Robert Blumen is right, Money is not Credit. But the problem is that the current economic theories do not differenciate them properly, including the classic austrian school of economics. In fact Mises did include Credit “Money” within the same category of Commodity Money (Money Proper or Money in the narrower sense). Indeed, just the term Credit “Money” is really confusing, that´s why I am quoting the word money in that context.
Considering credit “money“, which is a future good, within the same category of commodity money, which is a present good, leads to tremendous errors. For example, it leads to consider that someone lending out new credit “money” is granting new credit when is totally the opposite, he is receiving credit because he is issuing debt.
Only the owners of present goods shall grant new credit. The definition of credit is lending out present goods in exchange of future goods (promises to deliver present goods in the future).
Once you are aware of this, it is very easy to see how Central Banks are not lenders of last resort but first instance borrowers, and that commercial banks are mainly debtors. Just have a look at their balance sheet, their equity is ridiculous. Banks are way more than 90% indebted. Who are the creditors then? The creditors are the agents that give away present goods in exchange of Dollars, Sterling or Euros, which are future goods (bank liabilities), and those agents are mainly the “free” market (i.e. almost everyone except the banking system and the State).
So, I think that Robert Prechter´s understanding of current monetary system is superior than that of many austrian scholars, because he has noticed that today´s money is not money, it´s credit used as a medium of exchange. Unfortunately there´s been a long time since we don´t use money anymore (money understood as a present good). By the way, Mises failed on providing a monetary theory that clearly separates money from credit, but at least he noted 100 years ago that most fiat currency systems are in fact credit currency systems (p. 61 of Theory of Money and Credit). It is unbelievable how most austrians scholars describe our current monetary system as fiat!!
If we have a huge credit contraction, banks are not going to be able to issue new currency, because banks issue additional new currency when they “lend” (monetize) new credit. But if agents are not borrowing from other agents (through bank intermediation) and instead they are paying down debts, then dollars are being withdrawn from the system, these dollars will just disappear when used to pay down debts the same way they were created.
Remember, credit is inflationary at the moment of its monetization, but it is deflationary for the rest of its existence. There is a crucial difference between pure fiat currency and credit currency, the former will always remain in the system unless the issuer withdraws it, the later will always expire at some point in the future.
But all this credit contraction won´t happen as long as the main credit bubble, which is the Bond market, does not implode, because the Bond market is still allowing the government to issue new debt, so the banking system still has fresh new debt to be monetized and therefore pump new dollars into the system. These new dollars are still enough to offset the destruction of dollars caused by maturing outstanding debt.
So the Bond Market is the last bastion of the credit bubble, once it bursts, deflation will enter full throttle in the monetary system.
Regarding the classic austrian monetary theory not drawing a crystal clear line between money and credit, the austrian (“mengerian”) economist Carlos Bondone provides the solution. Departing from Carl Menger and disregarding the errors of Mises and Hayek, he proposes the following new monetary structure:
Currency: Indirect medium of exchange and unit of account. Currency Types:
- Money: Present good when it is used as currency (wheat, cattle, gold, silver, deposit certificates of gold or silver, etc.).
- Credit currency: Any currency that is not money, it can only be credit. Then there are the following types of credit currencies:
- Regular Credit currency: When the present good that cancels the debt is specified, and so is its quality, quantity and due date. This is the case for real bills maturing in gold or old bank bills that where redeemable for gold or silver.
- Irregular Credit Currency: When the present good that cancels the debt is not specifed or its quality or its quantity or its due date. This is the case for today´s currencies such as dollars or euros.
It is extremely important to clearly separate money from credit, so everyone can understand that credit currency is not money regardless that both of them may be used as currency (medium of exchange). Considering credit as a perfect substitute of money is as dangerous as using vacuum instead of air to keep a ship afloat.