CREDIT IS THE BASIS OF ALL ECONOMIC ACTIVITY / MACLEOD FINANCE

Credit is the basis of all economic activity

Understanding credit is vital if we are to navigate our way through the coming fiat currency crisis. Unfortunately, very few economists do.

ALASDAIR MACLEOD

Credit is the least understood topic of economics, not just by the general public but by economists as well. 

A credit crisis is in the offing, in the form of a fiat currency collapse. 

But when even economists of the Austrian school, who at least have a better grasp of their science than post-Keynesian macroeconomists tell us that the dollar is money and therefore not credit, they are not in a position to advise.

John Pierpont Moprgan in his evidence to Congress in 1912 had it right: Gold is money and all else is credit. 

Even under a gold standard, the dollar was credit, albeit technically a gold substitute. 

Even under a gold standard, gold was always held in reserve: hoarded, if you like by individuals whose gold hording was minimised by faith in the currency. 

Faith that is, that the conversion or credit issued by the issuer would always be freely exchangeable for gold at the predetermined rate.

This article reminds us of the relationship between credit, including currencies, and gold. 

It all goes back to Roman law from which our common laws arise.

Due to its abuse particularly by governments, it is credit which presents the greatest risk to our finances today. 

To appreciate why this is so requires an understanding of what credit represents, and how it differs from real money, which is physical gold without counterparty risk. 

Credit is always matched by debt: your financial asset is always someone else’s obligation. 

The collapse of credit’s value happens when a currency (which is also credit) is not attached by exchangeability to gold. 

That is the danger facing the entire dollar-based financial system today, now that we see the US dollar is ensnared in the US Government’s debt trap

Most people probably think that credit evolved after money in the form of coin, but that is incorrect. 

Credit existed long before, defined in the value of deliverable goods. 

A thousand years before Rome’s Twelve Tables which was their first stab at common law, the Phoenicians traded throughout the Mediterranean and even as far as Cornwall, where they procured valuable tin. 

The Phoenicians would have had the same problems faced by businesses today. 

In order to undertake their trading ventures, they required credit because they faced costs before they hopefully returned from their voyages many months later with vendible products. 

However credit was referenced, from the outset there was another factor faced by a would be debtor and that was the risk in his enterprise perceived by creditors and therefore the returns demanded.

As Demosthenes, the Greek orator and statesman, contemporary of Philip of Macedonia and his son Alexander at the same time as Rome promulgated the Twelve Tables put it:

“If you were ignorant of this, that credit is the greatest capital of all towards the acquisition of wealth, you would be utterly ignorant”.

Perhaps even more so today, we rely on credit for every aspect of our lives. 

Legal money is hardly ever used — today never in the major advanced economies. 

But even in the past, it was subject to Gresham’s Law, hoarded and not spent.

Credit is synonymous with debt. 

It’s not just that we have banknotes and token coins (representative credit), and bank accounts (credit whether you are a depositor or borrower). 

But when you employ a workman, you enter into an obligation to pay him, which is your debt for which he allows you a matching credit until you discharge the obligation with another credit, either in the form of banknotes or a transfer of your credit at a bank to a credit at his bank. 

Alternatively, you might buy an airline or rail ticket in advance. 

You pay with your credit at your bank and the airline or rail company credits you with an obligation to provide a service at a future date.

If you promise your son that you will pay his university fees and give him an allowance, you are entering into an obligation with him, the promise of credits to cover his or her future debt obligations for as long as he attends the university. 

Every transaction, every promise, every guarantee, involves credit with matching debt obligations. 

Demosthenes certainly had a point.

Legally, credit is an incorporeal asset in which all our financial wealth is represented. 

Ownership of gold is corporeal wealth in the form of common law money.

The distinction between corporeal money and incorporeal credit is that the former exists physically (it has a corpus), and the latter is always created between consenting parties in the form of an obligation by the debtor which has value for a creditor. 

The commentators who argue that bank credit should be banned appear to be unaware of this distinction, the true extent of credit in the economy, and the inequity and futility of banning dealers in credit, which is the function of a commercial bank. 

Nearly all trade would cease.

But debt and credit must anchor its value to something. 

At one level, it takes its value from a promise to deliver something else — a corporeal or other incorporeal property. 

But that assumes the purchasing power of credit is anchored. 

In history, the value-anchor was always a corporeal entity such as gold. 

Instead, today it is anchored to another incorporeal asset — central bank credit, or banknotes. 

In other words, the entire structure of national credit hinges on the government’s credibility as issuer of currency obligations.

Furthermore, each jurisdiction has credit values which refer to different currencies, diverse incorporeal liabilities in the form of central bank banknotes and bank deposits on the central bank’s balance sheet. 

A common corporeal gold standard has been replaced by potentially incorporeal chaos.

While the potential for chaos in credit values now exists, credit based solely on a government’s credibility can function for a considerable time. 

But we must recognise that the politicians have high demands placed upon them which inevitably leads them to debauch the currency as a means of surreptitiously transferring wealth from the citizenry to the government so that it can discharge its obligations. 

In the last eighty years, they have even made a virtue of it, claiming variously that the quantity of credit should be expanded to stimulate economic activity, more recently to ensure prices rise at a two per cent rate to bring forward consumption, and to artificially cheapen borrowings at the expense of savers. 

Slowly but surely, these inflationists have descended into the economics of unreason.

The effect on credit’s purchasing power relative to gold is illustrated in the chart below, which is of dollar credit relative to gold just in the last 25 years.

The dollar has lost all but 6.4 cents of its value expressed in corporeal money since the year 2000, continuing its declining trend which is now accelerating. 

Since 1971, the dollar has lost over 99% of its value relative to gold, and sterling has lost even more. 

These currency debasements are measures of the loss of the value of subordinate credit to date under a dollar-based fiat currency regime.

Every transaction, every promise of a transaction, and every commitment to a future transaction has been devalued and will continue to be devalued so long as credit remains detached from corporeal money, which is gold.

With the other side of credit, which is debt, entering a period of increasing risk of default the value of credit is only just beginning to be questioned. 

Those whose wealth is entirely comprised of credit, which is virtually everyone, will find the value of that credit in real terms —that is gold — increasingly undermined by the risk attached to defaults.

The only course for wealth preservation is to own real, corporeal money which legally and practicably is gold. 

And that is why the gold price denominated in fiat currencies appears to be rising faster. 

But it is not gold rising, but fiat currencies entering their inevitable and final collapse.