The Fundamentals
While money and credit are associated with wealth, they aren’t wealth. Because money and credit can buy wealth
(i.e., goods and services) the amount of money and credit one has and the amount of wealth one has look pretty
much the same. But one cannot create more wealth simply by creating more money and credit. To create more
wealth, one has to be more productive. The relationship between the creation of money and credit and the creation
of wealth (actual goods and services) is often confused yet it is the biggest driver of economic cycles, so let’s look
at this relationship more closely.
There is typically a mutually reinforcing relationship between a) the creation of money and credit and b) the
amount of goods, services, and investment assets that are produced so it’s easy to get them confused. Think of it
this way. There is both a real economy and a financial economy. Though they are related, they are different. Each
has their own supply and demand factors that drive them. For example, in the real economy, when the level of
goods and services demanded is strong and rising and the capacity to produce those things demanded is limited,
the real economy’s capacity to grow is limited and, if demand keeps rising faster than the capacity to produce,
inflation rises. In that example inflation rises because of what is happening in the real economy. Knowing that,
central banks normally tighten money and credit at such times to slow the demand. That is an example of
something that is happening in the financial economy affecting what’s happening in the real economy. During
normal times, which is through most of the long-term debt cycle, central banks turn on and turn off credit, which
raises and lowers demand and production. Because they do that imperfectly we have the short-term debt cycles,
which we also call overheated economies and recessions. In the financial economy, normally money and credit are
created by central banks and flow into financial assets, which produces lending that finances people’s borrowing
and spending with the private credit system allocating that money and credit. How financial assets are produced by
the government through fiscal and monetary policy has a huge effect on who gets the money and credit and the
buying power that goes along with it, which also determines what it’s spent on. For example you now see
governments atypically giving money, credit, and buying power to those they want to get it to rather than it being
allocated by the marketplace, so you are see capitalism as we know it being suspended.
Then of course there is the value of money and credit to consider. It is based on its own supply and demand. For
example, when a lot of it is created relative to the demand for it, declines in its value will occur. Where it flows to
is important in determining what happens. For example, when the money and credit that central banks are creating
no longer go into lending that fuels increases in economic demand and instead go into other currencies and
inflation-hedge assets, it fails to stimulate economic activity and instead causes the value of the currency to decline
and the value of inflation-hedge assets to rise. At such times high inflation can occur because the supply of money
and credit has increased relative to the demand for it, which we call monetary inflation. That can happen at the
same time as there is weak demand for goods and services and the selling of assets so that the real economy is
experiencing deflation. That is how inflationary depressions come about. For these reasons to understand what is
likely to happen financially and economically one has to watch movements in the supplies and demands of both
the real economy and the financial economy.
Similarly confused is the relationship between the prices of things and the value of things. Because they tend to go
together they can be confused as being the same thing. They tend to go together because when people have more
money and credit they are more inclined to spend more and can spend more. In other words, if you give people
more money and credit they will feel richer and spend more on goods and services. To the extent that spending
increases economic production and raises the prices of goods, services, and financial assets, it can be said to
increase wealth, because the people who own those assets become “richer” when measured by the way we account
for wealth. However, that increase in wealth is more an illusion than a reality for two reasons: 1) the increased
credit that pushes prices and production up has to be paid back, which, all things being equal, will have the
opposite effect when it has to be paid back and 2) the intrinsic value of things doesn’t increase just because their
prices go up. Think about it this way: if you own a house and the government creates a lot of money and credit and
the price of your house goes up you will still own the same house—i.e., your actual wealth hasn’t increased; just
your calculated wealth has increased. Similarly, if the government creates a lot of money and credit that is used to
buy goods, services, and investment assets (e.g., stocks, bonds, and real estate) which go up in price, the amount of
calculated wealth goes up but the amount of actual wealth hasn’t gone up because you own the exact same thing as