Economic Interconnectedness, debt, and the catastrophic propogation of business failure

Pete — Wed, 12 May 2010 03:25:30 GMT

Numerous times the too big to fail argument has been advanced. It has been said that various bailout's are necessary to prevent some party from becoming insolvent, otherwise given the interconnectedness of the world economy, everything may fall apart and there could be a worldwide depression. I even read someone who said the US must assist in the bailout Greece, lest Europe's economy should "topple economically because of investor panic and crushing debt". It is not in the self interest of the US to let this happen.

My question is: "Does central banking cause a much greater interconnectedness to exist, than would otherwise have been in its absence?". (I am familar with, but not asking here about ATBC).

I suspect central banking increases the probability that one business failure will lead to another, because central banking causes virtually all business and individuals to become debtors. This is, of course, because the banking system creates new money and lends it through the loan market. Hence, almost every business and individual has borrowed greatly against the banks, and imminent bankrupcy remains a possibility should some circumstance result in the failure to make a payment upon that debt.

On the other hand, absent central banking, the total amount of funds borrowed are commensurate with those saved by others. Thus, it is impossible that virtually all firms and inviduals will be in a state of indebtedness (as now is true) and hence on the brink of bankruptcy. The average business would have a positive value for the sum of its cash reserves less the sum of all funds borrowed. A business with some cash reserves would be able to sustain additional losses before going bankrupt .

Economics Questions

Economic Interconnectedness, debt, and the catastrophic propogation of business failure