Wait… but wasn’t that the problem to begin with?

Fed Chair Ben Bernanke, speaking before a group at the London School of Economics, defended the government’s handling of the bailout (maybe that should be plural at this point), saying “[t]he United States’ economic system is critically dependent on the free-flow of credit,” adding that “[i]t is like the economy’s oxygen.”

But wait. Isn’t credit how we got into this mess in the first place? I know, I know, it was bad credit and Bernanke’s talking about the good kind. But what is the good kind?

Credit has been a part of economics since time immemorial (see The Bible for plenty of examples). But the overabundance of credit in modern society has been criticized as creating phantom wealth. By doling out more credit than there is money to back it, lenders have been doing something (generally unintentionally) akin to a Ponzi scheme. Perhaps the underlying assumption was always that the Fed would be there to bail them out.

But where does the Fed get its money (especially since we’re not on the gold standard anymore)? From what I heard, the Fed indeed has the actual cash on hand to do this (i.e. they don’t need to print money). But if this bailout gets any bigger (reports are recently that the steel industry now wants some dough) the Fed may be forced to print money, especially if the Chinese and Russian banks are no longer in a position to lend us any. The problem with printing more money, of course, is that it leads to inflation because it’s essentially phantom money anyway.

I’m sure the Fed’s argument is that the infusion of cash will increase production capacity thereby increasing the amount of actual goods and services on the market and giving them some wiggle room to print money if needed (printing more money is generally alright if there are real-world items to back it with). But this is a top-down approach again. Through oversight the Fed presumably is aiming to make sure the money goes to tangibly increasing productivity. But, from my personal viewpoint at the bottom of the food-chain, I can’t see how it’s going to help me. Increased productivity is good, but only if there is a market for the product. People need money to buy products. Detroit may come out with some beautiful new well-made hybrid, but if I don’t have the money to buy it, it’s useless.

I don’t have an answer to the problem though I do think more money should be given to average Americans and less to corporations. I think we should let some of them fail and see what sort of innovations arise from their ashes. Frequently failure is a necessary step in progress. I think aspects of the software industry offer an interesting comparison. Many tech concepts have flamed out over the years but, frequently, bigger and better ideas have popped up out of what was left of them. While I understand why Detroit needs some sort of a bailout (since there would be an enormous ripple effect in the global economy), a more cautious approach might be wise. Otherwise, the government is simply going to be saving the economy by doing exactly that which led to the crisis in the first place – handing out cash with nothing to back it up.

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