I was reading up on Fractional reserve banking and I read many explanations from many places . But Murray Rothbards explanation kind of confused me and frankly sounds impossible . Well my confusions have been documented elsewhere by someone else so i paste them here :
Why should fractional reserve banking be allowed? Why not forbid such an event as that you describe:
“The only difference between full reserve banking and fractional reserve banking is depositor’s permission for bank’s loan and depositor’s sharing in the interest the loan is going to earn.”
It’s a very important difference. Without depositor’s permission lending is a fraud! It’s a crime on the depositor’s property. There can never be two contemporary claims on the same amount of money.
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Question II:
This was taken from Rothbard’s “Fractional Reserve Banking”: “Let’s see how the fractional reserve process works, in the absence of a central bank. I set up a Rothbard Bank, and invest $1,000 of cash (whether gold or government paper does not matter here). Then I “lend out” $10,000 to someone, either for consumer spending or to invest in his business. How can I “lend out” far more than I have? Ahh, that’s the magic of the “fraction” in the fractional reserve. I simply open up a checking account of $10,000 which I am happy to lend to Mr. Jones. Why does Jones borrow from me? Well, for one thing, I can charge a lower rate of interest than savers would. I don’t have to save up the money myself, but simply can counterfeit it out of thin air. (In the nineteenth century, I would have been able to issue bank notes, but the Federal Reserve now monopolizes note issues.) Since demand deposits at the Rothbard Bank function as equivalent to cash, the nation’s money supply has just, by magic, increased by $10,000. The inflationary, counterfeiting process is under way.”
In Rothbard’s example, with fractional reserve of 1/10, bank lends the amount of existing reserve ($1,000) times the inverse of the fractional reserve (10) resulting in a total of $10,000.
In your example, with fractional reserve of 1/6, bank lends the amount of existing reserve ($100,000) minus fractional reserve of 1/6 ($17,000) resulting in a total of $83,000. And you specifically state time and again that having lent 5/6 of the existing reserve the bank has no more money to lend.
Why the banks in your example cannot lend the amount of existing reserve times 6? Take for example the first bank in your sequence (Corn Bank), why does it lend only $83,000 when Rothbard Bank would have lent $600,000 (6 X 100,000)?
It appears that Rothbard’s fractional reserve banking and your fractional reserve banking operate on completely different principles. Which fractional reserve banking is the real fractional reserve banking? Will the real fractional reserve banking please stand up!
Answer II:
The article you quote proves that Murray Rothbard never grasped the real meaning of the fractional reserve banking. And Rothbard is not alone. This is not isolated error. Quite a few otherwise thoughtful individuals automatically assume that when required fractional reserve is say 1/10, the bank can lend its deposit on hand times 10, instead of only its deposit on hand minus 1/10 thereof.
Under fractional reserve banking, it is the banking system (not a single bank) that can produce a cascading series of deposits which will ultimately add up to the amount of the original deposit times the inverse of a fractional reserve (10 in Rothbard’s example and 6 in mine).
To assume that the bank of original deposit can bypass this normal economic process by creating out of thin air and lending out the grand total – which ordinarily the entire banking system would need to laboriously create one by one in a long sequence of business transactions – is a childish error. Here is why:
If Rothbard Bank would have lent out only $900, the borrower would have given his check to his supplier who would deposit it in his bank, which in turn would have presented it to Rothbard Bank for payment in cash. And having $1,000 on hand (whether of his own or on deposit), Rothbard would be able to honor the check for $900 drawn upon his bank. The supplier’s bank would then lend out $810 ($900 minus 1/10th), and so on, and so on… until the grand total of all descending loans in all subsequent business transactions would ultimately add up to $10,000.
But lending $10,000 with $1,000 on hand is a sheer folly. The presentation of $10,000 check for payment will put Rothbard Bank out of business the next day! Rothbard himself readily acknowledges this fact in the very next paragraph of the quoted article:
“[$10,000] …will be spent on the goods or services of clients of some other bank, say the Rockwell Bank. The Rockwell Bank is not particularly interested in holding checking accounts on my bank; it wants reserves so that it can pyramid its own counterfeiting on top of cash reserves. And so if, to make the case simple, the Rockwell Bank gets a $10,000 check on the Rothbard Bank, it is going to demand cash so that it can do some inflationary counterfeit-pyramiding of its own. But, I, of course, can’t pay the $10,000, so I’m finished. Bankrupt. Found out. By rights, I should be in jail as an embezzler, but at least my phoney checking deposits and I are out of the game, and out of the money supply.”
Since Rothbard obviously can see (as this quote proves) that lending more than available reserves leads to immediate demise of a bank doing it, this begs the question why he never re-examined his understanding of the fractional reserve banking.
If all the banks were to administer fractional reserve banking the Rothbard’s way, they would all cease to exist within a week.
Can anyone clear this up ?