Friday, June 21, 2019

In Order to Understand the Austrian Business Cycle Theory, We Must Distinguish Commodity Credit (Good Kind of Credit) from Circulation Credit (Bad Kind of Credit)

In order to understand the ABCT [Austrian Business Cycle Theory] it is necessary to grasp a distinction between two different kinds of credit first introduced by Ludwig von Mises himself. The first one, commodity credit, is, in Mises’s opinion, the healthy kind of credit. Somebody saves out of his income and transfers the savings to somebody else, mainly by means of financial intermediaries. As this kind of credit necessitates savings, it involves an exchange of present goods for future goods. In the words of Mises, credits of this kind are
characterized by the fact that they impose a sacrifice on that party who performs his part of the bargain before the other does—the foregoing of immediate power of disposal over the exchanged good.
In short, before commodity credit can be granted, somebody must have saved up goods or money that can now be lent to the debtors. The sacrifice of the savers is the necessary condition for this kind of credit.

The second kind of credit Mises calls circulation credit. In his opinion, it constitutes the unhealthy kind of credit. It does not stem from anybody’s savings, but from the power of banks to lend additional money into existence. It is not necessary to go into the details of fractional reserve banking here. That this kind of banking is able to create additional credit via lending out its own banknotes (in earlier times) or demand deposits that are at any time convertible into money is generally accepted by economists. The phenomenon is called the money multiplier. Mises’s point is that this kind of credit creation does not presuppose savings and therefore causes nearly no costs to either the issuing bank or anybody else. This
group of credit transactions is characterized by the fact that in them the gain of the party who receives before he pays is balanced by no sacrifice on the part of the other party.
According to Mises’s definition, what he calls circulation credit is not a proper credit transaction from an economic point of view. “[T]he essential element, the exchange of present goods for future goods, is absent.” No savings and no sacrifices are necessary:
If a creditor is able to confer a loan by issuing claims which are payable on demand, then the granting of the credit is bound up with no economic sacrifice for him.
Now, in all of his versions of the ABCT, Mises maintains that an expansion of circulation credit, as distinguished from an increase of commodity credit, causes a boom that must ultimately result in a bust. So far, the earlier and the later versions are homogeneous. However, they differ in the way that Mises explains the effect that an expansion of circulation credit has on the economy. It will be shown that it is on this point that Mises’s first theoretical book, The Theory of Money and Credit, has to be preferred to all of his later writings.

--Eduard Braun, “The Subsistence Fund in Ludwig von Mises's Explanation of the Business Cycle,” in Theory of Money and Fiduciary Media: Essays in Celebration of the Centennial, ed. Jörg Guido Hülsmann (Auburn, AL: Mises Institute, 2012), 194-195.


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