Fractional reserve banking question

Absoutely agree, and your reply doesn't seem to contradict my message. On the whole  I don't currently have a problem with the currency other people use, thats their decision.  I would think we might have a more efficient and reliable system if we agree to all use the same currency. In fact i wonder if the optimal currency might ultimately be dollars which are ultimately just  128 bit ID numbers stored on a central bank hard-disk.

But yes, a monopoly currency seems to raise trust issues for some people regarding what they see as a potentially corrupt,  government driven expansion of the money supply to fund political agendas the people don't agree with.  Thats fine.  Still,  I say 'on the whole' since i am undecided as to whether inflation is a good or bad, efficient or unefficient, fair or unfair mechanism of taxation -maybe if the  government gained the publics trust and were more transparent about the debasement process, with the reason for such inflation democratically agreed upon, maybe it might not be such a bad thing. What do you think?

How about simply more checks and balances with the existing system so that people can more confidentally observe what the government is doing with the money supply?

However, what I really cannot understand is why someone wants to trade with a backed currency.  If a receipt of an asset can potentially be circulated at the same time as the underlying asset of that receipt, then you have a currency system open to fraud, say by the banks, or by robbers stealing the underlying asset.  But how can a bank debase a currency if the currency isn't backed? e.g as in direct gold trading, or as in 'unbacked' paper note trading? sure, in the case of the latter  the government can print more notes to debase the currency, but a bank cannot do that surely?  Money must be returned before it is lent out again....

 From my understanding, if I trade with 'unbacked' money such as gold coins or special paper which represents its own value, the bank cannot defraud me, although the government can in the case of paper. On the other hand,  if i trade with asset backed money such as gold receipts, the bank can defaud me, but the government cannot. Or can it?  The government can still influence the amount of gold currently in circulation...

 

 

To the original question: inflation is simply the expansion of the supply of money.  What is money?  That which attempts to be used to trade with any other good.

FRB is inflationary and deal with demand deposits.  Demand deposits usually trade as money, because people assume that the bank has the underlying money.  Thus, FRB is one of two things.  Either the bank lends out the underlying money, thus unable to fulfill 100% of its demand deposit claims, or it increases the amount of demand deposits/claims without increasing the underlying money.  Obviously, this is an increase in the money supply, inflation, and will result in price inflation.

If on the other hand depositors loan the bank money for a specified period of time, and the bank loans the money out, this is not inflationary.  The risk and constraints prevent such debt from being traded as money.

 

The large problem of FRB is fraud.  FRB is fraudulent, as depositors find when a bank practicing FRB goes bankrupt and their claims are made simply invalid.  Fraud is not preferred by the market, but the market will not act against a bank if it has not discovered the fraud.  Under free banking, banks were constrained against practicing FRB, although many did to limited degrees.  It is only through government intervention that FRB can be widely and openly practiced.

FRB will fail.  If the government doesn't prosecute this action as fraud (which it often does not as such practices are often used to pay for major government events like war), it will grow and become a bigger problem.  Thus, government faces a change - it can yield back power to the market and prosecute fraud, or it can invent some scheme to prevent FRB from being a problem.

One scheme is central banking, or forcing the banks to cartelize.  This makes FRB that much more easily practiced, and causes a much larger problem.  In other words, as FRB would cause one bank to fail and leave massive fall-out, central banking could similarly fail, leaving a much more massive fall-out.  Yet...there is another scheme...yet again involving more state power and less market power.

This is fiat currency, which basically means that government debt, rather than free market money (such as gold or silver...but not necessarily any one thing, only what the market chooses) is the new base money.  Thus, in the case of a bank failures, depositors don't get screwed - the entire public does.  The depositors are paid simply by increasing public debt and thus the money supply.  This is double taxation upon the general public - once because their money is devalued and twice because their taxes collected will be used to pay down that debt.

 

Why didn't people reject this system, as it is based upon protecting fraud?  Because it was made illegal to do so.  Americans were forbidden from owning gold, and national commercial banks were not allowed to exist outside the federal reserve system.

These days, Americans can own gold, but it is still pretty much illegal, from a banking perspective.  E-gold is the best example of a true bank that does not practice FRB, and the American government has tried to put them out of business.  Why not use gold or silver currency outside of banks?  Several legal reasons: capital gains taxes, legal tender law, sales tax, prohibition of private minting.  But a main reason is simply the inconvenience of not being allowed to commercially bank through such mediums.  The government will most likely not honor any contracts made in alternative currencies, such as gold, given Fed money is the only "legal tender".

 

As for consumption of money, consider Fed money - it gets torn up and eventually destroyed, simply because it is used as money.  Thus, it would be consumed in its use as money.  The problem is its very easy to create new money.  And given the Federal Reserve System, there is even less requirement, as most money is in the form of accounts, probably electronic, rather than paper.  Similarly, gold and silver have many consumer uses in everything from computer chips and photography to jewelry.

But gold and silver, as heavy metals, are elemental.  They are very, very rarely converted into a different element.  When they are mined, it is doubtful they are 100% pure.  This means that gold put to consumer use can be used as money in that form, or melted down, purified, and used as money.  If deflation ever became a serious problem, more people would be likely to use their consumption gold as money, adding to the money supply.  Only the supernova of a dying star can create gold (at least in a cost-effective manner), so the entire increase of their supply comes from mining operations.  Mining is costly, and entrepreneurs can estimate the rate of expansion.  Similarly, as the population grows, demand and supply grow, thus money growth is needed to keep prices stable.  All of these things mean that rare metals find a unique niche satisfying desired qualities of money.

 

Confuse a cat, for modern-day bank runs, look what happened to IndyMac.  When a bank can't pay its obligations, it goes bankrupt.  Why didn't it simply print more money?  Because it couldn't - they would be prosecuted for counterfeit.  Only the Treasury can create the paper aspect of paper money.  Banks expand money by expanding its accounts through loans.  Only the cartel, as a whole, can create new money, through the FOMC, by monetizing debt.  Commercial banks can only LEND out up to 90% of their reserves.  This doesn't provide them short-term liquidity to meet debts - it does the opposite.  In this sitution a bank must borrow from another bank and if they can't, they may go bankrupt.  The cartel attempts to prevent bank failures by creating new money and lending it to failing institutions, thereby allowing them to pay their debts in debased money.  If they go bankrupt, all its deposits are virtually null and void.  Thus, you could see why a bank run would still happen.  Either you go redeem your bank account before the bank goes bankrupt, or you have to wait for an unspecified period of time for the FDIC to repay you.  The FDIC doesn't cover deposit amounts over $100,000, although they claim there are ways to insure over that amount.  Of course, there is always the possibility that the FDIC could go bankrupt as well...

Now, there is another possibility, which would likely happen if the FDIC busts, which I think is inevitable.  That is, there will be a bank run on the central bank - basically the entire system will be abandoned.  This will not happen as simply as everyone going to the bank and demanding gold.  That simply can't happen.  Rather, the abandonment will be in the market.  Everyone will simply be trying to sell their government money for market money.  The result will be that the price of market money will become higher and higher in terms of government money.  This is virtually the same as a bank run; the actual value of government money will collapse very quickly.

I've accepted worthless pieces of paper all my life.

Right, and why is that? Because you expect it to be able to buy something else. You do not accept it for any intrinsic value it possesses - it only possesses exchange value. Now why would the person receiving the money accept it? Because they are confident in the government's ability to compel acceptance of the medium of exchange. Absent this, they'd face a major possibility that people would see it for worthless paper.

But issuing currency in gold in order to be assured of a fixed money supply is surely going from the information age and  returning to the middle ages. Surely  the important thing is restoring public confidence in the current financial system.  Not returning to gold.

No, two problems with this 1) gold does increase sufficiently to match growth in productivity (around 2-3% p.a. IIRC) and 2) that isn't important; what is important is letting people use a currency they themselves are willing to do business with. That would have the consequence, of course, of restoring confidence in the financial system. The current system is rubbish and deserves no confidence. 

any paper notes deposited at a bank are removed from circulation and can no longer be spent by the depositor.

You're aware of credit expansion, right? Banks lend out a multiple of what is actually deposited in them. The current reserve requirement stands at 10% IIRC in the US, even lower elsewhere.

-Jon

confuse a cat:

From my understanding, if I trade with 'unbacked' money such as gold coins or special paper which represents its own value, the bank cannot defraud me, although the government can in the case of paper. On the other hand,  if i trade with asset backed money such as gold receipts, the bank can defaud me, but the government cannot. Or can it?  The government can still influence the amount of gold currently in circulation...

If you trade with physical gold, then the only way you lose is if someone physically steals the gold coin from you.

If you trade with warehouse receipts for gold, you can lose if someone steals your receipt or if the warehouse commits fraud.  How do you know that the warehouse isn't printing more receipts than the physical gold in its vault?  How do you know that someone won't raid the warehouse and steal their reserves?  (That happened with the Liberty Dollar and some E-Gold vendors.)

If you trade with fractional reserve gold receipts, then you may not be able to redeem your paper for gold.  Why use a receipt for gold instead of physical gold?  Gold isn't that heavy.

If you trade with unbacked fiat paper, you can lose if someone steals your paper or if the government prints more of them.

I'm completely convinced.  Taxation is theft and inflation is theft.  If you disagree, then it's merely a question of how I can best protect my property from you.

fsk:

Why use a receipt for gold instead of physical gold?  Gold isn't that heavy.

Several reasons:

1) liquidity - rather than carrying $1 worth of gold as ~1/10000 oz, which would be nearly invisible and easily lost, you could use an easily visible and carryable note...(or you could use silver)...making and issuing bank notes worth a certain denomination of gold is usually easier than melting down gold, minting coins, etc.

2) convenient exchange - by having deposits at the same bank, it is easier for people to simply trade notes rather than to trade gold/silver, especially for large transactions where gold would indeed be heavy.  also, people may prefer to write checks, which can more easily be sent long distances and do not require the time to physically count the money.

3) safety - having the ability to write checks allows one to not keep money, available for theft, on his person, while still retaining full purchasing power

meambobbo:

[...]

2) convenient exchange - by having deposits at the same bank, it is easier for people to simply trade notes rather than to trade gold/silver, especially for large transactions where gold would indeed be heavy.  also, people may prefer to write checks, which can more easily be sent long distances and do not require the time to physically count the money.

[...]

Nit: There is no reason that people would only accept bank notes from their own bank. Banks routinely accepted notes from other (solvent) banks. Banks would routinely meet in what were called "clearing houses" to settle accounts. So if someone paid you in the notes of some other bank, you usually had no problem depositing them in your own bank. In fact this process was a big part of what constrained banks from getting away with fraud—er, fractional-reserve banking.

 

 In my understanding I see two further steps that need to be taken for true and fair money. 1) Gold actually has alot in common with paper money in that it has what amounts to an artificial demand much like paper money. The only difference is that gold has had this artificial demand for a much longer period of time than paper money. Neither has a real intrinsic value other than people have believed they can use it to exchange for goods and services but neither of them can be eaten or driven or have any other practical use equal to their value. I believe it is extremely inefficient to use gold as a currency because  the more we produce the more labor we need to be out there mining gold which is a fairly ridiculous idea. 2) From my understanding the real big problem with paper money is the interest being charged on it. Interest and improper lending practices are the cause of inflation. There are 2 ways to look at this if I borrow $200,000 for a house and pay the %5 interest immediately I have $190,000 to "buy" a $200,000 house. The other way is if I get a $200,000 loan for a house and after 30 years it costs me $550,000 with interest I am obviously not going to sell it for the pre-interest cost. This is how interest causes inflation. Supply and demand can also cause inflation but on average, say within a country, interest causes much much more inflation than supply/demand constraints.

 The worlds hypnosis by gold is the actual cause of, and inevitably evolved into, our current system. The similarities are striking in that they are both representations of value that are supposed to be hard to acquire but neither has a real intrinsic value on its own. Neither will ever work because the interest of all existing loans has to be covered by future loans on an exponential curve. There were good reasons we switched from the gold standard and it is because the fundamental problem of ever increasing interest debt this causes our economy to be unsustainable no matter what is representing value. This problem is just easier to hide with a Fractional Reserve system than a gold backed system but still applies to both equally over time. If you do the math you will see that interest debt is ever increasing proportionately to GDP staring at %0 and over time theoretically reaching %100, loan defaults mitigate the speed at which this happens and total economic collapse will occur long before %100 is ever reached but the problem of this situation is inescapable.

 In my opinion the only way around this is a monetary system where %0 interest term loans are given out for assets. If you have a house you want to sell and it is worth $100,000 the bank gives you a 5 or 10 year loan for $100,000. Then say someone else does the same thing and you buy his house and he buys yours then the function of money has been fulfilled albeit in a very simple way. You each pay back the bank and the function of money to simplify trade has been fulfilled. It does not matter what represents the value in the framework of barter only that it actually represents the worth of the goods and services in the society. If a certain denomination of value would magically appear that was equal to the value of a good, that was definitely going to be sold, when it was created then an economy would function perfectly. Since this is obviously not possible we need to setup a system that simulates exactly this.

 Acquiring capital without assets is the Achilles heal of this type of system though but it can easily be argued that is also true of our current system. The extra risky or non-asset backed loans that can be made by banks due to their interest profits is not worth the trade though. The interest does much more damage than the extra risky loans do good. The extra loans that can be made due to those profits come nowhere close to offsetting the cost to society of the interest paid on loans. To overcome this problem there could be a trust system built up where people who have made small loans and paid them back without an asset backing it can get a bigger loan and so on. The loan could be made with the assumption that it will be used to create an asset that would back the loan in case of failure. In cases of outright fraud jail time could be imposed in effect imposing consequences on trying to steal loan money and therefore protecting it's value. The only way such a system would work is with complete transparency and strict accounting and appraisals.

 The big problem with our economy is that we have been hypnotized by paper money and gold to see them as having some intrinsic practical value when in actuality they have none or nowhere near the value we now accord them. In order to correct this we need to change the perception of money to be a representation of a good or service we have made through labor and want to trade for another good or service. Letting a bank charge us interest on our promise to work is an insanity clearly seen when this perception is attained. They are trading paper for our work. I am not arguing that banks should get no profits but it should be a cost plus situation where they also get money that represents a good or service they have provided not a percentage of societies work. Interest is the fundamental and unsustainable error in our current economy.

 Whether this type of system would be private or government would not really matter as long as the rules of the game were followed and every dollar lent out actually represented a product or service that was going to be sold and no interest was charged and as I said complete transparency and strict accounting and appraisals would be needed to make sure this was the case at all times.

Wow, Slider, I'd have to disagree with most of this.

1) Gold has far more intrinsic value than paper.  It is used in a wide variety of consumer products (jewelry, computer chips...).  Gold is currently prevented from being a completely functional currency, yet it still has a very high price.  If you believe gold's price is artificially over-valued based upon its history of monetary use, why did people ever start using gold as money?

2) Money cannot be overvalued or undervalued without price fixing.  Essentially, all supply and demand is measured in goods, not money.  Money simply eliminates the problems of exchange when you have division of labor.  When there is monetary freedom, there is no such thing as artificial demand.  If gold is suspected of being "artificially" over-priced, then it both buys and sells at "high" prices in terms of real goods.  In other words, the demand is expressed in terms of exchange ratios of real goods; how would that be artificial?

3) Value is relative.  You might prefer a sandwich over an ounce of gold, but someone else prefers the opposite.  In fact, they may prefer an ounce of gold over 1,000 sandwiches.  At this point, it becomes every sandwich lover's interest to obtain an ounce of gold.  Differing relative values, scarcity, and free trade transmute into overall market values, as commonly expressed in money.  If everything were designed so that everybody else would demand it, everything would have to be free.

4) Gold is inefficient as a currency because mining it costs too much?!  Are you suggesting the best currency would be the one that is most cheaply produced?  Should we use handfuls of air as money?  One of the most important aspects of money is for it to retain a stable value, without other conditions changing.  If the money supply can be changed whimsically, not just by a central authority, but by anyone, then money has completely lost its purpose, because price/value is directly related to supply.  If mining costs for gold rise higher than gold is actually worth to the market, the gold supply will become constant, enabling an extremely stably valued currency.  Yet, if there is huge profit in gold mining, supply will rise quickly, which pushes the gold price down so the profit margins disappear.  In this way, the growth of the gold supply is limited.  Plus, it cannot be manipulated as a monopoly by some central authority.

5) Interest on paper money, or any form of money, is not a problem.  Interest on artificial credit, which only one privileged organization can create is.  If the paper wasn't given value through government force, the paper most likely is promised to exchange for a fixed quantity of some good for it to have value.  This is real credit, and it should carry interest in loans.

6) Interest and improper lending practices are not the cause of inflation.  Most Austrians here believe inflation is an increase to the money supply.  The public mostly regards inflation to be general price inflation.  Thus, the cause of inflation (price increase) is inflation (money supply increase) unless there is economic recession; however, changes to the money supply always dwarf growth or recession annually.

7) People don't sell things at a higher price than the market demands for it.  Look at the housing market right now.  Prices are moving downwards because every sale needs a buyer, and jacking up the price is a good way to not find one.  Buyers, not sellers, ultimately determine prices.  The reason we have general price inflation is because the amount of money people have at their disposal to demand goods with is growing, because the overall money supply is growing.  The easiest example to see this is in commodity prices.  You don't need a loan to buy them, yet their prices continually rise generally.

...that's just your first paragraph and I'm already exhausted...I'll read the rest, but I don't think I really need to say any more.  Your entire premise is flawed.

meambobbo:

1) Gold has far more intrinsic value than paper.  It is used in a wide variety of consumer products (jewelry, computer chips...).  Gold is currently prevented from being a completely functional currency, yet it still has a very high price.  If you believe gold's price is artificially over-valued based upon its history of monetary use, why did people ever start using gold as money?

 

Dude, did you learn anything from the Austrians? Nothing has intrinsic value, just imputed value.

ok, you are vilifying and advocating the same thing: artificial credit.  Artificial credit is simply loaning someone a claim to something that presently does not exist.  Banks used to do it by lending you bank notes that could supposedly be exchanged for gold at any time, although they do not currently own that gold.  They were basically saying, "by the time our obligation becomes due, we will have the underlying asset."  They are loaning out things that they don't own...yet

Similarly, the American government and Federal Reserve create money by buying government securities with made-up money.  The money's value is represented by the value of the government debt, which is represented by the government's ability to tax the economy of the future.  Again, they are loaning out things they don't own...yet

Artificial credit has two effects on interest rates.  At first, it drives them down, as there is now a greater supply of "credit".  As this artificial credit causes the money supply to increase, price inflation increases, and interest rates proportionally rise to stay above inflation (otherwise, lenders are actually losing purchasing power after being repaid).

You are seeming to argue that some central institution (the banks - i guess as a cartel) should create money at their own whim, but only lend it out at "cost plus", rather than interest of its value in the market.  This is an impossibility.  There would be none of this "official money," although I would bet you could find people using unofficial gold coins.

And perhaps you have not paid attention to how "cost plus" has worked out with medicare.  You will perform the rare situation where prices continuously go up while supply remains limited.  Prices must be determined by supply and demand.  If this creates situations of obscene profits, then there must be free enterprise, which will show these profits to shrink as competitors flood the market and supply increases tremendously.  If there is not free enterprise, this is a classic case of a coercive monopoly, maintaining high profits by limiting supply.

 

You mean a good's value isn't related to the amount of time I spend to produce the good?

My bad.

I really cannot see now why FRB is always inherently fraudulent. It seems similar to insurance.

If an insurer took your money, you had an emergency and tried to make an insurance claim, and they said, "Oh, we don't have enough money to cover this, so we won't be," that wouldn't be fraudulent?  Insurers may mismanage capital and find themselves unable to cover claims, but if they simply spent all the money you sent them then refused to cover any claims, that would be fraud.

I think the public will tolerate a small amount of FRB.  But the fraud really isn't revealed until the bank is put in a position where it cannot own up to all its claims.  The fact that the bank is intentionally putting itself in a situation where it is impossible to fulfill the claims it has made is a pure example of fraud.

Now, if they claimed that demand deposits might be redeemable, that would be different.  They don't seem to advertise that.

There is a huge difference between clearly attempting to fulfill contracts and failing and purposefully attempting to avoid fulfilling them.

vp3434:

I was reading a debate between two people who disagreed on whether fractional reserve banking was bad.  I wanted to get to the root of why it is bad.  Would it be correct to say it's only bad to the extent that it requires the central bank to print more money to meet redemption requests?  For example, if I deposit $100 in a bank that lends $90 of it to someone who spends it on a product and the seller of the product then deposits the $90 in another bank, as long as I don't redeem my deposit before the loan is repaid, the central bank doesn't have to print money and lend it to my bank in order to repay me, right?  Or is this an impossible situation because the loan cannot be repaid without some sort of monetary expansion in order for the borrower of the $90 to cover the interest that accrues on the principal?  Thanks!

All those things, and also the gross injustice of a person having property, etc. seized to repay a loan of money a bank created from nothing. They are the only place to get money for a normal person, and all the prices on the markets reflect his availability of credit, thus increasing the demand in an ugly cycle, a la the housing bubble. It is a fraud. It allows the bank to profit from interest on money they lent literally by typing it into existence. The principla will dissapear as it is paid, but the interest will be kept. Of course, we are all forced to use and accept this illusion.

It's actually way, way worse than just this in our current system, but there's a start.

That would not be fraud.

1 a: deceit, trickery; specifically : intentional perversion of truth in order to induce another to part with something of value or to surrender a legal right b: an act of deceiving or misrepresenting : trick

 The refusal to obey terms of contract is not fraud. It should be prosecuted against banks or insurers naturally. And owners should be liable ot course, with their assets possibly. But insurers also put themselves in situations where it is impossible to fulfill the claims they have made. If earthquake hit no insurer could pay all the high damages for all clients, yet it is still a legitimate enterprise. Deposit insurance could develop for banks as it did, and insurance companies also insure themselves against such risks today.

The problem is this terminology that a contract violation is called fraud and when the state lets them get away with it.

 What I am saying is fundamentally different than most theories and requires a suspension of disbelief to understand. Understanding that our current system is flawed is halfway there.

1) You are right gold is worth more than paper money insofar as it has practical uses but these consumer products (jewelry, computer chips) do not solely elevate the value to what it is today. That is what I mean by artificial the price of gold is not reflected in it's real practical value but by the long term tradition of using it for trade. In this way it is very similar to paper money except the paper money tradition has not been around for quite as long.

2) I am saying that through what is a perceptual anamoly gold has been elevated to a value which it in practical terms is not worth much like money. When you get down to the basis for survival it is easy to see that a sandwich or shelter is worth something and gold is not. If you are starving you cannot eat gold if you need shelter gold would be a poor choice. Food,shelter etc have an intrinsic value that gold does not. If 2 people are on a desert island with no food 1 has a sandwich the other a million pounds of gold the guy will not sell the sandwich unless he is completely hypnotized by gold. In practical terms it can definitely be overvalued.

3) The function of money is to simplify trade. If everything were designed so that everyone else wanted it it would definitely not be free because you would still have to trade your labor skills products etc for someone elses labor skills products. Just because money is not involved does not mean it is free. If I misread what you meant sorry.

4) If we mined gold so that there is a certain weight of gold per product which would be necessary to remove the banks influence from inflating the money supply it could get fairly ridiculous at some point in the future. Automation advancements are increasing every decade so we would need someone mining gold to backup the automated production. The more efficient production becomes the more mining we would have to do. Gold is also a finite resource so while the production capabilties per person would be ever rising the gold mined per person would be ever declining. Would we have to slow down our production capabilities to keep in line with our mining capabilities. This is exactly what we do now when there is a credit crunch we scale back our production to keep it in line with our liquidity. If a country was run like a company no one would ever think such an inefficient use of manpower was a good idea why would it be a good idea in the case of a country.

5&6) Interest would not be a problem if it were spent back into the economy but as it is not generally spent back into the economy it is a huge problem. This is hard to see in a huge country but if it were to happen on a small island with a few people it would become readily apparent. On an island if person A got a loan from a bank for $1000 with %10 interest he would quickly realize he cannot pay $1100 since only $1000 exists. In our society this is hidden by the next loan, on this island that would equal person B getting a loan for a $1000 dollars then person A sells goods to B gets the $1100 and pays the bank but now person B has $900 and owes $1100 putting society on average even more into debt. Some people say but there is a wealth increase (or inflation) and person A and B's goods are worth more so they can refinance but interest is always higher than inflation so they are still on average always going deeper into debt. The only factor that mitigates this is loan defaults without them though the interest debt keeps getting switched from one person to another (growing and compounding in the meantime) indefinitely until someone defaults and eventually the country defaults. This is a huge problem and the fundamental reason our economy is unsustainable.

7)People also don't generally sell things for less than they pay for them either and as long as there is not a credit crunch it will generally sell. The market demand is guided strictly by the loans given out. This is interconnected with interest and the shifting interest debt. In my example of a house that is worth $200,000 that costs $550,000 with interest the difference of $350,000 has to be loaned to other people in society so that I can then earn it from them and pay of my loan which in effect shifts the interest debt to others. This works as long as there is enough trustworthy people out there to borrow the money and the economy is strong enough to support it but with the compound nature of this debt there comes a point in time where enough money cannot be lent out in the next wave of loans to service the interest on all previous loans (less the loan defaults) this causes the collapse of the value of goods because there is not enough money lent out to buy them all. So even though my example is simplified it is true.

 In an economy that works the only thing that would need to be simulated is the example I gave where if I produced a good worth $10 that I was going to sell I would get the $10 in effect a credit to hold me over until I did sell the good if another person did the same thing I could buy his good and he could buy mine in effect simplifying trade or I could buy 10 $1 goods from 10 people and one of them could buy my $10 good. If there was no interest and the money given out reflected the cost of goods up for sale there would be no inflation or bust and boom cycles. In the society there would be a 1,000,000 dollars of money in existence and a $1,000,000 worth of goods as long as that was the case and enforced through strict transparent appraisals,accounting and regulations there would be no problems. In the current economy I get a $10 loan for a good and have to pay interest so I now have $9.50 the same thing happens to the other guy now I have to earnthe extra 50 cents from him and I can buy his good but he only has $9 so he cannot buy mine. This is the extra complexity and imbalances that banks inject into the system by charging interest. We pay them vast sums of money to complicate what should be a fairly simple process.

 Also when I said cost plus I did not mean a monopoly a cost plus private banking system with strict transparent appraisals, accounting and regulations would work fine. They would not be based on an investment banking model but more of a management model which appraises the worth of a good which someone is putting up as collateral and loaning that amount for a set period of time interest free. This could be opened to competition as long as the businesses were strictly monitored for impropriety and the market would naturally keep the price down. If any bank lent out more money than the assets backing it it would be revoked the ability to give any further money out. Checks and balances could easily be put in place where a government agency controlled the printing presses and banks would control the loan appraisals. When the bank went to get the money the government would verify that there is appropriate collateral and in the much rarer case of non asset backed loans that the person has the appropriate credit rating and busines plan. Risky loans could have a set limit so that people would have the ability to work up to having assets over time to attain larger loans but could not get huge sums of money and disappear. This would drastically reduce the ability of banks to give out loans without any collateral backing it which is a necessity in our current system to make sure there is enough liquidity to pay off the interest on all previous non defaulted loans.

 Speculation is another flaw and when taken to the extreme would enable someone to buy all of a certain commodity and squeeze the supply driving up the price artificially we accept this problem to degrees but not when it is absolute but there really is no difference. Speculation should be abolished as it only serves to steal the work of people who buy and use the commodities whether it is one person hoarding it all by themselves or thousands of people doing it in concert should not matter as the end result is the same. With proper banking where money could not be lent out to buy a commodity again and again driving up the cost this would not be possible. The same can be said for a business plan where a loan is taken out to strip the assets out of a productive company because more money can be made from the assets that day than from the production created from those assets. If a country was run like a company these types of speculative business ventures would be seen as harmful as they should be. In a company this would be seen as department A making a million dollars at the expense of department B which lost 2 million any CEO would know that is not an effective business plan and so should we as a country.

   Here is an example of how interest debt is continually rising compared to GDP it is a post by someone else:

    The entire outstanding money supply is used to calculate interest owed.
   
    If money supply grows faster than real GDP or if debt grows faster than the ability to payback - then eventually, interest payments consume all GDP.

    This is the case.

    Take FED Funds at 1%, money supply growth at 5% and GDP at 3%.

    First Year

    Nominal GDP 100 x 1.01 = 1$ interest paid from 103 Real GDP available.

    5th Year

    Nominal GDP 127.62 x 1.01 = 1.27$ interest paid from 115.92 Real GDP available.

    10th Year

    Nominal GDP 166.88 x 1.01 = 1.66 Interest paid from $134.49 Real GDP available.



    Interest Paid as % of Real GDP

    1st Year = 1 / 103 = .0097

    5th Year = 1.27 / 115.92 = .0109

    10th Year = 1.66 / 134.39 = .0123



    Each year, interest paid gets bigger as a percent of Real GDP.

    Takes a long time. But its exponential.

    The net effect is the difference from Real GDP and Money Supply Growth. That differential is the exponential multiplier.

   Also I am not villifying artificial credit it is a useful tool when used properly I am villifying the rules it is set up to work under such as charging interest encouraging speculation and the lack of transparency, proper acounting, and appraisals. The idea of interest is rooted in history when someone would give out seeds and expect a percentage of more seeds in return. This is much more reasonable as seeds have the ability to create more seeds but paper money does not have the same ability to reproduce and create more paper money nor does gold which is essentially a finite resource.
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 I suggest reading the book Web of Debt and The Creature from Jekyll Island which explain the more fundamental cause of our economic problems then most theories do.

in the insurance analogy - it would be fraud if the insurers did not use their customers' payments in a manner that could cover claims. if the managers simply paid upfront costs to their employees and then used remaining funds to buy themselves expensive automobiles, leaving no funds in some trust, etc, to cover the claims that were the reason its customers paid them at all. it would be simply breach of contract if they made a valid attempt to use their funds to cover future disasters but came up short in some unforeseen, large-scale circumstance. banks can't operate with a high margin of FRB in a free market. the wildcat banks did - they were fraudulent. they had no plan to cover the claims they made. in using government protection and the central banking, fiat currency, and regulatory schemes, to support FRB, its not so much fraud as it is simply a bad plan, doomed to fail.

But the point of insurance is that you do not pay the full amount of possible future claims neither do others, and this works because the damages occur largely randomly, so the insurer can pay your claims mostly without problems.

Why are banking and insurance being compared?  They are two totally different services and business models.  I think it is safe to assume that the average depositor assumes there will be zero risk that his funds will not be available on demand.  If he thought there was any risk, he might not deposit his money.

Insurance 'works' because accidents are, well, accidental. The odds of you smashing your car are 1/10000. The odds of you trying to get the money you deposited back are 1/1 - so FRB will always fail.