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There's a big difference between commodity credit and circulation credit. Commodity credit is backed by savings, which enable producers to sell a portion of their goods, invest the money, but save the remainder. In this case, the producer can dispose of these products and lend money to another producer in the same field through a bank. At this stage, the bank serves as an agent between the two, while the second producer assumes the market and purchases the items, later selling them at a profit while continuing to manufacture other products. The process shows the continuity of investment from the first producer who saves his money in the bank while the second producer uses the same funds to grow their business.
On the other hand, circulation credit is a situation where the bank lends money deposited by people to a producer without the consent of the depositors. Since banks have a lot of depositors’ money at their disposal, they reduce the return rates which attract many producers. The producers acquire the credit and invest in the production of more commodities. The money is not used in obtaining real products but rather employed to the production costs such as wages, billing, and purchase of raw materials. According to Mises, this process disrupts the interest rates since it is the market prices that dictate the decision of both the borrower and lender. Real commodities establish demand and supply which sets the standard interest rates.
Circulation credits trigger a boom and then a bust in the business cycle. As interest rates lower, producers invest heavily in the production of commodities which are set at high prices due to the costs associated with their production. Consumers, on the other hand, fail to meet the set prices, and the producers’ capital is held up in the stocks. At this point, banks realize the underperformance among the producers and set the return rates back to normal. Low-interest rates improve the demand for goods and services hence creating an economic bust.
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