Some monetary reformers claim that borrowing to fund the production of a real asset like a machine or house creates more jobs than borrowing to buy an existing asset, which in the case of housing for example, allegedly tends to promote house price bubbles. Ergo, so the argument goes, preference should be given to the former type of loans.
Richard Werner seems to back this idea – see Twitter exchange below.
OK, let’s consider this taking housing as an example (and housing is not a bad example given the large proportion of all loans which are for the purchase of houses).
If the existing stock of houses is just enough to meet demand, no houses will be built. But if there is a marginal increase in demand, say in the form of X immigrants arriving plus families, and those immigrants borrow to have X houses built, clearly that will create a fair amount of work for bricklayers, plumbers and so on, which is allegedly beneficial because plenty of employment is created.
In contrast, if the immigrants borrow and buy EXISTING houses, then the price of houses will rise, which in turn will mean the value of houses exceeds the cost of producing them (counting house builders’ profit as a “cost”). Builders will then be induced to start building houses. And how many will they need to build in order to get supply and demand for houses back into balance? Well the answer is pretty obviously X houses! The net effect is the same!
Of course the real world is more complicated than the above over simple scenario, but I don’t see why adding those complexities makes any difference the above conclusion.
For example, it has been alleged that in the UK house builders have set up a cartel which artificially boosts the price of houses. See this Spectator article entitled “Radical reform is the only solution….”, in particular para starting “The UK house-building market….”
Now there is always a limit to how far those who arrange a cartel can exploit the situation before one cartel member breaks ranks and grabs the profits available. So let’s suppose house builders exploit that cartel to the extent of raising house prices by Y%, then much the same argument applies. That is, where demand exactly equals supply (and that will be when houses prices are Y% above the genuine free market price) no house building takes place. Then when the immigrants arrive and buy existing houses, prices will rise. That will induce builders to erect enough houses to bring supply and demand back into balance, i.e. X houses. The end result is the same.
House price bubbles.
The above is not to say that asset price bubbles are not a problem. However, asset price bubbles can inflate even where there is no borrowing at all. To illustrate with an extreme example, it would be perfectly feasible to have an economy where everyone bought their houses for cash. In that scenario, there is nothing to stop one person demanding more for their house than might be expected, at which point the rest of the lemmings that make up the human race might decide to mark up the price of their houses as well.
Tulip mania, house price mania etc can take off anytime regardless of the circumstances.
And finally, having criticised Richard Werner, please note that I am very much a Werner fan. He has produced enough decent and original material to deserve a Nobel prize. He originated the term “quantitative easing”. And the following two works by him are master pieces: simple clear and original.
1. Towards a Twenty-first Century Banking and Monetary System.
2. How do Banks Create Money….