"Warning Warning!" Says the Fed.

Yahoo! News - Borrow Cautiously, Greenspan Advises

Poor Alan Greenspan is joining the ranks of such maligned characters as the worrisome engineer, the blinking red light in action movies, that silly laptop fuel thingy in fast and the furious, and all those other silly warning notices that go ignored throughout any dire situation. As the headstrong hero of the story, Bush pushes through the easily avoidable turmoil to arrive bloody, soiled, yet victorious. I am not so sure Bush has got it in him though. I think it is much more likely that we end up, as a nation, just bloody, soiled, and drowning.

The government is borrowing too much and that is the bottom line. It really is not a unrealistically advanced concept to grasp.


Let's assume the bar below is the total amount of money available to be loaned out...that includes loans for cars, homes, college, missile defense systems, or Social Security reform programs.

l-----Total Supply of Loanable Funds----l

Ok so that is our "Loanable Money Supply." Let's go ahead and take out some percentages and give them to certain things. (NOTE: The amounts being taken out are for explanation use only. They are not accurate unless I got really lucky guessing.)

lPPPPP:--------------------------------------l

Let us say that the area taken by the P's are us, the people, borrowing money that we need for our everyday demands....cars, boats, homes, etc.

lPPPPP:CCCCCCCC:-------------------------l

The C's will represent companies borrowing money to finance their new buildings, factories, ad campaigns and the like.

lPPPPP:CCCCCCCC:GGGGGGGGGGGGGGl

Let us also say that area taken by the G's is the government borrowing money to pay for its aircraft carriers, missile defense, wars against terrorism, healthcare programs, etc.

The financial markets behind this lending and borrowing of money are free and behave as markets should. Quantities supplied and demanded will fluctuate to equilibrium and thus set a price and quantity. Awesome right? Of course....free markets rock.

So from these bar charts we can make the leap of reasoning and say they will translate into lines of "supply of loanable funds" and "demand of loanable funds."



The Green dot on the above graph represents the current level of price of loanable funds (price of loanable funds = interest rates). The Red dot indicates the equilibrium Quantity supplied of loanable funds which is a part of the money supply. So let us suppose now that we take into account the government spending HUGE amounts of money to revamp social security (I personally think social security is in need of reform but not if we need to borrow this much money).




The green line in the above graph now represents the increased level of demand that is now present because the Government is in need of borrowing a large amount of money to fund the Social Security reform. So our demand line shifts out and a new equilibrium is found. The gap is representative of the increase in government demand on loanable funds. (Last time I heard, the Social Security plan would cost about 2 trillion. In all fairness the opposing party will post their numbers sooner than the rest and as such you have to take info like this with a grain of salt.) Price has risen from the black dot on the left up to the Green dot. Quantity demanded also increases to the Red dot. This makes sense so far right...greater demand = higher prices, and more supply. The problem is this: When the Government or anyone else for that matter needs money they cannot just print more to their heart's content. Expanding the money supply like that causes huge problems with inflation..namely, it increases. Ok, so now we cannot change supply, but we need a certain level of safe inflation to be maintained and the only other factor that can change is price. So now the graph looks like this.



And this is our conclusion to the Econ lesson. Supply is shifted to the left (or decreased). This effectively controls the supply putting the red dot back where it belongs. But look at price it has shot up dramatically. The fact of the matter is this...when the government wants to borrow that much money it makes it more expensive to borrow money for the rest of us because we are facing a smaller amount of money available to be loaned after the government has taken what they want out of it. More expensive means higher interest rates. High interest rates mean that we are less likely to get new cars or homes and that companies are less likely to upgrade their facilities to increase efficiency. All in all we get an overall slowdown of the economy.

Phew! So what am I getting at?

We need to heed Alan's warning and if we are going to do this we need to do it slowly and at a measured pace so we don't end up pushing the brakes on our own economic development.