[AnthonyMouse]

> Paying back that loan in the normal way is neutral, preserving the money that was created.

Actually it destroys the portion of the money that was created.

Sort of.

The bank doesn't get to keep the principal it originally created, it gets destroyed. But then they're back to having some slack against their reserve ratio, so they can immediately go recreate the money again and loan it to someone else.

Which is how banks actually create money, and inflation -- by over time increasing the net amount of outstanding loan principal across all debtors.

This is also why it's important to have the government create a certain amount of money -- it's necessary in order to allow people on net to pay down their loans without causing deflation. Or even to prevent people from having to increase their net real debt as the economy expands.

And despite all the whinging about QE, the banks are still way ahead on the "average real debt per citizen" front.

[skookumchuck]

Banks don't create inflation. The proof of that is that there's net 0 inflation in the historical periods of free banking (like in the US before 1914).

> This is also why it's important to have the government create a certain amount of money

Somehow it all worked fine before the fiat money system started in 1914. A century of incredible economic growth, and no net inflation.

Any analysis of the causes of inflation need to take into account the US from 1800-1914.

[AnthonyMouse]

> Banks don't create inflation. The proof of that is that there's net 0 inflation in the historical periods of free banking (like in the US before 1914).

The US was on the gold standard then. There is obviously not going to be any currency inflation when the currency is pegged to gold.

> Somehow it all worked fine before the fiat money system started in 1914. A century of incredible economic growth, and no net inflation.

It all went fine except for the parts that didn't. Why do you think it was suspended in 1914? That was the start of World War I, when European companies started calling in their debts from the US and wanted payment in gold rather than dollars. That reduced the value of the dollar below the value of the gold. When that happens people start going to the banks and trading dollars for gold until the dollar supply decreases and their value returns to parity with gold, only the banks didn't have enough gold for that so everything went off the rails and it had to be suspended.

After that the gold standard was re-instituted, and to keep it solvent after the stock market crash the fed had to maintain high interest rates during the Great Depression, making it longer and more severe than it would have been.

We weren't actually off the gold standard until 1971.