The destructive force of bank credit
Commentators routinely confuse the deflationary effects of a contraction of bank credit with the inflationary effects of central bank policies designed to offset it. Central banks always ensure their stimulus is greater, so inflation, not deflation, is always the outcome.
In order to understand bank credit, we must enter the mind of a banker and understand how it is created, why it is expanded and why expansion is always followed by a sharp contraction.
But we have now moved on from a simplistic credit cycle model, given the global economy was already facing a tendency for bank credit to contract before the coronavirus drove supply chains into the greatest global payment crisis in history. The problem is now so large that to maintain both economic stability and price levels for financial assets the central banks, led by the Fed, will have to issue so much base currency that fiat currencies will become almost worthless.
In these conditions the banks that survive the next several months will then begin to expand bank credit anew to buy up physical assets instead of their normal financial fare, sealing the fate of fiat currencies with a final expansion of bank credit as the banks themselves dump worthless currencies for real assets.
Introduction
Never has it been more important to understand the psychology and motivation behind changes in the level of bank credit at a time when governments and central banks are relying on commercial banks to transmit Keynesian stimuli to distressed borrowers. And never has it been more important for analysts to differentiate between deflationary forces that come entirely from the contraction of bank credit and inflationary forces that arise from central banks’ monetary policy.
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