Excellent analysis. Now add in inflation, risk, and time-preference.
You mean monetary inflation?
When central banks issue more currency to fight deflation, the liquidation process is postponed but not avoided. Some of the new investments not based on real loanable funds but in inflation are made and the unavoidable collapse of credit becomes even worse.
When I said interest, I meant
basic interest, excluding risk premium. If the lending is risky, the borrower acquires at the same time a loan and an insurance. While the basic interest can be suppressed through demurrage (freigeld) or money abundance (LETS), the risk premium has to stay.
Time-preference is not applicable to all goods and services. It wouldn't be applicable to money with demurrage. No one would prefer to save fish forever instead of lending it because fish decays. Time-preference belongs to the
"abstinence theories" by the terminology of Boehm-Bawerk, but I don't think the austrian school is correct in this particular point.
To remove your prejudices regarding interest and time preference, I recommend you
this short story.
There is only one kind of inflation. If you want to call it monetary inflation, feel free.
A moment's thought should convince you that an insurance premium is exactly the same as a higher interest rate.
Time preference is indeed applicable to all things. The only way it couldn't is if you assume it only goes in one direction at all times and for all things.
The island story doesn't remove prejudices, it just tries to replace them. Also, it doesn't apply here, because you were talking about money.
I suppose I should also point out that inflation is indistinguishable from currency demurrage, in practice.