100% Reserve Banking and the Business Cycle

[Ozwest]

Well, i think you are looking for a safe haven for wealth. There is no such thing. Everything has risks. Even the warehouse bank can loose your money. It can be stolen, or the management can invest the money behind your back. You trust them to give you back the money on demand, and as long as you or anyone else have any problems getting money out, you continue to trust them. (There are many cases where banks that are supposed to warehouse gold, actually invest the gold, and then buy it back when the owner wants to visit his gold.)

Investing and putting money into a bank is much the same thing. When you put money in the bank, the bank invests the money. It eighter makes you a profit by loaning it out to borrowers, or it invests it in the stock market. As long as it better at making money than loosing it, the bank will stay in business. Most big banks are reliable, most of them have been in business for a hundred years., meaning they invest customers money profitably.

Cheers

Now is the time to be conservative. Google back to 1929, and observe...

 

[scooter]

DriftWood actually is showing some good, well-informed intelligence on this subject.

Getting all caught up in the "fractional reserves are evil" argument is a waste of time. The banking system is not evil in any way. It is actually a free market mechanism for issuing credit and facilitating investments.

The evil is when big government gets involved to bail out the bad players.

I also agree with your assessment on the dollar vs. gold vs. any other investment. There are times to hold any one of them. Had you bought gold in 1980, your savings and purchasing power now would be hurting pretty badly. Had you sold all your stocks and properties and held only dollars since 2001, same situation.

Being a good investor is knowing how to diversify and pick and choose your holdings for when the time is right. Dumping all of your money in gold at the top of a huge bull market run may or may not be a wise idea. It's up to you to take that risk into consideration.

 

[Acala]

fractional reserve fraud

Fractional reserve banking is a fraud.

Even before the Fed got involved, banks were loaning out money they didn't have. If you enter into a contract - like to pay specie on demand - when you know you can't perform (because you don't have the specie) that is a fraud. It is no different than me taking your grain into my silo, giving you a receipt, and then turning around and selling your grain. The fact that I will probably get more grain deposits from others to cover your receipt by the time you come to collect it does not make it okay. It is a fraud. And when the fraud is discovered, that's when bank runs happen.

Some folks say that the market will keep the lid on this in the absence of a central bank because other banks will immediately cash the bank notes from other banks.

But why not ban it since it is a fraud? Just because it has been going on a long time doesn't mean it is okay. It causes the business cycle.

Kill it!

100% reserve banking and freedom in currency.

 

[scooter]

It's not a fraud because anyone who takes the time to educate themselves or even read the stuff they sign when they open bank accounts will know it is happening. It's not like it is being done in secret. It's just the way banking works and has worked for hundreds of years.

The system has checks and balances. The depositors will never lose what they've put into a bank, however, banks can lose a lot of their own capital if they make too many bad investments or let their reserves get too low. The fraud is when the government steps in to bail out those banks who made bad investments, rather than just sticking to backing up the depositors.

 

[Paul.Bearer.of.Injustice]

Government has made banking a risk-free enterprise.
I agree with the idea that banking isn't evil, it is compound interest that is evil. it was devised by bankrupt governments and is nothing more than an accounting trick.

Human production does not grow exponentially - yet we expect our money supply to?
What do you think is going to happen when maximum inflation is reached at the (1+x)^n asymptote?

 

[jonahtrainer]

Government has made banking a risk-free enterprise.
I agree with the idea that banking isn't evil, it is compound interest that is evil. it was devised by bankrupt governments and is nothing more than an accounting trick.

Banking is not risk-free. The risk has simply been shifted to the taxpayers. Modern banking has most successfully privatized the gains and socialized the losses.

Fractional Reserve Banking is by definition a fraud. Rothbard presents the argument in The Case Against the Fed. In essence, as all deposits may be immediately withdrawn and as the bank does not keep adequate reserves on hand therefore all depositors who are entitled to their deposits may not redeem all their deposits at the same time as promised by the contract. Entering into a contract with intent to deceive the other party knowing that you intend not to keep the terms of the contract is fraud.

 

[DriftWood]

Government has made banking a risk-free enterprise.
I agree with the idea that banking isn't evil, it is compound interest that is evil. it was devised by bankrupt governments and is nothing more than an accounting trick.

Human production does not grow exponentially - yet we expect our money supply to?
What do you think is going to happen when maximum inflation is reached at the (1+x)^n asymptote?

Well, I don't think compounded interest (or interest on interest) is evil either. When you invest money with any company that makes money, and re-invest the profits you make back into the company, your money will grow at a compounded rate. There is nothing wrong with that. Doesn't that mean that there will exist ore money in the world tomorrow than today, wont it mean inflation? Not necessarily, when a business makes money, the money is not created out of thin air. It comes from other parts of the economy. It all equals out.

The same goes for banks. When they charge interest from borrowers.. they believe that the business or person will be profitable and will have a bigger pile of money tomorrow than the average person. The total amount of money in the world need not increase tomorrow, for interest on interest to make sense, only the borrowing persons portion of it. Interest does not cause inflation.

Inflation is only created when the FED gets involved and starts loaning money to banks. Banks can exist without a central bank that creates new money.

If a bank screws up and borrows to lots of people that can not make a profit, the bank will not make a profit, and it will not be able to pay an interest to lenders. A bank that makes a loss, like any business, is is in big trouble, its reputation will be lost, lenders will not loan money to it, it faces bankruptcy. Nothing "wrong" with that, badly run banks will fail on their own.. as long as the FED does not get involved.

Cheers

 

[taotree]

I read this referenced article:

http://www.newworldeconomics.com/archives/2008/020308.html

But I have questions regarding this:

"Now, nowhere in this exercise does the bank "create money." It borrows from one entity (the depositor mostly) and loans to another."

Reading wikipedia on this:

http://en.wikipedia.org/wiki/Fractional_reserve_banking

The "multiply money" or "create money" is because of the loop around and around.

Depositor 1 adds $100.
Borrower A borrows $90 and deposits it.
Borrower B borrows $80 and deposits it.
Borrower C borrows $70 and deposits it.
etc.

We can see that only $100 entered the system but now we have $200! Now, one could argue that it's the SAME money being borrowed. That would be true if Borrower A were borrowing directly from the Depositor, B from A, C from B, etc. That would be the same money being borrowed and no increase in money.

However, the critical point here is that those deposits are demand deposits. That means all four of those people have immediate and complete access to all their money--all $200 is available.

Therefore the statement "it borrows from one to loan to another" is incomplete because the bank still allows the one it borrowed from complete access to their money. So, either we have to accept that the depositor and borrower are both somehow using the exact same money at the same time (since the bank is giving them both access to it) or there was some money creation involved.

If this isn't correct, please be specific in showing me where it breaks down.

Thanks!

 

[DriftWood]

I read this referenced article:

http://www.newworldeconomics.com/archives/2008/020308.html

But I have questions regarding this:

"Now, nowhere in this exercise does the bank "create money." It borrows from one entity (the depositor mostly) and loans to another."

Reading wikipedia on this:

http://en.wikipedia.org/wiki/Fractional_reserve_banking

The "multiply money" or "create money" is because of the loop around and around.

Depositor 1 adds $100.
Borrower A borrows $90 and deposits it.
Borrower B borrows $80 and deposits it.
Borrower C borrows $70 and deposits it.
etc.

We can see that only $100 entered the system but now we have $200! Now, one could argue that it's the SAME money being borrowed. That would be true if Borrower A were borrowing directly from the Depositor, B from A, C from B, etc. That would be the same money being borrowed and no increase in money.

However, the critical point here is that those deposits are demand deposits. That means all four of those people have immediate and complete access to all their money--all $200 is available.

Therefore the statement "it borrows from one to loan to another" is incomplete because the bank still allows the one it borrowed from complete access to their money. So, either we have to accept that the depositor and borrower are both somehow using the exact same money at the same time (since the bank is giving them both access to it) or there was some money creation involved.

If this isn't correct, please be specific in showing me where it breaks down.

Thanks!

Yes, its easy to get confused.. took me awhile to see the table example on wikipedia correctly.

For one, its important to make a distinction between the two types of money. Base money (the stuff that FED creates) and Credit (the stuff that banks create). Credit is really not money at all (its the promise by a borrower to pay back the lender the money later). Any credit creation, will in the end have to be paid back in real money. So in the end all credit that is created, will be uncreated. I think most confusion about fractional reserve banking, inflation, fed etc comes from calling credit money.

The example on wikipedia.. is an account initially with $100 (base money), that somehow magically is turned into many small accounts with a total off $457.05 ($100 base money + $357.05 credit). We see that the base money has not increased but there is lots new credit created. That credit however will have to be repaid to the lenders by the borrowers with real money, so in the end the credit will go back to 0 and all that will be left is the $100 in base money.

But how can a $100 of base money create $357.05 credit. Should not $100 create a $100? No, this is the critical point. There is no limit to the amount of IOUs that can be created.

I can lend you $100, you can lend that $100 to your mom, she can lend it to her friend and eventually everyone in the world will have lent that 100 to someone else.. everyone in the world will hold a 100 IOU credit note, to a total amount of a gazillion... however at the end there is only one person that actually gets to spend that 100 dollars.. after he spent it, he makes some money and pays it back to the person he lent it from.. and the person he lent it from will pay back it back again, until everyone in the world has payed back that 100.. and you finally pay back that 100 to me. And that gazillion in credit has shrunk back to zero.

The specific example on wkipeida...i'll walk thru the boring details..

When the first guy 'A' with $100 base money lends out $80 base money to 'B'.. then 'A' only has $20 of real base money left and a $80 an IOU credit note.

Now 'B' with $80 in base money lends out $64 base money to 'C'..
then 'B' only has $16 in base money and $64 in IOU credit notes.

And so it goes on (forever).. but at no point is more base money created.. all that is created is more IOU credit notes, but all those have to be repaid with real base money.. so

'C' who bought a (toy) car with the $64 base money he lent.. well he works hard at the factory and pays back 'B' the $64 in base money. 'C' gets back his IOU note, and 'B' gets back his money. The credit that was created is now uncreated (C can burn that IOU note, he is now a debt free man).

'B' who never spent any money, still has his old $16 in base money, plus the $64 in base money that he got back from 'C'. He has $80 in base money and 0 in credits (because no one ows him any money). So 'B' has enough money to pay back 'A' $80 in base money.

'A' now has his old $20 in base money plus $80 in base money that 'B' paid back. A has again has $100 in base money and 0 in credit.

So you see.. in the end all loand have to be repaied. It does not matter that one dollar is lent out a billion times, that dollar will have to be repaid a billion times. (Or rather it does not matter if a billion people borrow a billionth of a dollar to the next person. There will still only be 1 real dollar to spend, however there will be half a billion IOU credits in circulation). The portion between credit and money does not matter. There is no correlation. All that matters is that the loans will be repaid. (As long as there are people with profitable use for money, there will be willing lenders.)

Hope that made sense. (I think that movie.. money as debt really screwed people up. Its hard to undo the conceptual damage that movie did. Kind of like that 911 loose change movie made lots of damage thru disinformation.)

Cheers

 

[Paul.Bearer.of.Injustice]

Well, I don't think compounded interest (or interest on interest) is evil either. When you invest money with any company that makes money, and re-invest the profits you make back into the company, your money will grow at a compounded rate. There is nothing wrong with that. Doesn't that mean that there will exist ore money in the world tomorrow than today, wont it mean inflation? Not necessarily, when a business makes money, the money is not created out of thin air. It comes from other parts of the economy. It all equals out.

The same goes for banks. When they charge interest from borrowers.. they believe that the business or person will be profitable and will have a bigger pile of money tomorrow than the average person. The total amount of money in the world need not increase tomorrow, for interest on interest to make sense, only the borrowing persons portion of it. Interest does not cause inflation.

Inflation is only created when the FED gets involved and starts loaning money to banks. Banks can exist without a central bank that creates new money.

If a bank screws up and borrows to lots of people that can not make a profit, the bank will not make a profit, and it will not be able to pay an interest to lenders. A bank that makes a loss, like any business, is is in big trouble, its reputation will be lost, lenders will not loan money to it, it faces bankruptcy. Nothing "wrong" with that, badly run banks will fail on their own.. as long as the FED does not get involved.

Cheers

Human production isnt an exponential growth function. Asset or real wealth creation are not governed by growth functions. Compounding does not occur in real world economies.
The only way compounding interest can work(until the dream is shattered) is in the make believe world of fiat currency.

 

[Ozwest]

Government has made banking a risk-free enterprise.
I agree with the idea that banking isn't evil, it is compound interest that is evil. it was devised by bankrupt governments and is nothing more than an accounting trick.

Human production does not grow exponentially - yet we expect our money supply to?
What do you think is going to happen when maximum inflation is reached at the (1+x)^n asymptote?

What's evil, is that the Fed is a membership of the most powerful bankers in America.

Is anyone able to tell me who runs the Fed? Who are the members?

Is there a list available to the public?

 

[ThePieSwindler]

Human production isnt an exponential growth function. Asset or real wealth creation are not governed by growth functions. Compounding does not occur in real world economies.
The only way compounding interest can work(until the dream is shattered) is in the make believe world of fiat currency.

Ok, but investment is a huge portion of economic growth, and is the driver of business and physical capital, or "real wealth" as you put it, and compounding interest is one of the primary vehicles of monetary investment and reinvestment. How does the fact that the currency is fiat have anything to do with anything? Compounding interest existed on the gold standard as well. All money is technically not "Real wealth", since it has really very little utility other than liquidity (of course, this is vital for commerce). The gold standard is just a way of fixing the money supply - it doesnt make the money any more of a "real" asset.

The reason the system of credit, debt, interest, etc works is because of the relationship between risk and reward. In "real world economies", this is what drives investment in "real wealth/asset creation".

If you're really arguing that financial capital and its growth are actually harmful to an economy instead of incredibly beneficial, i'm not sure what to say.

 

[Paul.Bearer.of.Injustice]

If you're really arguing that financial capital and its growth are actually harmful to an economy instead of incredibly beneficial, i'm not sure what to say.

You should have thrown in a "you don't care about children, do you?" to your strawman approach to hide the fact you have no idea what I'm talking about.

 

[Paul.Bearer.of.Injustice]

Ok, but investment is a huge portion of economic growth, and is the driver of business and physical capital, or "real wealth" as you put it, and compounding interest is one of the primary vehicles of monetary investment and reinvestment. How does the fact that the currency is fiat have anything to do with anything? Compounding interest existed on the gold standard as well. All money is technically not "Real wealth", since it has really very little utility other than liquidity (of course, this is vital for commerce). The gold standard is just a way of fixing the money supply - it doesnt make the money any more of a "real" asset.

The reason the system of credit, debt, interest, etc works is because of the relationship between risk and reward. In "real world economies", this is what drives investment in "real wealth/asset creation".

If you're really arguing that financial capital and its growth are actually harmful to an economy instead of incredibly beneficial, i'm not sure what to say.

COMPOUNDING INTEREST CAN ONLY WORK IF PRODUCTION CAN KEEP UP WITH AN EXPONENTIAL GROWTH FUNCTION.

You can't give someone an acre of land and expect food output to increase (1+x)^n regardless of how much debt/investment you are allotted, unless a miracle in technology occurred.

Flat interest is ethical and acceptable. A Gold standard and compounded interest are incompatible, which is why Nixon did what he did. Gold was a cap since its availability and production doesn't obey a (1+i)^n relationship.

 

[ThePieSwindler]

You should have thrown in a "you don't care about children, do you?" to your strawman approach to hide the fact you have no idea what I'm talking about.

Well then elucidate me, because thats what i drew from your post. The difference between a strawman argument and my point is that my point is backed up near unanimously by pretty much any economist, entrepreneur, CFA, etc, Its backed up by science, real science, not the global warming IPCC variety. If i misrepresented what you were saying, sorry, but i was hardly trying to set up a strawman, because i really dont need to. Theres so much in the way of grounds to my argument that i really dont need to hide behind fallacies.

So you're arguing against compound interest, and then vaguely tying it in to exponential functions and physical capital. What is this "real world" you are talking about? The reason the debt/interest system works is because of the risk/reward relationship. Its not a zero sum game either - wealth in many cases is a positive sum game. But because risk is tied to reward, you arent going to find mythically high rates of compound interest. But any reinvested interested will compound, because you are reinvesting in an already-higher priced asset.

You're arguing that financial markets detrimental for an economy, essentially, by trashing one of the fundamental tools of such markets. I'm saying every economist - whether Austrian, Neoclassical, Keynesian, or somewhere in between - is going to disagree with you. Raising capital through the risk/reward nature of financial markets is an important part of economic growth. This is economic science, this is the key to business... its the key to modern prosperity. It is the Keynesians that say consumption is most important; it is the austrians that emphasize investment and capital accumulation.

I agree wholeheartedly that the structure of financial markets needs to be chnged, and banking needs to be changed. But that does not mean they should be done away with. Maybe if you like low-tech agrarian pre-industrial societies that suffered from the problem of Malthusian catastrophe and very little division of labor, then sure. Interestingly, another thing that was linear in production was food, while population growth exponential... hmm. Until, of course, industrial society, and with it, modern financial institutions (banks, equity and debt markets, etc). Of course, these all existed before fiat currency, but they still worked in very similar manners to today, with less regulation. Before regulation, banks had reserves even smaller than reserve requirements today -so to have 100% reserve banking, youd NEED an institution like, say, a central bank, to set reserve requirements. Lo and behold, thats what the fed does anyways (perhaps one of its Okay functions). Of course, compound interest still existed, there were no reserve requirements, and we had a gold standard.

And how do you propose to get rid of these 'evils'? More government regulation to keep people from lending or borrowing money at interest rates in a free market? well then you've essentially advocating both a retardation of technological and human progress, and an increase in government regulation. Have fun with that.

 

[ThePieSwindler]

COMPOUNDING INTEREST CAN ONLY WORK IF PRODUCTION CAN KEEP UP WITH AN EXPONENTIAL GROWTH FUNCTION.

You can't give someone an acre of land and expect food output to increase (1+x)^n regardless of how much debt/investment you are allotted, unless a miracle in technology occurred.

Flat interest is ethical and acceptable. A Gold standard and compounded interest are incompatible, which is why Nixon did what he did. Gold was a cap since its availability and production doesn't obey a (1+i)^n relationship.

Take out "compounding interest" and replace it with "creation of financial assets and capital out of thin air" and you're actually getting closer to being right. Compounding interest has been around for much longer than fiat money, so that specific claim is wrong, but you aren't entirely off. I'd say i agree that things like leveraged derivatives (of which there exist more of those in value than the GDP of the world), yes, you are right. Thing is, production is somewhat of an exponential growth function itself. Of course, this is helped by capital markets. So the two often grow hand in hand. However, excess montary inflation, as well as debt outlays beyond total world assets (not necessarily total production), can certainly be a problem if production cannot keep up, but often enough technological and human capital growth can help make up for that. Risk/reward relationship also helps keep it in check - it is government that often distorts, but it can be private sources as well. However, a gold standard does not mean no compound interest - just look at history. Einstein even made his famous quote on compound interest back before Bretton Woods etc. A gold standard isnt a panacea - its only helpful because it protects against moral hazard-related inflation, and thats what i like about it. It doesnt fundamentally change the way financial markets work.

So i think the biggest problem is not compound interest, but leveraged derivatives. This is a point you made in another thread, although its also not specifically what is happening with curreny food/oil price rises (its part of it, but not the main component), its still a potential issue.

 

[scooter]

What's evil, is that the Fed is a membership of the most powerful bankers in America.

Is anyone able to tell me who runs the Fed? Who are the members?

Is there a list available to the public?

Are you serious? Determining who runs the Fed is pretty darn simple. 7 out of the 12 FOMC members are nominated by the president in public. The other 5 are presidents of the regional Fed banks.

Maybe the underlings in each Fed branch can't be named, but those in charge are public knowledge. Of course, if you believe the silly notion that some Rockefeller/Rothschild conspiracy is behind the Fed, then you wouldn't believe that the FOMC members decide anything at all.

 

[DriftWood]

Human production isnt an exponential growth function. Asset or real wealth creation are not governed by growth functions. Compounding does not occur in real world economies.
The only way compounding interest can work(until the dream is shattered) is in the make believe world of fiat currency.

There are three assumptions you make..
1. That the money supply should never grow.
2. That interest (or interest on interest) has to mean a growing supply on money.
3. That (exponential) credit creation will exceed human productivity growth.

I would disagree on all points.

On the second assumption.. If one person is making a profit it can be offset by another person making a loss. And the money supply stays the same. Only a redistribution of the available money has taken place. This is quite common.. When you lend your money to someone that has a great business idea. Then the person will make a big profit and be able to pay you interest. Where did this extra money come from? The bank or the fed did not create it. It came from the consumers that bought whatever the guy was making. You now have some of the money that they previously had, and they no longer have it. No extra money was created to pay interest to you.

On the first assumption.. if the money supply is not allowed to grow in step with an increase in demand for money it means deflation. Deflation is as bad as inflation (probably even worse). It means one ounce of gold yesterday, is worth the same as two ounces today. That might sound good but its not. It means you have to work twice as hard today, compared to yesterday, to make the same amount gold. If you worked hard half your life.. and made one gold bar. Even if you work just as hard in the second half of your life you will will never make another gold bar. So it might be better to just retire half way threw, and life on that one gold bar that you made really easy, as you will not be rewarded as well in the future for your effort. Deflation is not a good thing.. what you want is stable money.. that is money that does not inflate or deflate. That means the money supply has to increase in step with increases in demand for money. An increase in demand for money is just another way of saying that economy has grown more effective or expanded into new markets. Say when the tractor was invented.. all the sudden there was more potatoes in existence. All those extra potatoes being in existence and being traded increased the demand for money.

On the third assumption.. what happens when banks create to much credit? What is to much? Too much is when the borrowers can not make big enough profits to pay for the interest. It just means that their profitable business plan was not so profitable. They loaned more money than they could repay. What happens with that extra credit? What happens with the money that was wasted? Well it simply disappears. If i loan you $100, you get to spend the money, and I'm left with a $100 credit (a IOU note). So what happens if you cant pay back the $100 or the interest of $1 that you promised. Well nothing happens, the money is gone.. the promise to repay is broken.. the credit or the IOU note is worthless. Excessive credit creation will simply die on its own if it is not matched by a real productivity growth in the economy.

So people and banks can create as much credit as they want, that does not create inflation.. what creates inflation is when the central bank creates to much money. When they create money when though the economy is not growing, or becoming more efficient. Its pretty easy to tell when this is happening. You watch the price of some stable commodities (like gold). The fed should create and uncreate enough money to keep the price of stable commodities (like gold) level. Easy as cake.. even a monkey could be trained to do that, or better yet a computer could do it automatically.

Cheers

 

[Acala]

What?

The depositors will never lose what they've put into a bank.

What are you talking about? Remember the Great Depression? Does the phrase "Bank run" ring any bells? Man, you are losing credibility FAST!


And contrary to what you have asserted, there was nothing in any document I have ever signed when opening a checking account that says "you may not get your money back because we are not really holding it for you, we are lending it out".

 

[scooter]

What are you talking about? Remember the Great Depression? Does the phrase "Bank run" ring any bells? Man, you are losing credibility FAST!


And contrary to what you have asserted, there was nothing in any document I have ever signed when opening a checking account that says "you may not get your money back because we are not really holding it for you, we are lending it out".

A bank run of that sort could not happen in our modern system. People lost money in the depression because there was no facility to immediately convert credit money to notes. In today's world if a bank failed, their liabilities would just be transferred somewhere else or the Treasury would have to print it up.

As for your last sentence, you would have never been given such a document because "you may not get your money back" is not an option. The FDIC will assure you that you will get FRN's back for up to $100,000 in deposits, no matter what happens to the bank or who they've loaned your money to.

Even the completely clueless people of the world assume that a bank loans out deposits. I don't know many people who believe that they have a vault full of cash ready to hand out to 100% of their customers.