Put it this way… most of the talk on the town at present is about how we need to make up new regulations to prevent this from happening again in the future. What a completely insane discourse! Why should we need to make regulations to prevent people from loosing money? Surely they should want to avoid loosing money themselves?
Well if it were their own money they were loosing that might be true. However, the reason banks have lent out wads of cash that they’ll never get back and the reason it’s such a big problem is quite simply that it wasn’t their money that they lent out. 90% of the money they lent out was completely imaginary (but was none the less bidding resources away from real money) and the people who stand to loose the most are not the bankers but, once again, those who have real savings (depositors) - which is why no one wants to let the banks just sink like they ideally should.
Could that situation have come about if it weren’t for fractional reserve banking? If the only money banks could lend out was their own money, do you think they’d have made all these risky loans? Further, if they had, do you think anyone else would care if they went bankrupt? The answer is a resounding no.
The subprime disaster can be attributed entirely to a bad call in Car vs Car, in the English courts in 1811…
If people want to be protected from inflation, they would choose to hold the money that is least likely to inflate. Gold inflates very slowly, but there might be another money out there that is totally inflation-free.
Giving people interest in exchange for counterfeiting their deposits is giving the clients a cut of the scheme, but it is still inferior to full reserve, zero-inflation money.
To answer your first question. In a 100% reserve world, monetary inflation will be negligible, only occurring when raw gold is converted to gold bullion or gold coin and placed into circulation. This process will be self checking, however, if the purchasing power of gold begins to decline, gold production will shift to the non monetary uses of gold and gold bullion and coins may even be taken out of circulation. There will likely be a slight and steady DECLINE in the price level. Thus 100% reserve and gold will have a deflationary effect on prices. Your concerns of inflation are unfounded. Yes, I could put it in my own storage safe and “lock the door”. But how would I make any use of it??? As Joe Citizen, nobody is going to take my private warehouse receipt for something in my home safe.
As for your second paragraph, it is not offered because it is not possible under the current system. For it even to become possible a bunch of legalistic changes must take place and the Federal Reserve must be torn down by the roots. For example, all legal tender laws would have to be repealed. Gold would have to be reintroduced and distributed to the new 100% reserve banks and a process would have to occur for people to redeem their Federal Reserve Notes in commodity or commodity warehouse receipts.
I would not mourn TOO much for the banks under such a new 100% system. I think they will squeak by somehow. Seriously, any commercial bank would be operating both as a deposit AND as a loan bank. The pure rate of interest will be much higher as it will solely reflect time preference, so banks will be getting a good rate of return on their loans and passing those higher rates of return onto their loan depositers. I would imagine deposit banking fees would likely be very reasonable in such a system for the ordinary depositer. Anyhow, if you keep even a small portion of your bank deposits in a loan deposit, you will more than make up any fees you might pay on the demand deposit side.
If $10 gets deposited into the bank and $90 worth of loans are floated on top of this then where exactly did all the extra money come from if it wasn’t created?
Ya I think I have it wrong.. I’m still just a little unclear as to how this money gets created. The $90 in loans is just the same money loaned out multiple times, right? If someone deposits $10 in bank A, they lend out 9 to someone who deposits in bank B, bank B lends out 8 to someone who deposits in bank C. Even though there’s $27 in loans total, it’s still just the original $10 getting spread out, no?
What you’re missing is that the original $10 is still in the depositor’s account the whole time! The $9 being lent out is not $9 of the original deposit, because the whole $10 is still (supposedly) there waiting to be withdrawn at any time; it’s a new $9 that didn’t exist before.
And that $9 loan becomes a deposit for someone else once spent (say you take the $9 loan and buy a tshirt, tshirt guy deposits the money in his bank), with the $8.10 being loaned out becoming a $8.10 deposit, etc. Eventually, there is $100 worth of deposits , $90 worth of loans, and $10 worth of reserves (part of the $100 in deposits) from an original $10 deposit - so $90 created out of thin air, with nothing to back it.
Why does the bank have to create new money for this? Why can’t it just lend out $9 out of the original $10 deposit? I thought that was the whole point of fractional reserve banking, that banks would only lend out money that they have. It seems like they would only have to create new money if the original depositor wanted to withdraw more than 10% of his holdings at once, no?
Ok, but would libertarians have a problem with FRB if the banks actually lent out the money given to them by depositors? New money doesn’t have to be created for the banks to loan; they could lend out money entrusted to them by depositors (assuming this was all in a contract up front). So it’s not a problem inherent to FRB, it’s just a matter of artificially inflating the money supply.
It’s inherent in fractional reserve banking, because that’s the definition of fractional reserve banking - that it lends out money while also claiming the money is still there in your account for you to use at will. If you deposit your money in the form of a loan to the bank, to be repaid (with interest) at some time in the future, of course the bank can lend it out - you no longer have the use of that money during the period of the loan. Nobody has a problem with that - but that’s got nothing to do with “fractional reserve” banking.
Hi CR - People who know their stuff about 100% reserve backed banking have no problem with banks loaning against time deposits and CDs. The crucial point is that lending money against regular deposits increases the money supply.
Loaning against a time deposit does not (the money is made unavailable to the depositer for the time specified in their time deposit/or cd and available to the borrower) increase the money supply, and the interest rate differential (say the 10% paid on a loan minus the 5% paid to the person lending money to the bank) is a legitimate way for banks to make money, in any system.
Let’s look at it another way. If there were only one bank, a time deposit of $10 in a 100% reserve bank system could result in $0.50 in profit for the bank in one year ($1 in interest income from borrower at 10% - $0.50 paid to depositer). A regular deposit would result in fee based income and couldn’t be lent out - perhaps a 2% fee or $0.2.
In a 10% reserve backed system with one bank, a $10 time deposit would result in the same profit as above.
A regular deposit of $10, after a series of loans and further deposits ($9 loaned to someone, then spent and deposited by new depositer, +$8.1… = $90 in loans and new deposits) would result in $9 in interest income on loans minus whatever the bank paid out in interest on all deposits ($100 total). Let’s say the interest was the same, $5 or 5% on $100 in deposits.
So, from the $10 deposited in such a system of one bank and the series of loans and deposits that followed, the bank would make a 40% ‘profit’ or $4. 8 times what they would get for lending out a time deposit and 20 times what they would get for holding onto the money for regular deposits. Of course, this profit (and the benefits that borrowers of this newly created money get by spending it before its value declines) comes through inflation of prices beyond what they would be with 0 monetary inflation.
I went back to my professor for clarification; what he said is that banks do only lend out money they actually have on hand; no new money is created in this process. There are new claims on deposits, but that is different than new money actually being created. The reason the banks can still show your account as having 100% of the money you put into it is because when you withdraw or transfer funds greater than the reserve on hand, the bank can pay you by borrowing money from other depositors accounts. The only time new real money is created is when everyone wants to withdraw their money in excess of the banks reserve and a bank run ensues, then the Fed inflates the money supply to bail out the depositors or the bank.
What seems to be the problem here is the difference between your professor’s definition of money and what most other folks define as money. Your professor is defining money as federal reserves. Everyone else is defining money as stuff like M1, M2 and M3 (i.e. balances held in deposit accounts etc.). The fact is, you pay for houses and groceries using the later (bank balances). The only thing the former (reserves) are used for is to place some (albeit limited) restraint on the ability of commercial banks to create the later… but what is used as money in the market place is not federal reserves.
Essentially, I think your professor is either stupid or being intentionally disingenious to try to defend an undefendable position.
You’re not taking in all the factors when you talk about banks. Why do people use banks nowadays? To save? Sometimes. Banks have become clearing houses to pay our bills. Instead of carrying cash we use checks and debit cards. Carrying a check or debit card is recognized as being far more secure than carrying cash. If I lose a debit card I can call the bank and have it cancelled. If I lose cash there is no way to get it back. Say someone has a checking account with $2,000 in it. They view a checking account to be far superior to carrying around $2,000 in cash. And with more and more people paying bills online and buying things online cash is not really an option.
I can gain interest on my money just as easily, if not better, under a 100% reserve lending program as opposed to what we currently have or even under free banking. Money I’m saving can be put into timed deposit accounts, like a CD. I’m putting the money away for savings therefore there is no reason for me to need access to the money right away. When I place the money in the banks hands one of two things can happen. I can pay a fee to the bank to hold on to that money or I could allow the bank to use some or all of that money in the form of loans and what not. If they loan it out, as per our agreement, instead of me paying them, they are paying me. We both make money. A good bank will not make bad business choices so when the time is up on my deposit I can either withdraw the money or leave it there for it to gain more interest. If banks are not allowed to simply create new money every time they make a loan and they must use the deposits they have or the profit they earn the money will stay relatively safe. Of course we all must understand that both the bank and I are taking a chance by allowing them to loan that money out. If the bank makes a bad choice they may have to compensate me by taking money out of their profits. And if the bank is really bad I might not ever get my money back.
I could also do a demand deposit but the bank doesn’t have to pay interest on that money because they bank isn’t making anything off of it. If it is a demand deposit then more than likely you are willing to pay the nominal fee the bank charges for holding the money in safe keeping, with the understanding that they cannot loan that money out and it must stay right where it is.
If you have a checking account that you use to receive your paycheck (direct deposit) and pay your bills the bank could charge you a fee for that service, perhaps $5 or $10. Or, if you open up a savings account and allow the bank to loan that money out they might even wave the checking account fee. So say The Bank offers a checking account but has a $4 per month fee and a debit card cost an additional $1 per month. However, if you deposit $1,000 in the bank and allow them to loan it out you’ll receive 3% interest and they wave your fee. They would do that because that $1,000 they are paying 3% on could be loaned out to someone else at 18% which would give them a gross profit of $150, which is much better than the $60 they would have earned off fees charged to you. And you’d make $30 instead of paying $60 in fees. Another benefit is that because the bank is now asking permission to use your money (unlike our current system) they will be forced to offer higher interest rates. Bank of America is right now offering 2.4% interest on your money in a CD. Under 100% reserve banking they will be competing with other banks for that precious money to loan out and might offer a much better interest rate of 4% or 5% or even 8% depending on the time frame and how long you are willing to let the bank hold on to it.
100% reserve banking offers the customer a chance to earn a little money off of their savings, still provides the services we have come to expect from banks, and provides more security for our money.
Kingmonkey is correct, and there is an even more important point:
In a system of 100% reserve backed banking, the value of your money would go up over the long run, as prices would gradually fall as productivity increased. So even without interest your money would be becoming more worthwhile over time. Contrast that with today’s system, where after interest and taxes the value of your money is pretty much certain to fall over time.
And if you were willing to lend your money to the bank via a time deposit? You would get both interest and a dollar that was worth more - a double increase in your purchasing power.
Guess what? The interest you ‘earn’ on a non-time savings account or checking account today wouldn’t be possible without expansion of the money supply (inflation in the traditional sense) - another way of saying this is you aren’t able to earn interest on a non-time deposit without devaluing everyone else’s money and allowing banks to create money (on their balance sheets) that didn’t exist before.
Do the ends (devaluing everyone else’s money & allowing bankers to expropriate the wealth of everyone else) justify the means (an amount of interest which is often less than the inflation rate)?
