display | more...

Vendor financing is the process of lending money to someone so that they can buy products from you. This might sound bizzare, but it underpins key areas of the global economy, as well as lurking behind many of its problems.

The relationship between China and the United States is a classic example of vendor financing. China's economy is heavily based on exporting cheap manufactured products to the rest of the world, especially America. When China sells these manufactured goods to America, it gets paid in dollars. The Chinese government then ploughs these dollars back into the American economy by buying U.S. government bonds, which is a way of lending the U.S. government money. The vast amounts of dollars sent back into the American economy by China help to keep American interest rates low and allows American consumers to buy more Chinese goods. And so the cycle continues - for now.

The relationship between Greece and the rest of the Eurozone is another example of vendor finance. The Greek fiscal crisis has come about because Greece cannot repay the vast amounts of money that it borrowed from banks in other European countries - money that it used in part to purchase goods from these very same countries. Before the credit crunch, this arrangement suited everyone in the short-term (as did many other things which got us into this mess), but it was highly unstable in the long-term because Greece is far from creditworthy.

This reveals one of the main problems with vendor finance, namely that the person you're lending money to is hardly encouraged to take care in looking after their own finances when they know that your own survival depends on continuing to lend them money. Chinese money has fuelled not only a consumer spending boom in the United States but also a federal spending boom as first George W. Bush and then Barack Obama piled on deficit spending. Similarly, Greece's state spending boomed and its economy deteriorated because it could never see into the future to a point where the cheap money from the rest of the Eurozone would end. This is precisely the sort of problem - economists call it a "structural imbalance" - that opponents of the Eurozone warned of when the single currency was created.

The symbiotic nature of vendor finance - in the short-term, everyone gets paid - is what makes it pernicious. Vendor finance is easy. But it also has a tendency to be more unstable than other financing models for precisely this same reason. Eventually, the cycle must be broken by one party being brave enough to break away from the model; or, more likely, by an economic disaster. It is particularly difficult for politicians to tell their people that they must abandon easy money in the short-term for the price of long-term stability. As we're learning now in Greece and elsewhere, this is difficult enough in times of catastrophe, never mind when the sun is shining. All economic booms feel the same, and it's a feeling of something that will never end. But they all share another characteristic too - each one ends in a bust. Vendor financing is no different.

Log in or register to write something here or to contact authors.