Posted tagged ‘Fractional Reserve Banking’

How Money Disappears In A Fractional-Reserve Money System. By Frank Shostak

December 4, 2015

In this article from mises.org titled How Money Disappears In A Fractional-Reserve Money System, Frank Shostak does his usual brilliant job in explaining complex concepts. He covers the difference between real savings vs. savings created out of thin air via the electronic printing press, and how Fractional-Reserve banking increases the money supply. Here are some excerpts.

“Most experts are of the view that the massive monetary pumping by the US central bank during the 2008 financial crisis saved the US and the world from another Great Depression. On this the Federal Reserve Chairman at the time Ben Bernanke is considered the man that saved the world. Bernanke in turn attributes his actions to the writings of Professor Milton Friedman who blamed the Federal Reserve for causing the Great Depression of 1930s by allowing the money supply to plunge by over 30 percent.”

“Careful analysis will however show that it is not a collapse in the money stock that sets in motion an economic slump as such, but rather the prior monetary pumping that undermines the pool of real funding that leads to an economic depression.

Improving The Economy Requires Time And Savings

“Essentially, the pool of real funding is the quantity of consumer goods available in an economy to support future production. In the simplest of terms: a lone man on an island is able to pick twenty-five apples an hour. With the aid of a picking tool, he is able to raise his output to fifty apples an hour. Making the tool, (adding a stage of production) however, takes time.”

“During the time he is busy making the tool, the man will not be able to pick any apples. In order to have the tool, therefore, the man must first have enough apples to sustain himself while he is busy making it. His pool of funding is his means of sustenance for this period—the quantity of apples he has saved for this purpose.”

“The size of this pool determines whether or not a more sophisticated means of production can be introduced. If it requires one year of work for the man to build this tool, but he has only enough apples saved to sustain him for one month, then the tool will not be built—and the man will not be able to increase his productivity.”

“The island scenario is complicated by the introduction of multiple individuals who trade with each other and use money. The essence, however, remains the same: the size of the pool of funding sets a brake on the implementation of more productive stages of production.

When Banks Create the Illusion of More Wealth

“Trouble erupts whenever the banking system makes it appear that the pool of real funding is larger than it is in reality. When a central bank expands the money stock, it does not enlarge the pool of funding. It gives rise to the consumption of goods, which is not preceded by production. It leads to less means of sustenance.

(Read this article; Real Savings = True Credit. Printed Savings = False Credit, to get more analysis from Frank Shostak concerning real vs. printed savings.)

The existence of the central bank and fractional reserve banking permits commercial banks to generate credit, which is not backed up by real funding (i.e., it is credit created out of “thin air”).”

“Once the unbacked credit is generated it creates activities that the free market would never approve. That is, these activities are consuming and not producing real wealth.

“It is those non-wealth generating activities that end up having the most difficulties in serving their debt since these activities were never generating any real wealth and were really supported or funded, so to speak, by genuine wealth generators. (Money out of “thin air” sets in motion an exchange of nothing for something — the transferring of real wealth from wealth generators to various false activities.) With the fall in money out of thin air their support is cut-off.”

“Contrary to the popular view then, a fall in the money supply (i.e., money out of “thin air”), is precisely what is needed to set in motion the build-up of real wealth and a revitalizing of the economy.”

Printing money only inflicts more damage and therefore should never be considered as a means to help the economy. Also, even if the central bank were to be successful in preventing a fall in the money supply, this would not be able to prevent an economic slump if the pool of real funding is falling.”

Related Article Interest Rates Set By The Market vs. Interest Rates Set By The Federal Reserve, at austrianaddict.com.

Related ArticleThe Fed Has Proved The Lefts Trickle Down Straw Man Doesn’t Work, at austrianaddict.com.

Confusing Capitalism With Fractional Reserve Banking, by Frank Hollenbeck

August 14, 2014

File:20090110 money printing-01.jpg

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 ArticleThe Faults of Fractional-Reserve Banking, by Thorsten Polleit, at mises.org.

Related ArticleFractional Reserves and Economic Instability, by John P. Cochran, at mises.org.

 

 

 

 

Must Reads For The Week 6/14/14

June 14, 2014
The pen is mightier than the sword...

 The pen is mightier than the sword… (Photo credit: mbshane)

 

Rehypothecation Evaporation Concerns Grow, As Copper Plunges Most In Three Months, at zerohedge.com. Rehypothecation is simply selling claims on a commodity, a good, a product, etc, above the amount that exists. If the owner of the Mona Lisa wants to store the painting in your art warehouse, you give him a receipt for the painting. This receipt is a claim on a particular painting by the owner, to be redeemed at any time. What if you make a counterfeit receipt and sell it. There are now two claims on the Mona Lisa. If you own a grain elevator, farmers will store their corn, measured in bushels, in your bins, and you give them a receipt for X amount of bushels to be redeemed at any time. You don’t have to give the farmer back the exact bushels of corn he brought in because bushels of corn are homogenous, unlike the Mona Lisa. What if you started selling counterfeit receipts for the corn? What if you have twice as many claims on bushels of corn as you have bushels of corn in your grain bins?  Your theft will remain hidden until such time that you don’t have enough corn to cover a receipt that is presented. The rehypothecation of copper, and the examples of the Mona Lisa and the bushels of corn, are examples of  how our Fractional Reserve Banking System works. Banks can loan out 10 times the amount of money they hold in reserve. If they have $1million in reserve, they can loan out $10 million. Money never exchanges hands, it is transferred electronically when a check {warehouse receipt} is presented. Its a sweet deal for the banks because they get to collect interest on the electronically printed counterfeit money {warehouse receipts}. Unfortunately this counterfeit money has been released in the market and is causing the unintended consequences of misallocating scarce resources and inflation. Read  more about this topic in my article here.

Texas Mom Outraged Because Her Daughters School Won’t Allow Sunscreen, by Rebecca Klein, at huffingtonpost.com. I love it when the rules central planners make come into conflict with each other. In this case officials at the district banned sunscreen because it is a toxic substance. But what about the central planners who have regulated tanning bed use by minors because of the possible danger of skin cancer. Central planners are all or nothing rule makers. They don’t understand that life consists of tradeoffs. But more importantly they don’t understand that decisions concerning these kinds of trade offs should be made by each individual or in this case the parent.  In this case the individual has to trade off one danger, the risk of the toxicity of the sunscreen against the risk of getting skin cancer. As I have learned from reading Thomas Sowell, their are no categorical solutions, just incremental trade offs. Central planners don’t understand that the more incremental decisions they take away from individuals, and make them categorical decisions for everybody, {except for themselves} the more strife they create between us and them.

LET’S LOOK AT MINIMUM WAGE REALITY

1) A Report From The Bakken Oil Fields, Where The Jobless Rate Is 0.9% And WalMart Is Paying 2.4 Times The Minimum Wage, by Mark J. Perry, at aei-ideas.org. The Federal minimum wage rate is $7:25, as is North Dakotas minimum wage rate. Will the central planners, at the federal and state levels, mandate that the wages of these workers at the bottom of the wage scale be dropped to $7:25 an hour just to be “fair” to the other minimum wage workers in other states?  Or should the central planners pass a law that mandates a maximum level of the minimum wage? These planners apparently have more knowledge about what wages should be than the knowledge the market can bring to bear on wage rates. The market in North Dakota is obviously wrong for paying these low skilled workers over double what the mandated minimum wage is. Don’t these central planners exist to correct the inequalities produced in the market?

2) Seattle Business Charges “Living Wage” Tax In Response To $15 Minimum Wage Hike, by Jessica Chasmar, at washingtimes.com. Plans by central planners can’t work like the planners planned. Why? Because there is still enough of a free market remaining that businesses have options other than just paying the new minimum wage rate. They can raise prices like this company, they can replace labor with technology. they can replace low skilled low wage labor with more productive higher skilled higher wage labor, or they can look to cut costs elsewhere in the production process. If raising the minimum wage for low skilled labor would increase production and profit, businesses would already be paying a higher wage, just like what is happening in North Dakota because of the oil boom.

NOW LETS HAVE SOME LAUGHS

12 Things Men Do Differently Than Women, at economicpolicyjournal.com.

Pee Wee Obama, at theburningplatform.com. I’ve been trying hard not to do this, but I can’t help myself.

Compare this video of President Working Out In Polish Gym, to this, Olivia Newton John, Physical video.

I saw these cartoons at theburningplatform.com.

WHEN THESE POWER PLANTS CLOSE, WHERE WILL THE ELECTRICITY COME FROM?

149321 600 Rates Skyrocket cartoons

 COAL POWERED CARS, I PADS, AND I PHONES

149426 600 Coal Industry cartoons

SOCIALIZED MEDICINE BY ANY OTHER  NAME…..

149459 600 Making Obamacare Look Good cartoons

“The Fed Has Failed”, Analysis by Charles Hugh Smith

March 18, 2014

Here is a great article by Charles Hugh Smith, at oftwominds, titled, The Fed Has Failed, (And Will Continue To Fail), Part I. His analysis of what is the result when the Federal Reserve electronically prints counterfeit money through their policies of quantitative easing (QE’s) and  artificially low-interest rates is spot on. He sums it up in this statement;

“The Fed….. is handing guaranteed returns to the banks and financiers while strip mining what’s left of the middle and working classes’ non-labor income, i.e. interest and savings.”

The charts he uses show that the Feds policies have worked to bolster the financial sector {wall street and banking}, while stealing from the bottom 80% of the people who hold financial assets, decreasing the total number of people actively working by 4%,  and shrinking real wages and purchasing power of the people who remain in the labor force.

Before you read the article lets first give a brief explanation of how the Fed first creates and then injects counterfeit money into the economy, and then look at the result of the Feds counterfeiting.

COUNTERFEITING: 1) THE FED SETS THE DISCOUNT RATE IT CHARGES BANKS

The Fed sets the discount rate which is the interest rate it charges banks for loans. The zero interest rate policy {ZIRP}, that has been in effect for some time now, allows a member bank to borrow electronically printed counterfeit money from the Fed at zero or near zero percent interest. They can take the money and invest it in a bond, stock or other financial instrument that yields a higher interest rate than the rate charged by the Fed. It’s not hard to find a security that yields a rate higher than zero. Banks can also loan this money to individuals, at a low-interest rate, for mortgages on home purchases. So banks either purchases interest baring securities {bonds, stocks, etc} or create their own interest baring securities {mortgages} with the counterfeit money from the Fed.

COUNTERFEITING: 2) FRACTIONAL RESERVE BANKING

The banks can loan out more money than they get from the Fed because we have a 10% fractional reserve banking system. What this means is the bank can loan out 10 dollars for every 1 dollar they hold in reserve. So if the bank holds 1 million dollars in reserve it can loan out 10 million dollars. It can actually counterfeit another 10 million dollars in loans on top of the 1 million the Fed counterfeited and loaned to the bank. The bank is receiving monthly payments of interest and principle on the 10 million it counterfeited and loaned out. These payments can now be held on reserve which allows the bank to create more counterfeit loanable funds.

COUNTERFEITING: 3) PURCHASING SECURITIES THROUGH QE

Quantitative Easing is a fancy name for the Fed creating more counterfeit money and purchasing government bonds and mortgage-backed securities from banks on the open market. The Fed will buy the government bonds the bank originally purchased, and it will also buy the mortgages the bank originally created. The bank can now use the new counterfeit money the Fed created to purchase these securities, hold it in reserve and create 10 times that amount in counterfeit dollars.

To sum it up, the Fed counterfeits money and loans it to banks at zero percent interest. The banks can counterfeit 10 times as much money as they hold in reserve because of our 10% fractional reserve banking rules. The Bank purchases Government bonds, and creates mortgages with these counterfeit funds. The Federal reserve purchases these Government bonds and mortgage backed securities from the banks with more counterfeit money, and this money can be increased by a factor of ten, and the whole process starts over again. Where can you sign me up for this sweet deal.

FED COUNTERFEITING MISALLOCATES SCARCE RESOURCES

The counterfeit money injected into the economy allows first receivers to purchase something without any corresponding production. It is an exchange of nothing for something. It sends false signals through the economy propping up economic activities that would never be supported in an unhampered free market. The tech bubble of 2000, the housing bubble of 08, and the current level of the stock market are all examples of bubble activities that would never have happened if the Fed had not printed counterfeit dollars. The Tech bubble of 00, and the housing bubble of 08 were created by the Feds printing and artificially low interest rates. The counterfeit money injected since 08 has stopped the fall in housing prices, and has also created the stock markets five year bull run. All economic activities that have been created and/or maintained by this counterfeit money will eventually have to be liquidated sooner, if they stop counterfeiting, or later if they continue. One way or another the economic forces trying to correct the Feds  interventions will win out.

Click on the article above and read Charles Hugh Smiths analysis of the Feds failure. The charts are very good. Here are a few excerpts.

“The Fed’s policies have been an unqualified success for financiers and an abject failure for the bottom 99.5% who have to work for a living.”

“Keeping interest rates near-zero for five years and pumping $4 trillion into the system are both completely off the scale of central bank policy in the U.S.”

“The most charitable assessment we can make of Fed policy is that the “prosperity” it created is at best, ahem, grossly concentrated in the most parasitic and politically powerful sector: finance. Why should we be surprised that the Fed, itself a servant of the banking sector, should devise policies that enrich the bankers and financiers”.

Also read, “How The Fed Has Failed America”, Part II, by Charles Hugh Smith. Here is an excerpt from this article,

“The only way to eliminate the financial parasites is to stop subsidizing their skimming and scamming, and the only way to stop subsidizing the financial parasites is to shut down the Fed.”

Related ArticleCounterfeiting by the Federal Reserve, Although Legal, Still Results In Theft, by austrianaddict.com.

Related ArticleLet The Counterfeiting Continue! The Fed Is Stuck In Its Feedback Loop, by austrianaddict.com.

Related ArticleA Tornado vs. The Fed, Which Is More Destructive? by austrianaddict.com.

Related ArticleCapital Consumption, aka, Eating Our Seed Corn, by austrianaddict.com.

Related ArticleThomas Woods Explains The Austrian Business Cycle Theory, at austrianaddict.com.

Must Reads For The Week 2/8/14

February 8, 2014
The pen is mightier than the sword...

The pen is mightier than the sword… (Photo credit: mbshane)

11-Year-Old Boy Suspended Under “Dangerous Weapons” Policy For Voluntarily Turning In A Non-Firing Toy Gun, at economicpolicyjournal.com. Are these school officials examples of  “smart people” with no common sense, “smart people” with an agenda, or stupid people

Where The Hell Is Germany’s Gold? by Paul Rosenberg, at economicpolicyjournal.com. The Fed won’t let the Bundesbank (Germany’s central blank) see the gold the Bundesbank has stored in the vault at the Federal Reserve. Is the gold gone, or has it been used as collateral for thousands of loans through rehypothecation. Rehypothecation is similar to a grain warehouse storing peoples soybeans for a receipt (a promise) which can be redeemed on demand, and then selling thousands of receipts on the same soybeans. There are not enough soybeans to fulfill the promise of redemption created by the counterfeit certificates issued by the grain warehouse. Rehypothecation is a version of fractional reserve banking

Schoolteacher Cheating, by Walter E. Williams, at jewiehworldreview.com. It isn’t hard to believe that, yes, even teachers act in their own self interest. Excerpt from the article, “Jerry Jordan, president of the Philadelphia Federation of Teachers, identifies the problem as district officials focusing too heavily on test scores to judge teacher performance, and they’ve converted low-performing schools to charters run by independent groups that typically hire nonunion teachers.”  Students are being sacrificed on the altar of teachers unions.

An Overselling Of Global Warming, by Mark J. Perry, at aei-ideas.org. It isn’t hard to believe that, yes, even scientists act in their own self interest. Excerpt from the article, “Science changed dramatically in the 1970s, when the reward structure in the profession began to revolve around the acquisition of massive amounts of taxpayer funding that was external to the normal budgets of the universities and federal laboratories. In climate science, this meant portraying the issue in dire terms, often in alliance with environmental advocacy organizations. Predictably, scientists (and their institutions) became addicted to the wealth, fame, and travel in the front of the airplane (quoting Garth Paltridge, one of the world’s most respected atmospheric scientists):” Tax payers being sacrificed on the altar of Global warming.

Julie Borowski Video: The Minimum Wage Hurts The People It Is Suppose To Help, by Mark J. Perry, at aei-ideas.org. I’ve written about the minimum wage in these articles, Income Inequality Part II: Increase The Minimum Wage, and Minimum Wage Jobs Create Unemployment.

Censorship By Example: Payback For Dinesh D’Souza, by Edward Cline, at capitalismmagazine.com. I found this at libertypenblog.blogspot.com. Bureaucrats and leaders using Government power to silence people who disagree or criticize them is nothing new. Our second President John Adams used the Alien and Sedition Acts to silence critics. What do you think the IRS targeting Tea Party and Liberty groups was about? When you are losing the argument on the facts you have to find another way to win, and using force is effective, ask the mafia.

Justice Scalia On WWII Camps: “..Kidding Yourself If You Think The Same Will Not Happen Again“, by Jay Syrmopoulos, at benswann.com. In the words of F. A. Hayek, “…The battle for freedom must be won over and over again…”

I saw this at theburningplatform.com.

Michael Ramirez Cartoon