Credit expansion cannot increase the supply of real goods. It merely brings about a rearrangement. It diverts capital investment away from the course prescribed by the state of economic wealth and market conditions. It causes production to pursue paths which it would not follow unless the economy were to acquire an increase in material goods. As a result, the upswing lacks a solid base. It is not a real prosperity. It is illusory prosperity. It did not develop from an increase in economic wealth [i.e. the accumulation of savings made available for productive investment]. Rather, it arose because the credit expansion created the illusion of such an increase. Sooner or later, it must become apparent that this economic situation is built on sand.

Hat tip to John Hussman

Ludwig von Mises: The Causes of Economic Crisis (1931)

3 thoughts on “Ludwig von Mises: The Causes of Economic Crisis (1931)

  1. Dean Akin says:

    But at the most basic level, a farmer can use credit to increase his/her production which boosts the ‘real’ economic base. The problem arises when credit is diverted to activities which do not cause a corresponding expansion of economic base e.g. Assets with finite supply – mortgages in UK is a classic example.

    • ColinTwiggs says:

      I agree that not all credit is bad. If used to fund productive assets, the economy as a whole can benefit. For example a South American country borrows internationally to fund construction of a major hydroelectric scheme. The additional GDP generated by the scheme is sufficient to service the loans and pay off the debt within a reasonable time period. The country as a whole has benefited.

      Von Mises was talking about domestic credit expansion, however, where a deficit in one sector is funded from a surplus in another, else you have monetary debasement. If the central bank creates new money via credit expansion, there is no offsetting surplus. What normally happens is that the additional funds are channeled into non-productive, speculative investment as inflation expectations rise. The result is a bubble out of which no good will come.

      In the unlikely event that the surplus is invested in productive assets, then production will rise and inflation remains muted. There are now more goods chased by more money, rather than the same goods pursued by more money in the former, inflationary scenario. But that only happens in fairy tales ……and economic theory.

  2. Interesting quote. Credit expansion is always a difficult one for me to wrap my head around. I can see the perils of both the current fiat system and the alternatives. Until someone comes up with a better system, I guess we are stuck with the status Quo

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