Kevin Rudd, as he did with the last stimulus package in December, is hoping that people will go out and binge some more rather than pay off the excessive debt they accumulated whilst living above their means,
"We hope those who can will spend the money - whether it's buying a new washing machine, some more presents for the kids or a little trip away."
Doing so would keep the Australian economy ticking over, he said.
The reason Rudd urges people to go out and spend this money is because if they use it to pay off their debt or save it rather than splurging on consumption a corresponding shrinkage of the money supply will occur. This is because we live in a world of Fractional Reserve Banking, where
...banks keep only a fraction of their deposits in reserve (as cash and other highly liquid assets) and lend out the remainder, while maintaining the simultaneous obligation to redeem all deposits immediately upon demand.
If a loan (debt) is paid off and a new one isn't created, the money supply effectively shrinks. For the crisis to resolve itself this is required -- monetary policy sent incorrect signals to capital markets, reducing lenders’ ability to distinguish between good and bad loans; it also sent incorrect signals to potential borrowers about what they can and cannot afford. This created malinvestment which is now in the process of unwinding.
By encouraging people to continue spending, Rudd and his advisors are trying to keep the party going; unfortunately they won't succeed -- on the contrary, it will just make it a more drawn out and painful process. This is of course assuming the $42b stimulus gets approved -- Rudd is currently engaged in several 'forums' with special interest groups, no doubt wheeling in his barrels of pork, in an effort to make sure that the plans meet the requirements of these special interest groups (at the expense of everyone else). In short, bank customers' economic difficulties, one of the inevitable consequences of all credit expansion, render many loans irrecoverable, accelerating even more the credit tightening process (the inverse of the expansion process).
From Money, Bank Credit, And Economic Cycles by JESÚS HUERTA DE SOTO:
In fact, the bank may completely fail as a result, in which case the bills and deposits issued by it (which we know are economically equivalent) will lose all value, further aggravating the monetary squeeze.
Furthermore, one bank's solvency problems are enough to sow panic among the customers of all other banks, leading them to suspend payments one by one, with tragic economic and financial consequences.
Moreover we must point out that, even if the public continues to trust banks (despite their insolvency), and even if a central bank created ad hoc for such situations provides all the liquidity necessary to assure depositors their deposits are fully protected, the inability to recover loans initiates a process of credit tightening that is spontaneously set off when loans are repaid and cannot be replaced by new ones at the same rate. This phenomenon is typical of periods of recession. When customers default on their loans, banks become more cautious about granting more. Hence the natural reluctance of the demoralized public to request loans is reinforced by banks' greater prudence and rigor when it comes to giving them. In addition, as bankers see their profitability fall along with the value of their assets as a result of irrecoverable loans, they will attempt to be more careful, and other things being equal, to increase their cash on hand by raising their reserve ratio, which will have an even greater tightening effect.
Finally business failures and frustration arising from the inability to honor commitments to banks will contribute even more to the demoralization of economic agents and to their determination to avoid new investment projects financed with bank loans. In fact many businessmen eventually realize they allowed themselves to be carried away by unjustified optimism in the phases of expansion, largely due to the excessively generous credit terms bankers initially offered, and the businessmen correctly attribute their errors in judgment to these easy terms.
...we have seen that the fractional-reserve banking system can contract and drastically reduce the money supply just as easily as it expands credit and increases the money supply. In other words, the system generates an elastic and extremely fragile stock of money which is subject to great convulsions that are very difficult, if not impossible, to mitigate or stop. This monetary and banking system contrasts with inelastic systems (for example, the one that combines the classic gold standard with a 100-percent reserve requirement), which do not permit disproportionate expansion of the money supply (the worldwide production of gold has been growing in recent centuries at the rate of 1 to 2 percent per year). Moreover they offer the following advantage: due to the fact that these systems are inelastic (gold is indestructible and throughout history the world has accumulated a very inflexible stock of it), they do not permit any abrupt decline, nor (logically) any credit or monetary squeezes which exert debilitating effects on the economy, as opposed to the current situation for which the existing banking system is responsible.
From the above we can see that no amount of "stimulus" can stop the process from occurring -- the necessary correction process has already begun. If governments insist on sponsoring fractional reserve banking, the current crisis will always be an inevitable result.
