The money was not destroyed, the person who took out the loan has it. Maybe he spent it, so whoever he gave it to has it, but it was not destroyed.
Fractional reserve banking is a lovely canard that is trotted out constantly, but it is not the monster the internet makes it out to be. Don't believe popular logic just because it's repeated over and over.
Fractional reserver banking, at it's core, is a way of converting collateral into cash, without having to sell it so someone. No value was created. Money was created, but not value.
And writing that just helped me understand what happened: value (of houses) was destroyed, so the money value that went along with it vanished too.
I do not see fractional reserve banking as a monster but the mechanism that makes banking a viable business. I have no problems with it or fiat currency
If the bank is unable to reclaim the physical money backing the loan, for example by foreclosing and reselling or having and investor cover the loss, the physical money would be destroyed. You see this happening now with banks raising money by selling equity. In other words if the loaned money bought things with no value or less value than paid then physical money is destroyed. If the loaned money buys things with more value than loaned then physical money would be created. This is simplistic description but I think accurate.
There has to be a mechanism for money and value creation and destruction. Money cannot be conserved. There is clearly more value/wealth and money in the world than 100 years ago.
It makes me think about gold backed currency. Suppose someone builds a house, there is now more value in the world, but there is the same amount of gold. So if all currency was gold backed it would cause massive deflation as new value was created in the world, but the amount of gold remained constant.
That makes me think that money is not backed by nothing - it's backed by all sorts of physical stuff all over the world.
I agree with what you say about a gold backed currency, or any static currency supply, leading to deflation as new value is created.
I also agree with your other statement that money is backed by all the physical things. I would have said that money is a representation or abstraction of the value of all things that it can buy. As the number of things that can be bought increases the money supply needs to increase to maintain acceptable valuation. If the money available is static the value of things that can be bought would have to deflate to accommodate the new things that can be bought. It seems that the number of things that can bought increases with time so we have to live with one of the two scenarios and seem to prefer the the first. For most people the deflationary scenario would seem more unsettling than the inflationary one.
