Best of the Week
Most Popular
1. US Housing Market Real Estate Crash The Next Shoe To Drop – Part II - Chris_Vermeulen
2.The Coronavirus Greatest Economic Depression in History? - Nadeem_Walayat
3.US Real Estate Housing Market Crash Is The Next Shoe To Drop - Chris_Vermeulen
4.Coronavirus Stock Market Trend Implications and AI Mega-trend Stocks Buying Levels - Nadeem_Walayat
5. Are Coronavirus Death Statistics Exaggerated? Worse than Seasonal Flu or Not?- Nadeem_Walayat
6.Coronavirus Stock Market Trend Implications, Global Recession and AI Stocks Buying Levels - Nadeem_Walayat
7.US Fourth Turning Accelerating Towards Debt Climax - James_Quinn
8.Dow Stock Market Trend Analysis and Forecast - Nadeem_Walayat
9.Britain's FAKE Coronavirus Death Statistics Exposed - Nadeem_Walayat
10.Commodity Markets Crash Catastrophe Charts - Rambus_Chartology
Last 7 days
Precious Metals Warn Of Increased Volatility Ahead - 2nd Aug 20
The Key USDX Sign for Gold and Silver - 2nd Aug 20
Corona Crisis Will Have Lasting Impact on Gold Market - 2nd Aug 20
Gold & Silver: Two Pictures - 1st Aug 20
The Bullish Case for Stocks Isn't Over Yet - 1st Aug 20
Is Gold Price Action Warning Of Imminent Monetary Collapse - Part 2? - 1st Aug 20
Will America Accept the World's Worst Pandemic Response Government - 1st Aug 20
Stock Market Technical Patterns, Future Expectations and More – Part II - 1st Aug 20
Trump White House Accelerating Toward a US Dollar Crisis - 31st Jul 20
Why US Commercial Real Estate is Set to Get Slammed - 31st Jul 20
Gold Price Blows Through Upside Resistance - The Chase Is On - 31st Jul 20
Is Crude Oil Price Setting Up for a Waterfall Decline? - 31st Jul 20
Stock Market Technical Patterns, Future Expectations and More - 30th Jul 20
Why Big Money Is Already Pouring Into Edge Computing Tech Stocks - 30th Jul 20
Economic and Geopolitical Worries Fuel Gold’s Rally - 30th Jul 20
How to Finance an Investment Property - 30th Jul 20
I Hate Banks - Including Goldman Sachs - 29th Jul 20
NASDAQ Stock Market Double Top & Price Channels Suggest Pending Price Correction - 29th Jul 20
Silver Price Surge Leaves Naysayers in the Dust - 29th Jul 20
UK Supermarket Covid-19 Shop - Few Masks, Lack of Social Distancing (Tesco) - 29th Jul 20
Budgie Clipped Wings, How Long Before it Can Fly Again? - 29th Jul 20
How To Take Advantage Of Tesla's 400% Stock Surge - 29th Jul 20
Gold Makes Record High and Targets $6,000 in New Bull Cycle - 28th Jul 20
Gold Strong Signal For A Secular Bull Market - 28th Jul 20
Anatomy of a Gold and Silver Precious Metals Bull Market - 28th Jul 20
Shopify Is Seizing an $80 Billion Pot of Gold - 28th Jul 20
Stock Market Minor Correction Underway - 28th Jul 20
Why College Is Never Coming Back - 27th Jul 20
Stocks Disconnect from Economy, Gold Responds - 27th Jul 20
Silver Begins Big Upside Rally Attempt - 27th Jul 20
The Gold and Silver Markets Have Changed… What About You? - 27th Jul 20
Google, Apple And Amazon Are Leading A $30 Trillion Assault On Wall Street - 27th Jul 20
This Stock Market Indicator Reaches "Lowest Level in Nearly 20 Years" - 26th Jul 20
New Wave of Economic Stimulus Lifts Gold Price - 26th Jul 20
Stock Market Slow Grind Higher Above the Early June Stock Highs - 26th Jul 20
How High Will Silver Go? - 25th Jul 20
If You Own Gold, Look Out Below - 25th Jul 20
Crude Oil and Energy Sets Up Near Major Resistance – Breakdown Pending - 25th Jul 20
FREE Access to Premium Market Forecasts by Elliott Wave International - 25th Jul 20
The Promise of Silver as August Approaches: Accumulation and Conversation - 25th Jul 20
The Silver Bull Gateway is at Hand - 24th Jul 20
The Prospects of S&P 500 Above the Early June Highs - 24th Jul 20
How Silver Could Surpass Its All-Time High - 24th Jul 20
China Recovered in Q2. Will the Red Dragon Sink Gold? - 23rd Jul 20
UK Covid19 MOT 6 Month Extensions Still Working Late July 2020? - 23rd Jul 20
How Did the Takeaway Apps Stocks Perform During the Lockdown? - 23rd Jul 20
US Stock Market Stalls Near A Double Peak - 23rd Jul 20
Parking at Lands End Car Park Cornwall - UK Holidays 2020 - 23rd Jul 20
Translating the Gold Index Signal into Gold Target - 23rd Jul 20
Weakness in commodity prices suggests a slowing economy - 23rd Jul 20
This Stock Market Stinks - But Not Why You May Think - 22nd Jul 20
Protracted G7 Economic Contraction – or Multiyear Global Depression - 22nd Jul 20
Gold and Oil: Be Aware of the "Spike" - 22nd Jul 20
US Online Casino Demographics: Who Plays Online For Money? - 22nd Jul 20
Machine Intelligence Quantum AI Stocks Mega-Trend Forecast 2020 to 2035! - 21st Jul 20
How to benefit from the big US Infrastructure push - 21st Jul 20
Gold and gold mining stocks are entering a strong seasonal phase - 21st Jul 20
Silver Eyes Key Breakout Levels as Inflation Heats Up - 21st Jul 20
Gold During Coronavirus Recession and Beyond - 21st Jul 20
US Election 2020: ‘A Major Bear Market of Political Decency’ - 21st Jul 20
Summertime Sizzle for Gold and Silver - 21st Jul 20
Overclockers UK Custom Built PC Review - Delivery and Unboxing (3) - 21st Jul 20
Will Coronavirus Vaccines Become a Bridge to Nowhere? - 20th Jul 20
Stock Market Time for Caution?  - 20th Jul 20
ClickTrades Review - The Importance of Dynamic Analysis and Educational Tools in Online Trading - 20th Jul 20
US Housing Market Collapse Second Phase Pending - 20th Jul 20
Capitalising on the AI Mega-trend - 20th Jul 20
Getting Started with Machine Learning - 20th Jul 20
Why Moores Law is NOT Dead! - 20th Jul 20
Help the Economy by Going Outside - 19th Jul 20
Stock Market Fantasy Finance: Follow the Money - 19th Jul 20
Did the Stock Market Bubble Just Pop? - 19th Jul 20
Quick Souring of the S&P 500 Stock Market Mood - 19th Jul 20
The Six-Year Jobs Recession - 19th Jul 20
Silver Demand Exploding! - 18th Jul 20
Tesco Scraps Covid Safe One Way Arrow Supermarket Shopping System - 18th Jul 20
The Rise of Online Pawnbroking - 17th Jul 20
Gold Rallies Together With U.S. Covid-19 Cases - 17th Jul 20
Gold & Silver Measured Moves - 17th Jul 20
The Bizarre Mathematics Of How Negative Interest Rates Create Stratospheric Profits - 17th Jul 20
From a Stocks Bull Market Far, Far Away, Virus Doomsday Scenerio! - 16th Jul 20
Fiscal Cliffs and the Self-destructing Treasury - 16th Jul 20
Dow Stock Market Crash Watch - Update - 16th Jul 20
Gold & Silver Gaining on US Dollar Weakness - 16th Jul 20
How to Find the Best Stocks to Invest In - 16th Jul 20
Overclockers UK Custom Build PC Review - 2. System Build Changes Communications - 16th Jul 20

Market Oracle FREE Newsletter

How to Get Rich Investing in Stocks by Riding the Electron Wave

Why is deflation and depression inevitable in debt based monetary system like ours?

Economics / Deflation Jul 30, 2010 - 03:49 AM GMT

By: Mansoor_H_Khan

Economics Best Financial Markets Analysis ArticleMoney is civilization’s most liquid asset.   An asset is something of value.    Most liquid means that this is the asset most employees want to get paid in and this is the asset most vendors demand for payment.    For United States of America most employees demand payment in U.S. dollars and most vendors price their products in U.S. dollars and demand payment in U.S. dollars.

The next point to note is that prices of most products and services (by far) in the United States are determined by:
  1. Demand for the product
  2. Supply of the product
  3. Total Supply of Dollars

The first two items listed above are intuitive the last listed item listed above (#3) is not intuitive.  That is correct:   the total supply of dollars available in the economy has a very, very strong influence on prices. 

Let us continue.  Total Supply of Dollars is comprised of:

  1. Coins -  Coins are created by the U.S. Mint.
  2. Paper Bills - Paper Bills (like the Dollar Bill in your wallet).   Paper bills are printed by the U.S. office of printing and engraving.
  3. Bank Deposits -  Bank deposits are created by the banking system.  Any money accessible by “writing a check” counts as money.

Coins and Paper bills are put into circulation by the U.S. government by simply spending them.   How bank deposits are created is the key to understanding deflation and depressions.   Bank deposits believe it or not rule our world because they comprise 95% of the money circulating in the economy.  Money rules our world.  More precisely, those with the power to be able to create new bank deposits (i.e., bankers) rule the world.   Even politicians are easily manipulated by those who hold the power to create money (i.e., bank deposits). 

So how are bank deposits created?

A bank deposit is created when a borrower applies for and is approved for a loan.   The actual creation of the bank deposit is nothing more than a booking entry to a “checking account”.    The act of funding a loan is simply the act of increasing the balance in the checking account of the borrower.  This can occur directly (the bank can simply increase the balance in the checking account of the borrower if the borrower’s checking account happens to be in the same bank) or the bank can just “write a check” and give it to the borrower to spend or deposit it in his checking account.

Don’t worry too much about “how the check clears”?   This is not important to understand deflation and depressions.  Think of the newly created bank deposit (i.e., new money) as the loot and clearing checks between banks is just how the benefits of this loot is shared among the banks.

Think of the banking system as a one “giant bank” in your mind.  Think of it as one giant ledger which keeps tracks of who has how much money.  As individuals write checks to each other the increases and decreases are just entries to this giant ledger.   All new money (bank deposit) creation is simply an adjustment to this huge ledger.  Nothing more.   Sounds too good to be true.  It is true.  Banks however cannot just keep increasing the money supply without worrying about inflation.  Inflation is the balancing force.   The central bank can do various things to reign in bank lending when it is worried about inflation.

Actually, there is another balancing force.   Since new money is created when a loan is funded a bank must find credit worthy borrowers in order to increase the money supply (this last point is not 100% correct, I will explain later).  

So far so good.  So what is the problem?   The problem is that most money in the economy is born (i.e., created) when a loan is funded.  And the next point is even more important: 

Money dies when a loan is paid back by the borrower!

Yes.  That is correct.  When a borrower uses money (in most cases another bank deposit) to pay interest and principle to the lending institution the bank deposit used as payment “dies”.   Under normal circumstances this is not an issue because new borrowings (new bank deposit creation) normally more than offsets the money (bank deposits) destroyed when loan balance and interest charges are paid down.

So do you see that if the net of borrowings (creation of bank deposits) and paying loans back (destruction of bank deposits) is not such that more money is being created than being destroyed then we will have deflation (due to decrease in money supply) and eventually a depression.   

Eventually all debt based money creation systems (like ours) reach a point where the private sector refuses to borrow more because it will eventually become too indebted (even at zero percent interest rates) and the banks will get to a point where they will be too hesitant to lend because they will see the onset of deflation coming.  Some people call this “Peak Credit”.   But it may take a long time to reach “Peak Credit”.   Our current cycle of credit expansion started in 1940 (start of WWII) and ended in 2007.  Depressions are usually resolved via resets (massive defaults) and can easily lead to wars and chaos.   

So why would we ever design a monetary system which has to end in a deflationary collapse?  The answer is very simple:   It keeps bankers in power.

Of course, the resolution to this problem is very simple.   Bank deposits should be born (created) as equity and not debt just like Coins and Paper Bills.

Mansoor H. Khan

About the author: I am an Electrical Engineer by training (Bachelor of Engineering from Stevens Institute of Technology). I also have a Masters of Business Admnistration degree (MBA) from the University of Virginia.

© 2009 Copyright Mansoor H. Khan - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules