Credit is inflationary because people don't prefer cash

Credit is inflationary if people think it is cash or if they think it is as good as cash...

If the supply of cash increases in the economy, prices will rise; we can say that the price of cash has fallen (each unit buys less)... If the supply of credit increases in the economy and people think that it is in fact cash then so too will the price of cash fall.

If people don't know the difference between credit and cash (money) then the supply of either one will affect the price of the other. If issuing extra credit means more people think they have cash then prices will rise (inflation).

Sometimes when a child opens a present it decides to play with the box rather than the gift. So then is there any reason not to describe the box itself as the gift just as much as the contents?

If they do discover a difference and conclude that credit should be worth less than cash, then this is deflationary. If they are then reassured that credit is as good as cash (for whatever reason) prices will be restored to their previous level.

Given that legal tender derives its value from taxes and its ability to discharge debts in a court of law, then if people can be convinced that bank credit (and Treasuries) will also perform the same function equivalently then they will be reassured.

We can safely assume that the courts accept those forms of currency at the present time in the payment of debts so what reason could there be for the State to rescind that judgement? The courts would need to rebel against the banks and the Debt Management Office (which issues the Treasuries). This would be a major political shift, a revolution.

So then, if they have discovered that a difference between credit and cash exists, people will discount credit to the extent that they expect a revolution of this kind...


Credit is inflationary because people don't prefer cash... or at least, if they do they don't prefer it sufficiently to compensate for the convenience (and perhaps even payment on their balance, erroneously* described as interest) of having their currency in the bank. You can either have a bank account and credit or no bank account and cash. Given that cash can't be held in a bank (with all the privileges and fees that are typical) people are satisfied with credit.

The problem with cash is that as soon as you put it in the bank it turns into credit... cash turns into credit when you put it in the bank.

The rewards for putting the money in the bank (free banking, fees and so on) for most people, outweigh the perceived risk that credit will not in the long run be redeemable for cash assuming they even are aware of a difference between the two forms of currency. People prefer to keep their money in the form of credit rather than cash because the State rewards them for doing so.

*The money has not been loaned because the customer can still get access to it on demand, so it is not interest.

18th February 2009

Update: If they (the Government) did use the freshly-printed money to pay off account-holders then the depositor would have been correct to value credit equivalently to cash... Since that isn't going to happen (it wouldn't be politically expensive to default, only a small percentage of people have significant savings) credit is currently mispriced and it would be a good idea for depositors to ready themselves to beat the rush when people come to mistrust the banking system.

Depositors are naive to think that their money will be safe if there is a collapse of the banking system. (19th Feb'09)