Defaulting on debt deflationary?

[Mister Grieves]

I've read on some boards, I'm pretty sure this one as well, that when debts are defaulted on and bankruptcies run rampant that it is deflationary because wealth in terms of dollars is being destroyed. The thing is, that when I got to thinking about it it, nothing was destroyed- just transferred. A lender gives money to a lendee. The lendee purchases something with that money by giving it to a vendor of something.

When the person who borrowed the money defaults, nothing about the amount of wealth has changed, it's just that the vendor has the dollars and the lender has the product and the original borrower has no funds.

What am I missing or is it just a misleading myth?

[LibForestPaul]

Almost, bBut the money that was lent was created by the bank from thin air.

So in fact, that money that was created by the bank that found its way into a borrowers hand and into a vendors pocket went back into another bank.

But the borrowers promissory note is considered an asset by the lending bank.

When the bank has no assets, its no longer solvent.

Anyone here wants to correct this, feel free.

[Mister Grieves]

So no matter what, banks lending money they don't have is inflationary. I really don't see any way that can be undone by the fed or anyone else, aside from literally destroying all the money used in a transaction preventing it from ever finding it's way into the system. I just don't see anyone going along with that and it happening.

I'm thinking about people who are of the mindset that there is going to be widescale deflation vs. inflation or hyperinflation. It just doesn't seem possible the way our system is set up for there to inevitably be anything other than inflation of some sorts, so I'm not really sure where they're coming from.

[gonegolfin]

I've read on some boards, I'm pretty sure this one as well, that when debts are defaulted on and bankruptcies run rampant that it is deflationary because wealth in terms of dollars is being destroyed.

This is incorrect. Defaulting on debt is not deflationary as the money supply is unaffected. Paying off a loan is deflationary (such as I did with our mortgage recently).

Brian

[hugolp]

This is incorrect. Defaulting on debt is not deflationary as the money supply is unaffected. Paying off a loan is deflationary (such as I did with our mortgage recently).

Brian

I have heard that the fact of defaulting on the debt is not deflationary, because as you and Mister Grieves explained, but then the bank has a whole in its ballance sheet and it will lend more carefully, wich is a good thing, but its deflationary or at least it will stop inflation, since less money will be created, and at some point the money being destroyed by people returning loans could be bigger than the money being created by the bank because it has a whole in its balance. What does history says about this? Is this a process that has happen in history or it just the imagination of whoever told me this?

[jonahtrainer]

This is incorrect. Defaulting on debt is not deflationary as the money supply is unaffected. Paying off a loan is deflationary (such as I did with our mortgage recently).

Well, not completely incorrect. The definition of inflation is an increase in the money supply while deflation is a decrease in the money supply. During a credit expansion fictitious capital is created resulting in a larger liquidity pyramid. The debt instruments in the liquidity are fictitious because they are unsustainable and the underlying economy cannot produce the earnings required. Eventually a credit contraction begins. During the credit contraction the fictitious capital evaporates either by being paid off or defaulted on. The result is a smaller liquidity pyramid.

In this case, the issue is which part of the liquidity pyramid is being focused on to determine whether there is 'inflation' or 'deflation'.

[gonegolfin]

Well, not completely incorrect. The definition of inflation is an increase in the money supply while deflation is a decrease in the money supply.

... and when a debt default occurs, the money supply is unchanged. Period. Hence, the act of defaulting on debt is not deflationary. Sure, that default may affect future credit expansion. But the actual event of a default is not deflationary.

Brian

[jonahtrainer]

... and when a debt default occurs, the money supply is unchanged. Period. Hence, the act of defaulting on debt is not deflationary. Sure, that default may affect future credit expansion. But the actual event of a default is not deflationary.

Brian

It raises the issue of what is the money supply? That drives down to a deeper issue: what is money? The Constitution does not define what money is; only that it is something that is coined rather than printed. Money and currency are not the same thing although both are included in the world's liquidity pyramid. With the current fiat currency system the definition of inflation and deflation is much more useful when adapted to current practicality and used to zoom in or zoom out to different areas of the liquidity pyramid.

Sure, the power money area can be inflating because there is new gold and silver being produced that is in excess of the amount of current stocks being consumed while at the same time an area like Auction Rate Securities which function like cash can evaporate through either a rapid decline in liquidity or default of the counter-party and either of those events would be tremendously deflationary in its effect on the current liquidity pyramid. Both forces are currently at work and feed on each other which is what has triggered The Great Credit Contraction and is a reason why current officials are impotent in being able to stem the tide. Economic law is at work.

[gonegolfin]

It raises the issue of what is the money supply?

Whether you use narrow money supply or broad money supply, it does not matter. In the case of currency outstanding + demand deposits, money supply is unaffected. If you extend this to mean savings, time deposits, institutional money markets, short term repos, etc., money supply is still unaffected. What is potentially affected is the ability to issue future credit.

Brian

[Brian4Liberty]

If defaults on mortgages result in more in more distressed houses on the market, it seems like that would be deflationary in terms of housing prices. That is just one parameter in the total equation though.

[hugolp]

If defaults on mortgages result in more in more distressed houses on the market, it seems like that would be deflationary in terms of housing prices. That is just one parameter in the total equation though.

It may drive housing prices down, but it wont affect the money supply. You are changing meanings by using deflationary as a decrease in prices, instead of a decrease in the money supply, like it has been use in the previous posts.

Prices are also affected by psicologic factors, not only by the quantity of money. And in the case you are refereing the fact that house prices go down is because of a psicological factor. People were buying houses because they expected the price to go up. If they expect the price to go down now, because there is less and less buyers, they will want to get rid of the house quick, lowering the price. Its mainly a psicological factor.

[Isaac Bickerstaff]

When a debt is paid, the money that the loan created is destroyed. When a loan defaults, the debt that created some money is erased but the money is not destroyed. According to the most common (in my opinion, bull$#@!) understanding of inflation, a loan default would be inflationary.

The reality is that the money a bank takes in as interest payments goes into an "interest income" account. If a loan defaults, the bank that made the loan must make up the missing principle from its interest income account. This is how your local banker is duped into enslaving you and himself to bigger evil banks.

[enter`name`here]

I don't think loan defaulting is deflationary in and of itself. Unless it occurs in an amount significant enough to cause bank failures, which is deflationary.