Often those trying to "be fair" will argue that the common people are to blame for our current crisis as we "live beyond our means" and "borrow too much". It is a common refrain among those who like to be seen as even handed and level headed. It sounds great, but, in truth, it is an absurd proposition.

Why? Because we have spent the past 20 years living in relatively inflationary times. Thanks to the constant expansion of the money supply, there has been a glut of money on the lending market, driving interest rates lower than normal. In fact, that was part of the reason for the inflation in the first place. On the other hand, salaries, returns on investment, and other forms of income have been rising with an inflation premium. That being the case, the interest on debts has fallen far behind expected returns on the same money. So it only makes sense to borrow.

Allow me to demonstrate. Suppose there is no inflation. The market returns 5% on an investment. Lenders, to pay a fair return and allow a buffer for costs and defaulted loans, will likely charge 6% interest for their best credit risks. At that point, borrowing is only sensible in an emergency, or for necessities, such as homes, which cannot be paid all at once. It makes little sense to purchase on credit.

Now add in a 3% inflation. At this point, investments will pay quite a bit more. As they pay costs in pre-inflation dollars, but reap profits in post-inflation dollars, they will show a profit of 8% or more. In fact, as it is early in the inflation, a lot of extra money will be sitting on the market. This will allow for cheap expansion for companies that can get to the money*, so returns may actually be at 9% or more. On the other hand, with excess money on the market, rates may drop to 5% or 4%. That means that it makes perfect sense to borrow for any expenditures, as having the cash bears a higher return than the loan costs. For example, you could borrow $100 for a year at 4% and invest in a 9% stock, earning $5.

Of course many will argue those borrowing too much are not investing that money, they are simply spending it as well. And that is true. However, the logic is the same. If you can borrow money now and then either continually refinance, or just pay it off in depreciated dollars, it often makes sense to buy on credit. Even those who took paper equity out of their homes were operating on the same logic. It only make sense to extract the excess value. If the market goes down, that equity will not be available, and if it keeps going up, odds are good inflation will have made the equity you extracted worth much less, making it a good idea to extract the equity while available.

Now, I am not saying this is a prudent fiscal policy. It all is founded on both the inflation continuing without a deflationary crisis and the individuals borrowing having a constant income. There is risk involved. But provided you accept that risk, it really does make financial sense to extract paper profits from a house or to buy on credit when inflation makes it profitable to do so. Of course such rampant lending does tend to undermine the overall economy, as we have seen, but that is one of the costs of inflation, poor allocation of resources. Just as in the 1920's Germany spent a fortune on unneeded industrial infrastructure that later proved nearly worthless, our inflation went into housing, consumer credit, and (earlier) the dot-com bubble.

If we truly want to enforce some economic discipline, perhaps the place to start is with our government. Gert rid of their ability to endlessly overspend by "monetizing" debt. Restore the gold standard, eliminate the Federal Reserve, and make the government sell bonds if it needs to run a debt. Better yet, make the government live within its means. As a pleasant side effect, our monetary inflation will come to an end and we will be free of the very distortions of the market that make such "excessive borrowing" common among consumers.

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* To be clear, I am not saying mild inflation is good for business. It may spur business activity, but those who promote this forget that activity is not always good. Growth may be beneficial, but it may also be cancerous. And inflation, while spurring activity, tends to stop lenders from discriminating between fruitful activity and much less beneficial activity. And so we end up with situations such as the absurd overvaluation of the dot-com stocks, or our 200%, even 300%, increase in housing prices over 8-10 years (at least in some markets). These events were not responses to real worth, but were simply inflationary funds finding some outlet, regardless of whether or not it was economically justified.