds and are careful to confirm creditworthiness and the quality of collateral. [SJB note: or they would be, if contemporary banking were not so awash with moral hazard put there by governments.] There would be no argument for the government making loans if it followed the same strict standards as private lenders. The government almost invariably follows different standards: the purpose of government entering the field of credit is to ensure loans are made which would not be made by private lenders.

Government takes risks with other people’s money that they would not take themselves.

However, what is really loaned is not merely money, which is the medium of exchange, but capital (in the absence of an inflationary expansion of credit, which will be dealt with later). Capital is scarce and the question becomes who shall receive that capital.

Credit is not something which a bank gives to a person. It is something that person already has, which causes the bank to make a loan. Credit is trust and collateral. A banker is assured of repayment because the borrower already has credit. It is to people with credit that private lenders make loans. The government goes into the credit business because people cannot get loans. Government inherently makes loans to people who represent greater risks. More money will be lost to them. More resources will be wasted by them. They will be less efficient.

The amount of real capital at any moment – as opposed to monetary tokens run off the printing press – is limited. The consequence of extending loans to those who would not otherwise receive it is to put scarce capital into the hands of people who are less able to make the most of it. Private lenders only make loans where there is a definite expectation of repayment with profit: that is an indication that loans will be used to produce what people actually want. Government does not suffer the same tests of the market.

While those who make private loans are those most suited to doing so successfully, government lenders “are either those who have passed civil service examinations, and know how to answer hypothetical questions hypothetically, or they are those who can give the most plausible reasons for making loans and the most plausible explanations of why it wasn’t their fault that the loans failed.”

Furthermore, the making of government loans leads to favouritism, cronyism, corruption and scandals. It increases demands for socialism: if the government is going to take the risks, why should it not also get the profits?

Government has nothing to give to business which is not first or ultimately taken from business. Government credit schemes are just one more example of seeing short-run special interests and forgetting the general interest in the long run.

The net result of government action in credit markets is to reduce the wealth of society, not to increase it.

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