Sorry China Skeptics, The Communist Party Can't 'Expand Credit'

By John Tamny

September 11, 2014

"There is a strange idea abroad, held by all monetary cranks, that credit is something a banker gives to a man. Credit, on the contrary, is something a man already has." - Henry Hazlitt, Economics In One Lesson, p. 43

Ask most any devotee of the Austrian [economic] School about the ability of politicians to boost the economy with government spending, and the individual will properly scoff. Governments don't have any resources other than the ones they've extracted from the private economy first, so to believe that there's "stimulus" when Congress spends is the obtuse equivalent of believing that Nancy Pelosi and John Boehner are better at allocating capital than are Warren Buffett and Peter Thiel.

It can't be repeated enough that as governments have no resources, they cannot stimulate the economy with precious resources taken from those who created them in the first place. "Government stimulus" is an oxymoron, plain and simple. Private economic growth props up government, not the opposite as the astrologists who masquerade as economists would like you to believe. 

Of course that's what's so puzzling about certain modern Austrian School thinkers who think government can "expand credit." Governments can do no such thing. Just as governments cannot expand the economy by consuming what they've taken from us, so can they similarly not expand access to economic resources, which is all that credit is. Governments can only give what they've taken first. End of story.

Austrian School thinkers intuitively understand the above in the spending sense. As Ludwig von Mises himself observed about government spending in Human Action, those who support it "do not realize that such public works must considerably intensify the real evil, the shortage of capital goods." Government spending shrinks the economy by virtue of it diverting capital away from its most productive - and capital increasing - uses.

Despite the truth about government spending, certain Austrian devotees of the present once again believe that governments can expand credit. As FreedomWorks vice president Adam Brandon recently put it about the property boom in China:

"This is the Austrian theory of business cycles, which, in brief, holds that the expansion of credit by government sends false market signals to investors. The overstimulation of consumer demand then results in investments that don't pay off, and economic pain as the market corrects itself."

The problems with Brandon's well-intentioned assertion are many. For one, governments once again cannot create credit. Credit amounts to real economic resources (think computers, tractors, trucks, and human labor), and as governments tautologically have no resources, they can't expand access to them. Governments can certainly distort the direction of resources in ways that logically restrain economic growth, but they can't decree an increase in the resources we use to work and produce. That's an impossibility.

Despite what many want to believe, money is not credit. If it were, serial devaluers such as Argentina and Zimbabwe would be awash in it. They're not. And because money is not credit, it's similarly the case that government cannot achieve an "overstimulation of consumer demand" as Brandon asserts. Demand is a function of supply, and as such it's always and everywhere created in the real economy. As Mises explained it in Human Action:

"One must disregard the intermediary role played by money in order to realize that what is ultimately exchanged is always economic goods of the first order against other such goods."

To assert, as some Austrians unwittingly do, that government can expand credit and/or demand is for a proud School of economic thought to not just fail at refuting the truth that is Say's Law, but also for its devotees to be at odds with the intellectual father of the Austrian School, Mises himself. Supply is the source of demand. Always.

To Austrians like Brandon, the influx of credit into China is a cause for concern. This concern is driven most by the rush of credit into residential building in the rising country. Austrians have a point there. Though Brandon oddly asserts that the "residential real estate market in China is the most critical sector of the world economy," Austrians old and new understand that housing is about consumption of precious capital, as opposed to capital-expanding savings and investment.

Housing doesn't make us more productive, it doesn't open up new markets for us, and purchases of it won't lead to software innovations or cancer cures. Housing once again is consumption; as in purchase of it is an affect of economic activity, not the driver of it. In that case, when governments redirect limited resources toward housing, they're not boosting economic activity and expanding credit, rather they're restraining economic activity (consumption comes at the expense of investment) while reducing the creation of credit. "Credit" amounts to real economic resources, so if government policy is creating the incentive to consume economic resources over saving meant to expand resources, the base of capital (meaning credit) is being shrunk.

Applied to China, Brandon correctly points out that China's economic rise and the move of its citizenry into cities naturally brought with it demand for housing. Of course it did. People produce with an eye on bettering their condition, including where they live. Brandon's concern is that alleged government expansion of credit is behind all manner of what Austrians term "malinvestment" in the residential space. At best he's half right.

Austrians like Brandon point to "ghost cities" in China that are defined by a great deal of residential construction alongside very little in the way of purchases of same. They may be right, it's possible that government policies have diverted enormous amounts of resources to housing, but this rush into the real can't be seen as an "expansion of credit by government" as Brandon presumes. Instead, it amounts to an economy-sapping and credit shrinking diversion of always precious capital by China's political class.

Once again, governments have no resources. Because they don't they can't expand credit in the modern Austrian model any more than they can spend the economy to prosperity in the discredited Keynesian model. Assuming the worst, credit is once again being diverted to housing by government. Nothing more, nothing less. It's entirely possible that the growth of all this residential stock will prove wise in light of the rush among Chinese into cities, but given the track record of government investment, logic dictates that Chinese politicians aren't expanding credit as Brandon presumes; rather they're reducing it by virtue of trying to allocate it. Politicians are always and everywhere lousy investors. China is assuredly no different.

Of course that's what's a little bit puzzling about Brandon's main point. While he's most likely properly worried about excesses in the housing space, any excesses an unnatural creation of government largesse with the resources of others, what his argument seems to miss is how much more credit would be flowing in the direction of Chinese producers (including toward housing investments) absent all the government meddling. Lest we forget, credit amounts to access (at a cost) to the labor, plant and equipment that power the economy forward. When you borrow money you're not borrowing money, rather you're exchanging your own resources and reputation for access to labor, plant and equipment.

Politicians are terrible investors, so it's only natural that government-directed investments in China would be shrinking the availability of resources; a.ka., credit. Conversely, credit - meaning resources - logically multiplies when market forces propel it to its highest uses. One easy example of this would be Ford Motor Co. Cars didn't immediately start rolling off the assembly line when Henry Ford incorporated his eponymous company in 1903, but with feverish reinvestment of his profits Ford was able to turn what was small into a global behemoth. 

Modern Austrians seemingly focus too much on the amount of credit as though they could possibly know how much is too much, and how little is not enough. They can't possibly know what is too much or too little, but they should know what the late, great Wall Street Journal editorial page editor Robert L. Bartley understood well, that "a rapidly growing economy will demand more of the world's supply of real resources." What this tells us is that China's government hasn't expanded credit; rather the government's allowance of a largely free economy has been a magnet for those around the world who have access to the economic resources that we know as credit.

The credit boom in China has been driven by a boom in economic freedom. The latter can't be seriously debated. To presume otherwise, that government planning has served as a lure for all the capital flows into China is to believe that the bloody 20th century was a mirage; that central planning actually works. We know it doesn't, so the only conclusion about China is that the credit inflows signal a happy truth about China's leaders not being nearly as meddlesome as some presume. Brandon suggests that China's markets aren't liberalized enough, that's certainly true in that politicians can always free things up more, but what's false is his insinuation that illiberal markets have driven the credit boom. The latter is an impossibility. Central planning repels economic resources. Central planning doesn't work. Period.

Brandon concludes with, "The question for China, then, is not if the crisis will come, but when." Fearful of overinvestment in housing, Brandon predicts a collapse. There he arguably gets it backwards.

Indeed, assuming he's correct that government has directed too many precious resources into housing, the "crisis" is now; as in how much more vibrant and evolved would China's economy be absent this misallocation of resources toward housing consumption? Brandon would seemingly argue in response that the real crisis will be when markets correct the mistakes of politicians, but how could a reversal of government-directed consumption cause a crisis? If anything, what Brandon fears would be an economic positive if it ever came to pass.

One can only conclude from this that Brandon is thinking about what happened in the U.S. when the markets started to correct our own government's authoring of an economy-sapping rush into housing consumption in 2007 and 2008, but this would be a misread. Markets fix government errors all the time, and it's invariably healthy.

What can't be stressed enough is that the minor housing correction in 2007-2008 (as Michael Lewis described it in The Big Short, housing prices weren't even in decline - they merely stopped rising - when the markets started to correct) did not cause a "financial crisis" as is so commonly assumed, but the Bush administration's response to the housing adjustment did. If there's no bailout of Bear Stearns there's no expectation that Lehman Brothers will be saved, and no subsequent market crack-up. The "crisis" in '08 was manmade, and only indirectly had something to do with the housing correction.

Applying all of this to China, it should be said once again that as governments tautologically cannot expand or create credit, the Chinese government's efforts to stimulate housing with private resources has restrained economic growth, capital formation, not to mention the influx of even more credit into the rising nation. That's the crisis. A correction of what is non-economic won't lead to a crisis as Brandon assumes; instead it will be intensely healthy assuming Chinese politicians don't do as ours did in 2008 and bail out those too exposed to government-directed housing consumption in the first place. Markets work. Let's allow them to.

John Tamny is editor of RealClearMarkets and Forbes Opinions, a senior economic adviser to H.C. Wainwright Economics, and a senior economic adviser to Toreador Research and Trading (www.trtadvisors.com). He can be reached at jtamny@realclearmarkets.com.