Best of the Week
Most Popular
1. 2019 From A Fourth Turning Perspective - James_Quinn
2.Beware the Young Stocks Bear Market! - Zeal_LLC
3.Safe Havens are Surging. What this Means for Stocks 2019 - Troy_Bombardia
4.Most Popular Financial Markets Analysis of 2018 - Trump and BrExit Chaos Dominate - Nadeem_Walayat
5.January 2019 Financial Markets Analysis and Forecasts - Nadeem_Walayat
6.Silver Price Trend Analysis 2019 - Nadeem_Walayat
7.Why 90% of Traders Lose - Nadeem_Walayat
8.What to do With Your Money in a Stocks Bear Market - Stephen_McBride
9.Stock Market What to Expect in the First 3~5 Months of 2019 - Chris_Vermeulen
10.China, Global Economy has Tipped over: The Surging Dollar and the Rallying Yen - FXCOT
Last 7 days
Semiconductor Sector – Watch the Early Bird in 2019 - 21st Jan 19
From ASEAN Economic Development to Militarization - 21st Jan 19
Will China Surprise The Us Stock Market? - 21st Jan 19
Tips to Keep Your Finances Healthy in 2019 and Beyond - 21st Jan 19
Tips for Writing Assignment in Hurry - 21st Jan 19
UK House Prices, Immigration, and Population Growth Mega Trend Forecast - 21st Jan 19
REMAIN Parliament to Subvert BrExit with Peoples Vote FIXED 2nd EU Referendum - 21st Jan 19
Pay Attention To The Russell Stocks Index and Financial Sectors - 20th Jan 19
Hyperinflation - Zimbabwe's Monetary Death Spiral - 20th Jan 19
Stock Market Counter-trend Extends - 20th Jan 19
The News About Fake News Is Fake - 20th Jan 19
Stock Market Bull Trap? January 22 Top Likely - 19th Jan 19
After the Crash, the Stock Market Made a V-shaped Recovery. What’s Next - 19th Jan 19
David Morgan: Expect Stagflation and Silver Outperformance in 2019 - 19th Jan 19
Why Brampton Manor Academy State School 41 Oxbridge Offers is Nothing to Celebrate! - 19th Jan 19
REMAIN Parliament Prepares to Subvert BrExit with Peoples Vote FIXED 2nd EU Referendum - 19th Jan 19
Gold Surges on Stock Selloff - 18th Jan 19
Crude Oil Price Will Find Strong Resistance Between $52~55 - 18th Jan 19
Stock Market’s Medium Term is No Longer Bullish. It is Now Mixed - 18th Jan 19
SPX and Gold; Pivotal Points at Hand - 18th Jan 19
Fable Media Launches New GoWin Online Casino Affiliate Site in UK - 18th Jan 19
The End of Apple! - 18th Jan 19
Debt, Division, Dysfunction, and the March to National Bankruptcy - 18th Jan 19
Creating the Best Office Space - 18th Jan 19
S&P 500 at Resistance Level, Downward Correction Ahead? - 17th Jan 19
Mauldin: My 2019 Economic Outlook - 17th Jan 19
Macro Could Weaken After US Government Shutdown. What This Means for Stocks - 17th Jan 19
US Stock Market Indexes Reaches Fibonacci Target Zone – Where to Next? - 17th Jan 19
How 2018 Was For The UK Casino Industry - 17th Jan 19
Gold Price – US$700 Or US$7000? - 16th Jan 19
Commodities Are the Right Story for 2019 - 16th Jan 19
Bitcoin Price Wavers - 15th Jan 19
History Shows That “Disruptor Stocks” Will Make You the Most Money in a Bear Market - 15th Jan 19
What Will the Stock Market Do Around Earnings Season - 15th Jan 19
2018-2019 Pop Goes The Debt Bubble - 15th Jan 19
Are Global Stock Markets About To Rally 10 Percent? - 15th Jan 19
Here's something to make you money in 2019 - 15th Jan 19
Theresa May to Lose by Over 200 Votes as Remain MP's Plot Subverting Brexit - 15th Jan 19
Europe is Burning - 14th Jan 19
S&P 500 Bounces Off 2,600, Downward Reversal? - 14th Jan 19
Gold A Rally or a Bull Market? - 14th Jan 19
Gold Stocks, Dollar and Oil Cycle Moves to Profit from in 2019 - 14th Jan 19
How To Profit From The Death Of Las Vegas - 14th Jan 19
Real Reason for Land Rover Crisis is Poor Quality of Build - 14th Jan 19
Stock Market Looking Toppy! - 13th Jan 19
Liquidity, Money Supply, and Insolvency - 13th Jan 19
Top Ten Trends Lead to Gold Price - 13th Jan 19
Silver: A Long Term Perspective - 13th Jan 19
Trump's Impeachment? Watch the Stock Market - 12th Jan 19
Big Silver Move Foreshadowed as Industrial Panic Looms - 12th Jan 19
Gold GDXJ Upside Bests GDX - 12th Jan 19
Devastating Investment Losses Are Coming: What Is Your Advisor Doing About It? - 12th Jan 19
Things to do Before Choosing the Right Credit Card - 12th Jan 19
Japanese Yen Outlook In 2019 - 11th Jan 19
Yield curve suggests that US Recession is near: Trading Setups - 11th Jan 19

Market Oracle FREE Newsletter

UK House Prices, Immigration, and Population Growth Trend Forecast

The Fraud in Fractional Reserve Banking

Politics / Central Banks Nov 26, 2014 - 02:13 PM GMT

By: Frank_Hollenbeck

Politics

Suppose you bring a fur coat to a dry cleaner, and discover that the owner allowed his wife to wear it before cleaning it (which is also the subject of an episode from Seinfeld).  Or, suppose you gave your car keys to a hotel valet and, when attempting to pick up the car later, were told your automobile was lent to teenagers who took it for a joy ride while you  slept at the hotel. You would not be too happy, and for good reason. When you surrendered your clothes or your car keys it was a bailment. You retained ownership and gave the clothes or car keys for safekeeping. In no shape or form, did you surrender ownership of the items or lend out your property.


Suppose you lived in the 18th century and had 100 ounces of gold. It’s heavy and you do not live in a safe neighborhood, so you decide to bring it to a goldsmith for safekeeping. In exchange for this gold, the goldsmith gives you ten tickets where each is clearly marked as claims against 10 ounces. Now, gold is heavy and burdensome to carry, so in a short period of time, those claims will start circulating in place of gold. This is the creation of near monies. This doesn’t mean you have given up your ownership claims on gold, but have used a simpler way of transferring ownership of this gold.

Of course, now the gold just sits in the vault, and no one usually comes to get some of it or even check that it is still there. Quickly the goldsmith realizes there is an easy, fraudulent, way to get rich: just lend out the gold to someone else by creating another 10 tickets. Since the tickets are rarely redeemed, the goldsmith figures he can run this scam for a very long time. Of course, it is not his gold, but since it is in his vault, he can act as though it is his money to use. This is fractional reserve banking with a voluntary reserve requirement of 50%. Today, modern US banks have a reserve requirement of between 0% and 10%. This is also how the banking system can create money out of thin air, or basically counterfeit money, and steal the purchasing power from others without actually having to produce real goods and services.

Now the goldsmith, or what we will now call a bank, is limited in the amount of fraud or counterfeiting it can commit. Imagine a bank has 100 ounces of gold but outstanding claims on 200 ounces of gold. The bank has to keep a certain amount of gold in its vaults since depositors on occasion will exchange tickets for gold. Another constraint is that depositors, if they get suspicious that there are more claims than available gold, may run to the bank demanding to redeem their “on demand” claims into gold. This run, really reflects the totally fraudulent nature of banking. Banking holidays, implemented in the 30’s, or capital controls, implemented in Cyprus recently, are actions to benefit the fraudster (the banks) instead of the victim (the depositors). The world has been turned on its head.

Suppose you are the goldsmith and your rich uncle promises to lend you as much gold as you need if you happen to run out – what could be considered a central bank’s lender of last resort function. Are you likely to commit more or less fraud? Suppose this rich uncle tells you that if things go bad, he will make sure everyone get their gold back (deposit insurance). Again, are you likely to commit more or less fraud? And since you have no skin in the game, are you likely to take even more risks, for higher returns, in your lending activities?

Austrian economists typically have a hard time explaining why fractional reserve banking is fraud. The standard response from the average Joe is “everyone knows that the bank loans out your money.” Or, they will say “all banks in the U.S. include a clause in the depositors’ contract that specifically says that the relationship between the depositor and the bank is exclusively one of creditor and debtor”. Suppose the bank takes your money and loses it all. How does the bank satisfy your expectation that the money is there on demand to pay your rent and electricity bills? It’s simple. They take the money from someone else. If the bank had told you it is lost and unfortunate, there would be no fraud. The fraud occurs the minute the bank takes someone else’s money. The victim of the fraud is the other depositor. The bank runs a Ponzi scheme (a fraudulent activity) that can continue for a very, very long time, but is no less a Ponzi scheme and should be treated as such. Although, you and the bank may be well aware of what is going on, it still should be treated as fraud. The fact that you are aware, or even unaware, of the Ponzi scheme does not diminish the fraud. Government deposit insurance just shifts the ultimate cost of the fraud to other depositors, taxpayers or anyone using currency to conduct transactions.

Why is counterfeiting illegal? The counterfeiter is happy since he gets real goods and services, and the store owner is happy since he made a sale and can also get more real goods and services if he spends the money quickly before prices go up. So where is the problem? The transaction has been beneficial to both. It is illegal because of third party effects. The counterfeiter takes from the economic pie but does not contribute to the economic pie. He has basically stolen real goods and services by reducing the purchasing power of the money in everyone else’s wallets. When the fractional reserve banking system creates money out of thin air, it is also a form of counterfeiting, and has undesirable third party effects. Economists know that it is the rapid expansion of money and credit, unjustified by the growth of slow moving savings, that have created the booms and busts of the last two centuries, and the hardships that have gone along with them.

Eliminate fractional reserve banking and you eliminate most booms and busts. Unable to create money out of thin air, banking would now just be another sector without the ability to sink the entire world economy.

We need to start a serious discussion about ending fractional reserve banking and central banking at the same time. Our current banking system is not free market capitalism. Banking in its current form should be outlawed because it is both fraud and theft. We have a duty to our children to leave them with an economic system that is not constantly swinging from booms to busts. A system that is stable filled with opportunities that only a true capitalist system can provide.

Frank Hollenbeck teaches finance and economics at the International University of Geneva. He has previously held positions as a Senior Economist at the State Department, Chief Economist at Caterpillar Overseas, and as an Associate Director of a Swiss private bank. See Frank Hollenbeck's article archives.

You can subscribe to future articles by Frank Hollenbeck via this RSS feed..

© 2014 Copyright Frank Hollenbeck - 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.


© 2005-2018 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules