The Quantitative Theory of CREDIT

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jamster777's picture
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The Quantitative Theory of CREDIT

 Has anyone read "The New Depression" by Richard Duncan?

In this book, Richard Duncan proposes that we replace the Quantitative Theory of Money with the Quantitative Theory of Credit.

The Quantitatve Theory of Money is the mechanism by which many economists like Milton Friedman explain inflation/deflation.  The theory stated in an equation is:


where M = Money supply, V = Velocity of money, P = price, and T = volume of transactions.  Bacically MV is the number of dollars that were spent in a given period of time and PT is the cumulative value of all the transactions that took place.  V is supposedly relatively independent and based on technical factors in the economy, and T is considered to change only in a transient manner.  So, if  M goes up or down, then P has to eventually follow. Hence inflation/deflation.

Duncan proposes that this is no longer correct because money is now dominated by credit.  Financial products like mortgage-backed securities have now become (1) a store of value, (2) a unit of account (since they are denominated in dollars), and (3) liquid.  In other words, these products new meet  all the basic characteristics of money and is therefore indistinguishable from fiat money.  If this is the case, then the Quantitative Theory of Credit woudl be


where C is the amount of credit (debt instruments etc) in the economy. This was a compelling argument for me.

So if this were true, what would it mean for the inflation many of us have been anticipating?  $3 trillion of QE might be a lot compared to the base money supply, but how does it compare to the $50 trillion in dollar-demoninated credit?  If there were a massive deleveraging of the economy, could the Fed conceivably print enough money to make up for all that collapsed debt and cause asset inflation to boot?

What about the price of gold?  We don't really have just M3 chasing all the gold in the world, we have the $50 trillion in credit chasing it plus all the other currencies.  Would a few trillion dollars printed up by the Fed really change that dynamic much? If there were debt deleveraging could the price of gold still go up given the huge reduction in credit?

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