permanent money creation via loan default?

[Pianist4Freedom]

I asked this question in my previous post, but did not receive an adequate answer----if someone defaults on a loan, and the bank is unable to recover its loss, then does that mean that the deposits created by whomever received money from the debtor remain in circulation? How does such money get "erased" as it does when a loan is paid off normally?

 

[scooter]

The money only becomes permanent if the bank fails completely, thus requiring federal funds to satisfy deposits. At that point the money that was expanded via fractional reserves is permanent. If the bank stays solvent and maintains reserves during the time period that a loan defaults, and they don't recoup the full value, they will first take the hit on their profits and loan loss reserves. If they begin to lose profitability and they take a hit to their deposit reserves, but still maintain solvency, the money on the markets will temporarily not match their previous levels versus total reserves. However, if they stay in business they will spread that loss out over their long-term profitability and the new money still does not become permanent.

Permanent new money can only come from the government. Either by government debt or by using debt to finance a bank failure.

Keep an eye on all of these new assets that the government has taken control over. If they prove to be big losers (I think they will), then the money supply will expand drastically, causing some quite shocking inflation down the road. Will it be balanced out by the asset deflation caused by a severe recession? That remains to be seen.

 

[tmosley]

That's an interesting way to think about it. Inflation only becomes permanent through default. If everyone defaults, there's a ton of inflation (as we have seen), but if everyone pays off their loans, the money disappears, and we get deflation. You are right on the first point.

As to your second question, when you pay off the loan, the money simply vanishes, much like it just "appeared" when the loan was issued (based on a fraction of the amount loaned being in their vaults--supposedly). When you pay back the loan, the principle disappears, but they keep the interest, which they can either keep in the vaults to lend more money, or take as profit and spend.

It's a man eat man world, not by nature, but by the machinations of the bankers. They have set us against one another while sitting back and collecting interest on the whole monetary system.

 

[Pianist4Freedom]

It seems to me there are valid criticisms of fractional reserve banking but I have difficulty thinking of it as two groups of people: evil lazy bankers versus the pure, virtuous hard working people that have deposits with them.

It seems to me the whole system is dependent upon initial participation and incentives. Why does debt exist at all? People want what they want now rather than later, whether it be just stuff for themselves, or starting a business, etc. People don't want to wait. Hence there is a demand for debt.

The second thing is that if given the choice, people would rather part with paper to pay off taxes than with a hard asset such as silver. Hence there is demand for fiat money.

How do you convince absolutely everyone in society to be disciplined enough to want to almost never use debt, and to never accept fiat money (when given the opportunity to pay off taxes with it?)? I'm beginning to think these things are a part of human nature, and that it may be unrealistic to completely get rid of it. It is almost as unrealistic as socialism. Instead....as has always been the case in history, we will always be somewhere between the two extremes.