I have given thought to this and I can't find any a priori demonstration that fractional reserve banking is bad. Sure, it multiplies money in the economy and may create inflation, but it might very well be equilibrated with the investment-spending-saving behaviors of the people.
I usually check any issue by asking if it violates some hardcore axiomatic principle, but I can't think of any principle violated by fractional reserve banking.
People who deposit money in a bank already know the money will be used for loans. If they had a problem with that they would put the money in a safe box instead. So there is no moral problem involved.
Then there is the inflationary issue.
Some guy deposits money in the bank, the bank will pay a fee to the first guy (being a intermediary) and could lend all the money at a higher fee to someone else. The second guy uses it to buy a new car for his taxi company. The car dealer will pay for his expenses (including buying more cars) and deposit the rest of the money. The car manufacturer, at his time, will pay his expenses and deposit the surplus. The same will happen with every other person who becomes and indirect receiver of the loan. Most of the money will be flowing through the market, only a small part will be saved. An equilibrium will be achieved sooner or later. The bank (if it expects to recover the money) can only lend to people with guarantees and projects that have a sound plan, which are scarce. The surplus of money in any economy is scarce too. The lending doesn't go on ad infinitum, it will stop at a point that depends on the current situation of the economy.
The only problem could occur when someone doesn't really want to loan the money, but just it keep there to facilitate the handling of money by issuing checks instead of having to carry (for example) gold or silver with him all the time. Then he agrees to pay a fee to the bank, and expects to be able to withdraw the money at anytime. If the bank makes loans using that money then the banker really is committing fraud. Otherwise, he is not.
The issue really comes down to sound banking practices. Fractional reserve, as based in fixed term deposits, isn't immoral at all. The danger for any person making a deposit would be the same as if he was lending it directly to some friend. His friend's project may fail and he may have to execute the guarantee, maybe will lose his money, maybe will have to go to a trial to recover something.
Actually, informal loans could be considered banking operations with a zero-reserve.
So, what's the problem? What am I missing here? Why is everybody against it?
Pity the theory which sets itself up in opposition to the mind!
Carl Von Clausewitz
gussosa: The only problem could occur when someone doesn't really want to loan the money, but just it keep there to facilitate the handling of money by issuing checks instead of having to carry (for example) gold or silver with him all the time. Then he agrees to pay a fee to the bank, and expects to be able to withdraw the money at anytime. If the bank makes loans using that money then the banker really is committing fraud.
The only problem could occur when someone doesn't really want to loan the money, but just it keep there to facilitate the handling of money by issuing checks instead of having to carry (for example) gold or silver with him all the time. Then he agrees to pay a fee to the bank, and expects to be able to withdraw the money at anytime. If the bank makes loans using that money then the banker really is committing fraud.
What you have just described as "fraud" is fractional reserve banking.
gussosa: The issue really comes down to sound banking practices. Fractional reserve, as based in fixed term deposits, isn't immoral at all.
The issue really comes down to sound banking practices. Fractional reserve, as based in fixed term deposits, isn't immoral at all.
"Fractional reserve, as based in fixed term deposits" doesn't make any sense.
It's the fractional reserve system, not fiat, that's the problem - in theory, you could have 100% reserve banking with fiat money, and it wouldn't be a problem. I'm just saying it doesn't make sense to talk about "fractional reserve" on term deposits (even in a strong 100% reserve system, term deposits would have "0% reserves" - it doesn't make sense not to loan that out)
bigwig:If there aren't bank runs (99% of the time), doesn't it mean that depositers would not touch that money and thus allow it to be loaned out in a free market?
Not necessarily, because money can be transferred from one account to another without being withdrawn and redeposited - i.e., it doesn't have to exist to be used in payment. Given Internet banking, etc., a modern bank could allow you to specify how much you want to keep on demand for immediate use and let you put different amounts in various-length term deposits (e.g., they could offer 24 hour, 7 days, 30, 60, 90 days, 6 months, 1, 2, and 5 years, say), where they'd offer continuously varying higher or lower interest rates on each length depending on their need for loanable funds, etc. (I mean the offered rate would vary perhaps several times a day; once you committed some money to it, you'd get whatever rate was offered at that time); when you put some money into, say, a 7 day account, it would disappear from your current balance and be returned (with interest) 7 days later (you could have some sort of calendar display showing your future balances as well as the current balance) - now the banks could legitimately loan out your money (with no reserve requirement!), except whatever you keep on demand (for which you'd pay a fee), and hardly anybody would keep any significant amount on demand, and bank runs would be impossible. But that's not what they do today.
Just once, Maxliberty makes sense
Eduard - Gabriel Munteanu:But they do oppose lending money while making guarantees that they're still available instantly and on-demand.
Say after me: money is FUNGIBLE. If the bank has more reserves than you personally can demand from your account then "they're still available instantly and on-demand."
scineram:Say after me: money is FUNGIBLE. If the bank has more reserves than you personally can demand from your account then "they're still available instantly and on-demand."
Up until the bank run that is...
In theory this is only true for 10% of their customers at any given time so does that mean they are only engaging in 90% fraudulent activities? I suppose it's only fraud if they can't pay back 100% of their demand deposits then?
Oh, and the whole bailment law that banks are immune to for some odd reason while any other warehouse that store fungible goods are universally accepted to be committing fraud if they issue more certificates than goods they store. Who in their right mind is going to store their corn harvest in a 10% fractional reserve grain silo?
The only reason we don't see bank runs today is because the risk of failure has been socialized through the FDIC who steps in to nationalize the bank and perform an orderly liquidation of assets to pay whatever portion of the debts that the taxpayers don't have to cover. And the 'lender of last resort' who can provide banks with almost unlimited liquidity to pay down their accounts to keep the run from picking up steam.
Up to the point of failure it is just a case of money management as Max says. But, then again, the same can be said for any other ponzi scheme.
The real question is if he intends to practice fractional reserve banking on his proposed gold backed interweb bank???
February 17 - 1600 - Giordano Bruno is burnt alive by the catholic church. Aquinas : "much more reason is there for heretics, as soon as they are convicted of heresy, to be not only excommunicated but even put to death."
Anonymous Coward:In theory this is only true for 10% of their customers at any given time so does that mean they are only engaging in 90% fraudulent activities? I suppose it's only fraud if they can't pay back 100% of their demand deposits then?
I think the people who deposit at length terms already know (and approves) the money won't be there. So there isn't any problem. The fraud happens only when the bankers touch the current accounts.
So it's just current accounts that shall be 100% reserve. I don't know if they already are but I suspect not from what I have researched.
By the way, I just wrote an article on this subject, in Spanish. If someone can comment (I could have made some mistakes or even a reeaally big fat one) I will appreciate it.
I loved your grain storage example. It's my area of business.
My quick take on things.
the "Fractional reserve banking" system isn't a problem so much as the creation of new money to loan out under a fractional reserve banking system (which Rothbard and I both perceive as fraud). If system worked where-in banks loaned out money they had on hand (up to the reserve amount, of coures), and created no new money, the only issue would be that of bank runs.
However, that's not the case; under our FRB system, banks create new money when they issue loans (Ie: if they have $1000 in deposits, and they have a 10% reserve ratio as dicated by company policy, they could loan out up to $900...however, if they did loan out $900, it would not be of their actual deposits, and would, in fact, be completely new money created out of thin air).
If we had a FRB system in which NO new money was created, I could probably tolerate it; there would definitely not be any inflation (except from a central bank, of course), just the risk of bank-runs.
That said, at the end of the day, I agree whole-heartedly with Rothbard; Common Law needs to recgonize any system of FRB as fraudulent in nature.
That's my opinion, anyway.
Resident Christian Minarchist.
Maxliberty: Look at the run on the bank in the movie "It's a Wonderful Life", the customers all want their money. Our hero Jimmy Stewart tells them that their money is invested in the houses of their neighbors and if they want their money they will have to wait the sixty days they agreed too when they opened the account.
Look at the run on the bank in the movie "It's a Wonderful Life", the customers all want their money. Our hero Jimmy Stewart tells them that their money is invested in the houses of their neighbors and if they want their money they will have to wait the sixty days they agreed too when they opened the account.
If they agreed to wait 60 days, then there's not a problem; and that's not an example of fractional reserve banking. The problem is where they didn't agree to wait 60 days - where the bank agreed to return their money instantly, on demand.
scineram: Paul:What you have just described as "fraud" is fractional reserve banking. This is nonsense. Under frb he does not agree to pay a fee to the bank. So that fraud has nothing to do with frb.
Paul:What you have just described as "fraud" is fractional reserve banking.
This is nonsense. Under frb he does not agree to pay a fee to the bank. So that fraud has nothing to do with frb.
What? They're lending out demand deposits, but he isn't paying a fee so it's somehow not fraud? Pull the other one.
Fox McCloud: the "Fractional reserve banking" system isn't a problem so much as the creation of new money to loan out under a fractional reserve banking system (which Rothbard and I both perceive as fraud). If system worked where-in banks loaned out money they had on hand (up to the reserve amount, of coures), and created no new money, the only issue would be that of bank runs. However, that's not the case; under our FRB system, banks create new money when they issue loans (Ie: if they have $1000 in deposits, and they have a 10% reserve ratio as dicated by company policy, they could loan out up to $900...however, if they did loan out $900, it would not be of their actual deposits, and would, in fact, be completely new money created out of thin air).
The two are inextricably tied together - the only way the bank can lend money out of a demand deposit is by creating new money, because, by the very definition of demand deposit, the money is simultaneously available to the depositor (even though the bank might not have the cash available, it can still be moved from one account to another - I can buy stuff and pay for it by a book entry moving money from my account to the seller's account, without ever having to have cash available to the bank)
scineram: Say after me: money is FUNGIBLE. If the bank has more reserves than you personally can demand from your account then "they're still available instantly and on-demand."
Same thing is true of wheat. Yet its illegal for a wheat warehouse to have more outstanding claims then they have wheat.
As Mises said: A theft occurs when the item is removed, not when the owner discovers the item is gone.
Paul:What? They're lending out demand deposits, but he isn't paying a fee so it's somehow not fraud? Pull the other one.
What you call demand deposit is a loan to the bank. So it is not fraud to relend it.
People are warehousing wheat. They do not loan it to the depository.
Paul:The two are inextricably tied together - the only way the bank can lend money out of a demand deposit is by creating new money, because, by the very definition of demand deposit, the money is simultaneously available to the depositor
I have to disagree. As long as it is deposited by definiton it is not available to you. It cannot be simultaneously available. That would be intellectual property. :D
scineram: Paul:The two are inextricably tied together - the only way the bank can lend money out of a demand deposit is by creating new money, because, by the very definition of demand deposit, the money is simultaneously available to the depositor I have to disagree. As long as it is deposited by definiton it is not available to you. It cannot be simultaneously available. That would be intellectual property. :D
Have you ever actually used a bank?
Every time a society or civilization embarks on a journey down the road called 'fractional reserve banking' it has always ended in disaster. There is no occurence in history where once FRB is adopted that the fractional amount didn't become lower and lower until it eventually became zero. None.
FRB and therefore fractional money is receipt money in transition to FIAT money. Fractional money always becomes FIAT because the amount of reserves held against newly created money will always be reduced to nothing.
FRB is in itself inflationary and if we could seperate people from money you would be correct. But this is not the case. FRB robs a man of his labour. You can not seperate money from labour - this is what FRB seeks to do and this is why golds purchasing power remains constant throughout time irrespective of how much paper money is in the system. That is because gold is intrinsicly linked to labour - you may be able to create money out of thin air with FIAT or almost out of thin air with fractional money but you can never create labour out of thin air. The story of gold and labour is essential to understanding FRB. Effectively when FRB is invoked which does not lead to inflation but is inflation- that is inflation of the currency, the monetary unit is diluted. Money representing a mans labour is effectively taken from him seemingly unnoticed through higher prices as the market eventually works out what is happening to the monetary unit. Therefore when fractional reserve banking is inacted, those lending this fractional money spend it into existence at it's birth. At its inception it is potent but as it cycles through society it is diluted giving the appearance of rising prices which is obviously illusionary - for what is occurring is the debasement of currency. In essence therefore FRB robs a man of his labour, his lifes work - there has been a transfer of labour from those who have done the work to those who haven't lifted a finger. A purchase in gold can capture a mans labour for that day - if sent to his future he can guarantee that he will preserve his lifes labour and efforts, the gold ultimately buying him in his future what it bought him on the day of his efforts.
Cheers,
Matt
Matthew
www.jwspaidtosave.com/asiapacific
Paul:Have you ever actually used a bank?
To clarify the situation and use the same language, so we can keep this debate in order.
From Wikipedia
A bank account is a financial account with a banking institution recording the financial transactions between the customer and the bank and the resulting financial position of the customer with the bank.
Savings accounts are accounts maintained by retail financial institutions that pay interest but can not be used directly as money (by, for example, writing a cheque). These accounts let customers set aside a portion of their liquid assets while earning a monetary return.
A time deposit (also known as a term deposit, particularly in Canada, Australia and New Zealand; a bond in the United Kingdom) is a money deposit at a banking institution that cannot be withdrawn for a certain "term" or period of time. When the term is over it can be withdrawn or it can be held for another term. Generally speaking, the longer the term the better the yield on the money. A certificate of deposit is a time-deposit product.
The opposite is a sight deposit which can be withdrawn at any time.
In the United States transactions deposit is a term used by the Federal Reserve for checkable deposits and other accounts that can be used directly as cash without withdrawal limits or restrictions. They are the only bank deposits that require the bank to keep reserves at the central bank. This is in contrast to "time deposits" (aka term deposits).
A certificate of deposit or CD is a time deposit, a financial product commonly offered to consumers by banks, thrift institutions, and credit unions.
CDs are similar to savings accounts in that they are insured and thus virtually risk-free; they are "money in the bank" (CDs are insured by the FDIC for banks or by the NCUA for credit unions). They are different from savings accounts in that the CD has a specific, fixed term (often three months, six months, or one to five years), and, usually, a fixed interest rate. It is intended that the CD be held until maturity, at which time the money may be withdrawn together with the accrued interest.
In exchange for keeping the money on deposit for the agreed-on term, institutions usually grant higher interest rates than they do on accounts from which money may be withdrawn on demand, although this may not be the case in an inverted yield curve situation. Fixed rates are common, but some institutions offer CDs with various forms of variable rates. For example, in mid-2004, with interest rates expected to rise, many banks and credit unions began to offer CDs with a "bump-up" feature. These allow for a single readjustment of the interest rate, at a time of the consumer's choosing, during the term of the CD. Sometimes, CDs that are indexed to the stock market, the bond market, or other indices are introduced.
A transactional account (North America: checking account or chequing account,[1] United Kingdom and some other countries: current account or cheque account) is a deposit account held at a bank or other financial institution, for the purpose of securely and quickly providing frequent access to funds on demand, through a variety of different channels. Because money is available on demand these accounts are also referred to as demand accounts or demand deposit accounts.
Transactional accounts are meant neither for the purpose of earning interest nor for the purpose of savings, but for convenience of the business or personal client; hence they tend to not bear interest. Instead, a customer can deposit or withdraw any amount of money any number of times, subject to availability of funds.
Current account is the name given to a transactional account in the United Kingdom and countries with a UK banking heritage, offering various flexible payment methods to allow customers to distribute money directly to others. Most current accounts come with a cheque book and offer the facility to arrange standing orders, direct debits and payment via a debit card. Current accounts may also allow borrowing via an overdraft facility.
Current accounts have two different ways in which money can be lent: overdraft and offset mortgage.
In the UK, virtually all current accounts offer a pre-agreed overdraft facility the size of which is based upon affordability and credit history. This overdraft facility can be used at any time without consulting the bank and can be maintained indefinitely (subject to ad-hoc reviews). Although an overdraft facility may be authorised, technically the money is repayable on demand by the bank. In reality this is a rare occurrence as the overdrafts are profitable for the bank and expensive for the customer.
An offset mortgage is a type of mortgage common in the United Kingdom used for the purchase of domestic property, the key principle is the reduction of interest charged by "offsetting" a credit balance against the mortgage debt. This can be achieved via one of two methods either lenders provide a single account for all transactions (often referred to as a current account mortgage) or they make multiple accounts available which allow the borrowers to notionally split their money according to purpose whilst all accounts are offset each day against the mortgage debt.
In the UK some online banks offer rates as high as many savings accounts along with free banking (no charges for transactions) as institutions which offer centralised services (telephone, internet of postal based) tend to pay higher levels of interest. The same holds true for banks within the EURO currency zone.
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