A Credit Expansion Economy; C. Carson

The way things are going, it would not surprise me that if we had a male child he would be named Boy. While we may be unusually defi cient in devising imaginative titles, my family is not much different from other people in its penchant for nam ing things. It is a trait common to the human race, and one which aids discourse greatly. By naming things we distinguish them from others, provide a convenient individual ref erence for them, and either recog nize or accord individuality to them. The more precisely we identify them with names the more accurate is our discussion about them, assuming that accuracy is our aim. This last is especially the case when it comes to such things as patterns of action, trends, developments, and other so141 142 THE FREEMAN March cial phenomena. These tend to be somewhat amorphous quite often, and naming is a part of the process of getting a handle on them.

Now to the subject at hand. Ours is a credit expansion economy. In deed, credit expansion may be the feature which distinguishes it best from others and is in many ways the most crucial aspect of our economy. A credit expansion economy is one tha t is geared to and more or less de pendent upon continual (if not con tinuous) credit expansion. That is not to deny the applicability of such terms as interventionist economy, welfare state, a managed economy, and the like, to describe our present hodgepodge economic system. The Moving Force But I am not looking for a new term or phrase to describe the whole ve hicle, so to speak. Rather, I am trying to get a handle on the mainsail, the oars, the propeller, the motor, or the motive power that is peculiar to our economy. Not, mind you, what moves people to produce or trade-these are market phenomena, not peculiar to any contemporary economy-nor what moves government to inter vene, but rather the key or central mechanism of the intervention. I be lieve that an apt name for it is credit expansion, and that the use of the name may help to bring some thing~ into focus more clearly than we can without it.

It may be objected that what I am here calling credit expansion has al ready been clearly identified and has a name. It is none other than infla tion, and an economy geared to it could be called an inflationary econ omy. That might be so, if certain things were accepted. If it were com monly accepted and generally agreed that inflation means increasing the money supply (including credit expansion) the terms might be made to serve the descriptive purpose I have in mind. However, that is by no means the case. When President Reagan declares that his administration has brought inflation under control, he is clearly referring to price increases, not to monetary or credit expansion. News casters and almost all public com mentators use the word in that meaning, as do most people in con versation. Even those who are aware that monetary increases are the cause of the general price rises are inclined to think ofthem as the cause of price increases rather than infla tion. Trying to use the word in its original signification is somewhat like spitting into a contrary gale force wind. It doesn't get very far.

But even if the term inflation had not been so widely appropriated for referring to price increases, I think it would be useful -to refer to our economy as a credit expansion econ omy. However it is employed, infla tion is a generic term, and histori1985 A CREDIT EXPANSION ECONOMY 143 ans, at least, need terms to refer to particular cases. It is highly useful, for example, to name each particular war, for instance World War I, al though generically.it was clearly a war. All credit expansions are prob ably inflationary (whatever the word is taken to mean), but not all infla tions have been achieved by credit expansions. In any case, we need a name for the central operative feature by which government attempts to exert con trol over and spur our economy. My nominee is credit expansion. There can be no reasonable doubt that we have had, and have, an ongoing credit expansion in the United States. The impact of the credit ex pansion, and its ongoing character, can be seen most clearly in the rise of the national debt since the early 1930s. At the end of the fiscal year 1930 the national debt was slightly under $16.2 billion. By 1940 it had risen to nearly $43 billion; by 1950 to over $256 billion; by 1960 to over $284 billion; by 1965 to just under $314 billion; by 1970 to over $370 billion; by 1975 to over $533 billion; and by 1979 to over $826.5 billion.

Between 1979-1984, the national debt has approximately doubled, and in recent action Congress raised the debt ceiling just above $1.8 trillion. If this continually mounting debt were plotted on a graph, it would provide about as clear a picture as we could get of what is perhaps the most important dimension of the on going credit expansion. Obviously, if there is debt, there must be credit which has been ex tended in equal amount from some source or sources. And if the debt has continually mounted over a period of more than fifty years, there must have been a credit expansion which made it possible. In fact, that has been the case. The means did not ex ist in 1930 from all available sources to provide $1.7 trillion, say, in credit to the United States. Nor have the liquid resources been adequate to provide the credit increase from $16 billion to $1.7 trillion. The major portion ofthe increase has come from credit expansion. To put it another way, the major portion of the debt in crease did not result from borrowing from savings; it arose instead from the expansion of credit, per se.

Monetizing Debt The credit expansion, per se, takes place by monetizing debt. Monetiz ing debt can be visualized concretely in this way. A borrower executes a note for a certain amount of money which he proffers to a creditor. The creditor runs offthe amount of paper money desired on a printing press and gives it to his debtor. Thus, a debt would have been monetized. Credit would have been expanded by increasing the supply of currency. The trouble with this simple illus tration is that it is misleading. It 144 THE FREEMAN March equates the increase of the supply of currency with credit expansion. Whereas, in our system, the increas ing of the supply of currency, Le., Federal Reserve notes, is an adjunct only to credit expansion, not the thing itself. The total of currency in circulation is to the total credit as cash flow is to the total assets of a corporation, say. Indeed, credit ex pansion is much more nearly an in crease above the amount of currency in circulation than it is any increase in the currency. The increase in cur rency is always only a small portion of the total of the credit expansion.

In our system, it is usually that amount reckoned to be sufficient for cash holdings and transactions. What I am here calling credit ex pansion usually occurs upon a basis of a fraction of reserves of savings against the total of the amount of credit. Credit can be expanded either by increasing the reserves of savings or reducing the fractional amount required against credit extended. From one point of view, then, the credit expansion (that portion of credit extension beyond the actual savings) is created out of thin air. In effect, however, the credit expansion is achieved by debasing the cur rency. In practice, as the credit is ex panded, each unit of our savings is reduced in the amount it will buy to give the created credit its buying power. Hence, credit expansion is the other side of the coin, so to speak, of the debasement of our currency and its declining purchasing power. The expansion of credit is done by banks in the United States. Indeed, banks, or bank-like institutions, have exclusive franchises to expand credit by fractional. reserve proce dures. Although commercial banks, i.e., banks of deposit, are central to this undertaking, an. assortment of other banks, public and private, play some role in it. The lynchpin of the credit expansion system is the Fed eral Reserve system, whose active arms are the regional Federal Re serve banks. These banks can ex pand credit in a variety of ways: by rediscounting the notes held by member banks, thus increasing their reserves; by raising or lowering the reserve requirements of member banks; and by buying government securities. Federal Reserve notes are our paper money now, and they can undergird credit expansion by in creasing the currency supply.

A Spending Spree This credit expansion system pro vides the life blood of the American economy today. It has made credit expansion the key ingredient to such prosperity as we can expect to have. Credit expansion not only fuels an increasing proportion of government spending but also much of private spending as well. While the national debt best exemplifies the vast credit expansion that has taken place, 1985 A CREDIT EXPANSION ECONOMY 145 credit expansion is entailed in public and private debts, as well as foreign loans and support by the United States of international lending in stitutions. (Private debts differ sig nificantly from public, in that pri vate indebtedness fluctuates, and individuals and organizations ac tually retire portions or all of their debts from time to time. Thus, pri vate debts are not dependent on an ongoing increasing credit expansion to the same extent as the govern ment debt is.) Credit expansion pro vides the means for the purchase of a large portion of durable goods in the country, fosters the concentra tion of wealth to provide the capital for industrial expansion, and spurs demand through government redis tribution programs.

But to see most fully that the American economy has become a credit expansion economy, it is nec essary both to consider the role of money in the economy and the im pact of credit expansion on the money. Money plays, or has played., three fairly distinct roles in society. It is, first and foremost, the medium of exchange. That is, it is ordinarily that through which exchanges of goods for goods are effected. Second, money is that in which the prices of goods are expressed. (This has some times been described as the "stan dard of value," but since this is somewhat more controversial as a form ulation, I will say only comparative valuations get expressed in the market as prices.) Third, money has historically been used for saving, or, in the conventional phrase, for the storage of wealth. A Money Economy Ours is basically a money econ omy. That is, our economy is based on exchanges of goods for goods and services (or goods)for services. As in dividuals and families we ordinarily produce only a few, if any, of the nu merous goods that we use. Instead, we usually specialize in producing some goodfor the market and in turn buy in the market the goods that we want. The medium through which we effect the exchanges is money.

Hence, ours is predominantly a money economy. Today, however, 'to say that we have a money economy translates correctly as a credit expansion econ omy. Our currency today is not money in any but a residual sense of the word. It is the paper residue of a long term credit expansion which has turned our money into credit. Thus, when we make exchanges, we exchange our goods for credit and ex change credit for goods. I am not re ferring simply to the widespread use of credit cards and checks in trans actions. They are excellent symbols of what has happened, but if every transaction was made in cash the above statement would still hold. Our currency is no longer backed by 146 THE FREEMAN March anything; it consists of bills of credit, to use a phrase from earlier times. This may be made clearer by de scribing how the transformation took place. Early Days of the New Deal The first major steps toward de monetizing United States currency occurred in the early days and months of the New Deal (1933).Prior to that time, the main currency had been redeemable in gold. The gov ernment called in all gold and all currency redeemable in gold. These were paid for with Federal Reserve notes, which thereafter became the general currency in this country.

These notes were forced into circu lation by making them legal tender, invalidating all contracts calling for payment in gold, and prohibiting ownership or transactions in gold ex cept for those especially licensed to do so. Even so, the currency was not completely demonetized in 1933 and the immediately ensuing years. The Federal Reserve banks were still re quired by law to hold gold reserves in some sort of relationship to their issues of notes. Moreover, the gov ernment put itself in position to de fend the dollar abroad in gold, when it became necessary to do so. Ac tually, it was not necessary for quite a while. The government raised the price it would pay for gold from $20 to $35 per ounce (devaluing the dol lar technically), and in the ensuing years much of the gold in the world was drawn into the United States. The dollar had been only partially demonetized. In a roundabout way it was still being partially backed by gold. It had some silver backing as well. The subsidiary coins, several of them, had significant silver content.

Also, the government issued $1 sil ver certificates which could be re deemed in silver. No doubt about it, the currency had been debased, and the situation would Worsen in the ensuing decades, but it was still in some degree monetarily backed. Moreover, control over the money had shifted from the people to the government. However, with the ongoing credit expansion and the supporting in crease of the currency, the monetary base of the currency could not be maintained. In the late 1960s and early 1970s, the government ceased to support the dollar at any fixed ra tio of precious metals, both at home and abroad. The subsidiary silver coinage was replaced with a base metal alloy-cupra-nickel. The gov ernment called in the silver certifi cates by fixing a date after which it would not redeem them in silver. This was followed by refusal to de fend the dollar abroad at any fixed ratio to gold. Not even the residue of backing in gold or silver remained after 1971.

The United States had fullfledged fiat money, Le., money by govern1985 A CREDIT EXPANSION ECONOMY 147 ment decree, money because govern ment by its tender laws proclaimed Federal Reserve notes to be money. While the phrase does aptly describe the relation of government power to the currency, it is doubtful that this paper currency should, be dignified by the name of money. The only base on which it is issued is credit. It is basically credit extended to the gov ernment in return for debt instru ments, Le., government securities. Thus, the older phrase, bills of credit, much more precisely describes Fed eral Reserve notes. These notes do serve some money like functions; they are in that sense as-if money, if you will. They can be used as if they were money. Thus, Federal Reserve notes serve in a fashion as a medium ofexchange. We exchange goods for them, and take them in exchange for our goods, or at least to the casual observer, that is what we appear to be doing. That is more appearance than reality, however. What we actually do is give credit for payment to those who give us the notes in return for some good, or receive credit for payment from those who have sold us some good.

This character of the transaction is borne out by the language on Federal Reserve notes: to wit, "This note is legal tender for all debts, public and private." Granted, one of the func tions of money is to extinguish debt; it is an after-the-fact function of a medium of exchange. Indeed, it attributes much more to a medium of exchange than the market ever would. It is a legal concept, not a market concept. In the market, the creditor and debtor may fix by agree ment what amount of goods will sat isfy the debt. Any legal good or ser vice may be specified. By contrast, Federal Reserve notes are legal ten der for all debts. Be all that as it may, Federal Reserve notes do serve as a medium of exchange for extinguish ing debt. Federal Reserve Notes In this sense, Federal Reserve notes are a simulacrum ofa medium of exchange, bearing a faint or re sidual resemblance to a medium. They offer credit only in exchange for goods, not a quid pro quo. That in itself might not matter, but they are not promises to pay in any spe cific amounts ofany good. Hence, the person who accepts them does so in the hope only that he can trade them for some good that will provide him his quid. Of course, if he is going to extinguish a debt with the Federal Reserve notes he receives, which is more than likely in a credit economy such as ours, he does get a known quantity. Otherwise, he has ac cepted a raffle ticket, so to speak, in exchange for his goods. It will bring only what it will bring, if anything, when it is offered in the market for goods. If it be objected that such is the case, too, with goods, the answer 148 THE FREEMAN March is, yes, but they are goods already and do not need to be exchanged for something to have that status; whereas, paper currency-Federal Reserve notes-is not a good. It is only credit.

But if our bills of credit are unsat isfactory in their. prime function as a medium of exchange, they are even less so in performing the other func tions of money. The second function of money, as I said, is to serve as that in terms of which prices are ex pressed, or relative valuations of goods are made. Our Federal Re serve notes do that job very poorly and often produce confusion rather than clear signals in the economy. Prices of goods fluctuate in any case. Normally, however, the fluctuations of prices indicate changes in supply or demand or both (at different rates) of particular goods. Thus, a rise in price of a good may signal to producers the desirability of increasing their production. On the other hand, a drop in price may signal declining demand for a par ticular good. When the currency con sists of bills of credit in an ongoing credit expansion, rises in prices may signal nothing more than another expansion of credit. Relative valua tions may be more than a little con fused as well. While prices may be rising in general, they do not do so in lockstep fashion but rather within the exigencies of particular busi nesses as the effects of the expansion are felt there. Prices tend to become ephemeral, continually changing, usually upward, with no readily dis cernible distinctions among the things impelling them on their course.

A Store of Wealth? In regard to the third function of money-as a storage of wealth-bills of credit tend to be much more nearly anti-money devices than they do money. In an ongoing credit expan sion such as ours, the currency is al most continually depreciating. As the credit expands, any given unit of the currency tends to buy less and less. In consequence, storing it is somewhat like storing a perishable commodity. It must be used imme diately after it is obtained, or it will become progressively worth less and less. A dollar earned in 1970, say, and simply saved without interest, would have shrunk in purchasing power to about 30 cents by 1984. And that does not take into account any appreciation that might have taken place in a stable currency as the re sult of efficiencies in production. In sum, then, it is highly doubtful that our Federal Reserve notes qual ify as money. To call them fiat money is almost equally doubtful, for the phrase suggests that government can create money by fiat, when in fact it has only created bills of credit.

These bills of credit are to money as cupra-nickel is to silver. To call.them 1985 A CREDIT EXPANSION ECONOMY 149 money only serves to hide from us the full function of a commodity money. It obscures, too, the working of the process by which our currency becomes worth less and less as it sinks to its true level, which is worthless. Worst of all, by calling Federal Reserve notes money, we hide from ourselves the fact that we do not have any money. We have credit instead, and that credit rests on the one hand on our desiccated savings in dollars and on the other on our mounting national debt. We have a potential avalanche of paper which is ever increasing as credit is expanded and debt increases. This precarious condition has been arrived at by taking away from the American people control over their own economic affairs. Government has usurped that control over their affairs which people had when they had a currency based on precious metals. It has taken their money from the people and given them in its place bills of credit. The currency has been thoroughly institutional ized by making virtually all banking and credit institutions the instru ments both for putting the! currency into circulation and for credit expan sion. Since much of this;' has come about gradually and has been going on for the better part of a lifetime, it is difficult for most of us to conceive how things could be different from what they are, or begin to grasp the full advantages of having actual money in our possession. We have been thoroughly acclimated to play money, as it were, or, as children would say, "play like" money.

Precious Metals Lend Stability Money backed by precious metals can be saved, and, even if it is not loaned out for interest, the amount it may buy may increase with pro ductivity. Since the amount of it does not increase at will, prices which are measured in it tend to remain fairly stable except for shifts in supply and demand. Thus, changes in prices tend to be good market signals. Wages may increase in the amount of goods they will buy even though the monetary amount of them may remain the same. Raises in wages or increases in income indicate real in creases rather than futile attempts to catch up with the depreciation of the currency. Transactions can be completed on a quid pro quo basis, although one party pays in money, for when the currency is either pre cious metals or redeemable in them, goods have been traded for goods, even though the money may be used later to purchase other goods.

Moreover, unless some fractional reserve system is used to increase the currency, there need be no busi ness cycles occasioned by expansions and contractions of the currency. And, government indebtedness can be checked by the necessity of ap pealing to those private persons or 150 THE FREEMAN March groups willing to make loans. The debt could not grow and grow, for none could be found to make the loans to sustain it. Both public and private would have to live ulti mately on current income plus sav ings, not upon credit expansion. As matters stand, however, gov ernment power has been vastly aug mented by its arbitrary control over the currency. It can increase the cur rency at will, and thus ultimately destroy what we have by way of a medium of exchange. It can expand credit more or less at will, and with that power often exercise decisive control over the economy. Attempts of government to manage the econ omy are centered in this power to ex pand or contract credit and to in crease the currency. It can often spur economic growth by expanding credit, or slow it down by contracting credit. More precisely, it can take ac tions aimed at doing these things and create havoc within the economy.

How Monetary Manipulations Affect Individuals Economy is an abstraction, of course, and the actual impact of these manipulations falls upon peo ple. Individuals, families, and groups are caught in the matrix ofthese ma nipulations. Their freedom and in dependence is curtailed and circum scribed by the credit activities of government. Since their currency continually deteriorates, they turn to all sorts of expedients to minimize the impact and to somehow guard what they have gained from dissi pating. They buy common stocks, in vest in land, purchase jewelry and precious stones, seek the highest in terest rates they can find on their savings-ever questing for some thing that will appreciate to offset the currency depreciation. The credit expansions and con tractions produce wave-like altera tions in industrial activity, tempo rary expansions alternating with contractions with their shutdowns and bankruptcies. Farmers shift from crop to crop in desperate efforts to read correctly the confused sig nals of distorted markets. But of course there are hundreds of inter ventions in the market, in addition to credit and currency expansion. All these interventions confine eco nomic activity and channel activi ties within the framework of what freedom remains.

The master intervention, however, the intervention by which govern ment has planted its power at the heart of all productive and exchange activity, is control over the supply of credit, upon which we must depend for facilitating exchanges in the ab sence of commodity money. Thus, we have essentially a credit expansion economy. There are a host of infelicities, in equities, and dangers in a credit ex1985 A CREDIT EXPANSION ECONOMY 151 pansion economy. Many of them have been detailed by writers who have explored them, usually in con nection with inflation. But I will conclude this discussion with some remarks about what I suppose is the greatest economic danger. I have suggested already that this vast credit expansion can be thought of as a mountain of paper precariously perched so that it can become an av alanche. Our system of credit expan sion built upon fractional reserves and a fraction of currency to the to tal of the debt is highly vulnerable to a liquidity crisis. To put it bluntly, if a large number of people de manded cash for their claims at the same time, the mountain of credit would come tumbling down.

FDIC Offers No Safeguard Against LiqUidity Crisis The United States government has erected safeguards against such a liquidity crisis, the most notable of which is the Federal Deposit Insur ance Corporation. The great diffi culty with this, however, is that in this case the very safeguard could become an instrument of destruc tion. If large numbers of people de manded cash from credit institu tions, the most immediate result would be a great credit contraction as the reserves against credit were withdrawn. If the FDIC intervened, as it almost certainly would, both to make good on its insurance promises and in a desperate effort to forestall some sort of crash and depression, it would quickly exhaust its own re serves. If the government came to the rescue by printing large quan tities of paper money, it could well set off hyper-or runaway-infla tion. In short, our intricate and vast credit expansion has us poised be tween a debilitating credit contrac tion and runaway inflation. The great expansion of branch banking in many states in recent years, the portending interstate banking, and huge loans, both foreign and domes tic, increase the likelihood of the kind of bank failures which could trigger a liquidity crisis.

The above is not a prediction; it is only a scenario of what may be the most probable course to a collapse. How and when the collapse will come, or what particular conse quences will follow, we cannot know in advance. That it will collapse is approximately as certain as that a balloon will eventually burst if more and more air is blown into it. If, in stead of an indirect credit expansion, we had inflated more directly by is suing huge quantities of unbacked paper currency, a runaway inflation would long since have wiped it all out. By resorting to an intricate, complex, and sophisticated credit ex pansion, supported by a fractional increase of the actual currency, the whole process has been strung out almost indefinitely. But indefinitely 152 THE FREEMAN does not mean forever; it only means that we do not know when the string will run out. Whatever the future holds, it is high time we face squarely what has been going on with as precise lan guage as can be had. It needs to be very clear that the villain ofthe piece is not rising prices. We need to un derstand, too, that there is more in volved than increases of the cur rency; that is a necessary adjunct to it but not the whole thing. The vil lain of the piece is an ongoing credit expansion which has produced a credit expansion economy. When we think of it that way we can see more clearly that we have substituted credit for money, and built a Frank enstein credit economy which holds us in its grip. Once we see that clearly, we may be able to see that Reprints. ..

the way to loosen that grip and re gain control of our own financial af fairs is to restore commodity money, reduce our debts, and bring credit under control. One of the lesser credit organiza tions sponsored by the United States government is entitled the Produc tion Credit Association. I think the United States government has be come a Credit Production Associa tion. We need to get the government out of the business of credit produc tion, allow the economy to be de voted to its appointed task of pro ducing goods in terms of supply and demand, not pushed this way and that by credit expansion, and allow prices to signal the market condi tions. To call what is going on credit expansion helps me to see that more clearly. ~d A Page on Freedom Each of these brief messages is a handy way to share with friends, teachers, editors, clergymen, employees and others a thought-starter on liberty. It also serves to introduce the reader to our work at FEE.

See page 131 for this month's Page on Freedom. (Copies of previous messages are also available; specify title When ordering.) Small quan tities, no charge; 100 or more, 5 cents each. Or, feel free to reprint the message in your own format if you'd prefer. We hope you'll enjoy this feature! Order from: FOUNDATION FOR ECONOMIC EDUCATION, INC. IRVINGTON-ON-HUDSON, NEW YORK 10533 Robert Awenius The Forgotten Man IN the last ten years of the 19th cen- . tury and the first ten years of the present the American republic was thrust into a great drama of Amer ican Destiny carried to the far reaches of the world. America breached the trade barriers of Japan and China, and after winning the Spanish-American War, wrenched Cuba and the Philippines from Spain. The Philippines became an American colony and the idea of American Destiny moved strongly across the Pacific Ocean. We wit nessed American imperialism; we were told it was our duty to carry the American concept to the world.