I find it helpful to think in terms of “two economies” – intimately connected, of course, but thinking of them individually helps our understanding.
The first or “real” economy is an energy system. Energy is essential for all of the goods and services that we use. The scale of this economy is determined by access to energy, after the deduction of the energy cost of accessing energy (ECoE). This energy economy is the senior of the two systems.
The second or “financial” economy is subservient to the first. It consists of money and credit, whose only value is as claims on the “real”, energy-determined economy of goods and services.
The financial system introduces a time element into the “when” of who consumes the output of the energy economy. Lending defers consumption for some, whilst borrowing brings consumption forward for others. But this process does not add to the output of the energy economy.
The system of money and credit is a management tool for the real economy. It can help us to manage the real economy better, or lead us into managing it worse. Like any management process, it is capable of being misused and manipulated, and that’s part of what we are living through now.
The process by which money is “loaned into existence” makes credit creation the driver of the scale of claims (on the real economy) that are created. But creating claims doesn’t add to the quantity of goods and services for which these claims are exchanged. The creation of excess claims (money and credit) simply means that this excess has to be destroyed at some time in the future – destroyed, because they cannot be honoured by the real economy.
The destruction of “excess claims” explains the GFC process. This mechanism could be discussed here in a future article.