In your first comment, there is no flip side that favors the debtor. The default occurs because the debtor cannot pay *in the first place*; the formal realization is not a net gain to his situation (though it may cut his losses).

If default renders a central bank’s assets worthless, its currency should indeed be worth less. However, central bank assets are still small relative to the universe of assets and debt, which more than compensates if for instance mortgage bonds held by the Fed default.

And yes, once a default happens, the debtor is freed (at least if he can declare bankruptcy or otherwise truly have the slate wiped clean). This is why after defaults run their course the economy is free to inflate again (people again can start taking on debt — I consider the expansion of debt to be inflation in today’s credit-based system).

However, while defaults are happening en mass, money is much in demand and its value goes up. It is the process of mass default and the change in mentality that goes with it, not the final result, that drives the change in value of money.

To me, it follows that when a central bank asset depreciates, the currency be worth less. If default renders a central bank asset worthless, then its currency should be worth less. Similarly, if default renders a bank’s assets worthless, it’s banknotes should be worth less.

The case of the non-FDIC bank going under that you brought up I do agree is deflationary because the checks on that bank are no longer any good, and so money is extinguished.

I guess I still see deflation as requiring not just the “wipeout” of the asset side, but also the “wipeout” of its corresponding liability.

While this proceeds, cash is very much in demand. The debt is not rolled over — it is wiped out. Rollovers aren’t defaults, and are not deflationary, but defaults aren’t rollovers. In a rollover, creditors get paid because borrowers get new loans. In this environment people are unable to get new loans.

In the end, debt balances are much lower. This finally sets the stage for the cycle to start again with the accumulation of new debt (which is inflationary), but deflation takes years to play out. Just look at the length of a typical Kondratieff winter: perhaps 8-15 years.

On a separate note, isn’t there counterparty risk to holding funds in any brokerage account or even Vanguard. Certainly there is counterparty risk in owning gold ETF’s. Physical gold is not much better, for you could be risking more than money when you try to exchange it. With treasuries at risk for default, where does one hide?