Fractional Reserve Banking

Economics Economics Questions
1

Comments please:

Fractional reserve banking in a free banking atmosphere, with privately issued notes, and voluntary contracts between banks and clients. An application of marginal utility analysis to fractional reserve banking.

The client agrees to allow the bank to create new banknotes, thus diminishing the value of each unit of the client’s held banknotes.

Inflating the notes by creating more of them, the bank then directs the additional notes to projects the bank believes will be wealth creating, in that these projects will repay to the bank the value of the notes as stipulated by contract plus some agreed upon amount of interest.

If the bank is correct in its assessment of the projects to which it has guided the newly created notes, the bank receives back the original value of the inflated notes plus some additional amount of interest.

We assume that in simply creating the new notes, the bank creates no new wealth. Creating the new notes simply reduces the value of each individual note held by the bank plus its clients.

Thus, if we consider the bank and its clients a “family,” each family member agrees by contract to a diminishment in the value of each of the notes it holds, in order to allow the family’s directors to loan out the newly created notes to projects deemed potentially profitable. Upon the creation of the new notes, each individual “money piece” (each note) decreases in value. Each individual family member sees the value of his held notes decline.

Rather than recalling existing notes from various family members to make loans, the family’s directors create new notes, as agreed by contract, thus decreasing the value of each family member’s held notes.

But the total value of all notes held by the bank family, before and after the creation of the new notes, does not change. There are more notes now than before, each with a diminished marginal utility. Tomorrow, the newly created notes will be loaned to a debtor.

Tomorrow, the newly created notes will be loaned to the debtor, and now (tomorrow) the debtor owes the bank family the value of those loaned notes plus interest.

If the loan is successful, the debtor will have paid back the value of the notes plus interest. The bank family will be wealthier than before. This is because of the new wealth (the interest) paid to it by the debtor. The debtor is the person for whom the bank family agrees to inflate their notes (by creating new notes rather than recalling existing notes from family members) and to whom they agree to turn over the newly created notes, in the expectation of increasing the family’s pool of wealth.

The inflation of the family’s notes through the creation of new notes does not diminish the family’s total wealth. When the bank family creates new notes, they do not create something out of nothing. Instead, they diminish the value of their own held notes by creating new notes, which are then lent out and received back with interest if the loan is successful. The bank family is then wealthier than it was before.

2

No sane person is going to use money that loses value. The only way to get people to use phony money is by force, like the gov’t does, or fraud…or both.

The family analogy has little to do with a free-market society composed of individual actors motivated by self-interest.

But the family analogy probably underscores the collectivistic undertones of the system. " We’re all in the same boat!"

3

My brief argument rests on the a priori concept that an increase in the supply of a homogeneous good, absent an increase in the demand for it, constitutes, a priori, a diminished value of that good relative to demand. My intention was to apply this concept to the creation of new banknotes within the “bank family,” that is, the bank and its existing clients (for the sake of illustration here, not including the prospective new debtor).

“Whenever the supply of a good increases by one additional unit, provided each unit is regarded as of equal serviceability by a person, the value attached to this unit must decrease.” (the law of marginal utility as rendered by Hoppe)

When within the “bank family” (bank + existing clients), the number of notes increases from 100 notes to 200 notes, this decreases the value of each individual note if we assume no additional demand for them. This is because each note is in the cash holdings of some individual in the bank family.

When the bank family creates new notes, they do not create something out of nothing. Instead, they diminish the value of their own held notes, by creating new notes, that are then lent out, and if the loan is successful, paid back with interest. The bank family is then wealthier than it was before.

4

the family will suffer boom and bust also.

5

This argument does not refer to the case where the bank family (bank + existing clients) holds 100 notes, and issues 100 additional notes to the public, when those 100 extra notes aren’t demanded by the public.

Before the bank family (bank + clients) puts the extra 100 notes in circulation, the family creates 100 new notes. Now there are 200 notes held by the bank family (bank + clients) where yesterday there were only 100.

The purpose of creating the new notes is to (eventually) circulate them. But by my assumption, they are not yet circulated.

By the law of marginal utility then, as each individual “money piece” is held by some individual in the bank family, then the value of each money piece has declined for those holding the money pieces (notes). This is before they are put into circulation.

My argument hinges on this insight.

6

that doesnt address my post.

ABCT

7

Oh. Sorry.

Quite the opposite I believe.

The total wealth of the bank family (bank + clients) stays the same when the new notes are created (before they are circulated).

But each individual money unit decreases in value.

When the new notes are loaned out and paid back with interest, the bank family (bank + clients) is more wealthy than before.

There is no boom and bust as far as I can see. There is a diminshment in the value of the individual money units before the loan, and then an increase in total wealth if the loan is paid back with interest.

The increase in wealth of the bank family results from the newly created wealth due to the loan (the interest).

8

check their handy chart.

fractional reserve banking is a sufficient cause of the ABCT

9

Lent out to who, for what purpose, and why would these people accept/redeem these admittedly devaluing notes at parr with anything else in the market?

Why so complex? There’s no way to avoid the problems associated with fractional reserve banking. You can probably get people to agree to it beforehand and accept the risk for a possible return. But in the end what’s the real difference between that and a time deposit aimed at investing, other than the ability to redeem the first instantly, but if on a free market certainly not at parr with the face value as the whole market will know the nature of the notes.

10

I believe the bank and it’s clients lend out the money to prospective debtors for the purpose of earning a profit (interest) ???

The notes have been devalued previously within the bank family (bank + clients), as explained. The bank family agrees to devalue their own individual notes.

Why would someone accept these notes? I’m not sure exactly. But if no one did, there certainly would be no problem with fraud or initiating a boom/bust cycle.

Why would the bank redeem the notes? Perhaps to maintain its reputation and stay in business ???

11

The current challenge is to demonstrate this with regard to this new conception.

12

you make assertive statements and put question marks on them. and then other question marks follow actual questions but appear to be for rhetorical purposes. hard to follow.

13

whats new? where is the difference between what you are talking about and the process of fractional reserve banking?, actualyl your lead in says you are just talking about fractional banking and thats exactly what block and barnett wrote about.

the only difference seems to be the style you used to communicate the story.the attempt to make it seem benevolent by throwing in words like ‘family’ and ‘agreed’

14

If you disagree, then show where you think it goes wrong.

15

Loaned to whom ? Again, why would people accept inflated paper ?

Are you using “family” as figurative language for the mafia ?

Yes, the “family” also known as banking mafia may end up being more wealthy if they succeed in ‘circulating’ unbacked paper.

Just like thieves may get more wealthy by stealing.

16

you are wrong to think that fractional reserve banking wont lead to boom and bust. you nowhere argue either what does cause boom and bust, and that what you propose is not it, and neither do you understand that you havent put forward an argument as to why fractional banking is not boom bust inducing, you have merely presented arguments that it is inflationary. not treading new ground there im afraid. if im short its only because if you only follow the link i offered you will be reading some actual scholarship on the subject, and its not even very long or hard to follow.

17

Hi Juan.

The notes are loaned to prospective debtors. As mentioned, the notes are inflated prior to being loaned to the debtor. The debtor doesn’t have to worry about that. If no one accepts the notes, they can’t initiate a boom/bust cycle, at least that is my understanding.

“Family” is a concept designating the bank + its existing clients.

18

It’s well known that the ‘profit’ in such schemes comes from devaluing notes held by people who DON’T agree with the devaluation … or are not even aware of the fact that such over-issuance has taken place.

You are attempting to define fraud out of existence. A stock ‘argument’ used by advocates of … ‘financial engineering’.

19

The scheme you are referring to is not the scheme I posted.

20

Of course he has to worry. Are you assuming that these notes are a ‘common medium of exchange’ ?