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Fractional Reserve Banking is not fraudulent

In an article by Wendy McElroy, she argues that not only is fractional reserve banking not fraudulent, but that it would do well in a free market.

http://dailyanarchist.com/2013/05/13/fractional-reserve-bank...



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in a free market the bank would pay the depositors

in a free market the bank would pay the depositors most of the interest gained.

they would have to compete with 1000s of other banks who all want to hold your money and the only incentive they have is the interest payments on deposited money.

the profit they make by fractional banking can ONLY go to the consumer. if they dont pay a high interest rate on deposits some other bank will.

the issue is money being made from thin air. hence inflation. the article is dead on in this regard... it means having a different currency for each bank. I foresee intense bureaucratic nightmares arising from this prospect. like if you are a business owner... are you going to keep track of and accept 5000 or 10000 different currencies? but then again if they were all pegged to gold you could automate the transaction headaches.

Tools of war are not always obvious. The worst weapon is an idea planted in the mind of man. Prejudices can kill, suspicion can destroy, and a thoughtless, frightened search for a scapegoat has an everlasting fallout all of its own.

You don't seem to understand how banknotes work...

Banks took each others banknotes at face value more or less. They they would meet up and exchange them much like they do in modern times when competing banks settle checks written by their competitor's customers.

There's no more bureaucratic headache involved beyond that of a check being written and given to someone as payment. In fact there are LESS, because you can be more certain the bank will be able to redeem the banknote where as you have to worry much more about people passing bad checks.

im not talking about banks taking the money but the business

as a business owner, trying to keep track of 10k different currency and the relative value of them would be a logistical nightmare. Not only that but you basically would have to take the banks word that the intrinsic value (pegged to a standard like gold) is honest.

for example... lets say there are 3 differnt banks in my city alone...
all have there own currency. assuming there is no FDIC insurance... i would have to keep track of those 3 banks to be sure that those notes do not become worthless if the banks are about to go bankrupt. scale this out to 10k currency and now i have to track them all to be sure any one of those banks aren't on the verge of collapse leaving me holding the bag of worthless currency.

Tools of war are not always obvious. The worst weapon is an idea planted in the mind of man. Prejudices can kill, suspicion can destroy, and a thoughtless, frightened search for a scapegoat has an everlasting fallout all of its own.

You pays your monies...

..and you takes your chances. If the bank of Joe offered better returns than the bank of Janis because Joe took bigger risks and extended himself further via FRB, Joe's customers stand to make a killing or lose their shirts. Caveat emptor, folks.

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Can truly free markets and

Can truly free markets and FRB go hand in hand? To have a real free market, don't you need sound money?

Whenever fictitious 'credit' is created, is it not a manipulation of the money market?

Yes

free markets and FRB can work together, because people will value the inflated currency for what it's worth.

The problem with inflated dollars is not that they are inflated. The problem is dollars are unconstitutionally recognized as legal tender, giving it automatic superiority. You have to have it to pay debts - taxes, court orders, etc.

So dollars don't have value as would be assigned by a free market; dollars have value because government enforces that they do. If dollars were not legal tender (as they are not supposed to be) then the market would assign the true value they are worth, which by now is somewhere below toilet tissue.

I agree it works

But banks (& customers) would have to weigh up their risks about how much credit they lend in comparison with how much gold they have in their vaults in the case of a bank run.

Lord Acton, Lord Chief Justice of England, 1875 - "The issue which has swept down the centuries and which will have to be fought sooner or later is the People v. The Banks."

In a true free market without

In a true free market without the Fed, banks could opt to continue fractional reserve banking but it would be considered risky, am I right?

You are exactly right

Even before the advent of fiat currencies, hardly any bank held 100% reserves. However, the % they did hold was far higher than the 10%, 5% or even <1% we see today. High reserves were necessary because of the risk, but restricting itself to having only 100% reserves meant the only investments a bank could ever make would be "sure things". And "sure things" usually don't offer much ROI. Such a bank would only be a storehouse of value, and not a significant source of capitalist investment.

Over the years banks have lobbied to change to rules, making it safer for them to hold lower and lower reserves and thus invest in more and more risky ventures. I wrote a blog post about this historical progression back in March if you care to read it: http://www.greywyvern.com/?post=355

Absolutely Agreed

I have made argument before many times. The problem is the state granted monopoly power.

Séamusín

Of course it would work in a

Of course it would work in a free market. It may involve an element of risk but which business doesn't?

Moneylending is an old and successful business model. With or without govt. it will work. Without govt. some bankers may get lynched though. Still working on whether that's a good thing or bad...

Question

I agree that it's not fraudulent, but I don't get why it would succeed.

Wouldn't increasing the money supply create a host of problems like:

  • decreasing the value of the currency
  • price inflation
  • lowering the interest rate thereby encouraging spending rather than saving, leading to malinvestments and bubbles for people who are using this currency
  • benefiting the first users of the newly printed money at the expense of later users

Wouldn't competing currencies which don't inflate the supply do better?

You're conflating Fractional

You're conflating Fractional Reserve Banking with the Federal Reserve Bank.

In any case, your first two points are almost the same thing. The answer is that if I am borrowing money for a business then it is also a bet on my ability to outgrow inflationary forces. I am sure you'd rather have competition between people rather than a central mandated system to control inflation.

All the other points you make are good but in a free market people are entitled to selfishness, putting their own financial interests above those of society as a whole.

It's funny...

People can't refute your arguments so instead they created their own echo chamber "fractional reserve is bad" thread.

Hahaha.