Credit is not the same as money (even if you can't see it)

David Glasner at Uneasy Money: Milton Friedman Says that the Rate of Interest Is NOT the Price of Money: Don’t Listen to Him!


In the days before the internet, I wrote to Milton Friedman three times. He wrote back every time. That was great.

Not only that, but I could tell from Friedman's answers that he read and understood what I said. That's a rare and precious thing. For this reason I will always think of Milton Friedman as a great economist, no matter how many problems I have with his economics.


David Glasner quotes Friedman, from the Friedman Heller debate:

... the interest rate is not the price of money... The interest rate is the price of credit. The price of money is how much goods and services you have to give up to get a dollar.

That's it. That's it exactly. I had written to Milton Friedman, and my explanation for what I was thinking was: the interest rate is the price of money. Friedman wrote back to me, saying the interest rate is not the price of money; the interest rate is the price of credit; the price of money is what you have to give to get the money.

I remember, because I had to think about it for years before it made sense to me. Literally, for years.

It made sense, finally, when I realized that credit is not the same as money. Here's how I see it: I can get money two ways. Either I work for it, or I borrow it. If I work, I help to build this civilization and the money is my reward. If I borrow it, I'm going to have to pay it back, with interest.

Credit is not the same as money. The idea came to me direct from Milton Friedman. Having embraced the idea, I can easily see people who have not taken that idea to heart. People like David Glasner, who writes:

What is wrong with Friedman’s argument? Simply this: any asset has two prices, a purchase price and a rental price. The purchase price is the price one pays (or receives) to buy (or to sell) the asset; the rental price is the price one pays to derive services from the asset for a fixed period of time. The purchase price of a unit of currency is what one has to give up in order to gain ownership of that unit. The purchasing price of money, as Friedman observed, can be expressed as the inverse of the price level, but because money is the medium of exchange, there will actually be a vector of distinct purchase prices of a unit of currency depending on what good or service is being exchanged for money.

But there is also a rental price for money, and that rental price represents what you have to give up in order to hold a unit of currency in your pocket or in your bank account. What you sacrifice is the interest you pay to the one who lends you the unit of currency, or if you already own the unit of currency, it is the interest you forego by not lending that unit of currency to someone else who would be willing to pay to have that additional unit of currency in his pocket or in his bank account instead of in yours.

I have a problem with that. Glasner says there is always a rental price for holding money. If it's money you borrowed, he says, the rental price is the interest you pay on the loan. If it's money you earned, money you "own" as Glasner says, there is still an opportunity cost for holding it, and this is its "rental price".

But if the dollar in my pocket is borrowed, I can still choose to lend it out and collect interest on it. If I fail to do that, then by David Glasner's logic I am paying the rental price twice for that dollar, once for interest, and again for the lost opportunity.

So, looking at it Glasner's way, if the dollar in my pocket is my own, I am paying the rental price which is an opportunity cost. But if the dollar in my pocket is borrowed, the rental price I pay is opportunity cost plus interest cost. The cost (or "rental price") of a borrowed dollar is different from that of a dollar I own. Therefore, a borrowed dollar is different from an earned dollar.

An earned dollar is "money". A borrowed dollar is "credit". The opportunity cost for holding money applies to both money and credit. The interest cost applies only to credit.

Milton Friedman was right: The interest rate is the price of credit. David Glasner cannot see it, because he has not embraced the idea that credit is not the same as money.


One more point. I want to leave out the "opportunity cost" part and look at the rest. Glasner says:

But there is also a rental price for money, and that rental price represents what you have to give up in order to hold a unit of currency in your pocket or in your bank account. What you sacrifice is the interest you pay to the one who lends you the unit of currency ...

Glasner says that in order to hold a borrowed dollar, I have to pay interest to the lender. That's incorrect. I don't have to pay the interest because I'm holding the dollar. I have to pay the interest because I borrowed the dollar! Look what happens when I finally spend that dollar: The fellow who receives that dollar does not have to pay interest on it even if he holds that money. The interest obligation stays with the borrower.

The interest obligation is part of the same loan agreement that created the credit you could spend. That's what credit is: a "medium of exchange" dollar that moves through the economy, and a dollar of debt that stays with the borrower.

When you borrow a dollar you receive a dollar of money and a dollar of debt sandwiched together. When you spend it, you peel off the money layer, spend that part, and keep the rest. The borrower retains the debt. But the borrowed dollar, once spent, is freed of the debt obligation and is thereby transformed from credit to money.