This way of thinking originates in the writings of Irving Fisher who held that a major risk factor is the debt liquidation. According to Fisher, this can occur on account of a shock such as a decline in the stock market. As a result, this is likely to generate a decline in money supply. The decline in money supply, in turn, is likely to cause a decline in the prices of goods, labeled as “deflation” and this will produce an economic slump. Why, however, should the debt liquidation cause a decline in the money supply?
Take, for example, a producer of consumer goods, who consumes part of his produce and saves the rest. In the market economy, the producer can exchange the saved goods for money. He can then make a decision to deposit the money with a bank. He can also decide to lend his money to another producer through the mediation of the bank. By lending his money, the lender transfers his savings to a borrower for the duration of the lending contract. Once the contract expires on the date of maturity, the borrower returns the money to the original lender plus interest. The repayment of the debt, or the debt liquidation, does not have any effect on the supply of money.
Loaned savings are key for economic growth. It is savings that fund the production of the capital structure (e.g., tools, machinery), which permits the more productive and efficient expansion of consumer goods. This facilitates further increases in savings, all other things being equal. The process can continue with the buildup of an even more sophisticated production structure. The increase in lending is great news to the economy. By means of lending, savings are channeled to the various parts of the economy, thereby promoting economic growth……
Contrary to much popular thinking, the threat to the US economy is not the high level of debt as such, but the artificial monetary and credit expansion unbacked by genuine savings. Lending as a result of increased savings can cause stable economic growth. Artificial expansion of money and credit to supply loans emerges because of the monetary policy of a central bank. It is “monetary policy,” not the size of the debt, that poses a threat to the economy.
It is the central bank that is the problem, not the debt and not the consumers or producers, only the central bank and its crony banks! They are creating money out of thin air, or another way to put it is, they are creating something out of nothing. This means they are creating inflation, with no two ways about it, which, when the banks are called on this problem causes bankruptcies, in the original sense of the word. As Ron Paul says, End the Fed!