Thursday, 24 January 2008

Counterfeit capital

Here's a curly one for you: What's the difference between capital expansion and credit expansion?  It's important.  The answer could well affect your future for some years to come.
Give up?  Here's George Reisman with the answer, in his latest column:
Capital in the form of credit is normally and, certainly, properly, extended out of previously accumulated savings. In sharpest contrast, credit expansion is the creation of new and additional money out of thin air, which money is then lent to business firms and individuals as though it were a supply of new and additional saved up capital funds.  Its existence serves to reduce interest rates and to enable loans to be made and debts to be incurred which otherwise would not have been made or incurred. Always and everywhere, to the extent that private banks participate in the process of credit expansion, they do so with the sanction and generally with the active encouragement of the government.
See the difference?  One's real, and one's illusory.  New capital is the product of genuine productive activity, and is limited by the extent to which the fruits of production can be saved and reinvested; credit expansion on the other hand is a political tool that gains whatever value it has by diluting existing money.  As Don Boudreaux points out:
Government cannot create genuine spending power; the most it can do is to transfer it from Smith to Jones. If the Treasury sends a stimulus check to Jones, the money comes from taxes, from borrowing, or is newly created.
Stimulus like this is a way governments' bankers fake prosperity.  It's a way of 'putting a penny in the fusebox,' allowing economic activity to artificially expand and to keep expanding, yet just as putting a penny in your fusebox now only makes the eventual explosion of your whole circuit board more likely, so too does the cheap 'socialised financing' of fake credit risk a more serious meltdown of the world's economies.
You see, just as reality can't be faked indefinitely, neither can that phoney credit expansion continue indefinitely. As Warren Buffett is supposed to have said, "It's only when the tide goes out that you learn who's been swimming naked."   Those loans that were made and debts that were incurred which otherwise would not have been made or incurred are what intelligent economists recognise as malinvestment (a misallocation of resources often following a period of artificially excessive credit). They are chickens searching for somewhere to come home and roost once colder economic winds start blowing.  The headlines you've been reading in recent days and weeks is the sound of their feathers flying overhead as their financial perches collapse.
Now with that in mind, can you deduce the result of the 'economic stimulus' packages touted by statists of different persuasions to offer a 'soft landing' for all those desperately roosting chickens.  The common factor with all these packages is yet further expansion of created credit, consuming even more real capital.  Like drug pushers doling out another fix, the world's central bankers dole out more and more and more printed money in a bid to stave off the inevitable.  If you or I were to print money it would be called "counterfeit", but when the banks print money it's called "stabilizing the economy." 
The problem is it doesn't.  That counterfeit capital consumes real capital.  Only governments' central banks can create credit out of thin air, and as Reisman points out, it's the expansion of easy credit that creates the boom-bust cycles that conventional wisdom blames on free markets, and sets everyone up for the 'easy fix' of more easy credit once the 'easy credit boom' starts turning to a real and genuine bust -- and, once the bust finally and definitely hits, it consumes the real and genuine capital produced over preceding years and by the sweat of previous generations like a firestorm going through a forest.
It's no accident that of the two leading periods of credit expansion in history, the first, in the 1920s, led to the Great Depression of the 1930s, when it took more than a decade to build up sufficient real capital to dig the way out of the hole the central bankers had gotten the world into. 
And the second leading period of credit expansion?  That was the 1990s.  Sit tight now as the central bankers keep tinkering through the 2000s.
* * * * *
NB: George Reisman offers a course of study based on his book Capitalism that every intelligent adult needs to understand the many fallacies of conventional economics which a colleague of mine intends to offer here in Auckland, starting in late February/early March.  It is a comprehensive, in-depth defence of the capitalist economic system, that he proposes to run once a week over the course of the coming year.  Think of it as essential economic self-defence.
Details of the course contents can be found at Professor Reisman's site.  For more information and the proposed schedule of the Auckland study group, please ring Julian on (09) 623 8111.  Be aware that places are strictly limited.
If you have or plan to have any kind of intellectual career, not only as a professional economist, but as a writer or journalist, as a teacher of philosophy, history, literature, psychology, mathematics, or any of the natural sciences, at whatever level; if you are interested in politics, whether as a potential candidate for office or simply as a voter who wants a serious understanding of the issues; if you are a businessman who wants to know how to defend himself and his company from scurrilous attacks; if you are anyone who wants to know what he is talking about when it comes to matters of politics and economics, this program is a necessity for you.


  1. "Government cannot create genuine spending power; the most it can do is to transfer it from Smith to Jones."

    In fact, a government does less than that: some of the transfer is lost as transaction fees, i.e. the cost of the bureaucracy that effects the transfer.

  2. When I was a young child I wondered why the government didn't just give everybody free money (sinse they control the mints).

    Now that I am older I understand why. Dissapointingly there still seem to be some people who do not understand that more money does not equal more wealth.

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  5. transfer in this respect is best described as theft.

  6. Hi PC,

    One question: where did the capital originate from? I think you'll find it started life as credit as most money does.

    Without doubt the regulators should take responsibility for running such a shoddy financial system allowing paper to be printed all over the place by banks with very little restriction.

    Most of the money supply is debt in one form or another. My savings are merely someone else's debt.

    For example:

    I buy a property for $1m taking out a loan for $900,000 plus $100,000 of savings. Some time later i sell it for $2m.

    I repay the loan and have $1.1m in savings.

    The person who bought the property borrows $1.8m from the bank plus $200,000 in savings.

    So i have savings of $1.1m now but the other guy has a debt of $1.8m....the money supply has been increased via debt increase.

    98% of all money is interest bearing debt whichever way you want to slice it.

    As we are seeing now the system is so overloaded with this "money" that it is starting to eat itself.

  7. what do you expect from people who believe that the world was created in 7 days?

    the Republican candidates were asked on that U-Tube q and a session whether they believed everything written in the bible. With the exception of Giuliani, they all said yes they did.

    So... what do you expect? common sense?


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