When people hoard cash, prices fall. There’s a deflationary effect. Converesely when people dishoard cash, prices rise. There’s an inflationary effect.
Credit cards cause people to dishoard cash because they don’t have to carry such large cash balances in their wallets or in their checking accounts. Therefore credit cards cause price inflation, just as surely as any increase in the money supply. What’s wrong with that argument?
If the credit card company can hand you thousands of dollars in purchases on demand, that means they have a supply of thousands of dollars available. That means credit card balances are part of the supply of money.
It means the credit card company has counterfeited thousands of dollars on demand.
Aside from whether or not the credit card company can counterfeit money, isn’t there another issue?
For example, suppose I normally keep an average cash balance of $5,000 in my checking account. Suppose I hardly ever let my cash balance drop below $3,000 because I might need that money for a rainy day.
Now suppose I obtain a credit card with a limit of $10,000, I use my credit card for all my payments, and I pay my credit card off every month. My average credit card balance might only be $2,000, but because I’ve got $8,000 in reserve, I can reduce my checking acount balance almost to nothing. Let’s say I reduce my checking account balance to $500. That means I’ve dishoarded $4,500.
That’s got to be inflationary, even if the credit card company is paying for my purchases without any credit creation on its part.
Well, inflation and deflation supposedly mean ‘increase’ and ‘decrease’ of the money supply. Whether people save or consume is not the same thing as printing fiat-money or destroying it - so your usage of the terms may be misleading.
You don’t have 8,000 in reserve. You can get that much ‘credit’ but you need to pay back interests+principal.
If credit is backed by real savings then it’s not inflationary.
Yeah I realize that, which is why I said inflationary effect i.e. having the same effect as printing money.
That’s true, but I’m not spending the $8,000. I’m using it as my “rainy day fund”. In effect I’ve reduced my checking account by the amount I was holding for reserve purposes, and transferred it to my credit card. I no longer need that cash. The credit card company hasn’t increased its cash reserve, so there’s got to be a cash dishoardment.
I understand that argument. I’m not saying what I spend on my credit card has an inflationary effect. I’m saying it’s what I don’t spend i.e. the balance remaining (or credit available), which I’m using in lieu of a cash reserve in my checking account, that has an inflationary effect.
I’m not sure I follow. The principle that ‘backed’ credit is not inflationary always applies. The way different individuals arrange their own financial positions can’t have any overall effect, can it ?
Fine. Those are savings, right ?
I don’t get that. $5000 in a checking account means you have $5000 in savings. The credit card with a limit of $10,000 on the other hand is a way to obtain credit - If you borrow money from the credit card company then you don’t have savings anymore, you a have a debt.
Well, no not exactly. That’s my cash reserve or my “ready cash” or reservation demand for cash . That’s not the same thing as savings.
I’m not contending that the money you spend using your credit card does anything to increase the money supply, or has any inflationary effect. It doesn’t because your credit card company immediately pays the store, and so long as the credit company doesn’t create credit itself, there’s no inflationary effect. That’s not the issue.
The issue is I no longer have to keep my cash reserve. When I had it in my checking account it was just sitting there, but I needed it there to cover unexpected expenses. Now that I have a credit card, I no longer have a need for this “dead” cash because I can use my credit card to cover unexpected expenses. The unused balance on my credit card serves the same function that my cash reserve used to do.
If everybody does this, it reduces the demand for cash, and must therefore have an inflationary effect.
So, you can save for a rainy day, or you can rely on the availability of credit - that’s what you’re saying, no ?
Well, that’s an individual choice. You may think that’s convenient, while some other people may prefer, say, to keep gold coins in their houses.
…But that doesn’t sound possible. If everybody stops saving and instead relies on credit - where will the capital to be lent as credit come from ?
A scenario where everybody has replaced savings by a credit card doesn’t sound realistic to me.
I fail to see how that is different from savings.
They certainly can be inflationary, especially if you default on the payments (as more and more people are these days). This is because of the grotesque fraud of fractional reserve lending, which creates temporary dollars. Normally, the principle would basically be destroyed as soon as you paid it back, the only permanent money being the interest you pay. However, if you default, the temporary money you spent becomes permanent money and thus increases the money supply.
However, because credit cards, like all easy credit enabled by fractional reserve lending, creates bubbles and malinvestments, particularly in consumer goods (similar effects with mortgages caused the bursting housing bubble), it can actually cause an eventual crash in prices of the affected goods or commodities. However, the overall effect will still be price inflation, concentrated in non-bubble areas because of the increase in money supply. In the case of credit cards, this is especially pernicious, because they are most commonly used for discretionary spending, and as such the goods and services in that category will drop in price, while the cost of essential goods, such as food and fuel, increase greatly.
Leonidia is correct that credit cards reduce the demand for cash holding, and indeed the so-called “inflationary effect” shows up in the prices of goods which are normally paid for by credit card. A merchant marks up the prices of those goods to take into account his extra finance costs. Some merchants require their customers to pay a credit-charge for the use of their card, sufficient to cover the fee which the bank charges them, and then their displayed prices reflect the discount for cash.
The “free interest” obtained by using a credit card is somewhat illusory, since the merchant is really charging you indirectly by raising the price of the goods. Often he would give you a discount for paying cash, or if not then you could buy more cheaply from another merchant who would. TANSTAAFL!
Turning now to the question of whether credit card balances should be included in the money supply, there are two balances to consider here - the drawn balance (i.e. the amount owing on the card), and the undrawn balance (i.e. the residual amount up to the credit limit of the card).
Now, the undrawn balance is NOT money. Like any line of credit, it is a conditional right to BORROW money on demand, usually for a predefined term, and at an interest-rate which might make it very unattractive, unless there is a so-called “interest-free” period.
As for the drawn balance, that is a loan from the bank (or whoever has issued the card). The amount in question has been paid in cash to the merchant, so there is no credit creation if the transaction takes place instantaneously, i.e. online. If, however, the transaction takes place offline, i.e. if you sign a slip which lies in the merchant’s drawer until he deposits it in the bank, then that is indeed credit created out of thin air for the brief period of its existence, and should be included in a strict reckoning of the money supply.
Everyone seems to be missing the point;
I’m not taliking about fractional reserve banking, nor am I talking about defaulting on the loan, nor on whether or not merchants deposit the cc slip right away.
I’m talking about something more subtle, so follow closely here.
Most people who have only a checking account never let their balance get close to zero. They keep a certain amount in reserve. That money just sits there, but it serves a very importatnt function. It’s there because people need a reserve “just in case”. It’s what Rothbard calls the reservation demand for money. Now the total demand for money is made up of this “reservation demand” and the “exchange demand”. (I’m ignoring any non-monetary uses) When the reservation demand decreases, that necessarily increases the exchange demand, and this casues prices to rise. Put another way, previously idle cash is being used to buy goods, so prices go up. That’s pretty starightforward stuff.
OK, now suppose you didn’t need this reserve cash any longer because you could use the unused balance on you credit card as the back-up instead. You’ll probably never have to use this back-up, just as you wouldn’t have if it were cash lying around in your checking account. But it’s available if you need it and it serves exactly the same function as if it were reserve cash…except there’s no actual cash there!
And the reserve cash that was in your checking account has been set free. Make sense?
No. Your demand for money has gone down, yes, but the bank’s demand for money has gone up by the same amount. The bank (or card company) still needs to pay the merchant, remember.
And you still keep as much money on hand to pay for goods that are not bought by credit card. Their price is unaffected.
Lance, I’m not talking about the money the credit card company uses to pay for my purchases. Your’re absolutely right that that doesn’t affect the money supply, but that’s not what I’m talking about at all.
“the reserve cash that was in your checking account has been set free”
Look, the reserve cash that was in your checking account has NOT been set free. It has been captured. The card company needs exactly that reserve for the same reasons as you used to. It needs to accomodate all its cardholders’ impulse to buy.
The analysis would be much more complex if FRB were taken into account, but you have excluded this (“I’m not taliking about fractional reserve banking”).
Why has it been captured? Explain that process. The reserve cash that was in my checking account has been spent. It doesn’t have anything to do with the cc company. I’m now “using” my cc as my “reserve” fund, but I haven’t used my cc for that purpose yet.
Maybe I can make this easier to follow. Suppose I have two checking accounts. One I use for purchases, and I routinely run that one down to zero, or close to it. The other one I keep strictly for reserve purposes. I never really use it. Now, I get rid of my second checking account, spend the cash reserve and obtain a cc instead. I don’t make purchases on the cc; because I’m using my first checking account for that. I just carry the cc in case I need it as a reserve. Follow it now?
You’re looking only at the drawing of the credit, not at the line of credit itself. In issuing you with a card, the company must immediately add to its provision for any purchases that might be made. It must keep a float in cash in order to be in a position to pay merchants on demand. It must also be ready to liquidate investments if its float becomes too small, and it must in turn be ready to raise more funds if its pool of investments shrinks too small.
In short, it has to mimic what you, too, had to do when you had to decide how large a cash-reserve to keep, before you got a credit card. You, too, would have maintained a larger cash float, and you might have dipped into your savings to make a large purchase or to do your Xmas shopping.
The company does not, of course, maintain a 100% reserve up to everyone’s credit limit, but only enough on hand to meet all the expected payments for a day. Your cash reserve has effectively been transplanted.