While money and credit are associated with wealth, they aren’t the same thing as wealth. Because money and credit can buy wealth (i.e., goods and services), the amount of money and credit you have and the amount of wealth you have look pretty much the same. But you cannot create more wealth simply by creating more money and credit. To create more wealth, you have to be more productive. The relationship between the creation of
money and credit and the creation of wealth is often confused, yet it is the biggest driver of economic cycles. Let’s look at it more closely.
There is typically a mutually reinforcing relationship between the creation of money and credit and the creation of goods, services, and investment assets that are produced, which is why they’re often confused as being the same thing.
Think of it this way: there is both a nancial economy and a real economy. Though they are related, they are di erent. Each has its own supply-and-demand factors that drive it. In the real economy, supply and demand are driven by the amount of goods and services produced and the number of buyers who want them. When the level of goods and services demanded is strong and rising and there is not enough capacity to produce the things demanded, the real economy’s capacity to grow is limited. If demand keeps rising faster than the capacity to produce, prices go up and in ation rises.
That’s where the nancial economy comes in. Facing in ation, central banks normally tighten money and credit to slow demand in the real economy; when there is too little demand, they do the opposite by providing money and credit to stimulate demand. By raising and lowering supplies of money and credit, central banks are able to raise and lower the demand and production of nancial assets, goods, and services. But they’re unable to do this perfectly, so we have the short-term debt cycle, which we experience as alternating periods of growth and recession.
Then of course there is the value of money and credit to consider, which is based on its own supply and demand. When a lot of a currency is created relative to the demand for it, it declines in value. Where the money and credit ow is important to determining what happens. For example, when they no longer go into lending that fuels increases in economic demand and instead go into other currencies and in ation-hedge assets, they fail to stimulate economic activity and instead cause the value of the currency to decline and the value of in ation- hedge assets to rise. At such times high in ation can occur because the supply of money and credit has increased relative to the demand for it, which we call
“monetary in ation.” 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 de ation. That is how in ationary depressions come about. For
these reasons we have to watch movements in the supplies and demands of both the real economy and the nancial economy to understand what is likely to happen nancially and economically.
For example, how nancial assets are produced by the government through scal and monetary policy has a huge e ect on who gets the buying power that goes along with them, which also determines what the buying power is spent on.
Normally money and credit are created by central banks and ow into nancial assets, which the private credit system uses to nance people’s borrowing and spending. But in moments of crisis, governments can choose where to direct money, credit, and buying power rather than it being allocated by the marketplace, and capitalism as we know it is suspended. This is what happened worldwide in response to the COVID-19 pandemic.
Related to this confusion between the nancial economy and the real economy 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. To the extent that spending increases economic production and raises the prices of goods, services, and nancial assets, it can be said to increase wealth because the people who already 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 e ect when the bill comes due and 2) the intrinsic value of a thing doesn’t increase just because its price goes up.
Think about it this way: if you own a house and the government creates a lot of money and credit, there might be many eager buyers who would push the price of your house up. But it’s still the same house; your actual wealth hasn’t increased, just your calculated wealth. It’s the same with any other investment asset you own that goes up in price when the government creates money—stocks, bonds, etc. The amount of calculated wealth goes up but the amount of actual wealth hasn’t gone up because you own
the exact same thing you did before it was considered to be worth more. In other words, using the market values of what one owns to measure one’s wealth gives an illusion of changes in wealth that don’t really exist. As far as understanding how the economic machine works, the important thing to understand is that money and credit are stimulative when they’re given out and depressing when they have to be paid back. That’s what normally makes money, credit, and economic growth so cyclical.
The central bankers who control money and credit (i.e., central banks) vary the costs and availability of money and credit to control markets and the economy. When the economy is growing too quickly and they want to slow it down, central bankers make less money and credit available, causing both to become more expensive. This encourages people to lend rather than borrow and spend. When there is too little growth and central bankers want to stimulate the economy, they make money and credit cheap and plentiful, which encourages people to borrow and invest and/or spend. These variations in the cost and availability of money and credit also cause the prices and quantities of goods, services, and investment assets to rise and fall. But banks can only control the economy within their capacities to produce money and credit growth, and their capacities to do that are limited.
Think of the central bank as having a bottle of stimulant it can inject into the economy as needed. When the markets and the economy sag, it delivers shots of the money and credit stimulant to pick them up. When the markets and economy are too strong, it gives them less or no stimulant. These moves lead to cyclical rises and declines in the amounts and prices of money and credit, and of goods, services, and nancial assets. These moves typically come in the form of short-term debt cycles and long-term debt cycles. The short-term debt cycles of ups and downs typically last about eight years, give or take a few. The timing is determined by how long it takes the stimulant to raise demand to the point that it reaches the limits of the real economy’s capacity to produce. Most people have seen enough of these short-term debt cycles—popularly known as “the business cycle”—to know what they are like, to such an extent that they mistakenly think they will go on working this way forever. I distinguish them from the long-
term debt cycle, which typically plays out over 50 to 75 years (and so contains about six to 10 short-term debt cycles).4 Because the crises that occur as these long-term debt cycles play out happen only once in a lifetime, most people don’t expect them. As a result they typically take people by surprise and do a lot of harm. The long-term debt cycle that is now in the late-cycle phase was designed in 1944 in Bretton Woods, New Hampshire, and began in 1945, when World War II ended and the dollar/US-dominated world order began.
These long-term debt cycles are driven by the amount of stimulant left in the central bank’s bottle. They start after previously existing excess debts have been restructured and central banks have a full bottle of stimulant. They end when debts are high and the bottle of stimulant is nearly empty or, more speci cally, when the central bank loses its ability to produce money and credit growth that passes through the economic system to produce real economic growth. Throughout history, central governments and central banks have created money and credit, which weakened their own currencies and raised their levels of monetary in ation to o set the de ation that comes from de ationary credit and economic contractions.
This typically happens when debt levels are high, interest rates can’t be adequately lowered, and the creation of money and credit increases nancial asset prices more than it increases actual economic activity. At such times those who are holding the debt (which is someone else’s promise to give them currency) typically want to exchange the debt they are holding for other storeholds of wealth. Once it is widely perceived that money and debt assets are no longer good storeholds of wealth, the long-term debt cycle is at its end, and a restructuring of the monetary system has to occur.
Since these cycles are big deals and have happened virtually everywhere for all of recorded history, we need to understand them and have timeless and universal principles for dealing with them well. But most people, including many economists, don’t even acknowledge their existence. That’s because to get a sample size of observations that is large and diverse enough to give one a good understanding, one has to have studied them over many hundreds of years in
many di erent countries. In Part II we will do just that, examining the most important of these cycles across history and around the world, with reference to the timeless and universal mechanics of why money and credit work and fail to work as mediums of exchange and storeholds of wealth. In this chapter, I will synthesize all those cases so I can show you how they work archetypically.
I will begin with the basics of the long-term debt cycle from way back when and bring you up to the present, giving you the classic template. To be clear, I’m not saying that all cases transpire exactly like this one, but I am saying that they almost all follow this pattern closely.