The Two Classes of Credit: Commodity Credit and Circulation Credit

Every serious discussion of the problem of credit expansion must start from the distinction between two classes of credit: commodity credit and circulation credit.

Commodity credit is the transfer of savings from the hands of the original saver into those of the entrepreneurs who plan to use these funds in production. The original saver has saved money by not consuming what he could have consumed by spending it for consumption. He transfers purchasing power to the debtor and thus enables the latter to buy these nonconsumed commodities for use in further production. Thus the amount of commodity credit is strictly limited by the amount of saving, i.e., abstention from consumption. Additional credit can only be granted to the extent that additional savings have been accumulated. The whole process does not affect the purchasing power of the monetary unit.

Circulation credit is credit granted out of funds especially created for this purpose by the banks. In order to grant a loan, the bank prints banknotes or credits the debtor on a deposit account. It is creation of credit out of nothing. It is tantamount to the creation of fiat money, to undisguised, manifest inflation. It increases the amount of money substitutes, of things which are taken and spent by the public in the same way in which they deal with money proper. It increases the buying power of the debtors. The debtors enter the market of factors of production with an additional demand, which would not have existed except for the creation of such banknotes and deposits. This additional demand brings about a general tendency toward a rise in commodity prices and wage rates.

--Ludwig von Mises, The Causes of the Economic Crisis: And Other Essays Before and After the Great Depression, ed. Percy L. Greaves Jr., trans. Bettina Bien Greaves and Percy L. Greaves Jr. (Auburn, AL: Ludwig von Mises Institute, 2006), 193-194.