Where did the 'Fractional Reserve Banking' meme begin?

[stevea]

I'm not defending anything, only suggesting that the foundations of the criticism of fractional reserve banking are very reasonable and rational points.

Your quoted example is oversimplified. If the Rothbard bank gets a deposit of $1000 it must put $100 on reserve and only has $900 to loan. If someone borrows and then deposits all $900, then the bank can put $90 more in reserve and has $810 to loan ... after an infinite number of borrow/redeposit transactions then all $1000 is on reserve and the bank has lent $10000 creating $9000 in money supply (same number you arrive at, but it's NOT in one fell swoop. And yes this is inflationary.

The reality is alluded to in your second paragraph. The guy who borrows the $900 obviously intends to spend it - so he will not keep it on deposit long if at all. He transfers the money to a 2nd party who may well deposit it. ... the $810 to be loaned to a 3rd party and redeposited by a 4th and so one.

The consolidation of all the banks $10000 loan in a single borrower is a case that does not occur. The bank obviously wants and needs and generally a divisified portfolio of loan assets.

Special economic conditions can cause a large fraction of borrower to fail to repay at the same time, or else a large fraction of depositors to want to withdraw at the same time (see the news for examples). In such cases a backing central bank (federal reserve for the US) issues credit to the banks until the crisis subides.

The example presented is not a credible counterargument to the value of fractional reserve banking.

Although the fractional reserve system causes the creation of money supply for additional deposits, and that is inflationary, this inflation only occurs when there is "new money" to deposit. Nearly all of the existing M2 and M3 are already on deposit with associated reserves - these aren't being multiplied further. Also note the central bank or government has complete control over this since they can increase the reserve requirement to reduce the money supply. More commonly the Fed issues or repurchases bonds to adjust the money supply.

The terms "counterfeit" and "pyramid" in your quotation, marks the article as incendiary prattle from some paranoid fool.

Yes it's a complex system to analyse, but not beyond a 1st year book on economics. No it is neither a pyramid scheme or a license to print money.

 

[Patrick_R]

Yes you are correct.

And what if the bank cannot repay creditors? Does it not go to the fed which bails them out with a new line of credit, therby expanding the money supply again?

As I understand it fractional reserve banking expands the money supply and encourages investment. But I think it is reasonable to question if the pain of inflation is worse than the increased investments.

 

[lomiller]

It’d need to be very special economic conditions. Since banks can also borrow from other banks the only way the money isn’t available is if people are burying it in their back yard.

Even in the current crisis this isn’t happening, a better description is that the banks are attempting to deleverage at once. I.E. they are attempting to go from 40:1 reserves down to 15:1 and there isn’t enough cash in the system for them to do it. If they had been prevented from leveraging 40:1 in the first place, of course, this wouldn’t be an issue.

 

[The Central Scrutinizer]

I'm not defending anything, only suggesting that the foundations of the criticism of fractional reserve banking are very reasonable and rational points.

An article from Rothbard on fractional reserve banking: http://www.lewrockwell...

This is as far as I got. You realize Lew Rockwell is an idiot, right?

 

[Francesca R]

As I understand it fractional reserve banking expands the money supply and encourages investment. But I think it is reasonable to question if the pain of inflation is worse than the increased investments.

It "encourages" borrowing by lifting what would otherwise be a legal restriction on the creation of credit. One could roll back restrictions further by allowing chartered banks, or anyone, to lend and borrow as much as they jolly well liked.

Why is someone, who elsewhere appears to be warm to libertarianism, apparently sympathetic to the criminalisation of undercollateralised credit?

 

[Tippit]

It "encourages" borrowing by lifting what would otherwise be a legal restriction on the creation of credit. One could roll back restrictions further by allowing chartered banks, or anyone, to lend and borrow as much as they jolly well liked.

Why should borrowing be "encouraged" at all? It is precisely the scarcity of capital which would discourage malinvestment and fraud. As I recall the real estate asset bubble was created by a combination of massive monetary inflation over decades and "liberal" (some might say predatory) lending standards. Why do statists like you insist that that every demand for credit must be satisfied by perpetually debased currency and artificially low interest rates? Given a static or at least relatively static supply of money, it is the interest rate itself which will expand or contract with the demand for money. This would force creditors to actually manage risk, rather than rely on the corruption and massive fraud inherent in the bailout nation.

I'm sorry, just because you want to live in a home that is far beyond your means should not and does not entitle you to the credit to do so.

The same goes for business loans, or any other loans. When credit is naturally scarce (and not unnaturally so), and lenders can't expect to be bailed out for their indiscretions, lenders will typically make sound and rational lending decisions, unlike those evident from the last two decades.

Why is someone, who elsewhere appears to be warm to libertarianism, apparently sympathetic to the criminalisation of undercollateralised credit?

Probably because he, unlike you, recognizes the inherent unfairness and instability introduced by the system as it exists today, and rightfully objects to it. Nor does he, unlike you, apparently have a vested interest.

 

[Francesca R]

Why should borrowing be "encouraged" at all?

Wrong question. Why should it be outlawed? Are you a statist?

It is precisely the scarcity of capital which would discourage malinvestment and fraud.

You want to enforce capital scarcity under the threat of violence? How about the same in respect of food and shelter scarcity? Might cut back on obesity levels and "undeserved" McMansions.

When credit is naturally scarce (and not unnaturally so)

Criminalisation of voluntary lending isn't "natural" scarcity. It is unnatural scarcity. The merits of doing it lie in the appraisal of its benefit to society. But poor form for calling it by the wrong name.

 

[Tippit]

Wrong question. Why should it be outlawed? Are you a statist?

Despite the obvious dishonesty of your spurious analogy, I will humor you in the interest of other readers.

The practice of lending something of value isn't inherently fraudulent, hence, borrowing should not be outlawed.

The practice of central banks and governments creating money out of thin-air and monetizing debt as a surreptitious and poorly-understood form of regressive taxation is fraudulent. So is the inherently unstable form of fractional reserve banking that seeks to liberalize bank deposits by promising them to borrowers and depositors at the very same time. Both of these criminal practices are the primary causes for prior and current economic debacles, and hence should be outlawed.

Anti-statism isn't to be confused with anarchism. The fact that you try to obfuscate systemic monetary corruption with such innocuous terms as "borrowing" in an attempt to label me as one of your own is dishonest, to say the very least. I am about as far from being a statist as one can get, but I'm all for laws with the goal of monetary reform, and throwing the corrupt bankers and politicians who run Wall Street and Washington into jail.

You want to enforce capital scarcity under the threat of violence? How about the same in respect of food and shelter scarcity? Might cut back on obesity levels and "undeserved" McMansions.

Criminalisation of voluntary lending isn't "natural" scarcity. It is unnatural scarcity. The merits of doing it lie in the appraisal of its benefit to society. But poor form for calling it by the wrong name.

Or, less dishonestly, I want to end the practice of institutional counterfeiting, and abolish the practice of lending deposits while simultaneously promising them on demand. It has nothing to do with creating "capital scarcity", and everything to do with abolishing the very system that creates economic instability. Please, lend all you want. Just lend your own hard-earned capital, or don't lend demand deposits. It's really simple.

How honest can you really be when you have to resort to labeling the abolition of the fiat money frenzy on Wall Street and Washington as "creating unnatural scarcity"? About as honest as I've expected you to be on these forums, I suppose. If they are responsible for creating an inordinate amount of monetary inflation, how can you rightfully conclude that abolishing this practice is tantamount to creating scarcity? That sort of doublespeak is certainly at home in George Orwell's worst nightmare, I guess.

 

[Francesca R]

I want to [ . . . ] abolish the practice of lending deposits while simultaneously promising them on demand.

That's very clear. As I said--poor form for referring to this intervention as somehow reverting to a "natural" state.

To be consistent you ought to want to outlaw insurance. After all, if every policy holder claims at once the insurer can't pay. That could be extended to myriad promises to provide service or goods, in public and private sectors, in which demand above a critical level cannot be met. Your prescription is one of folly for the dark ages. Risk pooling happens everywhere. Yet you only, inconsistently, have a problem with it in banking.

It has nothing to do with creating "capital scarcity"

At a stroke you create a Tippit-made capital famine. Fortunately I believe you stand no chance of being listened to. But you're free to tie yourself up in contradictory knots for public display all you wish of course.

Please, lend all you want. Just lend your own hard-earned capital, or don't lend demand deposits. It's really simple.

I will lend/borrow to the extent I desire thank you, with legal backing.

 

[Tippit]

That's very clear. As I said--poor form for referring to this intervention as somehow reverting to a "natural" state.

To be consistent you ought to want to outlaw insurance. After all, if every policy holder claims at once the insurer can't pay. That could be extended to myriad promises to provide service or goods, in public and private sectors, in which demand above a critical level cannot be met. Your prescription is one of folly for the dark ages. Risk pooling happens everywhere. Yet you only, inconsistently, have a problem with it in banking.

While there are similarities between fractional reserve banking, and insurance, there are marked differences. Insurance companies are valued on the basis of their floats, which enable the companies to invest at very low costs-of-capital and at vast profit which enable them to subsidize risk. Insurance premiums are not deposits, and insurance claims are not demand deposits, this is where the similarities end. If you're really asking me whether the practices of AIG were fraudulent and in need of much better regulation, I'm pretty sure you can guess my answer. The destruction and subsequent bailout of AIG was hugely destabilizing to the economy, and criminal as far as I'm concerned. No doubt you will just rationalize this as business-as-usual.

I'm afraid my position is quite consistent.

At a stroke you create a Tippit-made capital famine. Fortunately I believe you stand no chance of being listened to. But you're free to tie yourself up in contradictory knots for public display all you wish of course.

I will lend/borrow to the extent I desire thank you, with legal backing.

There are plenty of viable and sustainable roads that lead to monetary reform which will in turn lead to a more just and equitable society. The fact that this view isn't prevailing at the moment in these dark ages of economic ignorance and large-scale swindling probably won't reflect the future.

Do not insult other posters.

Replying to this modbox in thread will be off topic  Posted By: Cuddles

 

[The Central Scrutinizer]

There are plenty of viable and sustainable roads that lead to monetary reform which will in turn lead to a more just and equitable society. The fact that this view isn't prevailing at the moment in these dark ages of economic ignorance and large-scale swindling probably won't reflect the future.

Lead us to the promised land, oh great exalted one!

 

[Francesca R]

Insurance premiums are not deposits, and insurance claims are not demand deposits

Insurance claims represent potential bankruptcy and system-wide hazard in the event that too many of them are incurred at once. To avoid this possibility you would need to advocate only insurance where all liabilities were covered by hard cash. Why don't you?

If you're really asking me whether the practices of AIG were fraudulent and in need of much better regulation, I'm pretty sure you can guess my answer.

Poor attempt at suggesting this is about AIG. You don't just get to claim AIG behaved fraudulently, for consistency you need to declare all insurance a fraud, and declare risk pooling to be a crime.

I'm afraid my position is quite consistent.

No it isn't.

 

[Tippit]

Insurance claims represent potential bankruptcy and system-wide hazard in the event that too many of them are incurred at once. To avoid this possibility you would need to advocate only insurance where all liabilities were covered by hard cash. Why don't you?

This sounds fine by me. I'm not an expert on insurance capitalization requirements or the regulation in general, but it would be prudent that liabilities have a 1:1 ratio to liquid assets. I also don't support any government bailout of any insurance company, ever. Insurance companies bear risk which is underwritten by reinsurance companies, and policy holders should bear the ultimate risk of whether any or all of these companies will remain solvent.

Poor attempt at suggesting this is about AIG. You don't just get to claim AIG behaved fraudulently, for consistency you need to declare all insurance a fraud, and declare risk pooling to be a crime.

I never said it was all about AIG, AIG is an example of what is obviously a serious problem. What I'm tired of is the recurring theme of privatized profits and socialized risk, no matter what the business model happens to be.

 

[Francesca R]

This sounds fine by me. I'm not an expert on insurance capitalization requirements or the regulation in general, but it would be prudent that liabilities have a 1:1 ratio to liquid assets.

Such a requirement would do away with the concept of insurance. If you want me to insure the cost of your house burning down (disregarding any possibility that you might elect to secretly torch it yourself), and I need to maintain a liquid balance of assets equal to the replacement value of your house, then premium I am going to charge you will be prohibitive. I'm not going to base it on the discounted probability of your house burning down because that is simply the expected loss unadjusted for risk, and by law I have to cover the biggest possible loss as though it is certain. If I insure all the real estate in your town then I need a cash balance of equal value to all the real estate in your town. You would gain no advantage above setting aside the replacement value of your house yourself (less actually since I would need to cover my costs and earn something too).

I also don't support any government bailout of any insurance company, ever. Insurance companies bear risk which is underwritten by reinsurance companies, and policy holders should bear the ultimate risk of whether any or all of these companies will remain solvent.

The parties you list usually do bear all that risk, and since the Lloyds debacle in the 1990s which led to the creation of Equitas, almost all insurers now have limited liability in insolvency.

What I'm tired of is the recurring theme of privatized profits and socialized risk, no matter what the business model happens to be.

I am not sure from this statement if you oppose all limited liability, but you will realise that it amounts to a put option on the state (society) in virtually all walks of commercial life. The implicit "social contract" which you apparently object to--though I don't think you understand it well--is that society benefits via positive externalities from commerce, and in return it grants limited liability as part of its chartering of many commercial agents. The downside to society is that if a bank, insurer, car company, national airline or any other concern goes insolvent with big enough unmet liabilities when it stops trading (or if it was clear that this would happen), and those liabilities becoming put to the state are serious enough to threaten a worse outcome than a state bailout would do, then public rescue is rendered in the public interest.

 

[stevea]

There really isn't much differrence between banking and insurance, despite Tippet's objections.

The entire notion of insurance involves pooled risks. The probability my home may burn or that your cargo ship may sink are each small, but the joint proability that both happen is much smaller yet. Further the chance that all homes may burn and all ships sink it certainly conceivable but highly improbably. Insurers limit coverage to avoid the risks of act of war, yet they must account for hurricanes and floods than can affect millions of policy holders. Obviously if they must keep 100% liability reserve available, then no one would bother to purchase insurance - the cost would match or exceed the benefit.

Banks have a similar situation, they take deposits and loan these out knowing some borrowers will default. Obviously they distribute their risk across many borrowers, but this is still a set of pooled risks. Default represents a loss of their loan asset. With sufficient losses they won't be able to repay depositors and will default.

The only aspect of Tippet's argument I can agree with is that a clear statement of risk and a limitation on withdrawal should be given depositors. Perhaps only the immediately guaranteed part, the reserve assets should be considered part of M3. This has no impact on the transaction but it makes the paranoiac charge that banks mint money disappear.

===

Also the comment that

Even in the current crisis this isn’t happening, a better description is that the banks are attempting to deleverage at once. I.E. they are attempting to go from 40:1 reserves down to 15:1 and there isn’t enough cash in the system for them to do it. If they had been prevented from leveraging 40:1 in the first place, of course, this wouldn’t be an issue.

Isn't realistic. The US federal reserve ratio has been 10% for a long time. Canada has none at all since 1992. The UK, if I understand correctly has about a 3% voluntary rate. The 40:1 and 15:1 type numbers do not refer to US Federal deposity banks. Private lenders and do as they please - buyer beware.

The problem w/ AIG is that we didn't let the people who incorrectly estimated the systemic risk lose their bet. AIG should have failed, the bond holders should have failed to the extent that AIG was insolvent and that their packaged mortgage loans fails. The folks who took mortgages and couldn't repay should have failed. Instead the Federal goverment is propping up all the losers using money from those who rejected this sort of risk. The government has a place in making sure this sort of business catastrophy happens in an orderly fashion. It has no business in assuming the bad risk or propping up the losers.

Predatory lending ???? What a complete nonsense term ! Some mean old bankers stalk you and forces you take loan money you'd like but are unable to repay ??? That's an insane scenario. It's more like this ... banks wanted to make low quality loans since they could sell these, even to the GSEs, at the same prices as higher quality loans. Greedy, short-sighted individuals agreed to take these loans and live-high until the party ends. It's tortured logic to call the loan-takers victims; they are barnacles on the hull of society.

===

History ... I think the Lyndon LaRouche was one of the early whackadoodle paranoiac opponents to the US Federal Reserve. If I understand correctly Ron Paul is against the Federal Reserve's independence (which is IMO is mostly fictitious) and want's it organized under the government more like most European Central banks. He also rails against fiat currency, which is pretty far out ... OTOH Milton Friedman also pointed out that all fiat currencies eventually fail and usually b/c they are debauched by their government.

 

[se7ensnakes]

While the Edisons, Fords, Wright brothers of this country created wealth for this country and intellectual growth, the fractional reserve system of creating phantom money stole the wealth from the system. We are where we are because of these types of entrepreneur. Fractional Reserve banking was borne of a scam because it essencially gave wealth to people that all they did was to move money. In many instances it also gave wealth to people that created money out of nothing. Imagine if you will where all we did was to move money around. Imagine if everyone did this. Then, we will grow poor and broke, indebted to anything that produce actual goods. A group of these banks can make as much as if not more than Ford Corp or Boeing. But what we get from it is just a lot of debt.
Additonally, our monetary system was borne out of bankers manipulating monetary policy. The great majority of the people have no clue what fractinal reserve banking is, how they are actually lenders of last resort, how the central banks create money out of thin air for the benefit of banks. When someone deposits money in a bank, the majority of the people have no idea that they are actually loaning that money to the bank. Most people dont know how money enters circulation, how it is created. Additonally, you are in the belief that using wealth to manipulate the political machinery of the usa is okay.

 

[se7ensnakes]

The Federal Reserve is not the lender of last resort..we are. Everyone that make purchases is, unknowingly and unwittingly a lender of last resort. To allow a certain industry to be privileged is unconstitutional. In this country there are no kings and queens and nobility, everyone should be on equal footing. Fractional reserve banking allows a certain group of people to create phantom money. If i own a rental store, all i could do is rent what i have. If i rent a cement mixer, all i could do is rent a cement mixer. I cannot rent and IOU cement mixer. My business does not rely on anything other than what i do there. If all my customers were to come in at once, I do not get in trouble. I dont need the government to insure anything for me. I rent pound pound what i actually have. Most companies are like this except for banks. What more this system of fractional reserve banking exist because of he ignorance of the great majority of the people. No one publicly debated this type of system where it became a voting issue. This system exist because it remains under the radar of most people.

 

[The Central Scrutinizer]

While the Edisons, Fords, Wright brothers of this country created wealth for this country and intellectual growth, the fractional reserve system of creating phantom money stole the wealth from the system. We are where we are because of these types of entrepreneur. Fractional Reserve banking was borne of a scam because it essencially gave wealth to people that all they did was to move money. In many instances it also gave wealth to people that created money out of nothing. Imagine if you will where all we did was to move money around. Imagine if everyone did this. Then, we will grow poor and broke, indebted to anything that produce actual goods. A group of these banks can make as much as if not more than Ford Corp or Boeing. But what we get from it is just a lot of debt.
Additonally, our monetary system was borne out of bankers manipulating monetary policy. The great majority of the people have no clue what fractinal reserve banking is, how they are actually lenders of last resort, how the central banks create money out of thin air for the benefit of banks. When someone deposits money in a bank, the majority of the people have no idea that they are actually loaning that money to the bank. Most people dont know how money enters circulation, how it is created. Additonally, you are in the belief that using wealth to manipulate the political machinery of the usa is okay.

Obviously, you are "most people".

 

[drkitten]

While the Edisons, Fords, Wright brothers of this country created wealth for this country and intellectual growth, the fractional reserve system of creating phantom money stole the wealth from the system. We are where we are because of these types of entrepreneur. Fractional Reserve banking was borne of a scam because it essencially gave wealth to people that all they did was to move money. In many instances it also gave wealth to people that created money out of nothing. Imagine if you will where all we did was to move money around. Imagine if everyone did this. Then, we will grow poor and broke, indebted to anything that produce actual goods. A group of these banks can make as much as if not more than Ford Corp or Boeing. But what we get from it is just a lot of debt.
Additonally, our monetary system was borne out of bankers manipulating monetary policy. The great majority of the people have no clue what fractinal reserve banking is, how they are actually lenders of last resort, how the central banks create money out of thin air for the benefit of banks. When someone deposits money in a bank, the majority of the people have no idea that they are actually loaning that money to the bank. Most people dont know how money enters circulation, how it is created. Additonally, you are in the belief that using wealth to manipulate the political machinery of the usa is okay.

The Federal Reserve is not the lender of last resort..we are. Everyone that make purchases is, unknowingly and unwittingly a lender of last resort. To allow a certain industry to be privileged is unconstitutional. In this country there are no kings and queens and nobility, everyone should be on equal footing. Fractional reserve banking allows a certain group of people to create phantom money. If i own a rental store, all i could do is rent what i have. If i rent a cement mixer, all i could do is rent a cement mixer. I cannot rent and IOU cement mixer. My business does not rely on anything other than what i do there. If all my customers were to come in at once, I do not get in trouble. I dont need the government to insure anything for me. I rent pound pound what i actually have. Most companies are like this except for banks. What more this system of fractional reserve banking exist because of he ignorance of the great majority of the people. No one publicly debated this type of system where it became a voting issue. This system exist because it remains under the radar of most people.

 

[The Central Scrutinizer]

The Federal Reserve is not the lender of last resort..we are. Everyone that make purchases is, unknowingly and unwittingly a lender of last resort. To allow a certain industry to be privileged is unconstitutional. In this country there are no kings and queens and nobility, everyone should be on equal footing. Fractional reserve banking allows a certain group of people to create phantom money. If i own a rental store, all i could do is rent what i have. If i rent a cement mixer, all i could do is rent a cement mixer. I cannot rent and IOU cement mixer. My business does not rely on anything other than what i do there. If all my customers were to come in at once, I do not get in trouble. I dont need the government to insure anything for me. I rent pound pound what i actually have. Most companies are like this except for banks. What more this system of fractional reserve banking exist because of he ignorance of the great majority of the people. No one publicly debated this type of system where it became a voting issue. This system exist because it remains under the radar of most people.

It's the joohs, isn't it?