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Where has all the money gone? | 24 comments (24 topical, editorial, 0 hidden)
Re: What about the prior owner? (none / 1)
My new understanding is, money is "destroyed" when a debt is repaid.

Returning slightly back to rdf's scenario:

The bank had to get the money to lend so it either uses deposits, or, more frequently lately, issued bonds to the public.

It is misleading to say than a bank uses deposits. In principle, a bank loan does not diminish any deposits by a cent. A bank loan is just a new money created our of thin air (which comfortably goes to the "prior owner" in this scenario). The are rules for this money creation out of thin air - see Fractional reserve banking. Roughly speaking, a bank can legally create 90% (or 80%) of its existing deposit volume in new money. But as the new money comes back in deposits somewhere (be it in the same bank), the total new money originated from an original deposit "reserve" may aggregate to several times more than an original "real" money deposit.

The compound interest does not play a role in money creation. All it does is requires extra more money to be created somewhere, for the loan to be repaid fully.

A bank needs to issue the bonds to the public only when its loan volume approaches the deposit volume - normally quite an extreme utilization. But with the quite recent demand of more loans (during the boom), and probably with even more recent demand of deposit withdrawals (during this bust), banks may indeed be forced to raise all their value through public bonds.

In rdf's scenario, new money was created with the loan, and on aggregate there was less money destroyed with the default and bankruptcy of Joe. The monetary volume is increased precisely by the amount of debt not repaid, minus the interests already paid. I know, the natural instinct to look for a more sane circulation of our wonderful monetary system. But the system indeems seems to be that crazy after all, even if appearances were probably kept skilfully very normal for quite long.

by das monde on Mon Jan 19th, 2009 at 03:20:26 AM EST
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Re: What about the prior owner? (none / 0)
das monde:
My new understanding is, money is "destroyed" when a debt is repaid.

Correct. Writing it off is in accounting terms the same as repaying it.

It is the case that banks create money when they create loans and instantaneously create a matching deposit. So the reverse is also true.

Banks also create money when they pay their staff and any other costs add also in paying dividends, again instantaneously creating deposits in the system.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Mon Jan 19th, 2009 at 06:07:26 AM EST
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Re: What about the prior owner? (none / 0)
Writing it off is in accounting terms the same as repaying it.

In accounting formality, yes. But if some credit "created" some monetary volume, and then a portion of it was written off, it sets borrower's account from negative to zero, freeing him up from draining his productivity to repay the debt. What a bank writes off in his books is its claim on debtor's money - the money that was never created in the real world. This kind of default leaves some fiat money in the system that is unmatched by contended debt.

by das monde on Mon Jan 19th, 2009 at 06:27:42 AM EST
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Where has all the money gone? | 24 comments (24 topical, 0 editorial, 0 hidden)
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