To help small businesses, in aggregate, there is only 1 solution – more customers willing to spend money.

That’s it. This problem is not nearly as complex as the politicians would like you to think. And it can’t be resolved with government “programs”.

Here’s a really simple outline of an economic situation and transaction.

John Jones makes $100,000 per year. He made this in 2007 when things were good and he makes it today. In 2008 John used to go to his local Bill’s Grinder coffee shop every morning for a $4 cup of coffee.

In 2008 Bill’s Grinder was doing pretty well, Bill was making a decent living, paying his bills and even had started a little college fund for his kids.

Then came late 2008 – banks crashed and the stock market headed south.

John’s retirement nest egg got cut in half. In early 2009 John decided to rebuild his nest egg. John did a lot of things but among them he decided to only get his $4 latte on Fridays instead of every day of the week. John saves $20/week and Bill’s Grinder loses $20 per week. But Bill doesn’t really lose the full $20/week. He loses the profit on $20/week. The $20 loss is shared by several businesses, Bill needs less coffee so his coffee supplier gets a little less, same for cups, etc.

Now, Bill has a bunch of customers who do the same thing John did. In total, Bills sales are down $500/week!!! That’s a lot for a small business.

Recently President Obama said he wants banks to start lending money to small businesses. How will that help Bill? If Bill gets a loan will John start buying coffee 5 days a week? Not likely.

A focus on loaning Bill money might make Bill breathe easier for a while (until he has to pay back the loan!) but it will not get John to buy more coffee.

Where should the focus be? On getting John to buy coffee again! Can the government help with that, not directly?

Just think about it, if the government subsidizes or guarantees loans so banks will lend to Bill then the government will have costs/losses. Who pays for those loses? Probably John who will see his taxes go up and reduce his coffee money again! So John cuts spending again to offset his higher taxes, now John doesn’t stop at Bill’s at all!

It’s another example where the medicine (government solution) is worse than the disease.

What could/should the government do? Cut John’s taxes and cut government spending. One of the reasons banks aren’t lending to Bill is that they can lend to the government with a 100% guarantee of pay back. Why lend to Bill with the risk? Why does the government need to borrow money from the banks? Because the government is spending more money then they take in. (Ironic isn’t it, Bill’s about to be in that same situation).

I once heard the analogy about government stimulus programs. It’s like taking a bucket full of water from the deep end of a pool, pouring it into the shallow end and hoping the pool gets fuller.