Real and Unreal
What the heck is the “real” economy, and how is different from the “unreal,” or financial services economy? Well, the real economy mostly produces and distributes things, like cars and trucks and gasoline and food – things that are sold for money. Banks (and the other entities that provide financial services) don’t actually produce any thing. Their job is to keep track of, protect, and safeguard the money, and to allocate funds towards activities that can produce a return on investment. Banks provide a service, and they provide cash. By allowing people to undertake new projects – buying a house, building an office building, opening a new restaurant or a new factory – banks enable borrowers to produce more things. Banks enable the economy to grow. Bank lending is a very important component of a larger process called capital investment, and it is because of this vitally important capital investment process that we call our economic system “Capitalism.”
In normal times there are many potentially profitable investments and not enough investment funds, or capital, to make them all happen, so banks get to pick and choose which projects they will fund and which they will decline. Banks ration credit, allocating the capital to those investments which – in the opinion of the banker – are likely to produce good enough returns to insure the loans will be paid back with interest. In normal times this gives bankers considerable power, because they get to decide which projects go forward and which ones get sidelined. In normal times, bankers can afford to be selective.
For this reason our economy functions best when many different banks compete with each other for good investments. Bankers often disagree on which projects are worthy and which are not. They might agree on 50% of all projects – this one can’t miss, but that one is a loser – but there are many grey areas and many projects that are just plain hard to evaluate. So it’s a good idea to have lots of banks and lots of different bankers, so everyone pushing every project has some chance to raise money. The existence of a great many banks, all competing with each other, all employing slightly different ideas about what is likely to work and what is not likely to work, makes our economy dynamic and creative.
When the banks have relatively little money to lend in relation to the number of proposals they receive, money is said to be “tight.” Banks will then demand extremely good collateral, charge high interest rates, and make borrowers jump through hoops in order to borrow money. But when banks have a great deal of money in relation to the number of proposals they receive, banks can’t afford to be so choosy. Banks need to keep their money working. The more money they leave sitting idle, the lower the return they earn for their shareholders. And banks have to pay overhead, too – the cost of all those buildings, the parking lots, the drive-through windows, the tellers, and the bankers who actually make the loans. All those things and services cost money. So if a bank lets too much money sit idle, earning no return at all, the bank will quickly go out of business.
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