Fractional reserve banking isn’t a part of a true free market capitalist system. It is intervention into the free market that Government, through the court system, has sanctioned. The Government sanctions it because it is how they fund the growth of government without the people knowing it is going on. People understand getting taxed, but understanding fractional reserve banking isn’t quite that easy. This article by Frank Hollenbeck titled, Confusing Capitalism With Fractional Reserve Baking, at mises.org, does a great job in explaining fractional reserve banking and it’s consequences. Here are some excerpts form the article explaining how fractional reserve banking came about.
“In the past, we had deposit banks and loan banks. If you put your money in a deposit bank, the money was there to pay your rent and food expenses. It was safe. Loan banking was risky. You provided money to a loan bank knowing funds would be tied up for a period of time and that you were taking a risk of never seeing this money again. For this, you received interest to compensate for the risk taken and the value of time preference. Back then, bankers who took a deposit and turned it into a loan took the risk of shortly hanging from the town’s large oak tree”
“During the early part of the nineteenth century, the deposit function and loan function were merged into a new entity called a commercial bank. Of course, very quickly these new commercial banks realized they could dip into deposits, essentially committing fraud, as a source of funding for loans. Governments soon realized that such fraudulent activity was a great way to finance government expenditures, and passed laws making this fraud legal.”
A key interpretation of law in the United Kingdom, Foley v. Hill, set precedence in the financial world for banking laws to follow:”
Foley v. Hill and Others, 1848:
“Money, when paid into a bank, ceases altogether to be the money of the principal; it is then the money of the banker, who is bound to an equivalent by paying a similar sum to that deposited with him when he is asked for it. … The money placed in the custody of a banker is, to all intents and purposes, the money of the banker, to do with it as he pleases; he is guilty of no breach of trust in employing it; he is not answerable to the principal if he puts it into jeopardy, if he engages in a hazardous speculation; he is not bound to keep it or deal with it as the property of his principal; but he is, of course, answerable for the amount, because he has contracted, having received that money, to repay to the principal, when demanded, a sum equivalent to that paid into his hands.”
“In other words, when you put your money in a bank it is no longer your money. The bank can do anything it wants with it. It can go to the casino and play roulette. It is not fraud legally, and the only requirement for the bank is to run a Ponzi scheme…..”
“The primary cause of the financial panics during the nineteenth century was this fraudulent nature of fractional reserve banking. It allowed banks to create excessive credit growth which led to boom and bust cycles. If credit, instead, grew as fast as slow moving savings, booms and bust cycles would be a thing of the past.“
“Banks will always be able to use new technologies and new financial instruments to stay one step ahead of the regulators. We continue to put bandages on a system that is rotten to the core. Banking in its current form is not capitalism. It is fraud and crony capitalism, kept afloat by ever-more desperate government interventions. It should be dismantled. Under a system of 100 percent reserves, loan banks (100 percent equity-financed investment trusts) would be like any other business and would not need any more regulation than that of the makers of potato chips.”
How many people would you have to ask to get the right answer to this question; Is the money you deposit in a bank yours, or the banks? They won’t believe you when you tell them it’s the banks money, and they probably won’t understand why, even after you explain it.
In a previous article titled, Keynes Was Correct In 1919 (here), I quote John Maynard Keynes from his book, The Economic Consequences Of The Peace, he said, “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”
Keynes knew how difficult it is to understand money creation by the Fed through Fractional Reserve Banking.
Related Article – The Faults of Fractional-Reserve Banking, by Thorsten Polleit, at mises.org.
Related Article – Fractional Reserves and Economic Instability, by John P. Cochran, at mises.org.
AUSTRIAN ECONOMICS ADDICT 