By the end of the twentieth century, debt had long since been accepted as a natural part of economic life, and borrowing and lending accounted for an enormous part of the economy in all developed countries. It had become common for the amount of debt (including the debts incurred by individuals, companies, and government at the local, state, and national levels) in a developed nation to add up to more than three times the total value of all goods and services produced by the country's economy.
Several conditions are necessary to support an economic system in which debt plays such a big role. First, the members of such a society must be likely to repay what they owe. A credit system in which most people try to avoid payment is unsustainable. Second, there must be a sophisticated legal system that emphasizes the protection of private property. A debt is a loan of one person's or organization's private property to another person or organization; if debts are to be reliably collected, laws must be able to defend creditors' property rights. Third, the society's money must maintain its value. When a country's currency is unstable (that is, when its money tends to lose or gain value erratically as a result of rising or falling prices), then a creditor cannot count on the value of the money he or she will eventually be repaid.
Most debt is transacted not by borrowers and lenders in direct contact with one another but by intermediaries, such as banks. Banks take in money from depositors and lend it out to borrowers. Depositors are paid interest by the bank for the use of their money, and the bank charges borrowers a somewhat higher rate of interest. The difference between these rates of interest is one of the key sources of any bank's profits.
Debt is often based on created money: figures on paper (or in computer systems) rather than hard cash. Banks do not hand over actual coins and bills to borrowers. Instead, they give borrowers a checkbook with the amount of the loan recorded as a balance (the amount of money available) in a checking account. People can write checks or withdraw money that is subtracted from these balances, but a bank does not have actual currency on hand equal to the full value of all its bank accounts. Banks make loans, instead, in proportion to a small amount of currency that they are required by law to keep on hand. If, for example, Community Bank has $10,000 in currency, it might need to keep only $1,000 in reserve and can lend out the rest. The borrowers then take the money and place it in a bank account, which can then be lent out to other borrowers. This process continues, and the initial $10,000 in currency allows Community Bank to make loans equal to 10 times that much money. Community Bank thus literally creates 90 percent of the money in its accounts out of thin air.
This form of money, which exists only as numbers in banks' computer systems, accounts for much of the total money supply in a country at any given time. In 2006, for instance, there was about $800 billion in physical cash in the United States. If the money supply had been calculated to include not just cash but also checking, savings, and other forms of bank accounts (all of which represent money owed by banks to account holders or by borrowers to banks), however, it would have amounted to more than $7 trillion. Debt, therefore, is one of the chief sources of the nation's money supply. Its importance to the economy can hardly be overstated. Not only does debt fuel business ventures, make possible large purchases, and allow for the construction of highways and the fighting of wars, but it also provides much of the basic material (money) for the entire economy.
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