Every loan and mortgage that the banks issue creates new bank deposits (the numbers in your bank account).
This leads to massive instability in the economy. As banks increase their lending, it gets easier and cheaper to borrow and debt rises. Bank managers who used to lend money to conservative businesses now start giving credit cards to teenagers. Since every mortgage issued returns to the banks and can be used to fund more mortgages, the banks look for more people to lend to, starting with the ‘highest-quality’ borrowers, and eventually ending up with ‘NINJAs’ (No Income, No Job or Assets). Eventually it gets to the point where some people simply can't afford the interest on their debt, and then individuals, households or companies start to default, as happened in sub-prime America in 2007.
This inevitability is referred to as the ‘credit cycle’ or the ‘business cycle’ by central bankers and economists, but could just as accurately be called the 'debt cycle':
- increasing debt, then
- too much debt, leading to
- inflation targets breeched as resources in the economy, especially labour, become scarce leading to
- interest rate increases leading to
- greater transfer of wealth to the investment sector as unearned income leading to mortgage defaults, leading to
- asset write-downs by the banks
- reduced lending
This cycle was at the root of the current recession as in all recessions. If we don't change the system (by stopping banks from creating huge quantities of money as debt) then we can look forward to endless cycles of boom followed by bust!
The current system is inherently unstable and highly pro-cyclical. Pro-cyclicality means that underlying changes in the system are amplified until they get out of control and cause a crash. When banks make loans, they create new money, but the new money then allows them to make more loans. This process continues and means that the banks will never ‘run out’ of money - they will just keep lending until the debt burden becomes too high, borrowers start to default, and the banks suddenly become insolvent on paper.
This pro-cyclicality and inherent instability is hugely harmful to ordinary workers. The system first creates a boom that pushes up the cost of essentials such as housing and rent, forcing workers to get into ever higher levels of debt. It then causes a crash that throws thousands out of work. Then, as the economy finally starts to recover, employers are slow to hire fearing that they may need to make further redundancies if the recovery turns out to be a false start.
All together, this makes it harder for workers to find jobs, makes the jobs that they do find less secure, and significantly increases the amount of debt that they will fall into.