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Source link: http://archive.mises.org/10237/credit-expansion-crisis-and-the-myth-of-the-saving-glut/

Credit Expansion, Crisis, and the Myth of the Saving Glut

July 7, 2009 by

Credit expansion was the source of the funds that fueled both the stock market and the real estate bubbles. In the case of the stock market bubble, credit expansion provided funds for the purchase of stocks. The sellers of the stocks then used the far greater part of their proceeds to purchase other stocks, whose sellers did likewise. In this way, the new and additional money created by credit expansion traveled from one set of stocks to another, raising the prices of the great majority of them. It continued to do this so long as the credit expansion went on at a sufficient rate. FULL ARTICLE


End the Fed July 7, 2009 at 10:07 am

“That inflow, representing a “global saving glut,” was responsible for the bubble and its aftermath.”

And I suppose everyone would be better off if the government went in and smashed everyone’s windows.

There is no such thing as “too much savings”.

2nd Amendment July 7, 2009 at 11:18 am

End the Fed,

“There is no such thing as “too much savings”.”

There is no such thing as “enough savings” in the first place.

Besides, what is saved today will be spent tomorrow. It’s not like all this money is being burned in the furnace or being destroyed, it will be injected back into circulation in the future.

And if we had sound money and a sound economy, just saving your money at the bank makes more money available for investments.

Saving would not destroy the economy if we had sound money and 100% reserve banking.

Nathan July 7, 2009 at 12:51 pm

100% reserve banking is just as much a government construct as fractional reserve banking. Under free banking, reserve ratios are determined by investors looking for a balance of solvency and returns on capital.

Beta Hater July 7, 2009 at 2:29 pm

Nathan: “100% reserve banking is just as much a government construct as fractional reserve banking.”

The 100% reserve is not a government construct. It is a contract construct: the 100% reserve is the defining feature of the bailment contract. There is no transfer of ownership in the bailment contract. The depositor contracts so the warehouse will maintain 100% availability. The Free Bankers often overlook the differences between the bailment and loan contracts.

Would you argue that every voluntary (mutually beneficial) contract is a government construct?

John Rolstead July 7, 2009 at 2:47 pm

Dr. Reisman,
Great article. But I think your opening comment about skipping the first sections if familair with the concepts does a disservice to the reader. The material covered in those sections is superb. I was not aware of the reserve to fiat money ratios that you mentioned. I have read your book and found it to be one of the best economics books available. It is very understandable and covers all points listed in this article.

You confuse government with law. Government is force, not law. Law is prevailing norms in society. We all agree to abide by the law because it benifits us all. The enforcement of law does not have to be provided by government. It could just as well be enforced by voluntary agreedment to arbitration. Bonding of individuals would give incentive to conduct oneself according to those norms, or else lose your bond. On the Law, see Frederic Bastiat.

Enforcement of 100% reserve requirements is a contractual obligation between the banker and the depositor. I do NOT consent to him loaning my money. In a just world, I would have the option to take him to court and sue for damages. A fantastic book on this topic is Money, Bank Credit, and Economic Cycles by Jesus Huerta de Soto.

End the Fed July 7, 2009 at 3:04 pm

Fractional reserve banking is fine, as long as banks are actually allowed to fail (instead of being propped up by “more liquidity”).

Sally C. July 7, 2009 at 5:28 pm

Brilliant article. I do wonder whether Greenspan was put under political pressure to keep interest rates low in order to stop the dollar from strengthening too much against the yuan. But that is the only mitigating factor I can think of – if that is indeed what happened. Otherwise, Greenspan carries an enormous burden of responsibility for this economic crisis. Did you or other Austrian economists warn him at the time?

Sally C. July 7, 2009 at 5:28 pm

Brilliant article. I do wonder whether Greenspan was put under political pressure to keep interest rates low in order to stop the dollar from strengthening too much against the yuan. But that is the only mitigating factor I can think of – if that is indeed what happened. Otherwise, Greenspan carries an enormous burden of responsibility for this economic crisis. Did you or other Austrian economists warn him at the time?

Sally C. July 7, 2009 at 5:29 pm

Brilliant article. I do wonder whether Greenspan was put under political pressure to keep interest rates low in order to stop the dollar from strengthening too much against the yuan. But that is the only mitigating factor I can think of – if that is indeed what happened. Otherwise, Greenspan carries an enormous burden of responsibility for this economic crisis. Did you or other Austrian economists warn him at the time?

Eric July 7, 2009 at 6:04 pm

End the Fed:

I think it’s the FED’s legal tender status which is the real problem. If banks and their depositors want to play a ponzi game, that’s fine, just so long as they can’t force the rest of us to accept their currency.

If there were also no taxes on money exchanges (and no capital gains either) I think the world would quickly solve the problem caused by the FED.

I think it’s much more plausible to see a future with competing currencies than outright ending of the FED.

End the Fed July 7, 2009 at 7:15 pm

“I think it’s the FED’s legal tender status which is the real problem.”

Well of course. That’s the only reason anybody can get away with fractional reserve banking (and not eventually go bankrupt). Loan out 99% of everyone else’s money, and when they want their money back, pay them with a bunch of counterfeit Non-Federal Non-Reserve Notes. After all, it’s “legal tender”, so you have to treat it the same as the original money.

Adam Odorizzi July 7, 2009 at 9:15 pm

Ha, article of the year. Period. Awesome.

EIS July 7, 2009 at 10:52 pm

“It represents the sum of all of the loans and investments that the banking system has made based on the foundation of the creation of money out of thin air.”

In all honesty, I still don’t understand the nature of FRB. People constantly say that money is being created out of “thin air.” But isn’t the velocity, that is, the circulation of the money, really the only thing increasing? Money isn’t being created, just exchanging at a faster pace. Please correct me if I’m wrong.

Also, credit cards are probably a form of fiduciary media. Where’s the money that backs them up, or supposed to back them up?

newson July 8, 2009 at 12:44 am

to eis:
mv=py is a dodgy, monetarist abstraction.

newson July 8, 2009 at 12:49 am

excellent article. longhand way of expressing what fritz machlup said:

“… continual rise of stock prices cannot be explained by improved conditions of production or by increased voluntary savings, but only by an inflationary credit supply.”

(“the stock market, credit and capital formation”)

scott t July 8, 2009 at 1:47 am

this link http://www.hussmanfunds.com/html/fedirrel.htm

contains the following excerpt –
“….a change came in the 1970s with the emergence of money market funds, which require no reserve requirements. Then in the early 1990s, reserve requirements were dropped to zero on savings deposits, CDs, and Eurocurrency deposits. At present, reserve requirements apply only to “transactions deposits” – essentially checking accounts. The vast majority of funding sources used by banks to create loans have nothing – nothing – to do with bank reserves.
These days, commercial and industrial loans are financed by issuing large denomination CDs. Money market deposits are largely used to lend to corporations who issue short term commercial paper. Consumer loans are also made using savings deposits which are not subject to reserve requirements. These loans can bunched into securities and sold to somebody else, taking them off of the bank’s books.”……….”The point is simple. Commercial, industrial and consumer loans no longer have any link to bank reserves. Since 1995, the volume of such loans has exploded, while bank reserves have actually declined .”

is the above posted inforamtion at odds with portions of the (claimed) dr. reisman article where it states —

“For the three years 2001–2004, the Federal Reserve created as much new and additional money in the form of additional bank reserves as was necessary to drive and then keep the federal-funds rate below 2 percent. And from July of 2003 to June of 2004, it drove and kept it even further down, at approximately 1 percent.
The new and additional money created by the banking system on the foundation of these new and additional reserves appeared in the loan market as a new and additional supply of loanable funds.”

can anyone clarify what seems to me to be somewhat opposite thing s being said?


Matt B July 8, 2009 at 2:29 am

I have a similar question. In Reisamn’s article he sates the following.

“In December of 1994, the monetary base was $427.3 billion. In December of 1999, it was $608 billion. In December of 2007, it was $836.4 billion.”

“In December of 1994 such reserves were $61.36 billion; in 1999, they $41.7 billion; in December of 2007, they were $42.7 billion.”

So i take it, nearly all of the credit expansion was the result of changes in reserve requirements. I know Reisman refers to this, but he doesn’t specify how much of the expansion was a result of the aforementioned changes. Am i missing something here? Did the fed, during 2001-2004, simply change the reserve requirments, instead of increasing bank reserves, when it wanted to lower the target rate?

Andreas July 8, 2009 at 3:23 am

Savings glut is real,

although I usually enjoy reading articles on mises.org and I am sure that credit expansion caused the crisis, the article does not provide evidence against a savings glut. It did not even explain the emergence. It seems to me that the author ignores the fact this strand of literature makes to point out further reasons of credit expansion (besides the Feds policy).

The banking sector expands credit lines, not the Fed. And if the banking sector finds ways to expand credit lines – it will. Reisman is right when saying the Fed also may encourage credit growth by too low interest rates. This is a widely acknowledged point in the debate. Even though there is noone who is sure when exactly and to what level the Fed should have raised the rates.

Bernanke’s argument is not new. The Chinese government stabilizes its exchange rate against the dollar. By stabilizing the rate, it must buy dollars and sell the Chinese yuan. This causes a monetary expansion in China and a huge accumulation of reserves. To dampen the monetary expansion the Chinese authorities restrict bank lending and so forth. Banks have to fulfil high minimum requirements (thereby dampening consumer spending as well).

The accumulated reserves are invested in long-term US government bonds allowing US banks to extent credit lines. This may as well be called savings glut. As goverment bonds are long-term, this allows for a reduction of long-term interest rates (e.g. mortgage rates). This contributes to credit expansion especially in the housing sector.

I do not question that a less expansionary monetary policy would have also led to fewer reserve accumulation as the appreciation pressure of the yuan would have been smaller. And the banks would have had a lower base to multiply by the money multiplicator. But the fact of the savings glut, due to exchange rate stabilization policies cannot be wiped away like this.

Anyways, I am sure that Hayek was right when writing that the “perverse elasticity of the banking sector” causes boom-and-bust. The central bank may contribute to this (and it did), but even a very restrictive central bank would not have hindered the banking sector from expanding credit lines too far.

To my mind there is no easy explanation. And pointing the finger to one actor in the game – to me is not very serious!

Jeff July 8, 2009 at 8:02 am

This is a very interesting piece, but I have to ask a clarifying question, because I’m new here. When Prof. Reisman writes that the Fed prints money, this is just shorthand for “buying Treasury securities” right?

Thank you.

Tallin April 12, 2011 at 4:47 pm

Good point. I hadn’t thohugt about it quite that way. :)

Paul Marks July 8, 2009 at 9:22 am

If I agree to pay back some gold (or some silver – or some other commedity), plus a certain amount of interest, on a certain day this is nothing to do with the government.

It might become something to do with the government if I do not pay the money and the person (or association, such as a bank) I borrowed from sues me in a government court. But the actual agreement is not government.

That is why banking that does not involve credit expansion (i.e. people lending out real savings – money they have chosen not to consume, and not to have till when and if I pay it back) is not a government construct.

It is only if people are lending out more money than actually exists in real savings, or people pretend that money that is lent out still exists “on deposit” in the possession of the savings (at the same time as it has been lent out) that we are off in Oz and strange things are happening.

ganpalou July 8, 2009 at 9:22 am

Riesman writes a beautiful, well thought out article. (Have you noticed that, every time Bernanke lies, a hair falls from his head?) I will reread the article, thoroughly, again.
If the article wasn’t so well delivered, its limitations would not be so obvious. Riesman clearly has an intuitive understanding, “a priori” in the terms of Kant, of Newtonian determinism and the use of differential, and partial differential, equations. He doesn’t refer to the math, but clearly thinks in those terms.
The shortcoming of the article parallels the shortcomings of Newtonian determinism: it is great for predicting the behavior and relationships over time of two bodies, two variables, but collapses when a third body, or variable, is introduced.
I refer Riesman back to Ricardo. It was not without reason that Ricardo used the term “Political Economics.” We have a good deal more sophistication in the shortcomings of Newtonian determinism than Ricardo had, yet Ricardo intuitively recognized the “Political” half of “Political Economy.”
In our case, the third variable is the “Pax Americana,” the military dominance of the U.S., and the willingness of the “Commander in Chief” to use the military in wierdly unpredictable ways to maintain this “Pax Americana.” When Japan bombed Pearl Harbor, we declared war on Germany. We fought in Korea for no good reason, and again in Viet Nam. When Al Queda burned the twin towers, we invaded Iraq. For everyone else, we have demanded that they play nice, or else, or we might bomb Belgrade again. Strangely enough, the world has accepted this bizarre behavior as better than the alternatives, and has supported it. That is the kind of thing one would expect from “Chaos Theory,” not from Newtonian determinism. And world acceptance of the stability of U.S. wierdness accounts for the infusion of international capital into the U.S. in spite its misuse. The other factor encouraging international investment and misuse is the “passive investment tax haven” status of the U.S.
Both Greenspan and Bernanke seem to believe that the “Pax Americana” will be accepted by the rest of the world forever, and that the Fed can print up hyperinflated “greenbacks” to retire their abuses. I am not so sure that the “Pax Americana” is a constant, and that we only need to concern ourselves with the investment/consumption, “Economy,” end of “Political Economy.”

Paul Marks July 8, 2009 at 9:26 am


Sadly there are all sorts of ways the Fed (or the Bank of England or…..) can inject money it has just created – not just buying T. Bills.

For example, it can buy the bonds of favoured corporations.

Central Banks (whatever they are called) are lawless and arbitrary things – driven by the whims of those who control them.

That they are presented as the guardians of savers (“fighting inflation”) is one of the biggest jokes in political economy.

Jeff July 8, 2009 at 9:50 am


Thanks for your reply. I see you what you mean in terms of the Fed’s ability to manage the money supply. I just want to make sure nobody thinks that the Fed actually prints the money.

I otherwise agree with your assessment of the Fed and, in fact, central banks generally.

John Rolstead July 8, 2009 at 5:01 pm

As Paul stated, the Fed can buy any asset with newly created money. That money is usually in the form of a check. That check is presented to the receiver’s bank for payment in dollars. The bank then presents it back to the Fed. The Fed exchanges the check for increased bank reserve balance at the Fed. The bank then has more reserves. The bank can then loan out those reserves at up to the inverse of the reserve ratio. The current reserve ratio is 1/10. So they can loan out up to 10 times thier reserves. – See Jesus Heurto de Soto’s book.

What the Fed has done since the Treasury decided that the last thing they wanted was to have a market for mortgage backed securities is to buy up MBS from the banks at face value. They are exchanging paper assets that are probably worth 30 cents on the dollar with real dollars. This is a great help for the banks. The Fed will hide these assets on thier balance sheet until things settle down. You can see this in the ballooning Fed balance sheet.

But just wait until the banks start lending all that new money! If only they could find people willing to borrow!

Jeff July 9, 2009 at 6:48 am


Thank you for that example. It clears my mind up about this, in that it’s an increase in M2. That makes perfect sense, and I agree with what you and others have posted about the destructive nature of such transactions.

Many thanks,

Adam Odorizzi July 9, 2009 at 2:31 pm


You may want to actually read the article, mate. Difficult to rectify what you said with the notion you read it.

Andreas July 9, 2009 at 3:16 pm


I did read the article. And I am aware of what Bernanke means by the savings glut. To my mind Bernanke is completely right with his analysis of the savings glut. And nothing of it is represented in this article.

ganpalou July 11, 2009 at 8:31 am


I agree with your conclusion, that blaming one person, or institution, doesnt explain the phenomenon, but your comment isnt terribly clear, at least to me.
For this phenomenon, I have been impressed by:
1. A definition of inflation as “an excess of liquidity, not an increase in prices” by the minister of the interior of China, during the Sechuan earthquake cleanup. I sounded like it was delivered by a Harvard MBA. The Chi-Coms, no less, were preaching the dogma.
2. That bundled derivitives were upgraded, and bought as face value liquid assets. I can imagine trying to sell them, but not buying them.
3. That Fannie Mae and Freddie Mac upgraded and dumped a tremendous amount of these assets on the markets.
3. That “inhouse” and “outhouse” accountants for financial and other businesses allowed these assets on the books and, in effect, wrote the justification for the practice.
4. That trustees of any corporations accepted the purchase of upgraded derivitives by the officers, and the justification, not to mention basing bonuses on the practice.
5. That financial houses were able to do business, not with 10 to 1 ratios, but 30 to 1. They had only 3% in the game.
6. It reminds me of the ’80s, when the Nikkei was at 60,000, and we were told that Japan was a great investment, that “They do their accounting differently.”

Matt July 12, 2009 at 3:50 pm

Great Article but no need to be so lengthy in identifying the dishonest of their deliberate use of obfuscating language as a cover-up of their dastardly deeds.

The FED was created for the benefit of continuous deficit spending by Congress and for the benefit of Banks to make risky loans way above deposits for guaranteed profits until this last economic downturn of their own creation.

The cause of the Depression we are now in can be placed directly on Congress and the FED… The old ways will be continued as can be seen with the Bailouts and Stimulus Packages now in effect. The American public has been and is given a snow-job. Will they wise-up? Stay tuned!

Andreas July 23, 2009 at 1:26 pm


China did have a savings surplus. This is represented by its current account surplus. Thus, they buy less than they sell. So there are left-overs (savings).

This is how it works:
To buy a house you need a mortgage with a duration of maybe 10 years. If the Chinese buy government bonds from American banks to invest their savings, this provides banks with long-term capital. And they did as US government bonds represent the American economy and were considered the savest of all investments.
With more long-term capital, banks can lower long-term rates. This is what happened.

I am not saying that US monetary policy or the banks’ creation of market liquidity had no impact – but Chinese savings did provide financial institutes with long-term capital and did put a downward pressure on long term rates.

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