Banking Basics

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nhaag replied on Thu, Nov 27 2008 2:22 AM

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First, I wouldn't claim, that the best way to understand banking is to imagine to set up a bank under the current conditions. It is like saying to understand how a car works you have to understand the licensing workflow that the goverment requires you to proceed with before you even build a car.

I only skimmed over the article, because the very first sentences showed me that this has nothing to do with explaining what a bank is and how it works.

I won't go into details, there is plenty of information here about banking, from scholars that deserve that name. Yet, some hints. First, as any other enterprise, banking in a free market serves a need or better several needs. One need is to safeguard the property you aquired if that property is in the form of a money. Another need banking serves is the need for credit to increase production or even start an enterprise.

If you had, say, 20 gold coins, and you fear that someone would come to rob it from you, you can go to a facility that would store those coins, handing you a receipt in turn and charging you for the service of storing it. To get those coins, or part of them.back, you would go to the facility again, present your receipt and withdraw the amount of coins you want, receiving a new receipt for the coins you left in the vault. This basically is a chequing account or more precise a demand deposit. Demand deposit because you can demand to withdraw your coins any time you like in full.

Now, if the idea hit you that you could make something more out of your coins than only hoarding them, you could look for someone who is in need for credit. You could lend your coins or part of it to him on the promise of repayment including interest. Because it is a lot of effort, to find people that are good debtors, e.g. you can be sure to get your money back and your interest paid, banks offer a service to do that for you. You open a savings account and the bank tells you that the money put in here can not be withdrawn at demand but only after a certain time or to some extend. This way the bank can lend out money to others, charging them interest and paying you part of that interest too.

As you see, there is a huge difference between a chequing account - using the banks storage facilities and pay them a fee- and a savings account or certificates of deposit - lending the bank money to get interest. In one case you just let the bank store your money. In the other case you lend your money to the bank, which is basically the same as if you rent out your property to someone else to use it as he wishes for a certain period of time.

The issue with banking starts when a bank beginns to think "smart" and realizes, that most of the money stored in their vaults is never withdrawn. Now they begin to lend out a percentage, they feel to be safe, of the money that is only given them to be stored rather than given to them as a credit. This is basically theft, because the bank told you that it will store your gold coins and not to use it while you don't  "seem" to need it.

Think of it like you park your car in a garage during your work hours. You pay the garage to keep your car safe during the time you work and you do expect that the car is just stored- because that is what the contract says. You do not expect that the garage owner starts renting your car for some time while you work, just because experience told him that most cars are not picked up before 4pm.

Yet, this is what banks do and they call it fractional reserve banking. It just means that they only keep a fraction of the demand deposits in store and lend out the rest. Like a guy who has the responsibility for the petty cash and knows, or hopes, that the next revision is 2 weeks away, would take out some dollars for his personal use, willing to put it back before the next revision is due. You think that behaviour is not theft?

I suggest to read Rothbard's "Mistery of Banking"  to get an understanding how it works and what consequences the current "legal theft" of banking has.