One Small Step....

"Soon my Treasury Secretary, Tim Geithner, will announce a new strategy for reviving our financial system that gets credit flowing to businesses and families. We'll help lower mortgage costs and extend loans to small businesses so they can create jobs. We'll ensure that CEOs are not draining funds that should be advancing our recovery. And we will insist on unprecedented transparency, rigorous oversight, and clear accountability -- so taxpayers know how their money is being spent and whether it is achieving results." - Barack Obama, in his weekly address, January 1, 2009

I have mentioned several times in private conversations in the past week, that we should be looking at increasing the availability of small business loan guarantees as a part of any economic stimulus package. I was therefore encouraged when I heard President Obama mention that, as a part of a (hopefully) soon to be announced strategy, there would be an increase in loans to small businesses.

We are told that small businesses are the biggest job producers in the country so often that it has become something of a mantra. If this is true, then this should certainly be an area of focus for economic stimulus. Not only does it create jobs, but these would be loans and at least have the possibility of being repaid. There was a book that I read in the mid 90s, Unlimited Wealth, by Paul Zane Pilzer, that made an argument that layoffs were, in the long run, good for the economy. His reasoning was that the company laying people off would be at least nearly as productive, but with less overhead, and that a percentage of those that found themselves out of work would not find work, but would instead make work - they would start their own businesses, hire people, and the economy would expand.

I am not trying to make quite the same argument here. I think it is difficult to say that unemployment on the scale that we are currently seeing it is good, even in the long run. What I am saying is that it is not enough to merely pump money into the economy. It is important for us to pump money into the economy in ways that are going to be the most effective, and the key to that effectiveness is the velocity of money.

Money's velocity is essentially a measure of how quickly money changes hands. It is important because it acts something like a multiplier. Let's say that the government gives someone a stimulus check in the amount of $1,000. This individual isn't sure what to do with the money, but they cash the check and keep the money in their wallet until, some months later, he buys a computer for $1,000. The owner of the computer store puts that money in his safe, where it sits for another couple of months, until he remembers it is there, and he deposits it in his bank account. Assuming that this is where the trail ends, and the money only changed hands twice during the year, there are two people that have seen their income increase by $1,000. For their $1,000 investment, the government saw the economy grow by $2,000, and the money's velocity would be 2/yr. If, on the other hand the person that received the money immediately spent it, and the money ended up changing hands 100 times in a year, that investment of $1,000 would result in an increase of $100,000. If we are going to be spending money to try to get ourselves out of our current economic downturn, we need to identify where we can put it where it will work the hardest, and move the fastest. My suspicion is that small business, and especially new small businesses, is one of those places that we can get the most bang out of our buck.

As the saying goes, however, "the devil is in the details." It will be interesting to see the specifics of the Obama plan when they are released. I am hopeful that the administration will not use the stimulus in order to do a little "social engineering," and use it to fund businesses that they deem to be "worthy." If they can resist this temptation, this can be a powerful tool in stabilizing our economy. It can start to expand the economy, which will increase the tax base, and (because these would be loans, or loan guarantees) at least some of this money would be repaid (some businesses, of course, would not be successful, and will default on their loans).