The money can be created, as I indicated, and can be destroyed. I do not mean to burn banknotes. Merely to repay a loan is a destruction of the virtual money involving own debt. If I sign a promissory note and others used this promissory note as payment, the promissory note is money. If I cancel the debt of the promissory note, the promissory note ceases to exist, the money disappears from circulation. Both money existed in the time before my payment, the promissory note and my money, and when cancelled it ceases to exist the promissory note. Destruction of money.
Also the fact that Central Bank charge interests of money to the banks is in fact a destruction of money. To understand this lets suppose that we are in the situation of a stagnant population and indebted to the maximum. Debts do not increase and therefore does not create more money. Interests which fall within the Central Bank comes to the end and after the money is in circulation, so this money is falling and falling into the bottomless pit that is the Central Bank which has the ability to create and destroy money at will. It is a destruction of money, but is controlled. If he do not want to destroy more, simply he drops in interest rates, but a central bank can not make a negative interest rates. In Japan they are approaching zero but are not zero.
The case of subprime them has been a case of destruction of money, at least temporarily. Poor quality USA loans were covered by bonds sold as being of good quality and that now anyone wants, this has provoked that in the market it have lost almost all value. Although in the background they are still supported by some houses that served as collateral, in the market they are worthless and therefore some bonds, some notes to the end and after a debt no longer have value. The disappearance of the value of that paper has represented in fact a disappearance of huge amounts of money in possession of mainly Western banks, above all Americans, of course. This disappearance of such money banks assets did them engage in multi-million dollar losses and has caused that their balance sheets are unbalanced and has done that they need to borrow more money to cover inter alia the money that they themselves have provided. The increase in requests for loans between banks did upload the interbank interest rate and the requests for money to central banks. It has led to the current liquidity crisis, the subprime crisis. No losses in themselves but the huge borrowing needs.
The idea of American Government of buying or to guarantee assets guaranteed by subprime can solve the problem, Because it returns to give value to these products. When the market believes that these products have value, it will again to be bought and sold, they will again have value, thus improving the balance sheets of banks and reducing their need for borrowing and making interbank rates lower. The new problem is the massive debt that the U.S. will contract for such purchases.
Another factor to take into account in the issue of destruction of money is the problem of trade balances. The brutal rise of Chinese products and oil imports, this one because of its price upward until July 2008, It represents a massive departure of Western currency towards these countries, and much of these currencies does not return to the Western banking system. If these countries reinvested the money in Western countries, the money is back to the system, but if it is simply stored for example in the form of foreign currency reserves, it create a problem similar to the destruction of money. That money becomes a money "disappeared" at least temporarily. This disappearance obliges the increase of request of loans between banks, rising the euribor, and to the requests for money to central banks by commercial banks, creating a liquidity crisis similar to that caused by the subprime crisis. In fact you have gathered both phenomena simultaneously last year. Two months oil falling will help balance, but if oil prices turned up, the problems can return before it have been solved.
Central banks have little choice that to make up for interbank lending market and increase the availability of money to lend to banks to fix the problem. This is what some analysts are waiting. This increase in money creation can have the side effect of making Western currencies fall against those countries where the money flows, which I think it may be quite beneficial for our economies in the long term, because we will import less from China and will export more to Middle East and China, rebalancing our trade balances.
As George Soros says “the banking system must be recapitalized” in order to came out of the financial crisis.