17 June 2009

Credit Restriction

From Prosperity and Depression: A Theoretical Analysis of Cyclical Movements, G Von Haberler, rev ed., 1939, published by League of Nations:

Prosperity comes to an end when credit expansion is discontinued. Since the process of expansion, after it has been allowed to gain a certain speed, can be stopped only by a jolt, theere is always the danger that expansion will be not merely stopped but reversed, and will be followed by a process of contraction which is itself cumulative.

If the restriction of credit did not occur, the active phase of the trade cycle could be indefinitely prolonged, at the cost, no doubt, of an indefinite rise of prices and an abandonment of the gold standard.

Well, we abandoned the gold standard, had unrestricted credit, so now we wait for an indefinite rise of prices?

Bookkeeping is more or less based on the assumption of a constant value of money. Periods of major inflations have shown that this tradition is very deeply rooted and that long and disagreeable experiences are necessary to change the habit. One of the consequences is that durable means of production - such as machines and factory buildings - figure in cost accounts at the actual cost of acquisition, and are written off on that basis. If prices rise, this procedure is illegitimate. The enhanced replacement cost should be substituted for the original cost of acquisition. This, however, is not done, or is done only to an insufficient extent and only after prices have risen considerably. The consequence is that too little is written off, paper profits appear, and the entrepreneur is temptted to increase his consumption. Capital in such case is treated as income.

The paper profits are also likely to add to the cumulative force of the upswing, because they stimulate borrowers and lenders to borrow and lend more. The foster the optimistic spirit prevailing during the upswing, and so the credit expansion is likely to be accelerated. This phenomenon has its exact counterpart during the downswing of the cycle.

Those interested in the above may also find Professor Fekete's paper Is Our Accounting System Flawed? of interest.

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