HOW TO RESOLVE THE CREDIT CRISIS: GIVING CREDIT WHERE CREDIT IS DUE

Economist John Kenneth Galbraith famously said, “The process by which banks create money is so simple that the mind is repelled.”  If banks can create money, why are we suffering from a “credit crunch”? Why can’t banks create all the money they can find borrowers for? 

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163 Responses

  1. It is Brock’s responsibility to show that sufficient amounts of the interest paid on loans is circulated back to prevent contraction of the money supply. If some of the interest is committed to future loans, then the ‘debt virus’ must be admitted.

    @moneycreation – I believe your formula should be that I/(P+I) is the number of lenders who must go bankrupt to furnish the liquidity to feed the debt virus.

  2. Oops – I meant I/(I+P) is the number of borrowers that must go bankrupt to feed the debt virus.

  3. You haven’t proven anything at all. You know nothing about logic. All you done is written an invalid statement in algebraic form. Where is your formula is a term relating to the money that the banks spend into circulation, let’s call it D?

    Brock

  4. It is Brock’s responsibility to show that sufficient amounts of the interest paid on loans is circulated back to prevent contraction of the money supply. If some of the interest is committed to future loans, then the ‘debt virus’ must be admitted.
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    Debt virus is that none of the banks’ interest income is circulated back. What you’re presenting might be considered to be debt virus lite. It is a type of bankers’ underconsumption thesis. It is incumbent on you to explain how and why bankers’ underconsumption will differ in its effects from the underconsumption of any other other group of consumers.

    By the way, bankers do not commit even a dollar of their income to future loans. They have no need to do that. The theorem is that loans CREATE deposits. Didn’t you know that?

    Brock

  5. Putting a side that Brock can’t mathematically that he is right there are other reasons for the bankers to inflate the currency.

    1) The obvious: Bank makes loans and it’s in their interest to make as much as possible.
    2) Credit compete with cash as medium exchange. If people use cash they deplete the base for the credit expansion so banks need to make people believe that credit money “grows”, This leads to the bubble economy where the only thing growing is credit but people belive that the stock exchange or real estate market “grows” in value (but in realty it’s inflation due to the credit expansion). In that way people are tricked into “save” their money in the virtual economy tinstead of taking out their cash. I wrote about this in my blog:
    http://moneycreation.wordpress.com/2009/01/16/3/

    The bankers wet dream is to make a totaly digital debt system as I described in this blog:
    http://moneycreation.wordpress.com/2009/01/19/the-bankers-wet-dream/

  6. It is incumbent on you to explain how and why bankers’ underconsumption will differ in its effects from the underconsumption of any other other group of consumers.

    What you refer to as underconsumption is equivalent hoarding.

    Hoarding is related to the interest rate set by banks. Hoarders deposit their funds in interest bearing accounts which banks use to create future loans. Ergo, present money supply is contracted.

    QED, the debt virus is proven, which is to say that creating money out of debt eventually will liquidate the entire economy which the banks will then own.

  7. I would not say the “debt virus” is proven but a less severe version of it where not all of the interest is available is most likely true. Also the banks would not own everything since they do not really own the principle only some of the interest. A less severe version of the debt virus would have the same effects they would just be slower.

    I do not think what the banks do is any different than what consumers do but that does not invalidate the fact that it creates huge inefficiencies such as boom bust cycles and other societal problems. Ideas such as social credit would help to correct these problems by correcting imbalances. A national credit would also work since it would have more flexibility to expand money supply under certain conditions and within the proper framework it would not be inflationary.

  8. Whether the banks hoard the money or savers hoard the money is immaterial. In either case, present money is removed to the future.
    This removal contracts the present money supply and requires borrowers to pay their present obligations by taking out additional loans.

    If the interest rate was zero, there would be no debt virus. Also if banks spent every penny of their earnings and no one saved anything, then there would be no debt virus. Otherwise the virus exists.

  9. What you refer to as underconsumption is equivalent hoarding.

    Hoarding is related to the interest rate set by banks. Hoarders deposit their funds in interest bearing accounts which banks use to create future loans. Ergo, present money supply is contracted.
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    Banks do not grant loans from their deposit liabilities. Banks pay interest on deposits to avoid losing central bank reserves that they have on deposit at the central banks to competing banks.

    QED, the debt virus is proven, which is to say that creating money out of debt eventually will liquidate the entire economy which the banks will then own.
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    One thing for sure, you haven’t proven it. For your information, money has been debt, according to Innes, for forty thousand years.
    http://www.geocities.com/new_economics/innes/

    Brock

  10. I would not say the “debt virus” is proven but a less severe version of it where not all of the interest is available is most likely true.
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    The truth of the matter is that in a normally growing economy, the banks are spending in expenses and dividends MORE than enough money for the public to pay interest back to the banks. In hypothetical steady state they are spending exactly the amount the public is paying back to them in interest. In a contracting economy, they are not spending enough to cover interest. But this is true for all firms, not just banks, in a contracting economy. Firms in general are not spending enough to cover their costs through sales over their retail counters. Account balances throughout the economy are diminishing to the point of total depletion, at which point economic activity stops.

    Also the banks would not own everything since they do not really own the principle only some of the interest.
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    I’m not sure what this means–perhaps you will translate. No one “owns” principAl. It is a term from the lending contract. As to the funds extended when loans are granted, they are owned by whomever possesses them at the moment.

    I do not think what the banks do is any different than what consumers do but that does not invalidate the fact that it creates huge inefficiencies such as boom bust cycles and other societal problems.
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    What banks “do” is enable modern, industrial civilization, which could not exist without banking. Without banking, most of the world’s six and a half billion people could not exist. Get real!

    Brock

  11. Whether the banks hoard the money or savers hoard the money is immaterial. In either case, present money is removed to the future.

    This removal contracts the present money supply and requires borrowers to pay their present obligations by taking out additional loans.
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    No it doesn’t contract the money supply. It does nothing to the money supply. The money still exists in the present. What may be happening is that spending from income is falling in respect of income, for some reason or other, causing a fall in the rate of profit from sales in reflux. That is easily compensated through the Social Credit adjustments of the Dividend and Retail Discount, which sustain the rate of profit.

    Keynes postulated a “falling propensity to consume” with increasing wealth, which is a long term phenomenon.

    “Hoarding” is a Gesellist fallacy. In reality, every dollar received is eventually spent.

    Brock

  12. @Brock
    In a contracting economy, they are not spending enough to cover interest.

    Please admit or deny that in a contracting economy, there is a debt virus.

  13. —–Also the banks would not own everything since they do not really own the principle only some of the interest.——

    This was meant for the previous post which said the bank would own everything.

    Did I say anywhere that the banks do not ““enable modern, industrial civilization”? 1000 years ago people used cows for barter and if people thought like you then that would never of changed.

    Unless you can answer these questions you do not have much to offer:

    Was the system Benjamin Franklin used in Pennsylvania also a myth invented by greenbackers?

    I still have not seen any explanation of the cause of long term inflation. Are you saying it is an unexplainable phenomena? I explained my understanding of the cause of two types of inflation and unrestrained Government spending would be one cause of the 2nd but do you have any rational alternative theory for what causes the 3rd?

    If the Pennsylvania system was not inflationary which historical records including writings of Adam Smith attest then the difference between the current system and that one must explain the reason why one is inflationary and the other was not.

  14. Please admit or deny that in a contracting economy, there is a debt virus.
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    Please get your words and terminology straight. The debt virus hypothesis is that only the principal of loans is created in the lending process, not the interest, so borrowers must further borrow to pay the interest, thereby compounding the debt. I specifically deny the debt virus hypothesis because it is demonstrably false. Touting it is not the mark of an educated person.

    In a contracting economy, referring to the period of credit contraction, past disbursements are continually being brought forward through the rules of accounting to be “expensed” against current sales, which are lower than past disbursements, causing an accounting loss rather than profit. This has the effect of suppressing production and consumption, in that it sends a false message to entrepreneurs and their financiers. Real factors are being influenced by financial factors to the detriment of society. See

    Brock

  15. @John Williams
    —–Also the banks would not own everything since they do not really own the principle only some of the interest.——

    This was meant for the previous post which said the bank would own everything.

    I meant that when borrowers default on their loans, the banks acquire the underlying assets. The debt virus is a game of musical chairs as borrowers one by one lose their assets. The Detroit Free Press recently had 137 pages of home loan defaults. Is there any question that the banks own those assets?

  16. I am only saying they would still have a liability on there books so legally I do not see how they would have any right to keep the property. The only part of lending that is the banks is their percentage of the interest. Legally I would imagine they have to sell the property and repay the debt possibly taking a loss.

  17. @Brock

    Come, come now, Brock, in a previous post you admitted (your words)


    In a contracting economy, they are not spending enough to cover interest.

    The context in which you made this statement was on the question of whether banks were spending enough through expenses and dividends to avoid a money contraction leading to a debt virus. Your answer was, I reiterate (your words)

    In a contracting economy, they are not spending enough to cover interest.

    Your answer is mere obfuscation, which can be taken as admission.

    Boiled down, your argument is that

    1. there is no debt virus because the banks spend the interest into circulation so that all the debts can be paid off;

    2. in a contracting economy, the banks cannot spend enough into circulation to cover the interest.

    3. even though the banks can’t spend enough to cover the interest, still,THERE’S NO SUCH THING AS A DEBT VIRUS because Brock denies the logic of his previous premises.

  18. I have found this article to be informative

  19. Was the system Benjamin Franklin used in Pennsylvania also a myth invented by greenbackers?
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    Well, there are two Benjamin Franklins. The one that really existed, and the mythical one created by the Greenbacker propaganda machine, with all the embellishments.

    I’m not aware that Benjamin Franklin “used” any financial system. He wrote a book entitled *A Modest Enquiry into the Nature and Necessity of a Paper Currency.* Have you read it?
    http://etext.lib.virginia.edu/toc/modeng/public/FraMode.html
    “Franklin advanced the notion that if paper money were put into circulation through a land bank — that is, lent on mortgage security — that the mortgages would secure the value of the paper money, preventing it from depreciating.” That is to say, the land bank would lend notes secured by land mortgages that were not redeemable in any commodity. Franklin’s money was fiat currency, pure and simple. These were placed into circulation through interest bearing loans. His land bank was a quite modern type of bank advanced before the Industrial Revolution. It was similar to Thomas Paine’s proposal, who tied it into the tax system.

    As to your questions about inflation, its causes are complex. You are naive if you think otherwise. There are different specific causes to different inflations. I think all the causes are monetary phenomena. I’ve already told you that I think some inflation is inevitable, and we’re better off with a little inflation than with a little deflation. That little inflation that I would prefer would be higher than what is permitted at present by the financial authorities, who believe the economy is precariously in a condition of unstable equilibrium. I believe that the economy is always tending toward some sort of equilibrium, but whatever that equilibrium might be, it is definitely not unstable. It can be stable at any rate of inflation. Inflation is minimized with Social Credit policy in that controls are placed on bank credit expansion and purchasing power is injected directly to final consumers without entering the costs of production. Inflation is thereby minimized while the utilization of productive potential is maximized. I see no merit in seeking zero inflation as a goal.

    Brock

  20. I meant that when borrowers default on their loans, the banks acquire the underlying assets.
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    When borrowers default, the lenders foreclose on the pledged security. Generally, the security has to be sold at public auction, where the lenders gets a credit bid in the amount of the default. The property goes to the highest bidder. If the auction price is higher than the default amount, the difference goes to the party who was foreclosed upon, not the lender.

    Brock

  21. 1. there is no debt virus because the banks spend the interest into circulation so that all the debts can be paid off;

    2. in a contracting economy, the banks cannot spend enough into circulation to cover the interest.
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    Not cannot but do not. Firms in general, in a contracting economy, do not, for whatever reason, spend enough into circulation to cover their costs of production, so they are forced to sell their products and services at a loss. Production and consumption then contract.

    3. even though the banks can’t spend enough to cover the interest, still,THERE’S NO SUCH THING AS A DEBT VIRUS because Brock denies the logic of his previous premises.
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    The language of this forum is English. You’ve got to keep your words and terminology straight. Debt virus has a specific definition. It doesn’t help matters when you simply make up what it means.

    Brock

  22. Principal lent into existence: P
    Interest owed on the principle: I
    Years that system has been in place: t

    Assume a one year time period with all money issued at the beginning and all debts due at the end. Money created at the beginning is P. Money due at the end is P + P*I. The community does not have sufficient funds to repay the debt. The following year, an additional P is required for money, but again it will only be lent at interest I. The problem compounds.

    In real life, loans are continuously created and paid off. Most having periodic payments in between. This smooths things out. However, it also allows continual growth of the communal debt P*(1+I)^t. This causes a scarcity of money, to which people respond by hoarding what little they have. Those who can reduce consumption to both pay their debts and save for the future take money out of circulation. Thus, even though lenders may spend some of their interest earnings into the economy, making up for part of the interest, it is not complete. Further, the lenders themselves hold onto some of the interest as reserves — hoarding just like the rest of the populace.

    ————-

    Value of goods and services produced: G
    Value of salaries and dividends paid: S

    If all businesses are profitable, they produce (G) more than they spend (S). Since the community’s spendable money comes solely through salaries and dividends, there is not enough to purchase all the goods and services. With technological innovation, fewer people are required to produce the same quantity of goods and services, increasing the difference (G – S). Because businesses cannot sell enough product to maintain profit, they will cut back expenses by laying off employees, cutting back production, or going out of business. All of these lead to economic depression or make an existing depression worse.

    ————-

    In both of the above cases, we have an economic disparity. The economy may be producing more than enough for everyone, but the money used to purchase goods and services is inadequate to meet everyone’s needs.

    An obvious solution to the second concept, printing money to make up the difference between G and S, will probably lead to inflation.

    A solution to the first concept, setting interest rates to zero, would seriously disrupt our economy as banks would no longer make money and thus would stop lending.

  23. Thus, even though lenders may spend some of their interest earnings into the economy, making up for part of the interest, it is not complete.
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    Actually, in a normally expanding economy, the banks are spending MORE than enough in expenses and dividends for the community to pay interest back to them as it comes due. It is reciprocal economic activity. The banks are paying for the goods and services being delivered by the community to them. The community is paying for the financial services being delivered to them by the banks. How could it be otherwise?

    Brock

  24. John,

    “The industrial revolution was a boom phase and it was definitely real. The tech boom was real and created a lot of efficiencies. So to say “The boom phase of the business cycle is never real” is untrue”

    The industrial revolution is an example where economic growth was much faster then the growth of the money supply. I gave that as an example previously in some of the exchanges with Brock. That should make you question the claims about the importance of a specific money supply growth to guide economic growth.

    The real growth of the economy is generally a steady and gradual incline. Where the booms and busts are the cyclical behavior which we have been experiencing in the modern economy. You could have a “real” boom, which results from a high saving rate in the economy, which is what was dominant during the industrial revolution. Any artificial booms created by banking were just on top of this real boom. Picture a cyclical behavior with a regression line that reveals a steady and modest growth, amid the cyclical behavior. The cyclical behaviors are very distracting and counterproductive. They were much more minor during the industrial revolution due to the Gold standard, and no efficient cartelizing device such as the Fed. And banks actually failed back then, and government intervention after the “bust” although existed, was severely limited. The result was a long period of fantastic growth, where the value of money actually increased. I believe in your terms, it what you refer to as deflation, although it should be referred to as simply price falls.

    As long as you refuse to accept the possibility of truth in what I am trying to convey, you will not find any coherent and consistent explanations for what you are observing around you.

    And the technology (.com) boom we’ve had was obviously not real, since it came to an end in 2000. It felt real during the boom and some people benefited from speculation, if they got out before the “bust”, but we had a recession if you recall, and the only reason that it didn’t feel worst then it was, is because the Fed (Greenpan) shifted the inflation to the housing sector in order to avoid a serious recession, only to start a bigger bubble in the housing market.

  25. If Ellen’s thesis present day banking is an all powerful spider that corrupts and dominates society is true, then it is to be expected that the banksters would send out trolls like Brock to obfuscate simple logic with mystifying sophistry.

    In this light, Brock’s obfuscations are encouraging because it is further evidence that Ellen is on the right track.

  26. Brock

    Benjamin Franklin helped to create the system which was used in Pennsylvania which used Colonial scrip before it was replaced by Continental currency. Adam Smith wrote about the currency used in Pennsylvania in Wealth of Nations saying it considerably lowered taxes and did not lose value to gold or silver so I do not believe it is greenback propaganda. I wonder if the sources that claim everything is greenback propaganda are pro-central bank propaganda. The difference between the current system and the one used in Pennsylvania would explain why one is inflationary and the other one was not.

    When or where inflation will happen is unpredictable but he causes are not complex it is caused by supply and demand and money growing faster than goods (still supply and demand). If the demand is higher than the supply then inflation will result possibly causing speculative demand and more inflation such as the dutch tulip mania. The opposite can also happen to money if there are fears money will lose purchasing power quickly causing demand for tangible goods that are perceived will hold there value such as gold, property etc as the price of those goods go up demand for money goes down causing a reinforcing spiral. High interest rates will create a demand for money stopping the spiral. Money supply growing faster than goods will cause a more pervasive inflation as labor and commodity prices adjust to a greater money supply the same as an increased supply of any good with an unchanged demand will eventually have a lower price. I do not know why you would say the causes of inflation are complex. Predicting when or where it will happen is complex because people are unpredictable but the supply and demand underlying inflation is not complex.

    The fact that Colonial scrip was not inflationary leads me to believe that while the principal only debt virus theory may be untrue the results still occur. If some of the interest earned from banks (dividends etc) is deposited at a bank and lent out then the only place for the interest on some loans to come from is other loans. Also even if the banks spend more than the interest owed if it is invested into The Foreign Exchange Market or other high finance investment where most of the invested money will not be available for borrowers to earn other loans will be the only place to get the interest owed. The interest on these loans are not tied to goods the same as principle is and so it can grow faster than goods. The interest in the Colonial scrip system was spent by government and all of it was available for borrowers to earn which is the reason it was not inflationary.

  27. I would appreciate if you could provide citation to the chapter and book in Smith’s *Wealth of Nations” in which your claims for colonial Pennsylvania might be found. This what I’ve found. Please note that it refers to money being lent into circulation at interest and that its success depended on its “moderation with which it was used.” Smith was not quite so complementary regarding colonial scrip in general. Of the other colonies, Smith wrote: “…from want of this moderation, it produced, in the greater part of them, much more disorder than conveniency.”:

    Book V: On the Revenue of the Sovereign or Commonwealth
    Chapter II: On the Sources of the General or Public Revenue of the Society

    “The government of Pennsylvania, without amassing any treasure, invented a method of lending, not money indeed, but what is equivalent to money, to its subjects. By advancing to private people at interest, and upon land security to double the value, paper bills of credit to be redeemed fifteen years after their date, and in the meantime made transferable from hand to hand like bank notes, and declared by act of assembly to be a legal tender in all payments from one inhabitant of the province to another, it raised a moderate revenue, which went a considerable way towards defraying an annual expense of about £4500, the whole ordinary expense of that frugal and orderly government. The success of an expedient of this kind must have depended upon three different circumstances; first, upon the demand for some other instrument of commerce besides gold and silver money; or upon the demand for such a quantity of consumable stock as could not be had without sending abroad the greater part of their gold and silver money in order to purchase it; secondly, upon the good credit of the government which made use of this expedient; and, thirdly, upon the moderation with which it was used, the whole value of the paper bills of credit never exceeding that of the gold and silver money which would have been necessary for carrying on their circulation had there been no paper bills of credit. The same expedient was upon different occasions adopted by several other American colonies: but, from want of this moderation, it produced, in the greater part of them, much more disorder than conveniency.”

    When or where inflation will happen is unpredictable but he causes are not complex it is caused by supply and demand and money growing faster than goods (still supply and demand).
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    The causes are more complex than what you think they are. Money supply growing faster than goods is in most cases a simplistic explanation. Consider the possibility that the costs of production, as a matter of defective accounting, are growing faster than goods.

    I do not know why you would say the causes of inflation are complex.
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    Because they are in fact more complex than your simplistic explanations.

    The fact that Colonial scrip was not inflationary…
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    This is denied by Adam Smith in the quotation cited above. He was complementary of Pennsylvania scrip but not so nearly complementary of the other colonial scrip.

    If some of the interest earned from banks (dividends etc) is deposited at a bank and lent out
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    But banks simply do not lend from their customers’ deposits. They create deposits when they lend.

    Also even if the banks spend more than the interest owed if it is invested into The Foreign Exchange Market or other high finance investment where most of the invested money will not be available for borrowers to earn other loans will be the only place to get the interest owed.
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    Most of it accumulates into positive account balances, just as it does from the spending of any firm. It is in the differential between the flux of entrepreneurial spending and its reflux through sales.

    The interest in the Colonial scrip system was spent by government and all of it was available for borrowers to earn which is the reason it was not inflationary.
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    Referring to the Pennsylvania scrip, not that of the other colonies, he said that it was not inflationary, because of the “moderation” on the part of the Pennsylvania authorities.

    Brock

  28. Warren Raftshol
    Totaly agree Brock is a troll.

  29. The citation you provide is the one I was referring too. The previous article you posted:

    http://etext.lib.virginia.edu/toc/modeng/public/FraMode.html

    would be the system implemented.

    The colonial scrip in other states were probably mismanaged and the policy suggested in the essay by Benjamin Franklin not followed. I do not know the exact reason the other colonial scrips were less successful but do believe the ideas put forth in the above essay are sound because they tie money to an asset. The current system does not couple money to assets allowing money to grow faster than the goods money represents.

    —-Consider the possibility that the costs of production, as a matter of defective accounting, are growing faster than goods.—-

    In my opinion this would be an accounting consequence of money growing faster than goods.

  30. The Debt virus. Broock more

    The formula for the debt virus is all to simple in a complex world, but it does not take a mathematician realize the basic foundations of interest and how it polarizes the economy.

    Firstly, rightly so, all capital from interest does not stay in the banks. It goes through salary, dividends, expenditure and hundred of other items. This alleviates the problem, it does however not stop the debt burden to increase on unserviced debt.

    An increase in interest rates are followed by higher insolvency in society, clearly marking a relationsship.

    The constantly increasing money supply makes current debt easier to finance, thereby the debtvirus should have been disproven which it has not. The formula shows that with increasing money supply, existing debt can be serviced eternally at the cost of debasement of the currency which is also what is happening in all fiat currencies.

    The biggest problem lies within the financial economy and productive economy. If to much money deviates from production into the paper economy, the productive economy is starved of capital making a smaller amount of capital services large amounts of saving. This is referred to as the debt overhang.

    One must also separate between debt as money and debt as debt.

    All money i debt, all debt is not money. Debt as money is referred to as intermediated debt and debt as debt is referred to as non intermediated debt.

    When intermediated debt no longer can service itself and non intermediated debt, the economy implodes.

    The economy implodes when people no longer has the means to go deeper into debt.

    When people cant go deeper into debt, the increse in intermediated debt stops and can no longer service non intermediated debt.

    The result, a pandemic and systemic failure with even intervalls and its nothing to be surprised about.

    If you look at statistics, a collapse in money supply is always followed by a strong recession since servicing debt becomes impossible.

    A way of improving the system is to take away the incentives for asset inflation (house prices, stock market etc) and increase incentives for the productive economy. A way of doing that is for instance heavy taxation on property and capital gains and low taxes on labor, clearly gearing the economy towards productive instead of head first in the wall wealth creation quasiponzi schemes that do implode regularly.

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