Wednesday, March 19, 2008

Is credit money?

In the current financial system, credit is, without a doubt, money.

Fractional reserve banking enables banks to make loans much larger than their deposits on hand, and these loans act as real live money, buying houses, cars, plasma TVs, etc.

The Austrians certainly have thought longer and harder about this than I have, but it's become clear that credit increases money supply (at least in a fractional reserve system that allows maturity mismatching), and can do it through mechanisms far outside the control of the Fed. One wonders what the point of a Fed is in an environment where so many institutions, many of them not even banks, can create such huge quantities of money through new credit facilities.

One of the primary financial innovations beyond the housing bubble in the US were easier credit facilities for borrowers (the now famous NINJA loans, Opt-ARMs, Neg-Ams, etc.) I don't think that the money these easier credit facilities created show up on M1, M2, M3, or MZM, or M Prime. But they clearly showed up in real estate prices.

So, what does money supply mean in the context where you have the Fed controlling interest rates, and all kinds of other institutions creating and extending credit? More soon.

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