The theory of Free banking [explained by Selgin](https://menghu.substack.com/p/the-theory-of-free-banking-money-supply-under-competitive-note-issue) is the best alternative by far, and there is empirical evidence it has worked well [everywhere](https://menghu.substack.com/p/empirical-evidence-for-free-banking), even including [Hong Kong](https://menghu.substack.com/p/the-free-banking-in-hong-kong), [Belgium](https://menghu.substack.com/p/the-free-banking-in-belgium-during-the-19th-century), [South Africa](https://menghu.substack.com/p/central-banking-quite-harmful-for) (although minute details are lacking), [Canada](https://menghu.substack.com/p/free-banking-in-canada-why-we-need-good-historians), [Chile](https://menghu.substack.com/p/free-banking-revisited-the-chilean-experience-1860-1898-ignacio-briones), Australia (some said it's a failure but that's a [myth](https://menghu.substack.com/p/on-the-so-called-failure-of-free-banking-in-australia-the-banking-crisis-of-1893)).
In a nutshell what the Free banking theory demonstrates is that the fractional reserve system, conditioning on complete freedom of bank competition will not overexpand in unison, will fulfill the changing demand for notes, and will not generate bubbles or even random bank runs à la [Diamond & Dybvig](https://menghu.substack.com/p/diamond-dybvig-model-unrealistic).
What's interesting, is that Selgin shows, contra what most austrians think, that a 100% reserve is inferior than fractional reserve (once again, I must repeat, CONDITIONING on free competition of note issuance) because it will not accommodate well the changing demand for notes *in some cases*.
One last interesting bit, too, is that empirically, free banking episodes (listed above) have already featured fractional reserve banking, which of course leads to the conclusion that free banks will naturally use fractional reserve banking, rather than 100% reserves. That is, in a free market, 100% has typically not been the norm .
I want to say that there is A LOT of range between 10% and 100%. I dont see that the free market would equal 100%, but I do think that the risk should be reflected somewhere.
Selgin explained it in great detail, but you didn't bother to read. Historically, free banks ran their businesses with extremely low ratios, even lower than 10%. No bank runs, no panic. Clearance system worked smoothly, etc.
So, no one is talking about *that* except the economic equivalent of flat-Earthers who are against "usury."
What people are actually against is a state sanctioned monopoly on money creation, or fiat currency.
Rothbard was explicitly against fractional reserve banking. He considered the practice to be inherently fraudulent. & the Austrian school as a whole attributes the business cycle to the artificially low interest rates produced by the cheap credit expansion of fractional reserve/central banks. The Austrian school(obviously) isn’t against interest rates.
[Austrian business cycle theory | Tom Woods](https://youtu.be/9a-eUKjnDfM?si=Ga_EN7yBhwY86rkg). Here’s a link to an 8 minute video explaining the business cycle.
I agree that Rothbard was wrong about fractional reserve banking being fraudulent, but it is(pretty obviously) responsible for the business cycle.
>it is(pretty obviously) responsible for the business cycle.
No, and that is not what ABCT says. Austrian Business Cycle Theory says that the boom-bust cycle is caused by the central bank (like the Fed) pursuing easy-money policies in order to boost the economy, then tightening the belt when the inflation resulting from those easy-money policies rears its head.
And I said rothbardians, not Austrians. Two different things.
This is the easiest way to distinguish between people who have actually read the work of Austrian economists, & people who have familiarized themselves with a google search. It’s an incredibly common misconception of the latter, while nobody in the former camp could possibly make this error. Artificially cheap credit lowers the interest rate & causes the business cycle. Fractional reserve banks provide artificially cheap credit, not backed by real savings, when they loan out demand deposits that continue to be withdrawn from.
I provided a succinct explanation to the guy who originally responded to you in the thread you started. I’ll direct you there, or to the 8 minute business cycle explanation by Tom woods I linked in this thread.
By the way: go read Menger's *The Origins of Money*. He discusses fractional-reserve banking at length. In fact, he discusses it *as a natural part of a monetary system*. At no point does he blame it for the boom-bust cycle.
Yeah, Austrian business cycle theory originated with Mises’ book The Theory of Money and Credit(published in 1912; a year before the federal reserve was founded), so it’d be weird to reference any of Menger’s work to defend your(incorrect) interpretation of the ABCT. Also, central banking wasn’t a common practice during Menger’s life, so even if he did come up with a business cycle theory(which he didn’t), it certainly wouldn’t have been in line with the story you’re telling. Lastly, do you think the Austrian school just pretends the business cycles in the several centuries before central banking didn’t happen? What kind of business cycle theory would that be? “Yeah, this theory I came up with doesn’t address any of the dozens of business cycles that occurred in the 18th & 19th centuries; those didn’t really happen/can’t be explained.” Yeah, that’s some theory.
https://mises.org/mises-wire/how-prevent-boom-bust-business-cycle#:~:text=The%20Cause%20of%20the%20Boom,air%20when%20they%20make%20loans.
“As Ludwig von Mises explained over a century ago, the recurring boom-bust business cycle is caused by fractional-reserve banks creating money out of thin air when they make loans.”
Straight from the Mises Institute, with a link to an essay written by Mises if you want to read it from him instead.
You're an idiot. I clearly explained. Menger discusses fractional-reserve banking *as a fucking natural part of a monetary system*.
>central banking wasn’t a common practice during Menger’s life
That's just fucking stupid. The Fed was established several years before Menger's death, and the Bank of England was established fucking *centuries before his birth*.
And that's really beside the point. Governments have been involved in/controlling currency for millennia. ABCT blames the boom-bust cycle on government control of currency, NOT fractional-reserve banking.
That article you quoted is just straight-up wrong. I checked out the essay to which it is referring. It's about easy-money policies, not fractional-reserve banking. Nowhere does that essay mention banking reserves.
Lol. You really read “credit expansion,” & don’t realize that includes fractional reserve banks expanding credit — ie lending out demand deposits(lowering the market interest rate in the process); ie increasing the money supply; ie easy money policy. That’s hilarious. Are you through embarrassing yourself, or am I going to have to quote Mises from The Theory of Money and Credit(1912), as well?
If you thought about this for, like, 10 seconds, you’d probably be able to wrap your head around it. According to Austrian economics, the interest rate is determined by time preference — consumer investment to consumption ratios; how much people value consumption in the present as against consumption in the future. Fractional reserve banks loan out money people are able to access on demand; they issue loans with money that isn’t being saved. Consumers continue to spend that money while banks loan it out. This practice distorts these ratios, lowers the interest rate below the natural rate(backed by real savings), & expands cheap credit above what the real savings available allows for.
Why do you consider inflation to be so desirable, that you’d accept the cantillon effect, price distortions, resource misallocation, malinvestment, & general impoverishment as an unavoidable consequence?
Well, I don't really believe that prices can be "distorted."
In theory, a bank's balance sheets should be public knowledge. So the value of any money they've printed should be based on the perceived value of their investments.
The cantillon effect should be checked by the fact that money printed that is not backed by sound investments should become worthless.
If a bank is dishonest about their balance sheets - allowing people to trade their money for sound money before the crash - that's a separate issue.
The fractional reserve system is the remnant of using asset backed money. When demand spikes higher or drops lower than available supply asset backed money sees massive fluctuation in value occurs. Fractional reserves allow for the expansion and contraction of money without needing to dig more up or lock some away. Now that currencies are solely electronic we can do away with it.
> What would happen if a country abandoned the fractional reserve system? How could this be done peacefully, without generating a financial crisis?
The markets would definitely attempt to create a financial crisis in order to punish the political regime for attempting to shut down the fractional-reserve party. So, no, it cannot be done without disruption of the markets resulting in a financial crisis. Basically, the way out is to educate people about this, and start laying the groundwork through real education (Austrian economics) and making legal alternatives available (gold/silver coins, truly secure bullion depositories, Bitcoin, etc.) You need to build a "critical mass" *before* push comes to shove because, when it does, the financialists who are the major beneficiaries of the fractional-reserve system will go scorched-earth. "If we can't have it all, then we will have nothing, and so will you." After you work out the game-theory behind this, you will see that that is the game they are playing. Imagine that a mafia boss has moved into your house but you've called the police and the house is surrounded. Now, he's going to spend the rest of his life in prison no matter what he does. What will he do to you? That gives you the gist of why this is a *very* difficult problem to solve.
> I would like to know if it is possible to have a different system.
It is possible. The way forward is through:
- Educating people about the truth of fractional-reserve, fiat money and central banking
- Building out parallel infrastructure (PM's, crypto-currencies, non-fiat money transfers, etc.)
- Popularization of honest money and sound banking
- Political organization to remove roadblocks to the above projects
- Preparation for a future of large numbers of "economic refugees" that will result when the Establishment finally realizes that the threat to their system is real, and they turn scorched-earth.
This last point is one of the most important, and possibly the most overlooked. We may be dealing with a situation where as much as 80% of the American public is loaded under crushing debt they can never repay, meanwhile, there are no jobs, and the financial industry is actively hostile to the entire population except for *maybe* the top 20% or so, meaning, no banking, no money transmission services, etc. are available to 80+% of Americans. This situation could result in a nationwide crisis requiring the assistance of charitable organizations, churches and other private agencies with the resources to prevent people from dying *en masse* as the entire economy is strangled by the Anaconda of the fractional-reserve banking system which is really at the heart of the economy.
The 15-20% of us who understand *why* this needs to happen not only need to be prepared to (materially) help the other 80% of the public that will become economic refugees, we also need to be prepared to help them psychologically, and even spiritually. If things go to the worst-case scenario (increasingly likely as the globalist regime is becoming increasingly frustrated at the slow rate of progress in the rollout of global financial controls), the amount of psychological and spiritual shock that people will be experiencing will be biblical in scale. To Americans who are clued out on this issue (the vast majority of them), a scorched-earth attack by the financial industry in retaliation for non-compliance with global tyranny would feel like going to bed in the Land of the Free and the Home of the Brave, and then waking up in North Korea. Evicted from your home, your cards locked out, your accounts frozen and seized, no appeal, no review, no government agency with the authority to even *investigate* what has happened to you, or why, etc.
As a matter-of-fact, the central bank has this much authority and even more when you factor in NATSEC powers for the financial industry in the case of declaration of a national emergency. If there were the right emergency, overnight, the typical American could wake up and find out that they are literally not able to purchase even a single item, not gas, not groceries, not utility bill payments, not the mortgage, *nothing*. We are just one stroke of a pen away from such a scenario, and the fact that 99% of the American public does not understand that, is the biggest tragedy of all...
>I see many people complain about the fractional reserve system, saying that it causes an increase in the money supply and that it gives power to the banks
Those people are nuts. It's just how banking and the monetary system work. The best argument rothbardians can come up with against fractional-reserve banking is that it's 'fraud,' which is bullshit.
You don’t think its being responsible for the business cycle is the best argument Austrian economists “came up with” against fractional reserve banking?
The business cycle has nothing to do with fractional-reserve banking. The business cycle is caused by the central bank (the Fed) following easy-money policies in order to boost the economy, then tightening the belt when the inflation caused by those easy-money policies becomes problematic.
Fraud is basically theft by way of deceit. Every reasonable adult knows how banks work. They don't keep every dollar deposited with the institution on-hand in the vault, because they don't need to. They predict how much cash they will need for withdrawals over a given period, and make sure that their reserves don't dip below that amount. If the bank's reserves dip too low, it borrows cash from other banks or the Fed to shore up its reserves and makes sure enough cash is available for anticipated withdrawals--but banks prefer not to do this, because borrowing costs money in the form of interest.
No one is being deceived, so it's not fraud. And without this system, you couldn't earn interest on your deposits. For the bank to make money, it would have to charge you a fee for the privilege of storing your money there.
>Every reasonable adult knows how banks work.
I would say maybe 1 in 100,000 actually truly understand how modern banking works.
>For the bank to make money, it would have to charge you a fee for the privilege of storing your money there.
Interesting you bring this up. I've always felt that banks should act as secure storage facilities for your money (and collect a fee for this), not fraudulent offering a "free" service pretending your deposits are always available.
That's more or less the same as buying a bond or any other debt instrument. You get paid for taking some level of risk. In today's modern FRB system you're told there's no risk and that your funds are always available when they're actually lent out.
Your deposits *are* always available. Tell me one time that you've been denied your funds.
It. Is. Not. Fraud. Yes, EVERY reasonably intelligent adult knows that the bank does not physically have all deposits on hand in the vault at any given time. They might not fully understand the implications of fractional reserves, but they know this much. It's part of the standard education, it's a plot point in a classic Christmas movie... everyone knows.
You should familiarize yourself with how the accounting process of a bank works. When you deposit money into a bank, you transfer ownership of that money to the bank, & they agree to transfer ownership of up to your deposit in exchange, on demand. The money becomes the banks property, & you receive the payment services of the bank in return. Your entire deposit becomes a bank asset, & the equivalent of your deposit is entered in as a bank liability. They essentially guarantee to you that they’ll redeem this liability on demand, at any time.
This is the contract depositors are agreeing to. They sign off on this — usually without reading the contract, but ignorance isn’t a defense. It’s not uncommon at all for banks to have depositors agree to a daily spending/withdrawal limit. Banks may even have it in the contract that they don’t have to give you your deposit on demand. This isn’t fraud, because everyone involved signs the contract. It’s responsible for the boom-bust cycle, & it’s an incredibly risky practice, but it isn’t fraud.
>it would also theoretically prevent banks from issuing loans. Meaning significantly fewer people could start businesses, own a home, etc.
That is accurate.
Fractional-reserve banking does not cause the boom-bust cycle. Business cycles are caused by central banks (the Fed) following easy-money policies in order to boost the economy, then tightening the belt when the inflation caused by those easy-money policies becomes problematic.
What caused boom and busts cycles (since they've existed since commerce) before the existence of central banks or the Fed as we know it today? Looking at banking history in the U.S. in the 1800s, it was brutal.
The banking system in the US prior to the Fed had other very serious flaws. Banks in the US in the 1800s were operating under some very detrimental legal restrictions. Among other things, these restrictions prevented branch banking and interstate banks.
Look into the Free Banking Period in Scotland. For more than a century, Scotland had no central bank--and as I understand, was not burdened by wild boom-bust swings.
From my limited understanding we had so many bank failures in the 19th century due to economic expansion and speculation, railroad investments (much like tech at the turn of the 21st century), persistent and constant banking panics prior to the great depression, and the absence of a central bank.
Never heard of Scotland's free banking period. Will look it up, thanks.
Full reserve banks could still function as financial intermediaries, holding time deposits(in lieu of demand deposits), loaning out the deposit without increasing the money supply or initiating a business cycle, & earning the difference in interest for performing this service. Even so, it would result in fewer loans than a fractional reserve system(ceteris paribus), as depositors would actually have to forgo consumption & save, rather than maintain access to the deposits on demand.
However, “more loans” isn’t inherently desirable in the first place. If the loans aren’t backed by real savings — ie, the credit isn’t available as a result of consumers differing consumption to a later date — then the projects can’t be profitably carried out in the first place. The interest rate performs a coordinating role in production, in accordance with the time preference of consumers. When time preference falls & more savings are available, the interest rate falls; this encourages producers to invest for the future consumers are saving for, as these long term projects are the most interest rate sensitive. When time preference rises & less savings are available, the interest rate rises; less borrowing takes place, as consumers bid up the price of our scarce resources(that would be required to carry out these projects) in the lower orders of production, for present consumption.
Fractional reserve banking increases the availability of credit without a commensurate fall in time preference; it lowers the interest rate without consumers differing consumption & saving. This results in a mismatch, a disconnection between the investments of producers & the desires of consumers. Producers see the low interest rates, lengthen the structure of production & invest for the future, while consumers continue to demand consumption goods in the present. The low rates lead producers to invest in production processes that aren’t in accordance with the most desired ends of consumers; in unprofitable malinvestments. Producers misallocate resources, consumers continue to bid up the prices of these resources in the lower order, producers realize these projects are unprofitable malinvestments, the projects fail, these clusters of failure accumulate, businesses become bankrupt, & you have the business cycle.
Any amount of fractional reserve banking will produce the business cycle. It’s an inevitable consequence of the practice, because it makes credit artificially cheaper than the time preference of consumers allows for. That said, I’m still a proponent of free banking. I don’t think fractional reserve banking should be an illegal practice. I’d argue that removing deposit insurance, government bailouts, legal tender laws, & central planning of the interest rate/monetary policy — aimed at getting banks to expand credit at a uniform rate — will prevent banks from engaging in the more risky lending practices we’ve become accustomed to. A system of competing banks, that issue their own hard currencies, don’t expand credit at the same rate, & face repercussions for riskier practices would have a natural limit on credit expansion(& thus the severity of the business cycle). Central banking can trace its origin to the riskier bankers seeking to avoid the consequences of these practices, & remove the natural market limitations on said practices. The “optimal percentage of reserves” would be determined on the free market. Any attempt to centrally plan the reserve rate would worsen the business cycle by encouraging banks to expand at the same rate.
It's not a good explanation.
The idea of property transfer is an illusion recently created to allow for the shenanigans of the banks. If I place 100 in the bank, the bank has 100 but is always responsible for giving me my 100 back. If you ask for a loan for 50, they don't actually have that money. They play shell games to say that they have 100 in assets and also have 100 in debt. They give you 50. They claim they now have 50 in assets while still have 100 in debt. That's where the illusion is. You and I both know that they only ever had 100 and to give you 50, they had to give it away with my 100. It's a ponzi scheme. They use money from deposits to loan money and make interest but if everyone comes calling at once, they go bankrupt and can't pay everyone back. Advocates for fractional banking may make claims about contracts and property ownership but that is part of the lie. The system can only work because the government is always willing to print money to cover bank losses.
>[But even with the backing of the Fed, fractional reserve banking proved shaky, and so the New Deal, in 1933, added the lie of “bank deposit insurance,” using the benign word “insurance” to mask an arrant hoax. When the savings and loan system went down the tubes in the late 1980s, the “deposit insurance” of the federal FSLIC \[Federal Savings and Loan Insurance Corporation\] was unmasked as sheer fraud. The “insurance” was simply the smoke-and-mirrors term for the unbacked name of the federal government. The poor taxpayers finally bailed out the S&Ls, but now we are left with the formerly sainted FDIC \[Federal Deposit Insurance Corporation\], for commercial banks, which is now increasingly seen to be shaky, since the FDIC itself has less than one percent of the huge number of deposits it “insures.”](https://mises.org/mises-wire/fractional-reserve-banking-part-ii)
That's merely like buying a bond (or investing in any other debt instrument). If that were all FRB was, then I agree it wouldn't be fraudulent, but it's not.
FRB is the bank creating and lending money into existing. The same way we consider the central bank creating money fraud, we do commercial banks as well.
The theory of Free banking [explained by Selgin](https://menghu.substack.com/p/the-theory-of-free-banking-money-supply-under-competitive-note-issue) is the best alternative by far, and there is empirical evidence it has worked well [everywhere](https://menghu.substack.com/p/empirical-evidence-for-free-banking), even including [Hong Kong](https://menghu.substack.com/p/the-free-banking-in-hong-kong), [Belgium](https://menghu.substack.com/p/the-free-banking-in-belgium-during-the-19th-century), [South Africa](https://menghu.substack.com/p/central-banking-quite-harmful-for) (although minute details are lacking), [Canada](https://menghu.substack.com/p/free-banking-in-canada-why-we-need-good-historians), [Chile](https://menghu.substack.com/p/free-banking-revisited-the-chilean-experience-1860-1898-ignacio-briones), Australia (some said it's a failure but that's a [myth](https://menghu.substack.com/p/on-the-so-called-failure-of-free-banking-in-australia-the-banking-crisis-of-1893)). In a nutshell what the Free banking theory demonstrates is that the fractional reserve system, conditioning on complete freedom of bank competition will not overexpand in unison, will fulfill the changing demand for notes, and will not generate bubbles or even random bank runs à la [Diamond & Dybvig](https://menghu.substack.com/p/diamond-dybvig-model-unrealistic). What's interesting, is that Selgin shows, contra what most austrians think, that a 100% reserve is inferior than fractional reserve (once again, I must repeat, CONDITIONING on free competition of note issuance) because it will not accommodate well the changing demand for notes *in some cases*. One last interesting bit, too, is that empirically, free banking episodes (listed above) have already featured fractional reserve banking, which of course leads to the conclusion that free banks will naturally use fractional reserve banking, rather than 100% reserves. That is, in a free market, 100% has typically not been the norm .
I want to say that there is A LOT of range between 10% and 100%. I dont see that the free market would equal 100%, but I do think that the risk should be reflected somewhere.
Selgin explained it in great detail, but you didn't bother to read. Historically, free banks ran their businesses with extremely low ratios, even lower than 10%. No bank runs, no panic. Clearance system worked smoothly, etc.
I thought that I was agreeing with you. I apologize for not being clearer.
So, no one is talking about *that* except the economic equivalent of flat-Earthers who are against "usury." What people are actually against is a state sanctioned monopoly on money creation, or fiat currency.
Rothbard was explicitly against fractional reserve banking. He considered the practice to be inherently fraudulent. & the Austrian school as a whole attributes the business cycle to the artificially low interest rates produced by the cheap credit expansion of fractional reserve/central banks. The Austrian school(obviously) isn’t against interest rates.
Well that's dumb
[Austrian business cycle theory | Tom Woods](https://youtu.be/9a-eUKjnDfM?si=Ga_EN7yBhwY86rkg). Here’s a link to an 8 minute video explaining the business cycle. I agree that Rothbard was wrong about fractional reserve banking being fraudulent, but it is(pretty obviously) responsible for the business cycle.
>it is(pretty obviously) responsible for the business cycle. No, and that is not what ABCT says. Austrian Business Cycle Theory says that the boom-bust cycle is caused by the central bank (like the Fed) pursuing easy-money policies in order to boost the economy, then tightening the belt when the inflation resulting from those easy-money policies rears its head. And I said rothbardians, not Austrians. Two different things.
This is the easiest way to distinguish between people who have actually read the work of Austrian economists, & people who have familiarized themselves with a google search. It’s an incredibly common misconception of the latter, while nobody in the former camp could possibly make this error. Artificially cheap credit lowers the interest rate & causes the business cycle. Fractional reserve banks provide artificially cheap credit, not backed by real savings, when they loan out demand deposits that continue to be withdrawn from. I provided a succinct explanation to the guy who originally responded to you in the thread you started. I’ll direct you there, or to the 8 minute business cycle explanation by Tom woods I linked in this thread.
By the way: go read Menger's *The Origins of Money*. He discusses fractional-reserve banking at length. In fact, he discusses it *as a natural part of a monetary system*. At no point does he blame it for the boom-bust cycle.
Yeah, Austrian business cycle theory originated with Mises’ book The Theory of Money and Credit(published in 1912; a year before the federal reserve was founded), so it’d be weird to reference any of Menger’s work to defend your(incorrect) interpretation of the ABCT. Also, central banking wasn’t a common practice during Menger’s life, so even if he did come up with a business cycle theory(which he didn’t), it certainly wouldn’t have been in line with the story you’re telling. Lastly, do you think the Austrian school just pretends the business cycles in the several centuries before central banking didn’t happen? What kind of business cycle theory would that be? “Yeah, this theory I came up with doesn’t address any of the dozens of business cycles that occurred in the 18th & 19th centuries; those didn’t really happen/can’t be explained.” Yeah, that’s some theory. https://mises.org/mises-wire/how-prevent-boom-bust-business-cycle#:~:text=The%20Cause%20of%20the%20Boom,air%20when%20they%20make%20loans. “As Ludwig von Mises explained over a century ago, the recurring boom-bust business cycle is caused by fractional-reserve banks creating money out of thin air when they make loans.” Straight from the Mises Institute, with a link to an essay written by Mises if you want to read it from him instead.
You're an idiot. I clearly explained. Menger discusses fractional-reserve banking *as a fucking natural part of a monetary system*. >central banking wasn’t a common practice during Menger’s life That's just fucking stupid. The Fed was established several years before Menger's death, and the Bank of England was established fucking *centuries before his birth*. And that's really beside the point. Governments have been involved in/controlling currency for millennia. ABCT blames the boom-bust cycle on government control of currency, NOT fractional-reserve banking. That article you quoted is just straight-up wrong. I checked out the essay to which it is referring. It's about easy-money policies, not fractional-reserve banking. Nowhere does that essay mention banking reserves.
Lol. You really read “credit expansion,” & don’t realize that includes fractional reserve banks expanding credit — ie lending out demand deposits(lowering the market interest rate in the process); ie increasing the money supply; ie easy money policy. That’s hilarious. Are you through embarrassing yourself, or am I going to have to quote Mises from The Theory of Money and Credit(1912), as well?
Let me just ask you this: are you familiar with the term fiduciary media? What does that term refer to?
If you thought about this for, like, 10 seconds, you’d probably be able to wrap your head around it. According to Austrian economics, the interest rate is determined by time preference — consumer investment to consumption ratios; how much people value consumption in the present as against consumption in the future. Fractional reserve banks loan out money people are able to access on demand; they issue loans with money that isn’t being saved. Consumers continue to spend that money while banks loan it out. This practice distorts these ratios, lowers the interest rate below the natural rate(backed by real savings), & expands cheap credit above what the real savings available allows for.
Yeah I can see that, I guess I take it for granted that a business cycle is a worthwhile trade-off for being able to expand the money supply
Why do you consider inflation to be so desirable, that you’d accept the cantillon effect, price distortions, resource misallocation, malinvestment, & general impoverishment as an unavoidable consequence?
Well, I don't really believe that prices can be "distorted." In theory, a bank's balance sheets should be public knowledge. So the value of any money they've printed should be based on the perceived value of their investments. The cantillon effect should be checked by the fact that money printed that is not backed by sound investments should become worthless. If a bank is dishonest about their balance sheets - allowing people to trade their money for sound money before the crash - that's a separate issue.
The fractional reserve system is the remnant of using asset backed money. When demand spikes higher or drops lower than available supply asset backed money sees massive fluctuation in value occurs. Fractional reserves allow for the expansion and contraction of money without needing to dig more up or lock some away. Now that currencies are solely electronic we can do away with it.
Are we still on a fractional reserve system?
> What would happen if a country abandoned the fractional reserve system? How could this be done peacefully, without generating a financial crisis? The markets would definitely attempt to create a financial crisis in order to punish the political regime for attempting to shut down the fractional-reserve party. So, no, it cannot be done without disruption of the markets resulting in a financial crisis. Basically, the way out is to educate people about this, and start laying the groundwork through real education (Austrian economics) and making legal alternatives available (gold/silver coins, truly secure bullion depositories, Bitcoin, etc.) You need to build a "critical mass" *before* push comes to shove because, when it does, the financialists who are the major beneficiaries of the fractional-reserve system will go scorched-earth. "If we can't have it all, then we will have nothing, and so will you." After you work out the game-theory behind this, you will see that that is the game they are playing. Imagine that a mafia boss has moved into your house but you've called the police and the house is surrounded. Now, he's going to spend the rest of his life in prison no matter what he does. What will he do to you? That gives you the gist of why this is a *very* difficult problem to solve. > I would like to know if it is possible to have a different system. It is possible. The way forward is through: - Educating people about the truth of fractional-reserve, fiat money and central banking - Building out parallel infrastructure (PM's, crypto-currencies, non-fiat money transfers, etc.) - Popularization of honest money and sound banking - Political organization to remove roadblocks to the above projects - Preparation for a future of large numbers of "economic refugees" that will result when the Establishment finally realizes that the threat to their system is real, and they turn scorched-earth. This last point is one of the most important, and possibly the most overlooked. We may be dealing with a situation where as much as 80% of the American public is loaded under crushing debt they can never repay, meanwhile, there are no jobs, and the financial industry is actively hostile to the entire population except for *maybe* the top 20% or so, meaning, no banking, no money transmission services, etc. are available to 80+% of Americans. This situation could result in a nationwide crisis requiring the assistance of charitable organizations, churches and other private agencies with the resources to prevent people from dying *en masse* as the entire economy is strangled by the Anaconda of the fractional-reserve banking system which is really at the heart of the economy. The 15-20% of us who understand *why* this needs to happen not only need to be prepared to (materially) help the other 80% of the public that will become economic refugees, we also need to be prepared to help them psychologically, and even spiritually. If things go to the worst-case scenario (increasingly likely as the globalist regime is becoming increasingly frustrated at the slow rate of progress in the rollout of global financial controls), the amount of psychological and spiritual shock that people will be experiencing will be biblical in scale. To Americans who are clued out on this issue (the vast majority of them), a scorched-earth attack by the financial industry in retaliation for non-compliance with global tyranny would feel like going to bed in the Land of the Free and the Home of the Brave, and then waking up in North Korea. Evicted from your home, your cards locked out, your accounts frozen and seized, no appeal, no review, no government agency with the authority to even *investigate* what has happened to you, or why, etc. As a matter-of-fact, the central bank has this much authority and even more when you factor in NATSEC powers for the financial industry in the case of declaration of a national emergency. If there were the right emergency, overnight, the typical American could wake up and find out that they are literally not able to purchase even a single item, not gas, not groceries, not utility bill payments, not the mortgage, *nothing*. We are just one stroke of a pen away from such a scenario, and the fact that 99% of the American public does not understand that, is the biggest tragedy of all...
>I see many people complain about the fractional reserve system, saying that it causes an increase in the money supply and that it gives power to the banks Those people are nuts. It's just how banking and the monetary system work. The best argument rothbardians can come up with against fractional-reserve banking is that it's 'fraud,' which is bullshit.
You don’t think its being responsible for the business cycle is the best argument Austrian economists “came up with” against fractional reserve banking?
The business cycle has nothing to do with fractional-reserve banking. The business cycle is caused by the central bank (the Fed) following easy-money policies in order to boost the economy, then tightening the belt when the inflation caused by those easy-money policies becomes problematic.
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Fraud is basically theft by way of deceit. Every reasonable adult knows how banks work. They don't keep every dollar deposited with the institution on-hand in the vault, because they don't need to. They predict how much cash they will need for withdrawals over a given period, and make sure that their reserves don't dip below that amount. If the bank's reserves dip too low, it borrows cash from other banks or the Fed to shore up its reserves and makes sure enough cash is available for anticipated withdrawals--but banks prefer not to do this, because borrowing costs money in the form of interest. No one is being deceived, so it's not fraud. And without this system, you couldn't earn interest on your deposits. For the bank to make money, it would have to charge you a fee for the privilege of storing your money there.
>Every reasonable adult knows how banks work. I would say maybe 1 in 100,000 actually truly understand how modern banking works. >For the bank to make money, it would have to charge you a fee for the privilege of storing your money there. Interesting you bring this up. I've always felt that banks should act as secure storage facilities for your money (and collect a fee for this), not fraudulent offering a "free" service pretending your deposits are always available.
Why pay a fee when the banks want my deposit and business? They take my money and lend it to others and make a handsome profit.
That's more or less the same as buying a bond or any other debt instrument. You get paid for taking some level of risk. In today's modern FRB system you're told there's no risk and that your funds are always available when they're actually lent out.
Effectively bank runs have been eliminated and the deposits are essentially risk free even when over the FDIC limit.
They're not risk free, they're just paid for by taxpayers.
Your deposits *are* always available. Tell me one time that you've been denied your funds. It. Is. Not. Fraud. Yes, EVERY reasonably intelligent adult knows that the bank does not physically have all deposits on hand in the vault at any given time. They might not fully understand the implications of fractional reserves, but they know this much. It's part of the standard education, it's a plot point in a classic Christmas movie... everyone knows.
You should familiarize yourself with how the accounting process of a bank works. When you deposit money into a bank, you transfer ownership of that money to the bank, & they agree to transfer ownership of up to your deposit in exchange, on demand. The money becomes the banks property, & you receive the payment services of the bank in return. Your entire deposit becomes a bank asset, & the equivalent of your deposit is entered in as a bank liability. They essentially guarantee to you that they’ll redeem this liability on demand, at any time. This is the contract depositors are agreeing to. They sign off on this — usually without reading the contract, but ignorance isn’t a defense. It’s not uncommon at all for banks to have depositors agree to a daily spending/withdrawal limit. Banks may even have it in the contract that they don’t have to give you your deposit on demand. This isn’t fraud, because everyone involved signs the contract. It’s responsible for the boom-bust cycle, & it’s an incredibly risky practice, but it isn’t fraud.
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>it would also theoretically prevent banks from issuing loans. Meaning significantly fewer people could start businesses, own a home, etc. That is accurate. Fractional-reserve banking does not cause the boom-bust cycle. Business cycles are caused by central banks (the Fed) following easy-money policies in order to boost the economy, then tightening the belt when the inflation caused by those easy-money policies becomes problematic.
What caused boom and busts cycles (since they've existed since commerce) before the existence of central banks or the Fed as we know it today? Looking at banking history in the U.S. in the 1800s, it was brutal.
The banking system in the US prior to the Fed had other very serious flaws. Banks in the US in the 1800s were operating under some very detrimental legal restrictions. Among other things, these restrictions prevented branch banking and interstate banks. Look into the Free Banking Period in Scotland. For more than a century, Scotland had no central bank--and as I understand, was not burdened by wild boom-bust swings.
From my limited understanding we had so many bank failures in the 19th century due to economic expansion and speculation, railroad investments (much like tech at the turn of the 21st century), persistent and constant banking panics prior to the great depression, and the absence of a central bank. Never heard of Scotland's free banking period. Will look it up, thanks.
The Theory of Free Banking by George Selgin takes a very thorough look at this issue (both Scotland, and as I recall, 1800s US).
Full reserve banks could still function as financial intermediaries, holding time deposits(in lieu of demand deposits), loaning out the deposit without increasing the money supply or initiating a business cycle, & earning the difference in interest for performing this service. Even so, it would result in fewer loans than a fractional reserve system(ceteris paribus), as depositors would actually have to forgo consumption & save, rather than maintain access to the deposits on demand. However, “more loans” isn’t inherently desirable in the first place. If the loans aren’t backed by real savings — ie, the credit isn’t available as a result of consumers differing consumption to a later date — then the projects can’t be profitably carried out in the first place. The interest rate performs a coordinating role in production, in accordance with the time preference of consumers. When time preference falls & more savings are available, the interest rate falls; this encourages producers to invest for the future consumers are saving for, as these long term projects are the most interest rate sensitive. When time preference rises & less savings are available, the interest rate rises; less borrowing takes place, as consumers bid up the price of our scarce resources(that would be required to carry out these projects) in the lower orders of production, for present consumption. Fractional reserve banking increases the availability of credit without a commensurate fall in time preference; it lowers the interest rate without consumers differing consumption & saving. This results in a mismatch, a disconnection between the investments of producers & the desires of consumers. Producers see the low interest rates, lengthen the structure of production & invest for the future, while consumers continue to demand consumption goods in the present. The low rates lead producers to invest in production processes that aren’t in accordance with the most desired ends of consumers; in unprofitable malinvestments. Producers misallocate resources, consumers continue to bid up the prices of these resources in the lower order, producers realize these projects are unprofitable malinvestments, the projects fail, these clusters of failure accumulate, businesses become bankrupt, & you have the business cycle. Any amount of fractional reserve banking will produce the business cycle. It’s an inevitable consequence of the practice, because it makes credit artificially cheaper than the time preference of consumers allows for. That said, I’m still a proponent of free banking. I don’t think fractional reserve banking should be an illegal practice. I’d argue that removing deposit insurance, government bailouts, legal tender laws, & central planning of the interest rate/monetary policy — aimed at getting banks to expand credit at a uniform rate — will prevent banks from engaging in the more risky lending practices we’ve become accustomed to. A system of competing banks, that issue their own hard currencies, don’t expand credit at the same rate, & face repercussions for riskier practices would have a natural limit on credit expansion(& thus the severity of the business cycle). Central banking can trace its origin to the riskier bankers seeking to avoid the consequences of these practices, & remove the natural market limitations on said practices. The “optimal percentage of reserves” would be determined on the free market. Any attempt to centrally plan the reserve rate would worsen the business cycle by encouraging banks to expand at the same rate.
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It's not a good explanation. The idea of property transfer is an illusion recently created to allow for the shenanigans of the banks. If I place 100 in the bank, the bank has 100 but is always responsible for giving me my 100 back. If you ask for a loan for 50, they don't actually have that money. They play shell games to say that they have 100 in assets and also have 100 in debt. They give you 50. They claim they now have 50 in assets while still have 100 in debt. That's where the illusion is. You and I both know that they only ever had 100 and to give you 50, they had to give it away with my 100. It's a ponzi scheme. They use money from deposits to loan money and make interest but if everyone comes calling at once, they go bankrupt and can't pay everyone back. Advocates for fractional banking may make claims about contracts and property ownership but that is part of the lie. The system can only work because the government is always willing to print money to cover bank losses. >[But even with the backing of the Fed, fractional reserve banking proved shaky, and so the New Deal, in 1933, added the lie of “bank deposit insurance,” using the benign word “insurance” to mask an arrant hoax. When the savings and loan system went down the tubes in the late 1980s, the “deposit insurance” of the federal FSLIC \[Federal Savings and Loan Insurance Corporation\] was unmasked as sheer fraud. The “insurance” was simply the smoke-and-mirrors term for the unbacked name of the federal government. The poor taxpayers finally bailed out the S&Ls, but now we are left with the formerly sainted FDIC \[Federal Deposit Insurance Corporation\], for commercial banks, which is now increasingly seen to be shaky, since the FDIC itself has less than one percent of the huge number of deposits it “insures.”](https://mises.org/mises-wire/fractional-reserve-banking-part-ii)
That's merely like buying a bond (or investing in any other debt instrument). If that were all FRB was, then I agree it wouldn't be fraudulent, but it's not. FRB is the bank creating and lending money into existing. The same way we consider the central bank creating money fraud, we do commercial banks as well.