Fundamental principle of lending: Lending is an exchange of present savings for future obligations or goods, while unbacked credit leads to economic impoverishment by diverting real savings from productive activities.
Real savings come before lending, and lending is an exchange of present savings for future obligations or goods. The use of money in lending transactions does not change this fundamental principle. Unbacked credit, on the other hand, leads to economic impoverishment, as there is no real exchange taking place. Instead, borrowers spend money they don't have, leading to the diversion of real savings from productive activities. The essence of lending remains an exchange of present savings for future obligations or goods, regardless of the medium of exchange used.
Fractional Reserve Banking: Banks can create credit from nothing, leading to potential instability in the financial system when they lend out more than they have on deposit
Fractional reserve banking allows commercial banks to create credit out of thin air, which can lead to problems when banks lend out more money than they have on deposit. This creates a situation where money seems to disappear, as the borrowed money is not backed by real savings and is instead based on the original savings of the depositor. When the borrower uses the borrowed money for purchases, they are essentially exchanging nothing for something. This can result in a mismatch between the amount of money in circulation and the amount of real savings, leading to potential instability in the financial system. It's important to note that when the loan is repaid on maturity, the money does return to the original lender, but the overall impact on the economy can be significant. This process highlights the importance of maintaining a sufficient reserve ratio to ensure that the amount of credit created is backed by sufficient real savings.
Credit creation: Credit creation out of thin air can lead to unsustainable consumption and a decline in real savings, eventually impacting the money stock and economic activity
When a bank generates credit out of thin air, it leads to the creation of new money without any corresponding increase in real savings. This results in an exchange of nothing for something and sets the stage for non-productive activities. In contrast, when a borrower receives a loan from an existing saver, the loan is fully backed by real savings. The creation of new money through credit out of thin air can lead to an unsustainable increase in consumption, eventually causing real savings to decline. In essence, the bank acts as a mediator in the transaction, but when credit is generated out of thin air, there is no original lender or saver, and the money leaves the economy when it is repaid to the bank. This process can lead to a decline in the money stock and economic activity if it continues unchecked.
Real savings and economic downturns: The decline in the money stock due to repaid and unrenewed loans is not the primary cause of an economic recession. Instead, it's the shrinking pool of real savings that leads to the decline in the money stock and ultimately an economic downturn. Even if the central bank prevents the fall of the money stock, a depression can still occur if the pool of real savings is declining.
The fall in the money stock due to repaid and unrenewed loans does not directly cause an economic recession. Instead, it's the shrinking pool of real savings resulting from previous easy monetary policy that leads to the decline in the money stock and ultimately an economic downturn. Even if the central bank prevents the fall of the money stock, a depression can still occur if the pool of real savings is declining. It's essential to remember that lending requires real savings as a foundation, and lending without real savings backing can lead to economic impoverishment. This perspective stems from the Chicago school of economics, particularly Milton Friedman's teachings. For further insights, visit Mises.org.
Lending without Saving Brings Recession and Poverty
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