The Only Three Questions That Still Count: Investing By Knowing What Others Don't, 2nd Edition

Multiplier Effects and the Heroin-Addicted iPod Borrower

Let’s shift to the heroin-addicted iPod borrower and the similarly stupid government. For readers who took a college economics class, you may recall when a bank makes a loan, it increases the quantity of money—it’s effectively just like printing money from thin air. Simply said, every loan has a “multiplier” effect. In America, money newly created through a new loan gets spent—changes hands—on average about six times in the first 12 months of its existence. Economists call how fast existing money changes hands velocity.

So pretend there is a banker stupid enough to lend money to a known heroin addict. The addict is tired of his old iPod and wants to borrow to upgrade it and buy more heroin. (Very dumb.) The banker lends to him (presumably charging him a higher rate than someone more responsible, like you). The addict buys some heroin from his drug dealer and the iPod from his iPod dealer. The money has changed hands stupidly. Now, the iPod dealer is rational and normal. He got some of that addict’s money and spends some on sales tax, some replenishing his inventory from Apple—which is pretty normal, and Apple likes it—and some feeding his family in normal ways, not stupidly at all. That’s the second spend—the money is spent four more times on average before the first year is out, and every time after that first stupid spend by the addict, it’s spent pretty darned normally—boringly so by normal, rational people and corporations. ...