Where did the 'Fractional Reserve Banking' meme begin?

portlandatheist

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portlandatheist
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So I remember learning about the Federal Reserve and how it works, how stocks work etc back in high school. No big deal, I'm no expert but have a cursory understanding. I've seen the 9/11 conspiracy theorists proclaim the evils of fractional reserve banking, then the Ron Paul supporters, but now I've heard about it from coworkers and at my local coffee shop.
Now, I know there are real concerns about our economy and the Zimbabwe crisis is a great example of a poorly managed currency but the entire Austrian school of economics is just plain stupid.
So where did this meme begin? It's all over the place here. Did it start with Ron Paulians? The 9/11 truthers? Austria? What is giving this movement life? The falling dollar? The credit crisis? Simply Bizarre.
 
Antipathy toward the idea of lending is as old as lending itself. But you've asked specifically about fractional-reserve banking, which is referring more to the deposit side of things.

The banking system of the 19th century US was not that great. Counterfeiting and fraud were routine, there was nobody to verify a bank's solvency, and no guarantee if it failed. So suspicions were well-justified, in contrast to the situation today.

During that period the people who were suspicious of banks wrote, and they spoke. That rhetoric is still available for reading, and people do read it, without much appreciation for its context.
 
portlandatheist said:
So where did this meme begin? It's all over the place here. Did it start with Ron Paulians? The 9/11 truthers? Austria? What is giving this movement life? The falling dollar? The credit crisis? Simply Bizarre.
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It is one of many things that I hear about on this forum but nowhere else, and certainly not from anybody I consider to be a serious analyst of economics or banking (then again, those people would all be "apologists for the present arrangement"in the eyes of these memetics).

The credit crisis (not the first such sudden and massive reduction in ability to borrow and willingness to lend) is something that exposes non-trivial weaknesses in the financial systems and policy objectives and incentive structures of the world, but calls to go back on XAU-backed currency and outlaw fractional reserve ratios are IMO incredibly daft suggestions lacking the foundations of analysis, logic and historical knowledge.
 
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Gold Buggism and Anti Federal reserve crap are much more common then this Anti Fractional Banking nonsense.
What is ironic is that most of the people who support this crap theory would say they are strong supporters of Capitalism and a Free Market, while they want to abolish one of the very institutions that makes a modern Free Market possible:the ability of banks to loan money to people to start and expand businesses.
 
As someone who's understanding of economics, sadly, starts and ends with his wallet could someone give me a quick rundown of fractional reserve banking, and the argument against it?
 
Sure,
Here's the basics of it. The banks in America don't have to hold all of their deposits in the bank at one time. Only a set reserve amount must be held behind. I believe it is 10% at this moment. So, if a man deposits $1000 at a bank, they must only hold $100 behind. The other $900 can be loaned out. The logic is that the man will not need his whole $1000 in deposits at any one time. If he does need a big deposit, then the bank can dip into the other 10% available.

The big problem people have with it is the multiplier effect on the money supply. That $900 loan will be spent as long as the receiver doesn't burn it in a field (if that was his plan all along, then the bank needs to reevaluate their lending policy). Most, if not all, of this money will work its way back into a bank somewhere as another deposit. This means that $810 dollars will be made in another loan. The cycle keeps going until it fades away. This effectively "creates money" and some people don't like that idea.

The benefits are pretty clear. It generally allows more economic growth. If the reserve requirement was dropped, then we'd see greatly reduced spending for big purchases and economic advancement would happen at a slower rate.

The drawbacks depend on your own thoughts in the end. If everyone wanted to withdraw their money, then the economy would pretty much implode. The likelihood of a nationwide bank run is pretty much nil though. In any event, if such a catastrophe happened to cause a nationwide bank run, then I assume a shotgun and a box of shells would be a better investment. For the most part, the Fed acts as a safety net. In the event of a local bank run, they'd be able to secure a low interest rescue loan from one of the Fed's branches.

Some state that the system does too much to encourage people to go into debt, although I personally think that the real problem lies with credit cards which are effectively out of the system. Mortgages and general loans are just investments that generally help one secure new wealth over time.

The last falls more to gold standard arguments that generally have more to do with fiat currency in general. Some people (I'm sure one from the forum will smell the blood in the water soon) believe that fractional reserve banking works with the fiat currency to grossly devalue the currency and that it will eventually become worthless. That's another discuss though.

I hope I covered everything.
 
AvarianParakeet said:
The big problem people have with it is the multiplier effect on the money supply. That $900 loan will be spent as long as the receiver doesn't burn it in a field (if that was his plan all along, then the bank needs to reevaluate their lending policy). Most, if not all, of this money will work its way back into a bank somewhere as another deposit. This means that $810 dollars will be made in another loan. The cycle keeps going until it fades away. This effectively "creates money" and some people don't like that idea.
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This analysis is wrong, though, because it overlooks the fact that debtors are on the hook to the bank, and that the bank is on the hook to its shareholders. When these things are properly accounted for, there isn't any "multiplier" or "creation." There is just a temporary transfer of the right to use money that already exists.
 
True. The assets aren't really changing at all since their gain is canceled out by the debt. It does keep the money moving though and effectively increase the spending power. I guess I should have described it more as the velocity (or speed, all my economics terms are jumbled :) ).
 
I would describe it as full utilization of capital. I'm not sure if that amounts to the same thing.
 
Gazpacho said:
This analysis is wrong, though, because it overlooks the fact that debtors are on the hook to the bank, and that the bank is on the hook to its shareholders. When these things are properly accounted for, there isn't any "multiplier" or "creation." There is just a temporary transfer of the right to use money that already exists.
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This is a bit of handwaving of the issue. The banks 'create' money, pretty much period. This is clearly understood economics, and I don't quite get how you're getting around it with the fact that the debt has to be paid back (hint: The banks lend out the money as soon as it's paid back, so that doesn't do anything to the system).

The concept that there's 'extra' money in the system is reasonably easy to understand when we use something like bonds. Assume there's no bank, no stocks, only bonds. The only sound investment is bonds, therefore (it's the only one, actually). Therefore, if we assume people do not sit on money because they would not miss the opportunity cost of missing bond payments, they will always either spend the money, or invest in bonds (which will then go to people who spend the money).

The only difference is that in this case, no one can call all the bonds at once. Which is what a run on the bank does.

In reality the extra money is spread through a range of investments, including bonds, stocks, and other investment options, not just banks. The multiplier effect remains though.
 
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portlandatheist said:
So I remember learning about the Federal Reserve and how it works, how stocks work etc back in high school. No big deal, I'm no expert but have a cursory understanding. I've seen the 9/11 conspiracy theorists proclaim the evils of fractional reserve banking, then the Ron Paul supporters, but now I've heard about it from coworkers and at my local coffee shop.
Now, I know there are real concerns about our economy and the Zimbabwe crisis is a great example of a poorly managed currency but the entire Austrian school of economics is just plain stupid.
So where did this meme begin? It's all over the place here. Did it start with Ron Paulians? The 9/11 truthers? Austria? What is giving this movement life? The falling dollar? The credit crisis? Simply Bizarre.
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There were several publications in the late 70's or early 80's that were aimed at the "Fractional reserve Banking" evilness along with the Fed as a private institution.

I honestly don't remember who actually wrote them but the person that wrote them seemed to think that economics was all about swapping pigs and fruit in villages and that was a good thing.
 
G-K-4 said:
Discussions of this sort always remind me of http://www.youtube.com/watch?v=_Er69b4HMl8this.

As a basic introduction, how accurate is the description in the movie?
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Err, it's been a while since I saw the movie, but from what I remember, okay, given Hollywood.

It's a hell of a lot more complicated than the explanation, I'm sure, but yes, the banks only have a fraction of what they 'have' in savings.
 
AvarianParakeet said:
Sure,
Here's the basics of it. The banks in America don't have to hold all of their deposits in the bank at one time. Only a set reserve amount must be held behind. I believe it is 10% at this moment. So, if a man deposits $1000 at a bank, they must only hold $100 behind. The other $900 can be loaned out. The logic is that the man will not need his whole $1000 in deposits at any one time. If he does need a big deposit, then the bank can dip into the other 10% available.

The big problem people have with it is the multiplier effect on the money supply. That $900 loan will be spent as long as the receiver doesn't burn it in a field (if that was his plan all along, then the bank needs to reevaluate their lending policy). Most, if not all, of this money will work its way back into a bank somewhere as another deposit. This means that $810 dollars will be made in another loan. The cycle keeps going until it fades away. This effectively "creates money" and some people don't like that idea.
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If you deposit $100 in a bank, the bank can only loan out $90 of it. Assuming that $90 is spent and the person who receives it deposts it you could loan out another $81, and so on. In the end you would have $1000 in debt (people who deposited money) $1000 in assets (people who you loaned money to) and you must have $100 in cash on hand. At that point you can no longer loan out money, but it means that $100 of real cash in the economy equates to $1000 of instantly redeemable cash equivalent.

This money multiplication is really just an outgrowth of the fact that $1 of cash circulates in the economy and creates more then $1 of economic activity. The people complaining about fractional reserve banking are essentially suggesting we limit economic activity to the amount of available money. They usually go a step further and say we should have a gold standard, so that economic activity is limited to the amount of gold in existence.


It isn’t really possible for everyone to want their money all at once unless their aim was too burry it in their backyard. Barring that, the cash is going to be sitting in someone’s account somewhere. The liquidity of individual financial institutions can be an issue, which is why the Fed has the power to act as a lender of last resort and lend banks the money they need if all their depositors try to get their money at once.
 
lomiller said:
It isn’t really possible for everyone to want their money all at once
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It is the same with the equity or bond holders of any traded corporation or the partners in a partnership, or the holders of any supranational or sovereign issuer (such as the US government). They can theoretically all "want" their money at once, but they can't all get it. What happens is that the price of their investment falls (or the yield to maturity rises, or the currency it is denominated in falls relative to others . . .) Until enough people change their minds and the demand and supply clears. In extremis the only way to achieve this is via a default event.

The liquidity of individual financial institutions can be an issue, which is why the Fed has the power to act as a lender of last resort and lend banks the money they need if all their depositors try to get their money at once.
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This is not fail safe either. Your (if you are US) FDIC only has enough readies for a few IndyMacs at a time. After that there is no plan B really. Oh yikes what a risky world eh?

Those who had no idea that such subterfuge was rife in the financial systems of the developed world probably would like to protest "informed consent", but I tend to think their ignorance was voluntary :)
 
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Those opposed to fractional reserve banking are not necessarily opposed to lending money. Its just that money that is lent out needs to be clearly identified as such. I mean that the deposits people have that are readily available for withdrawal should actually still be there in tha bank. Money lent out should first pay for investment instruments like CD's which cannot be withdrawn at will, at least not without a penalty.

As far as all the attacks on the Austrian school, how about actually saying whats wrong with it, instead of just calling it stupid?

I think of the Austrian School of economics as the most realistic, based on human nature as well as the assumtion that government is unable to change the fact that 2+2=4.

Abolishing fractional reserve banking would not end the practice of lending. It would simply introduce some self-discipline into banking by separating the money available for withdrawal from the money that is lent out.
 
SaulOhio said:
I think of the Austrian School of economics as the most realistic, based on human nature as well as the assumtion that government is unable to change the fact that 2+2=4.
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Why are you blaming the government here? The government does not do this. In fact, the government limits the banks ability to do this. The only way you could accomplish what you want is further government regulation.

Oh and yes. This does make the entire system a house of cards. A house of risky, unstable cards. And people wonder why I'm okay with some government regulation of the economy. Houses of cards are inevitable.
 
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