There is allot of confusion about fractional reserve banking.. fractional reserve banking is a free market investion, it would work even under a gold coin system, without expanding money supply.
When you deposit money with a bank, and the banks lends out that monet. It might appear that the money supply has increased because two people have claim to the same money. However that is confusing, money with debt. I'll paste the following from another thread i wrote..
You have to remember that this other person that spent your money is
now in debt to you. He will pay you back the full amount, and then some
(interest). So when he spends your money, your no longer have any money
in the bank. What you are left with is a note that says "Hi. I noticed
you where not using your money, so I took it and spent it. Dont worry
though, I'll give you back the money, and a little for your trouble
whenever you want". Ofcourse, that is a simplification.. what really is
going on is that all the depositors money is put into the same pool of
money, the overall money in the pool stays much the same.. sometimes
one depositors take out all their money, but they dont all do it at the
same time.. which means that there always is lots of money in the pool
gathering dust. So what they do is let borrowers, borrow money from
that pool. When the borrowers make mortage payments, they put money
back into the pool.. eventually every borrower will have put back all
the money they borrowed into the pool and then some (interest). You
see? There is always enough money in the pool to cover the random
withdrawl request by depositors.
Dont get confused though, no money is created here. Its just a
creative and innovative way of lending money. Both lenders and
borrowers preferr this way of lending as it is less restrictive, more
efficient and therefore cheaper. Imagine if you had $100 you wanted to
lend out. Would you rather lend it out signing a contract that read
"you will get back your money this time next year, and you will make
one years worth of interst." Or would you rather sign a contract that
read "you will get back your money whenever you want it, and you will
get paid interest depending on however long your money was lent out".
You see, the second contract is much better for you. You can decide
that you want back your lent out money at any time. This is what
happens with your money when you keep it with a bank. All your life
savings have been lent out to other people, who have spent it already.
However this does not matter as all the borrowers of the bank are
paying back their loand to the bank on a regular basis. There are so
many of them, that the bank always has enough money in its vaults to
pay you back your money whenever you needed it.
But what about bank runs? What happens if all depositors requested
their money back at the same time. This is rare, but sound banks have
nothing to fear. They can always raise money by selling assets. What
assets does a bank have? Its got lots of those borrowers that keep
paying back mortages every month. Thats a bond that pays x percent of
interest a year. It can sell that on the open market and raise money.
It could seel all its mortage backed bonds, and if the bank had not
undervalued the price of risk involved with its borrowers, then it
could raise enough money to pay back all the depositors at once. A bank
only has to fear a bank run if it prices risk incorrectly, that is if
it loans out money to risky borrowers at a low interest rate.
You see? This system would work just fine even under a gold coins
system. Its just another way to lend out money, no money is created in
the process.
Cheers