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The bad debt was used for capital creation. The capital created may be wasted. The restriction of consumption has already happened during the boom when the in

The bad debt was used for capital creation. The capital created may be wasted. The restriction of consumption has already happened during the boom when the investment of the money in creation of capital goods caused individuals to restrict consumption for other reasons. As an example, consider that perfectly good farmland in the central valley was being used to construct houses that would later be marked down to half their value during the bust. The land, labor and capital were being drawn away from other uses during that period of investment. So your argument that the payment must be made later in the real economy ignores the disruption that the initial boom created. The boom is not the free lunch that must later be paid for, the boom is the destruction of the existing structure of the economy that will hopefully increase efficiency enough to provide for increased consumption of consumer goods at a later time to make up for the restrictions during the boom. In China, instead of creating a period of reseting to the previous price relationships that existed before the boom and returning all the property back to the lenders or those who lend new money from them, they simply warp the economy in yet another direction that the central planners and their partially privatized counterparts in the bank think will improve production capacity. The government in China regularly lets very bad investments fail, and many important hedge funds and such have failed completely where in the west they would be saved. The U.S central bank has a balance sheet but they can create unlimited liabilities. Federal Reserve Notes are debt of the federal reserve that is redeemable for 1 for 1 with other federal reserve notes and has the handy and unique property that it is the only valid legal tender for paying federal taxes and must be accepted for settlement of any debt, which is what gives its intrinsic value.

slv77 11y ago
Going to the farmland example and assuming it is a closed system. The default process isn't painless as losses have to be allocated between the banks investors, farmer, suppliers and construction workers. While the question of who takes the loss is worked out there is considerable uncertainty. Who's going to make large purchase decisions when they aren't sure how much purchasing power that they have? The result is that while losses are being allocated the velocity of money slows which lowers GDP and as those effects ripple through the economy it creates deflation.

slv77 11y ago

Going to the farmland example and assuming it is a closed system. The default process isn't painless as losses have to be allocated between the banks investors, farmer, suppliers and construction workers. While the question of who takes the loss is worked out there is considerable uncertainty. Who's going to make large purchase decisions when they aren't sure how much purchasing power that they have? The result is that while losses are being allocated the velocity of money slows which lowers GDP and as those effects ripple through the economy it creates deflation.