Friday, April 17, 2009

Defining Credit Expansion: Inflation

There is another subpart of inflation called "credit expansion." Some economists say inflation is just an increase in the quantity of money. They differentiate inflation from credit expansion. However, inflation and credit expansion are both a part of the general overall increase in the quantity of legal money available to market participants.

There is a helpful comic strip that appeared in the Washington Star many years ago. In the first cartoon, the banker, sitting behind his desk, says: "Jeff, you have overdrawn your checking account three dollars." Little Jeff replies: "Oh — I'll just write you a check." In the second cartoon, the banker, rather alarmed, says: "Just a minute! You haven't any money in the bank! You overdrew what you had! Now you are using the bank's money!" Little Jeff, not to be taken aback, asks in the third cartoon: "Oh — do you use my money when I have it in the bank?" The banker, astonished, replies: "Er — why, yes, of course!" Jeff then demands: "Well, why can't I use yours?"

This is what happens in modern banking. You put your money in the bank. You think it is there. Yet the bank has been using it. It has been lending your money to others. This double use of the same money is called "credit expansion."

"Credit expansion" is any increase in the number of monetary units loaned that do not represent an equal number of saved monetary units voluntarily made available for lending. Any increase in the purchasing power units of a borrower not offset by an equal decrease in the purchasing power units of a saver is credit expansion, while an increase in borrowing and lending, which is merely an equal transfer of purchasing power units from a lender to a borrower, is not credit expansion.

If you save some money and lend it to somebody else, this is not credit expansion. But if a bank lends money to someone that no one has saved and deposited for lending, if the bank merely creates money by opening or adding to a depositor's account, it is, of course, expanding credit. The bank has increased the quantity of money, but there has been no increase in vendible goods. This means there is more money bidding for the same previously existing quantity of goods. This leads to the great disarray in the market place we call inflation.

So: mortgage credit expansion: housing bubble: bubble pops: generalized financial credit expansion: credit bubble: bubble pops.

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