Leverage also contributes to the overall risk in financial markets. Liquid financial markets make it more easy to enter and exit positions, making it appear that it is safer to operate with leverage. If markets are not liquid then leverage appears more dangerous as it is more difficult to exit a position. Liquidity of markets makes it possible to take more risk so the overall level of risk in the financial system may increase as a consequence of liquidity as liquidity may stimulate leverage.
Banks create money by issuing bank credit that can be redeemed for money. From time to time a bank cannot meet the demand for money of its depositors and then the bank goes bankrupt. Because banks hold deposits at other banks, one bank's financial troubles can cascade through the banking system. People can lose their confidence in the banking system and bank runs may ensue. Banks may stop lending money because they want to meet the demand from depositors for money.
This can cause a depression because a reduction in lending causes a reduction in spending and investments. During a depression business incomes drop in money terms so many businesses and people experience difficulty to repay their debts. This causes more businesses to go bankrupt and more people to become unemployed. More loans will then not be repaid and consequently more banks get into trouble. In this way a credit cycle can reinforce itself.
Marxist cycle and creative destruction
Technological developments often make older technologies obsolete and previous investments in those technologies worthless. In many cases those changes are accompanied by changes in the demanded quality and quantity of labour. Also the business cycle destroys existing capital in a similar way by creating businesses during a boom and destroying them during a slump.
Some Marxist theories state that existing wealth must be destroyed by war or economic crises in order to clear the ground for the creation of new wealth .
Related to the Marxist theories is the theory of creative destruction. It states that innovative entry by entrepreneurs is a disruptive force that sustains economic growth, even as it destroys the value of established companies and the skills of labourers that dominate the market because of previous technological, organisational, regulatory, and economic developments .
Usury and debt slavery
Ancient societies observed the adverse consequences of interest. Interest contributed to the concentration of money in the hands of a few people, while on the other hand many people were in debt or had become serfs of the money lenders. For that reason debts were forgiven from time to time . The Bible has provisions to forgive debts such as the Jubilee Year. Compound interest is infinite in the long run. This is only a problem when the money lenders do not spend the interest on their money but accumulate it.
When money became concentrated into the hands of a few, less money remained in circulation. It became more difficult to repay debts with interest because the debts and interest were fixed in money terms, while prices dropped and interest payments further reduced the available money in the hands of the public. The money lenders could take possession of the belongings of the borrowers and demand their labour as repayment. In this way many people became serfs of the money lenders. This phenomenon is called debt slavery.
Much of the study of economics involves the implications of government policies on the economy. Macro economic policies are the manipulation of taxes, expenses and money supply to achieve goals concerning economic activity, employment and price levels. Stated policy goals are often high economic activity, low unemployment and stable prices.
Economic problems are mismatches between supply and demand. Economists identify two different kinds of economic problems:
- Structural economic problems are often supply related, for example poor infrastructure or inadequate skills of labourers.
- Cyclical economic problems are often demand related, for example falling incomes and a low consumer confidence.
There are different types of macro economic policies aimed at addressing those problems:
- Fiscal policies are policies that involve the manipulation of taxes and expenses to achieve economic policy objectives.
- Monetary policies are policies that involve the manipulation of money supply and interest rates to achieve economic policy objectives.
- Regulation can also be used to influence economic growth. It is often assumed that less regulation reduces business costs and improves economic growth.
There are a number of influential economic views:
- Markets can deal with the issue (classical economics).
- The economy is often not operating at full capacity. The government can influence economic growth with spending and taxes (Keynesian economics).
- The central bank can influence economic growth with changes in money supply and interest rates (monetarism).
- People are not stupid and anticipate the effects of policy actions (rational expectations).
- Economic growth can best be achieved by lower taxes and less regulation (supply side economics).
There are a few alternative views:
- Fractional reserve banking causes economic booms and busts. Policy interventions aggravate those problems (Austrian School).
- Interest causes problems and international finance dominates communities and nations (community currencies, National Socialism).
- An unbalanced distribution of wealth can cause a revolution (socialism, Marxism).
- Economic growth is not sustainable (steady state economics, de-growth).