September 23, 2009

A Better Stimulus Plan: Drug Dollar Amnesty

Now that Fortune, Time, NPR, and New York Magazine are all talking up marijuana, it’s time to answer the eternal question: why are illegal drugs recession-proof? The answer isn’t just physiology (since marijuana is not physically addictive, any argument about inelastic demand is going to have to hold true for, say, Starbucks or Hagen-Dasz).

The popular theory is that drugs are more addictive (untrue: heroin buyers are more sensitive to price fluctuation than gasoline buyers, in the short run), or that drug dealers are more willing to take risk, so they suffer relatively less when aggregate risk increases.

I have another theory: drug dealers do well during recessions because they have such a short cash cycle.

Your average dealer’s balance sheet looks like this:

Cash:                              lots
Inventory (finished goods):        some
Property, plant, and equipment:    rounds down to zero

They have high inventory turnover, no receivables, liquid assets, and no fixed costs. They’re immune to inflation (they can just raise prices), deflation (no fixed costs), high interest rates, and credit crunches.

In fact, economic uncertainty makes all these factors more obvious and more attractive! Who wants to be beholden to the finance industy—whether it takes the form of Ben Bernanke or the loan officer at a local bank?

Paradoxically, certainty that obligations will be enforced exacerbates the economic effects of uncertainty. In a credit crunch, cash flees high-leverage, low-ROI businesses and seeks asset-light models instead.

A sensible stimulus plan could counteract this: let people make large, unexplained cash deposits in banks. Let them have their money without worrying about money laundering rules for as long as LIBOR makes it seem prudent. And when the legitimate money moves back into the market, force these nefarious types to take their cash back and sneak it into the legtimate economy the expensive old-fashioned way.

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I’m currently the Co-Founder and CEO of a startup providing equity research and M&A due diligence to investors analyzing online businesses.