The practice of banks being allowed to lend a percentage of a customer's deposit leads to more people being able to spend that money which allows prices to rise. This is why Fractional-reserve banking is said to increase the money supply: The spent money remains on deposit to the original customer.
Instead of only the depositor being able to spend the money, now a second person (the borrower) can spend the same money which means that more people can afford the same goods. The difference between the depositor and the borrower is that the borrower must repay the debt at a future date.
When the borrower has repaid the debt; the situation will return to one where only the depositor has use of the money (until it is loaned again).
It becomes impossible for the lenders to pay the money back unless lots of other people keep borrowing. At which point the Government print the extra money required to secure bank deposits (perhaps) and we start again.
If they don't print the required money for the depositors but instead invest in Government projects (with fresh money) that again, would reset the system and mean that it is a good idea to take out debt.
If they allow the banking system to fail it's a good idea to borrow because the system has been reset. If the banking system is not tested by the general public this could lead to a decreasing money supply if people are wary of their deposits. In this scenario it is important to be aware of the recourse rights of the lending institution...
We are able to acquire goods without doing the work first... Preferring to delay the work to a later date. If many people take the same course of action it becomes impossible to complete sufficient work to repay the debts.
A solitary person, if the money supply was constant, would be able to borrow money and pay off the loan over a period of time. If a great number of people do the same thing there will not be sufficient work to do in the future to repay the debt because the labour market will be saturated with people looking for work.
When this happens (assuming the work can't be done*) many of them will default leading to bank failures and perhaps printing money by the authorities (if they prefer to save the depositors, which they might not).
*If the work can be done (as a result of loss of purchasing power and increased money supply)... it would mean the lenders (bank depositors) realise, or must accept, that they will be able to get much less out of their debtors in terms of work than they may have anticipated. For example, they may have loaned an equivalent of work for a year but receive in return only the work of a few months.
The losses get "written down" so to speak.
If many people have taken out a loan over a similar period of time this will result in a contraction of credit as the loans get paid back. This will mean that a unit of money increases in value and becomes impossible for the borrower to pay back.
In either scenario (default or inflation) to have taken out the loan is to the advantage of the borrower and against the interests of the "lender", the customer. If the interest on a house is less than the comparable rent (and the loan has limited recourse) then there is no risk to the borrower to dissuade them from choosing to default at the end of the loan.
Only if the money supply is roughly comparable at the end of the loan to what it was at the start can the loan be thought of as (even approaching being) equitable to both parties. A slight decrease in money supply insufficient to result in default for the borrower would be the worst outcome for the borrower.
16th February 2009
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