Thursday, May 20, 2010

Differences between Money and Credit

Money and credit are very different things.

Money becomes credit by an act of lending. Credit becomes money by an act of spending.

Money is put into circulation by the Federal Reserve. Credit is put into circulation by anyone who borrows money.

Money is removed from circulation by Fed policy decisions. Credit can only be removed from circulation by the repayment of debt.

Oh, and we can use money to pay off debt. But we cannot use credit to pay off debt.

There are many differences between money and credit. Most important of them all is that credit-use carries costs that money does not: the cost of interest, and the repayment of principal. A dollar you earn and spend is gone and soon forgotten. A dollar you borrow and spend may be gone, but if you forget about it the bank will send a reminder -- and you'll pay for your forgetfulness.

My two graphs in the previous post show a change in our economy: a decline in the reliance on money, and an increase in the use of credit as money. Our medium of exchange has become more costly. Costs throughout the economy are greater, because of the increased cost of the medium of exchange.

Costs have consequences.

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