The Mechanics of a Depression

Michael Maloney: Guide
to Investing in Gold &
Silver (paperback)
August 2008
Pages 32-33

The popping of a credit bubble is a deflationary event and in the case of the Great Depression it was massively deflationary. To understand, how a deflation occurs, you need to know, how our currency is born and how it can join the ranks of the dearly departed.

When we take out a loan from a bank, the bank does not actually loan us any of the currency that was on deposit at the bank. Instead, the second, the pen hits the paper on that mortgage, loan document or credit card receipt that we are signing, the bank is allowed to create those dollars as a book entry. In other words we create the currency. The bank is not allowed to do it without our signature. We create the currency and then the bank gets to charge us interest for the currency, we created. This brand-new currency, we just created, then becomes part of the currency supply. Much of our currency supply is created in this way.

But when a home goes into foreclosure, a loan gets defaulted on or someone files bankruptcy, that currency simply disappears back into currency heaven, where it came from. So as credit goes bad, the currency supply contracts and deflation sets in.

This is, what happened in 1930-33 and it was disastrous. As a wave of foreclosures and bankruptcies swept the nation, one third of the currency supply of the United States evaporated into thin air. Over the next 3 years wages and prices fell by one third.