[Having drawn attention in my last post to Fritz Machlup's superb 1940 book, The Stock Market, Credit, and Capital Accumulation, it occurred to me that excerpts from that work concerning the circumstances in which an increase in the supply of "fiduciary" bank credit will not promote an Austrian-type business cycle would make a good entry for our recently inaugurated Alt-M Classics series. Machlup studied under Ludwig von Mises at the University of Vienna, and was for many years among the leading champions of Mises' work, including his theory of the business cycle. His opinions concerning the part that bank credit expansion plays in provoking cycles therefore deserve to be taken seriously by all students of the subject.



Mises' business cycle theory plays an especially prominent part in Machlup's 1940 book, the original German version of which appeared in 1931. (The English edition was prepared by none other than the great Vera Smith, based on Machlup's revisions to the German original. ) Indeed, despite it's more specific-sounding title, the book addresses many of the more important controversies being contested in the field of monetary economics during the crucial decades of the 1920s and 30s. Although copies of the 1940 book are as rare as hen's teeth, the Mises Institute has published a reprint. Better still, it has made a PDF of it available online.

Although they speak directly to the subject I addressed in my last post, the brief excerpts taken from Machlup's book below only begin to scratch the surface of the rich vein of insights to be found in it. So do by all means consider reading the whole thing! — George Selgin, Editor-in-Chief.]

There are certain considerations which can be stated in fairly simple terms, and which seem to me to enable us to find the limits within which it is possible to expand bank credit without incurring the penalties. Newly created credit places money capital at the disposal of the market without any corresponding release of productive factors due to voluntary refraining from consumption. Whereas the normal process of capital formation consists of two steps, saving and investing, newly created bank credit makes it possible for investment to take place in the absence of voluntary saving, and this is what gives rise to the development of disproportionalities in the production process. We are also familiar with the opposite case of one sidedness in the process: intended saving without investment, that is hoarding. In this case, the private saving … fails to produce any saving from the intended social point of view. In other words, it does not lead to any capital formation. The command over consumers' goods or over the corresponding factors of production, instead of being made over to an investor in the form of "capital disposal," is returned to the consumers (and other buyers) in the form of a deflationary fall in prices, or it is even lost if wage rigidities do not permit that the labour force be bought for a reduced amount of money.

This exposition points straight to the answer to our question. No disturbance in the productive structure of the economic system will be caused provided the investment without saving — which is financed by credit expansion — does not exceed the saving without investment — which is sterilized by hoarding. This leads to the conclusion that the limits of a healthy inflation of credit are determined by the extent of the simultaneous deflation due to hoarding.

High-flown inflationary aspirations do not receive much support from our conclusions. Our rule says that additional purchasing power may be created and lent to investors to the extent that there are funds that have been saved but not invested. In other words, unused purchasing power is substituted for by newly created purchasing power (pp. 1835-4). …

I use the term transfer credit if the purchasing power accruing to the borrower is counterbalanced by purchasing power forgone by somebody else, such as a voluntary saver or a disinvesting producer. My term "transfer credit" corresponds to Mises' term "commodity credit." For Mises' term "circulation credit" I have substituted the term "created credit," which clearly conveys the meaning that the purchasing power accruing to the borrower is not counterbalanced by any purchasing power forgone by anybody else (p. 224).

Transfer credit based on a true short-period postponement of consumption is of considerable importance in practice. The fact that from the point of view of the individual saver it is only intended to be a short-term loan does not limit the possible ways of using it as much as one might first think. For even though the individual savings are only saved for a Individual temporary period, collectively they may in large part be looked upon as long-term savings of the economic system. In most cases the temporary saver who withdraws his funds in order to make the purchase that he had previously postponed has a successor who is just saving part of his income for later use. The probability that the new savings will be sufficient to cover withdrawals of old savings is what makes it possible to invest these short-term funds in production. The system whereby this investment is made through the stock exchange has special advantages, for in this case the transformation of what are short-term credits from the private viewpoint into long-term savings from the social viewpoint can take place to the fullest extent, and if, when the temporary savings are withdrawn, there is no new saver to take the place of the old, the withdrawal will usually express itself not in a reduction of the capital supply but in a reduction of the consumption expenditure of the person who sells the securities at reduced prices (p. 225).