Fractional Reserve Flaw Query

drunken_munky52

At the heart of our economic system lies the monetary system. How can the fractional reserve policy (been a form of debt) allow for sustainability in our system? How can the creation of debt in the system to begin with, supposed to improve it?

Flamed Diving

Search in the forum for this term, there has been plenty of similar threads, recently.

drunken_munky52

Im sorry, but Ive done my own research into the FR system and the mechanics of it a very straight forward once all the terminology is translated into English. Other threads in this forum on the issue over complicate it.

I just want to hear from people who have studied economics to answer a few simple questions, because I cant get my head around why its simplicity is not apparent. I associate debt with the FR system quite frankly, but feel free to enlighten me.

1. Is the system inherently debt prone?

2. Is it designed to create debt?

3. Is not the aim of any economy to be debt free?

Flamed Diving

I have taken part in such a thread, where a member of the CT forum asked us to simplify our explanations, which we did. The thread contains dozens of lengthy posts, with diagrams and links to further research. I am not willing to go to such lengths again, perhaps find this thread and start posting in it. The OP was toracx (sp?).

Time Magazine

drunken_munky52 wrote: »

1. Is the system inherently debt prone?

The opposite side of debt is credit. Companies, people, governments regularly need credit. This emerges from the natural phase of life: people need mortgages to buy houses, then they pay it off over many years; small enterprises' lack of credit at the moment is so serious it has become a political issue; etc. Rather than asking "is it inherently debt prone", phrase it as "is it designed to make credit as available to those who need it?" and you get a more accurate and less-CT view imho.

2. Is it designed to create debt?

Nobody (people, companies, governments) take on debt unless they want to. It's not designed to create debt, it's designed to provide funds for mortgages, car loans, business expansions and government deficits.

3. Is not the aim of any economy to be debt free?

No.

The aim of an economy is to, roughly speaking, provide enough GDP per person so that we can all live comfortably. Businesses are currently closing because they can't borrow to see themselves through a difficult period. In this case, it is better for them to take on short-term debt than to close down. Thus it is not an aim of an economy to be debt free. You're thinking far too much from a personal point of view, and not thinking of the economy as a whole.

silverharp

Time Magazine wrote: »

The aim of an economy is to, roughly speaking, provide enough GDP per person so that we can all live comfortably. Businesses are currently closing because they can't borrow to see themselves through a difficult period. In this case, it is better for them to take on short-term debt than to close down. Thus it is not an aim of an economy to be debt free. You're thinking far too much from a personal point of view, and not thinking of the economy as a whole.

The was an problem developing in mautre economies like the US in that the amount of debt required to generate an extra $ in GDP was rising since the 1980's. At some level the debt was not self liquidating or tied to new production so it had to crack. There is something dysfunctional about an economy where the money and credit is growing faster then the underlying GDP

Flamed Diving

So you advocate a situation where [latex] \frac{\Delta M}{M} - \frac{\Delta Y}{Y} \leq 0[/latex]? Over all time?

silverharp

I'd look at it terms of marginal productivity of debt. Throw in some demograhics data which would show peak baby boomer earning and spending capacity tailing off in the next couple of years and you would see where I'm coming from, a lot of credit is going to go to money heaven over the next decade. In previous post bubble contraction real interest rates tend to rise possibly up to 8%-10%. That should be enough to clear the excess debt but it wont be pretty. It will be fascinating to watch

Flamed Diving

I know this is kind of splitting hairs, but hasn't marginal productivity been falling in the US anyway?

But yeah, I'm not disagreeing with the notion that debt rising by multiples of real GDP over decades is a bad thing. But having a little bit of money growth is ok. Right? We are all familiar with this argument, I presume.

silverharp

Flamed Diving wrote: »

I know this is kind of splitting hairs, but hasn't marginal productivity been falling in the US anyway?

But yeah, I'm not disagreeing with the notion that debt rising by multiples of real GDP over decades is a bad thing. But having a little bit of money growth is ok. Right? We are all familiar with this argument, I presume.

I'd summarise it by saying that in the US real incomes have gone nowhere in the last 20 years and have depended on taking on increasing amounts of non liquidating debt. There is nothing wrong with an increase in private credit so long as the decisions are left to the market but its pretty clear that the Fed cant control where the credit it encourages out the door ends up.