Think of a simple case.
There is a small economy with $100 money in circulation all of it held by the Bank. A guy named Maker wants to build and sell a widget, but he has no money. So he goes to the Bank and borrows $50. Maker then uses the $50 to pay Helper to help build a widget and then sells it to Customer for $100, who borrowed the $100 from the Bank. Maker then repays $50 to Bank.
At this point, Maker has $50, Helper has $50, Bank has $0 plus a call on Customer's $100 widget. Customer has $0 plus a $100 widget. The cash money supply has not changed, but there is now a $100 widget in the economy. The widget is an asset, so the fiat money supply is increased to $200
Case 1: Customer grows a patch of marijuana and sells some to Helper for $50 and sells the rest to Maker for $50. Then Customer repays the $100 loan to Bank, who now has his $100 back. Customer owns a $100 widget, but there is no change in the cash money supply. Since the widget is a $100 asset, the fiat money supply has increased by $100, the amount of the credit created by Bank.
Case 2: Customer grows a patch of marijuana and smokes all of it himself. Bank then forecloses on the widget which is worthless because it is tainted with marijuana smoke. Bank has $0, but Maker and Helper each still have $50, so the cash money supply is still $100, no change. However, Bank's asset, the widget, is worthless, so the the fiat money supply has been reduced to $100 by the destruction of debt.
In reality things get more complex, but I hope this gives you the general idea how money is created by credit and destroyed by debt default.
Best to all,
JRH |
