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Fractional Reserve Banking Made Easy

Economics / Central Banks Sep 30, 2009 - 04:11 AM GMT

By: Terence_Gillespie

Economics

Best Financial Markets Analysis ArticleThe paper bills in our wallet are not money. And they are not Notes as in "Federal Reserve Note" written on the top of the bill. They are actually just Tokens. Federal Reserve Tokens, if you like, is what should be written on top of the bills. They are not redeemable for anything other than themselves. And they represent only one thing: Your belief in their value. Hopefully, your belief extends to the next person you try to give them to.


The only real use for them is paying your taxes to either the state or federal government. You can be sure, however, that both will stop accepting them as payment even for taxes if you and I stop believing in the paper bills.

Paper money, or fiat, was originally accepted because you could redeem the paper for gold upon request. When people got used to the paper they felt more and more comfortable and were less likely to redeem it for their gold. They knew that they could redeem it at any time and the paper is lighter, more convenient and can be denominated in much smaller increments so that everyday transactions are made more practical.

By the time the gold imparts this trust to the paper the people storing the gold start using it for other purposes. The primary other purpose is to start using the gold as someone else’s money in addition to yours. When that happens the banker has now, in effect, doubled the amount of gold in his vault and is only in trouble if you decide to reclaim your gold. By that time many more people are storing their gold with the banker and he found that only a small percentage of people ever reclaimed their gold.

Now, at this point in the story nothing wrong has happened as long as:

  • You are told that your gold deposit is being lent out.
  • You are paid for storing your gold.
  • Your are not charged under the guise of a storage fee because the gold is no longer being stored by the banker.
  • There is a 1-to-1 relationship between the gold you lent the banker and the gold the banker has lent out.

Christians do not believe in charging interest to other Christians. But, even the Bible describes the business of lending while warning that "The borrower is a slave of the lender."

In the business of lending the difference between what you receive for the use of your gold and what the banker receives for lending it out is his legitimate profit. After all, if you don’t want the banker to lend it out then you can lend it out yourself and do all the work associated. More importantly, the gold is not taken out of circulation and can be used as legitimate capital for the borrower to invest in his ideas to create even more value for everyone.

As you might suspect, this is not how the story goes.

When the number of people who were likely to reclaim their gold was discovered then the banker could start to guess the amount of gold to keep on hand to make all his depositors believe he was storing their gold. This number becomes his required reserve ratio and fractional reserve banking is born.

The banker has used a combination of your gold, your trust in him and your infrequent need to reclaim your gold to pretend he has many times more money than the amount of gold that is actually stored with him. And since he is most likely not fulfilling the four requirements, above, he is probably charging you a storage fee, not paying you, not telling you he’s lent it out and is lending out much more gold than his depositors have deposited.

Even worse, the banker lends out gold that doesn’t exist and charges interest on the loan. The banker is now generating interest income on gold that he doesn’t have and that doesn’t exist. Fractional reserve lending is born. Here’s a video that describes how money is loaned into existence in today’s world. Start at 22:00 if you want to skip right to it:

There are three major problems with fractional reserve lending. The first problem is when the banker lends money that doesn’t exist to people who then use that money to purchase real goods then the money actually does now exist. The banker has loaned into existence new currency. The banker used to have to at least go to the trouble of printing up the actual paper bills. But, with computers he can even bypass that unpleasant task. This would be impossible if the banker had to attempt to fabricate the actual gold.

And that leads to the second major problem with fractional reserve lending: There is no longer any gold in the bankers vault. The "money" is just blips on a computer screen that can be typed in and deleted, as needed, to adhere to an extremely low, but legal, reserve requirement.

The third major problem with fractional reserve lending is that most of the deposits don’t come from people who received the money by creating real value. The majority of the deposits come from other loans that came from either the Federal government or the loaned out portion of another fractional reserve lending bank.

This leads back to the original point of this article: There is nothing backing the paper bills in our wallet but our belief in them. They are mere tokens redeemable for nothing and backed by nothing.

Although it may be convenient for the US, and the entire world, to continue believing in the US dollar there is actually no historical basis for the success of any fiat currency. That’s because no fiat currency has EVER survived in the history of the world. You read that correctly: It's not a matter of studying the good ones and seeing what they did right or wrong to make them succeed. None of them has ever survived.

Since the probability of any paper fiat currency collapsing is 100% then we can switch our focus on trying to guess when, not if it will fail.

For more on Fractional Reserve Banking and Lending and the history of many currencies around the world check out Larry Parks on YouTube or go to his website.

Terence Gillespie [send him mail] has worked at IBM, played jazz piano on cruise ships, is an instrument rated pilot, songwriter, and is attempting to optimize every aspect of life one article at a time on his blog at YourOptimal.com.

© 2009 Copyright Terence Gillespie / LewRockwell.com - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

1776Again
03 Oct 09, 23:29
The original derivative: the Federal Reserve Note

Will the Central Bankers around the world that now determine our fate , eventually admit the error of their ways ? Keynes was the original socialist, and so are the central bankers, whose shell games rob the collective "investors" and citizens. I don't think so; they will create yet another FIAT currency, and it is in the making behind the scenes.

The new currency will be yet another derivative, geared to those who play the shell games at the expense of the people of the world. The only way to avoid that fate is to realize that gold and silver have been the only real money, which is a store of value, as opposed to the derivative-based fiat currencies, which always fail over time.


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