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Credit Expansion vs. Simple Inflation

Economics / Inflation Jun 04, 2010 - 08:21 AM GMT

By: MISES

Economics

In dealing with the consequences of credit expansion we assumed that the total amount of additional fiduciary media enters the market system via the loan market as advances to business. All that has been predicated with regard to the effects of credit expansion refers to this condition.


There are, however, instances in which the legal and technical methods of credit expansion are used for a procedure catallactically utterly different from genuine credit expansion. Political and institutional convenience sometimes makes it expedient for a government to take advantage of the facilities of banking as a substitute for issuing government fiat money.

The treasury borrows from the bank, and the bank provides the funds needed by issuing additional banknotes or crediting the government on a deposit account. Legally the bank becomes the treasury's creditor. In fact the whole transaction amounts to fiat-money inflation.

The additional fiduciary media enter the market by way of the treasury as payment for various items of government expenditure. It is this additional government demand that incites business to expand its activities. The issuance of these newly created fiat-money sums does not directly interfere with the gross market rate of interest, whatever the rate of interest may be which the government pays to the bank. They affect the loan market and the gross market rate of interest, apart from the emergence of a positive price premium, only if a part of them reaches the loan market at a time at which their effects upon commodity prices and wage rates have not yet been consummated.

Such were, for example, the conditions in the United States in the Second World War. Apart from the credit-expansion policy, which the administration had already adopted before the outbreak of the war, the government borrowed heavily from the commercial banks. This was technically credit expansion; essentially it was a substitute for the issuance of greenbacks.

Even more complicated techniques were resorted to in many countries. Thus, for instance, the German Reich in the First World War sold bonds to the public. The Reichsbank financed these purchases by lending the greater part of the funds needed to the buyers against the same bonds as collateral. Apart from the fraction which the buyer contributed from his own funds, the role that the bank and the public played in the whole transaction was merely formal. Virtually, the additional banknotes were inconvertible paper money.

It is important to pay heed to these facts in order not to confuse the consequences of credit expansion proper and those of government-made fiat-money inflation.

Ludwig von Mises was the acknowledged leader of the Austrian School of economic thought, a prodigious originator in economic theory, and a prolific author. Mises's writings and lectures encompassed economic theory, history, epistemology, government, and political philosophy. His contributions to economic theory include important clarifications on the quantity theory of money, the theory of the trade cycle, the integration of monetary theory with economic theory in general, and a demonstration that socialism must fail because it cannot solve the problem of economic calculation. Mises was the first scholar to recognize that economics is part of a larger science in human action, a science that Mises called "praxeology." See Ludwig von Mises's article archives.

This article is excerpted from chapter 20 of Human Action: The Scholar's Edition and is read by Jeff Riggenbach.

© 2010 Copyright Ludwig von Mises - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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