Comment by caf | Hacker News Reader

Comment by caf | Hacker News Reader

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It works like this: imagine we create some new Bank. Customer A deposits his life savings of 1 million hackerbucks.

Now our Bank loans out 50,000 of those hackerbucks to Customer B. It does this by crediting her account with 50,000 hackerbucks, but notice that Customer A still has 1 million in his account - so now there's 1,050,000 hackerbucks in apparent existence - we've created 50,000 hackerbucks from thin air. If Customer B withdraws the loan money to go spend it, the Bank will have 950,000 in reserves and an asset worth 50,000 (the loan). Customer B will have 50,000 in cash.

What we've actually done is increase the "M2", one of the measures of how much money is in the economy.

If Customer B either repays the loan or defaults on it, that new money disappears. In the loan repayment case, the Bank goes back to having 1,000,000 in reserves, and in the loan default case the loan asset becomes worthless and it is left with only 950,000 in reserves (the other 50,000 is out there with wherever Customer B spent it).

Thank you for clarifying.

So the bank's speculative asset loses value: I struggle to see this as money being destroyed as it wasn't actually money, it was an asset with a price attached to it which has now changed. In contrast to money sat in your bank account, the price was never redeemable (you couldn't go spend it on beer) unless you used that asset to get the debtor to pay you back (or convinced someone else it was worth buying from you as a speculative asset). You might as well say money is destroyed when share prices tumble. Maybe this is the point of such arguments, to make the case that money is no different to any other asset, but we don't tend to treat it like that in reality. Or do we?

It's money in the same sense as the money that was created by the loan in the first place is money - it's not physical currency, but the insight is that the money created by financial means like this bids up prices in the same way as literally minting extra physical currency and distributing it would.

When that loan asset is written down the bank has to make up the difference from its equity - this ends up reducing the amount of loans it can write, so you get a contraction in the monetary supply.

So in the end, I guess the shorter answer is that a default destroys money in the same way that writing a loan creates it - you might well complain that no actual currency has been created or destroyed, but the argument is that it has a similar overall effect.

If Customer B repays the loan, the new money disappears but the money made in interest stays. Eventually does a bank get to a point where it has enough real money, that it can lend it out instead of increasing the money supply?

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