Economic: Monetary Policy: What is Ron Paul's take on Fractional Banking?

[rpwi]

For those of you that don't know, this is where a bank does not keep 100% of the money you deposit on hand...but instead sneakily lends out a portion (about 90%) and hopes that you (and your co-depositers) don't all of sudden withdraw your money at once.

Many critics (like Thomas Jefferson) see this as somewhat fraudelent and it that leads to either bank runs, tax payer bailouts to prevent bank runs or inflation.

I would be curious to know if Paul has commented on fractional banking and if he would outlaw it on a federal level?

If he would permit fractional banking, I assume he would eliminate a number of apparatuses the federal government uses to constantly prop up the system (which it is has to do, else it will be exposed for the fraudulent system that it is).

I assume he would kill the discount window (where banks can borrow money at below market interest rates)?

Assume he would abolish lending in general from the Federal Reserve to banks?

What would he do about FDIC? There would be a systemic bank run under a Paul administration but this would be a good thing (sometimes new seeds can't grow unless there is a forest fire). Bailing out the FDIC would probably be cheaper than bailing out the banks (would have been cheaper than TARP)...although long term think we should dump the FDIC.

In bailing out banks over the years, the Fed has acquired a number of assets (which they've downtraded for consistently lately...grrr). Do these get auctioned off? Not sure if I would trust the federal government to get a fair price for an auction this scale. Might have to let some of these assets mature on their own.

One of the biggest stealth bailouts the government uses for fractional banking is to raise the money supply when banks in general are about to be squeezed by depositers demanding their money back. Will Ron Paul continue to grow the monetary base though 'Open Market' mechanisms like the Fed Funds rate? Would M0 instead grow at a static level (like what Milton Friedman proposed) so erratic spikes in the money supply don't distort the market and the market doesn't game the Fed? Or would Ron Paul not grow M0 at all?

Would M0 or the monetary base even exist at all? I assume he would keep it in place while encouraging competing currencies in the market? Would the government buy gold to return the United States to fractional gold based currency? Perhaps even a 100% backed gold currency? This actually might be problematic as there isn't that much gold in the world and if gold = M0 then the price of gold would spike tremondously resulting in a huge transfer of wealth from the government to private gold sellers at a huge loss to the public.

Thanks in advance for any answers to these questions. Sorry about breaking the one question per post rule, but most of these are interconnected.

 

[chickensguys]

What is Ron Paul's take on Fractional Banking?
In short he considers it fraud. He also blames this policy on the bank runs before 1913.

 

[W_BRANDON]

Good thread, I've wondered about this. I read End the Fed, and don't remember there being much about it. Dr. Paul may have addressed the issue in other works or journals, but none that I'm aware of.

Fractional reserve lending has been around since the beginning of banking, as we know it today. So the practice of FRL is pretty standard around the world and goes back a long time, with differences in the reserve requirement ratio, 10% being typical.

To my understanding, commercial banks in the U.S. have found ways around reserve requirements all together with no real limit on the amount loans issued against demand deposits. Look at MF Global, it was leveraged around 40:1, which greatly exceeds the 9:1 reserve requirement that is supposed to be met.

Another issue of monetary policy I would like to hear Paul speak to, if he hasn't already, is the sustainability of our current debt-based monetary system. If you don't know, most money (>95%) in circulation was created as the principal of an interest bearing debt instrument, like a loan. In other words, nearly all the money in circulation is debt with a scheduled time to be extinguished. If this isn't bad enough, let's bring in the factor of interest, which is also demanded when the principal is scheduled to be repaid. The dilemma being, only the principal was created, yet the system demands back the amount of the principal plus interest.

With a debt-based money supply, the only thing worse than inflation, is deflation. Let me get to the point. If we found a way to retire our entire national debt of around $16 trillion tomorrow, there would immediately be a $16 trillion reduction in the money supply. You may see this favorably at first because prices would drop in time and the purchasing power would increase. However, people in debt will not find these funds available in the system to repay their loan with interest. There would be mass foreclosure, bankruptcies, and other financial hardships.

 

[Inny Binny]

Well, what you described in your first paragraph is credit. When someone loans out something. I'm pretty sure most people don't have a problem with their bank loaning out money to safe investments, whether it be 10% or 90% or even 100% if that is the agreement. Most are likely aware of the risk that all their money might not be available on-demand if an investment turns sour. There's nothing wrong with fractional reserve banking in theory.

Of course in practice there is that FDIC thing, which insures against liquidity shortages. The biggest banks will take risks worthy of a longer-term investment, while still allowing customers to withdraw on demand. This extra risk will increase the chance of illiquidity. The biggest banks get to pocket the difference on the yield curve, because they aren't allowed to fail.

But don't get into this idea that someone FRB is intrinsically fraudulent or something like that, because that just isn't true - otherwise all credit and loans would be illegal!

 

[rpwi]

...

Good points. Our debt based system has put an overemphasis on debt which has created a lot mal-investment. I strongly suspect that fractional banking is the real reason behind the business cycle, because of fractional banking we are constantly in either one of two states. Correcting mal-investment or creating it.

 

[Deborah K]

Watch this, he talks about adjusting the reserve in this video

 

[rpwi]

Well, what you described in your first paragraph is credit. When someone loans out something. I'm pretty sure most people don't have a problem with their bank loaning out money to safe investments, whether it be 10% or 90% or even 100% if that is the agreement. Most are likely aware of the risk that all their money might not be available on-demand if an investment turns sour. There's nothing wrong with fractional reserve banking in theory.

Disagree. Vast majority of people have no idea their checking accounts are being loaned to build houses and buy cars...but rather they believe the bank is using instruments like CD's to finance this.

It's not a matter of a bank investing in safe investments or not. As long as M0 (pretty much cash) is less than M1 (pretty much checking deposits plus cash outside of the banking system) we have a serious problem. If you check out shadowstats (great site BTW...would love to see the campaign use their numbers) you can see that M1 is currently at roughly 2 trillion while the monetary base is roughly at 1 trillion.

http://www.shadowstats.com/charts/monetary-base-money-supply

That one one trillion is seriously overbooked at a 2 to 1 ratio...and it doesn't matter how safe the bank invests this money because it will never be as liquid as cash. Now the banking system is either always in a state of constant crash or constantly creating inflation (when you create checking deposits not backed 100% by cash you create money and therefore inflation). This can only really happen because the Fed is constantly expanding the money supply to make fractional banking more liquid (otherwhise there isn't enough money to pay the interest on the debt). The other thing the Fed is doing is they are CONSTANTLY lending to banks through the discount window to prop up fractional banking. What I just described is just for M1...for M2 and high aggregates the problem is much worse.

Look at how banks started... People use to deposit their gold with goldsmiths for safekeeping and then use receipts as a means of payment. The goldsmiths got clever and noticed that their receipts weren't being redeemed frequently so lent out a portion of that gold to get rich. This was dishonest because they created more receipts than they had gold. Don't you think this is fraud? And if so, why aren't banks different?

Of course in practice there is that FDIC thing, which insures against liquidity shortages.

Somewhat...the FDIC hardly has the resources to bailout a bank crises that probably exceeds 2% of aggregate assets. In reality it would have to be bailed out in a true crisis (by printing money or borrowing). It's more of a psychological tool if anything.

But don't get into this idea that someone FRB is intrinsically fraudulent or something like that, because that just isn't true - otherwise all credit and loans would be illegal!

Of course it fraudulent...banks are lending what they don't have. Many famous politicians (like many of our founders) have railed against fractional banking. You just don't read about it in the history book.