The Lie of the Wealth Multiplier Effect of Loans

What is the "Wealth Multiplier Effect" of Loans? And why is it a lie?

Of course, "lie" might not be the right term for it. "Grossly misinterpreted stupidity" might be far more accurate, in this case. Regrettably, I am not in a position to fully determine which of those is true. So, you'll have to form your own opinion as to what is behind it all.

But, be that as it may, the "Wealth Multiplier Effect" of a loan is essentially a theory that states: when a dollar of money is loaned into the economy, it produces a value of many more dollars than one – 8 dollars is the amount most often cited, sometimes more.

How does that happen?

Well, when that one dollar is loaned to an individual, that individual will most likely spend that dollar, hence giving a profit to the business that the dollar is spent at, whose owner can now spend that profit at another business, giving a profit to that business owner also, etc, and all those purchased items will now be restocked, which means orders go out to the suppliers, giving them a profit which they will then spend at still other stores.

So, that one dollar loan echoes down the supply chain, and also out through the economy, generating added wealth every step of the way.

But it goes deeper than that (and it must do, because grants would also accomplish everything stated above, which would otherwise mean there was no advantage to loans). To banks, a loan is potential profit – that is, as the loan is paid back, all of its accumulated interest becomes their profit.

So, every loan made has the potential to make them a profit. And since it has that potential, and since there are a lot of eager investors out there, the banks can sell a slice of the action to investors – investors who will then earn a slice of the interest profit (as long as the loan is repaid). Thus allowing the bank to acquire more money immediately from the sale of loan shares, which fresh monies they can then loan out to other people.

And that's the theory. The theory of how one loaned dollar multiplies in the economy by eight times its own value. And the theory is true every step of the way.

Only, it is also most terribly wrong.

Because, you see, it is another one of those modern theories that omits a critical real-world detail – yes, it's yet another on of those. And once you at that detail into the equation, you don't get an eight times multiplier.

That detail: a simple fact – loans have to be repaid.

Oh, the theorists do mention that little point; it is not ignored. Yet, it is set aside, claimed to be not a factor. And, because of that, the theorists don’t even impose the logic of their own theory onto the repayment of the loans.

Which is, at best, negligent.

But, they do it on the assumption the economy is large enough to absorb any austerity that might be imposed on individuals as they repay their loans. Only, as the recent mortgage scandals showed, while a large economy can absorb a lot more risk than a smaller one, that just means that it can absorb more risk, not that it can magically absorb everything thrown at it.

Because, you see, when one takes out a loan, one does end up with a bunch of money now, but all of that money eventually has to be paid back. And more. Because of all that interest that has accumulated. Which means that a lendee will then have to enter into a period of austerity while they pay back the loan, since the loan gets stripped out of their income during that time.

And that means: during that period of austerity, they won't be purchasing their usual amount of goods and services. And that means that the businesses that normally would have received those monies now won't, reducing their profits. Which then reduces the amount that those business owners would spend in the economy, while at the same time reducing the amount of sold inventory that they have to replenish. Thus also reducing the profit of their suppliers, forcing them into a period of austerity too.

But on top of all that, when there are all those excess loan dollars floating around, new businesses get founded in order to make supplies for them to buy. Yet, when the lendees go into austerity, all of those businesses built around the lendees' loan money go under. Not only that, though, because of the excess supply made by all of those extra businesses, a lot of the original businesses will go under also. Take, for instance, the recent mortgage scandals.

A lot of those excess loan dollars were used to invest in property, and so a lot of new construction businesses were built in order to supply the desire for new homes. But now, in a time of austerity, all of those new businesses are no longer needed, but due to overbuilding when there was a lot of free loan dollars, there is now a lot of excess supply of housing, so there won't be a need for many new houses for quite some time, and hence a sizeable number of the original construction companies go under also.

In the end, it is a simple equation. No matter the size of the economy, if more money is loaned into it than it can absorb, then the economy will eventually face austerity. It is an incontrovertible fact.

There is also no mysterious "Multiplier Effect" of loans. Loans are just what they have always been – a way of giving banks your money. Masses of loans do cause an economy to boom, but the boom is a lie, because it a boom based on false profit. That money has to be repaid. So, the loaned boom is followed inevitably by the paying austerity.

A loan can be beneficial to an individual, but there is nothing mysterious or wonderful – it stills just a loan.