What Credit Is and What It Isn’t

Many of the improvements in financial conditions can be traced, in part, to policy actions taken by the Federal Reserve to encourage the flow of credit. For example, the decline in interbank lending rates and spreads was facilitated by the actions of the Federal Reserve and other central banks to ensure that financial institutions have adequate access to short-term liquidity, which in turn has increased the stability of the banking system and the ability of banks to lend.

—Ben Bernanke, Testimony before the Congressional Committee on Banking

Gary North already commented on Mr. Bernanke’s inability to answer some big questions. He also showed that Mr. Bernanke’s self-confidence is a bit premature: Banks are not lending. If history repeats itself, then Mr. Bernanke won’t be able to answer the questions any time soon, and his policies will be a failure for quite a while. There is a reason for it,and the reason is not the current economic situation, not even Mr. Bernanke’s policies. They are only a symptom of a deeper illness—ignorance about basic economic truths and definitions.

The opening quotation demonstrates this ignorance in the very area Mr. Bernanke is supposedly the nation’s expert: credit. He apparently believes credit is something that banks give to people and businesses. It’s all up to the banker to give or take credit away. So, if the government manipulates the bankers—or persuades them, I should say—they will start giving credit, and the economy will recover. All it takes is a few turns of a potentiometers up or down, and the credit flow will be assured, and the world economy will be saved.

Mr. Bernanke should read some basic books on economics that my children (homeschooled) read at a very early age. Henry Hazlitt’s Economics in One Lesson is one of them. It can save him from quite a few economic fallacies that he has fallen victim to. There he can read the following basic economic truth:

There is a strange idea abroad, held by all monetary cranks, that credit is something a banker gives to man. Credit, on the contrary, is something a man already has. He has it, perhaps, because he already has marketable assets of a greater cash value than the loan for which he is asking. Or he has it because his character and past record have earned it. He brings it into the bank with him. That is why the banker makes him the loan. The banker is not giving something for nothing He feels assured of repayment. He is merely exchanging a more liquid form of asset or credit for a less liquid form…[1]

That’s it. Credit is not something fluid, and its flow cannot be controlled by government agencies. Credit is a form of capital that the borrower already has. He is only capitalizing on it by exchanging it for a more liquid form of capital. The banker “buys” the borrower’s credit, hoping to be able to “sell” it back to him in the future at a higher price. If he misjudges the real value of the borrower’s credit, then he won’t be able to sell it back for a higher price. He might not be able to get anything back for it.

That can also explain the problems we have on the financial markets: The lending institutions have lost their ability to assess credit in what it really is. They have paid exorbitant prices for credits that have no value (subprime). The reason can be traced back to the lack of understanding about what credit is and what credit isn’t. The bankers have bought into the fallacy that credit is something they give to people and businesses. And the results are obvious. Bad ideas have bad consequences.

The morning after, the bankers are sober and the reality is ugly. They are more willing now to understand what credit really is, and they can see the economy has lost its capital of credit. Therefore they are not willing to spend money on it. Mr. Bernanke is less willing to understand. For the banks to lend when there is no reserve of real credit in the economy is like spending money on fake goods. We can spend millions of dollars on fake cars or fake houses but in the end people still won’t have cars for houses. Only the fake producers will be happy.

Of course, the wrong definition for credit itself is only a symptom of a deeper problem—philosophical and religious. It comes from a fallacious worldview, one based on materialistic presuppositions. In that view, the economy is a machine where capital, humans, and institutions are simply impersonal factors—if we have the right mix of them at the input, we’ll get the right results at the output. That’s what all politicians of the 20^th century believed and most of the economists.

The Christian worldview gives the only valid and practical foundation for understanding economics. Economy is not an impersonal machine, it is the sum total of the moral decisions of the economic participants under the covenant law and sanctions of God. In that view Hazlitt’s definition of credit is the correct one: Credit is the accumulated moral capital a person or a business has, based on their integrity, their time-preference (long-term commitment), and their hard work— in short, on their obedience to the Law of God.

This is what Mr. Bernanke and everyone else needs to learn.

Bojidar Marinov will be posing regular articles on American Vision’s site. He founded the Bulgarian Reformation Ministries that translates works of the Reformation as a ministry of discipleship to the church in Bulgaria and around the world. Since 1995 he has translated more than 30,000 pages and published 13 books. For more information, go to www.BulgarianReformation.org

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