All exceptionally good questions and observations. And the link Von gave, using a dollar of capital for every dollar of loans would solve the problems you describe.

There is nothing wrong with someone who has saved money to loan it out, at interest, to another party for them to engage in a productive endeavor. There is nothing wrong with even the interest charged. If the enterprise can not cover both the loan repayment and the interest, then it is doomed to fail. Where all the problems come in that you ask about and aluded to is with the ability to create new money out of nothing (fractional reserve lending) and lend it out. All fractional reserve lending increases the effective money supply. When a dollar is taken in as savings and lent back out, there is no increase in the money supply. But when money is allowed to be created out of nothing, increasing the money supply, it does exactly as you describe. It raises the price of goods, because there is more money or potential money around to try and buy them.

The farm economy of the 80's is a good example. Lending was easy in the booming farm economy of the times. High leverage was used. The Farm Credit System was allowed to keep minimal reserves in their fractional system. The easy money caused a land boom that was unsustainable. When the boom busted, what was thought to be equity propped up by all the liquidity of the fractional reserve system evaporated.

Imagine a farm land sale. There is one potential buyer that has cash. He can pay cash for whatever the bid is, but being a good businessman he will only bid what he feels the ground is worth. There is another potential buyer that has a wealthy uncle that has cash savings in the bank. The wealthy uncle tells the second potential buyer he will loan him the money to buy the ground. The third potential buyer goes to a bank that offers to loan him the money. The way that this loan will work is not with existing money, but with deposit money the bank will create when it makes the loan. In other words if this third buyer wins the auction for a million dollars, the bank will create a ledger entry that puts a million dollars in the third buyers checking account and then the buyer will write a check for the amount (disreguarding down payments, interest and everything else for the moment for illustration purposes). In the case of the third potential buyer, THE MONEY DID NOT EXIST UNTIL THE LOAN WAS MADE. LOANS CREATE DEPOSTIS ------ NOT THE OTHER WAY AROUND! This is fractional reserve lending. The bank only has to have about a hundred thousand dollars in capital to cover the million dollar loan.

In the above example, if fractional reserve lending did not exist, there would be only two potential buyers. WITH fractional reserve lending there could be potentially hundreds of buyers. Limited only by credit worthy buyers and bank capital to fractionally reserve lend against. So look at the difference in potential land prices if you have only two potential buyers, one with enough of his own capital and one with capital he can borrow from someone who has excess capital, or in a market with many more potential buyers that can qualify to receive money created out of nothing via fractional reserve lending.

Fractional reserve lending increases the money supply to bid against goods by the loan amount. If there is lots of lending, there is lots more money supply. If there is lots more money supply, prices go up. BUT............. when loans are paid off, the "money from nothing" also again becomes nothing......... it goes away. And this is what leads to the boom-bust cycles. When credit is easy, the effective money supply chasing goods expands and drives up prices. When the debt gets unsustainable, the credit cycle crashes in on itself and the effective money supply contracts and hence the bust. Fractional reserve lending adds to normal business cycle booms, and also enhances the bust by credit contracting.

In the example above where there were only the first two potential buyers, the second potential buyer was using real capital - savings. If the loan went bad, savings were lost but the money supply stayed the same. If the guy that borrowed fractional reserve money could not pay, the money supply would contract as the loan was extinguished. Fractional reserve lending helps create the boom, driving prices of things higher, then when credit is expanded too far to be sustainable it makes the bust even bigger by contracting the money supply.

What the Fed has been doing since Greenspan and even before, is to never let credit contract. The problem with this is, the imbalances created by the increased money supply never get the chance to reset and stabilize. So here we are, in this Alice in Wonder Land economy, where the Fed and money printing are needed to prop up an unsustainable economy and debt load.

As far as us living beyond our means, maybe we are and maybe we are not. But we are living beyond our means as long as we allow the financial Wall Street economy to siphon off a good share of our productivity. Look at what percentage of GDP the financial industry was 50 years ago and what percentage it is today, and consider that all financial activity can only move assets around as it creates nothing, and it is easy to see that if the financial industry was about a fouth of what it currently is we might very well have enough wealth to be living within our means. I doubt it, because there is so much spending on social programs that produce nothing. But at the very least, we would be a lot closer to living within our means.

Our government, along with the help of the Wall Street controlled financial industry, is a parasite that seems to be intent on killing its middle class host.

John