We’ve seen the effect, but there’s no theoretical basis for why that should be. That leaves idiots like Paul Krugman and Clive Crook plenty of opportunity to declare that it just isn’t big enough, or (in Krugman’s case) to declare that what we need is a short victorious war to get things back on track.

We live in an economy based on debt. Many people wail that this should not be so, and offer solutions for the problem; that’s irrelevant at the moment, as are arguments about how we got that way. Analysis must be based on the Cronkite Declaration (That’s the way it is) rather than either plans or recriminations, however valid either might be.

A debt-based economy works on the principle that one person’s debt is another’s asset. The borrower has cash in hand to spend; the lender has a note saying he’ll have money sometime in the future, which is valuable and can be used to underwrite more lending. If the borrower then engages in economically fruitful activity, the fruits of that activity are added to the assets of society as a whole, and we all become wealthier by some increment. Society as a whole also takes repayment of the debt as a sign that the lenders’ assets are in fact worth something, which also adds to the society’s prosperity.

It looks a little different on the micro level. The borrower’s assets haven’t changed; the fistful of green stuff is exactly canceled by the requirement to pay it back, leaving his net increment at zero. The lender’s valuable asset is canceled by the void where the cash used to be, leaving him, too, exactly where he started. From an overall point of view, the system increases wealth so long as most borrowers get to work with their newfound riches; down where the people live it’s a psychological problem.

The psychology gets even worse when an economic crunch comes, as they always do. The weakness of the debt-based system is susceptibility to “bubbles”, in which enthusiastic borrowers engage in more and more activity that is less and less productive, and enthusiastic lenders encourage that in order to get more debt-based assets and thus more paper wealth. Eventually a point is reached where it is no longer possible to keep up the pretense that borrowers are doing anything useful with the money, and the bubble pops.

You can see in your own behavior what happens then. What did you do when it started coming apart? –You started paying down your credit cards and other consumer debt, lest Citibank come and take your house away because you couldn’t cover your exposure any more, didn’t you? The same thing is true of borrowers who took out loans for business purposes. If they don’t service their debt and the bank forecloses, their business (and income) disappears, so it becomes a priority to keep up the payments and maybe get a little ahead if possible, instead of expanding the business and employment in the face of decreased demand from consumers who are doing the same thing.

“Stimulus” disappears into that like a stone dropped in a pond — there may be ripples, depending on the size of the rock, but they soon die out, and the change in surface level is undetectable. New money arriving in the hands of debtors is promptly applied to trying to shore up their position, and new cash appearing in the lenders’ possession goes to fill the gaping void left by the fact that the debtors’ paybacks are more chancy and the value of the notes they hold is less.

On the macro level, that means that both borrowers and lenders have fewer assets — borrowers, because they’re paying down the notes instead of keeping the cash for business expansion or even maintenance; lenders, because they’re shoring up their cash positions instead of using the new money as the basis for more loans. The effect isn’t quite that $1 of stimulus subtracts $2 of wealth from the system, but that’s only because at least some of the stimulus does land in consumers’ hands, which makes borrowers a little less nervous and lenders a little more confident. That effect, too, is minimal, because the whole system is based on the debt-asset balance; if consumers reduce their debt exposure instead of adding to consumption, they’re sucking monetary value out of the system even faster than business debtors are, because they weren’t making productive use of the money to start with.

It doesn’t really matter if the “stimulus” is positive (cash payments) or negative (tax relief). Either alternative places an increment of immediate cash in the hands of worried debtors, who promptly use it to pay down debt and relieve their worry, or equally worried lenders, who use it to fill up the void left by reduced asset value.

The size of the “stimulus” isn’t relevant unless it’s a significant fraction of the economy as a whole. Krugman and others use this as an excuse to call for it to be exactly that — but it can’t be. It has to be borrowed, and that borrowing comes (from the macro point of view) from the same lenders that lend to businesses and consumers. That reduces the amount businesses and consumers have in hand, because lenders can only lend according to their assets; the amount available for constructive activity diminishes in direct proportion to the amount borrowed to putatively “stimulate”. The only way it can have any positive effect is if the “stimulus” is borrowed from somebody outside the system — and there hasn’t been any such thing as “outside the system” for half a century or longer. The mechanisms are different and more complex, but the net effect is to take wealth out of the hands of those who might produce more wealth with it, shrinking overall wealth rather than increasing it.

Economies do recover from burst bubbles, by mechanisms not relevant here. Attempting to speed that process either makes it worse (if the so-called “stimulus” is small) or stretches it out over longer periods of time, increasing the pain. The cure is worse than the disease, and the people prescribing it need to be stifled.

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