What exactly is wrong with fractional reserve banking?

[rational thinker]

So I watched this video: http://www.youtube.com/watch?v=-r_-QRKyu6g

Kucinich talked about the moral hazard of nationalizing banks. He's right about that.

But his prescription of making the Fed part of the Treasury would be a moral hazard as well, because it would put monetary policy under control of the executive branch of the federal government, and all the associated political pressures. There's an even greater moral hazard there.

Frankly, I think the current quasi-public Fed is ideal, because it insulates the Fed from politics and the foibles of Congress and the President, giving the Fed the freedom to take the long view and act in the best interest of the country. (Not that it always does so, but it's easier for the Fed to do so than for Congress.) If it were under control of the executive branch, it would be awfully tempting to lower interest rates a month before election day.

Also, he mentioned ending fractional reserve banking. That makes no sense to me. Without fractional reserve banking, a bank would be the equivalent of a big mattress where you stash your money. What would be the point?

Please don't be upset with me. I really want to learn why I'm wrong. Thanks.

 

[Grimnir Wotansvolk]

Fractional reserve money is fiction. It simply isn't there.

What's wrong with having imaginary stockpiles of food and medicine?

 

[Isaac Bickerstaff]

Probably the best explanation of fractional reserve banking I have ever seen is in "Uncle John's Bathroom Reader". I know others here have attempted to explain the hazards of FRB, but let me give it a try.

The goldsmiths of many years ago would keep gold in their vaults for their clients. Often they would charge rent to store that gold. The goldsmith would write a note saying simply, "John Doe has twelve ounces of gold in my vault" He would sign his name and the client would have a "banknote". If the goldsmith had a good enough reputation, the client would be able to trade the banknote as he would the gold. Since paper notes were easier to deal with than gold, many of the clients left their gold in the vault and just exchanged notes without redeeming them.

The goldsmiths learned that they could loan out their clients' gold that they had on deposit and earn interest on borrowed gold. It did not take long for them to learn that if they loaned out banknotes, they could write banknotes many times for every ounce of gold that they had on deposit. Those banknotes were backed more by reputation than by gold. Often, the goldsmiths required actual gold as payment for the interest on the loans. When the loan was repaid, the banker could tear up the original banknote and pocket the gold that was paid as interest. Nothing fatally wrong with that system; just a little dishonest/unethical.

Fast forward to USA, 1933. The FED had created so much paper money that not only was it un-redeemable, but it was not behaving like gold-backed money. The wary public tried to redeem their gold and the bankers were in serious trouble. Instead of allowing the bankers to be dragged into the streets and publicly violated, FDR removed the gold from the equation altogether.

Hopefully, you can see that without some sort of permanent monetary base, the money is backed by debt and nothing else. When money is used to repay debt, it is "torn up" because it never existed in the first place. The money needed to pay the interest on the debt cannot be mined from the ground or grown or anything else; It must be loaned into existence.

SO, under a fractional reserve system with no permanent monetary base, any interest charged will result in someone defaulting on his loan. Historically, there have been fools out there to take on obnoxious amounts of debt and default, keeping the system from collapse, but as the volume of debt has risen, the interest demanded on that debt has become so onerous that eventually no one will be able to escape the burdens. Mass defaults and the bankers will officially own everything.

 

[Malakai]

Frac reserve is simply immoral, the banks become a magical entity who make money for doing nothing but creating and managing the money supply (which does not need 2 be managed).

 

[jack555]

So I watched this video: http://www.youtube.com/watch?v=-r_-QRKyu6g

Kucinich talked about the moral hazard of nationalizing banks. He's right about that.

But his prescription of making the Fed part of the Treasury would be a moral hazard as well, because it would put monetary policy under control of the executive branch of the federal government, and all the associated political pressures. There's an even greater moral hazard there.

Frankly, I think the current quasi-public Fed is ideal, because it insulates the Fed from politics and the foibles of Congress and the President, giving the Fed the freedom to take the long view and act in the best interest of the country. (Not that it always does so, but it's easier for the Fed to do so than for Congress.) If it were under control of the executive branch, it would be awfully tempting to lower interest rates a month before election day.

Also, he mentioned ending fractional reserve banking. That makes no sense to me. Without fractional reserve banking, a bank would be the equivalent of a big mattress where you stash your money. What would be the point?

Please don't be upset with me. I really want to learn why I'm wrong. Thanks.

Lets put it this way.If you tried to fractional reserve bank as a citizen you would be arrested. However, the government grants this privaledge to a private corporation. Then when the corporation fails it is the taxpayers who are forced to bail them out. There is nothing moral about this. Its like socialism except for the rich (bankers)!

The only reason we need banks if because they can help us earn interest tokeep up with inflation. If we were on a gold standard we could get close to eliminating inflation so this would not bea concern. If there were no inflation what would be wrong with banks being a big mattress?

 

[Truth Warrior]

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[Kotin]

just as private citizens cannot simply place money in a room and have double the amount, neither should the banks have such a privilege...


its immoral and impractical.

 

[Live_Free_Or_Die]

nt

 

[Nanerbeet]

Addressing the OP, the problem with fractional reserve besides diluting the currency by inflation-- is how "money" can suddenly vanish over night when the loan is called but the debtor is unable to pay. If money were a "zero-sum game," that is, if every dollar of debt was backed by exactly one dollar of money, there could be no deflation-- you could only have inflation as more money is printed.



What the economy experienced in 2008 was massive deflation. The government allowed banks to create as much money as they could lend, and when it all unwound, the government was forced to replace some of that lost money.



The only problem is-- it wasn't enough. The government is counting on banking to create more debt-backed money to start the whole cycle over again, so they're only printing enough (the Fed buying T-bills and MBS) to stimulate lending, they are not trying to replace losses with fiat backed dollars. And they will keep throwing money at the problem until it "works."