Sir Johnny on fractional reserve banking

Oh, dear Lord, he falls hard for this nonsense.

And that’s why many would go even further than this. There’s a growing
campaign to strip banks of their right to create credit (and then charge
interest on it), and to return that right to central banks. Few people realise
that 97% of all money in circulation (including “credit”) is effectively
“created out of thin air” by banks in the form of loans to people and
companies. John Bunzl, one of today’s leading campaigners for this
radical shift, insists on spelling out exactly what this means as it does
seem quite extraordinary to most people, once explained, that we’ve
put up with this situation for quite so long:

…..

Bunzl accurately describes this as “the world’s largest pyramid scheme”
which all governments have allowed themselves to get caught up in having
historically permitted private banks to take over the right to create credit
– a right which should always have been reserved for governments alone.
Putting an end to “fractional reserve banking” (in effect, insisting that banks
would only be able to make loans if they were 100% backed by deposits)
would obviously have a massive impact on the profi tability of those banks
– but might that not be a very reasonable price to pay for a much more
equitable and stable system?

No, it wouldn\’t. You\’ve completely misunderstood fractional reserve banking. You\’ve been gulled by a piece of rampant stupidity. Please go and read Adam Smith on banking. He got it right over 200 years ago. About time you got around to reading him./

11 comments on “Sir Johnny on fractional reserve banking

  1. Until something like 2001 or 2002 banks were still only lending out about as much as they had on deposit. After that time the British banks got further and further ahead of deposits.(By borrowing from foreign banks?) What changed, who knows. It’s abundantly clear that no one in Government or the chattering media know or understand. I don’t either but I haven’t positioned myself as the saviour of the world.

    It’s fiat money that gets you the 97% stat isn’t it, not fractional reserve banking?

    Is Sir Johnny thinking (with a 10% capital reserve for the sake of argument) banks receive deposits and lend out 10 times the value as opposed to receiving deposits and lending out 90% of it.

  2. I don’t think that’s right Gareth. Even amongst those who campaign for this “seignorage reform” (I used to be one and have signed the petition if only in the interests of trying to get something, anything about the nature of money itself onto the agenda from which point we can then promote our own pet schemes) they point to this “debt money” being 70% of the money supply in the sixties.

    Securitization, permitted in the eighties and the freeing up of building societies to finance loans other than from their savers balances, made a big change. But the figure of 97% has been widely reported since well before 2001.

    I don’t think anyone who promotes that suggests that a bank lends out ten times the value of the deposit, but that lending out 90% gives rise to a new deposit somewhere else in the system, with which that bank then lends 90%, deposited ina third bank that lends out another 90% and so on.

    But I do think there is a problem in that system. Whilst I now agree that the credit money created is not actually “real money” (the current crisis has shown me that in that the banks have to scramble about for some of the “real stuff” when the the dung hits the rotary air conditioner) but the deposits created from the borrower paying someone that credit money are necessarily treated as “real money”. So ultimately much more than the narrow money supply is effectively guaranteed by the central banks in the form of depositor protection and so on.

    The answer to me now is that this protection should be ended by making banks deal in their own private competing currencies rather than in something the government has to back with tax-payer money in the last resort – the “free banking” option. Inflation of the money supply then would directly be borne only by the banks and not the state and so much less likely to happen in the first place because their business would suffer by not offering their customers sound money.

  3. I think Jock has got it pretty much spot on.

    The only problem with fractional reserve banking is that, if everybody tries to get there money back at once, there won’t be enough liquid cash available – some will have to wait. So long as everybody involved understands that, I don’t see a problem.

    If you outlaw FRB, then you could apply the same argument to insurance; if we all get our house burgled at the same time, the insurance companies won’t have the cash available to pay out either.

  4. Tim, you must really learn something about economics.

    Adam Smith is completely wrong about fractional reserve banking. Everyone knows that. Even Neo-Classical economists and Keynesians accept it.

    Fractional reserve banking is a pyramid scheme, and it should be stopped.

    Of course this doesn’t mean that central banks should require full reserves. Rather they should be abolished.

    Paul Lockett: “If you outlaw FRB, then you could apply the same argument to insurance; if we all get our house burgled at the same time, the insurance companies won’t have the cash available to pay out either.”
    It isn’t the same thing. There is no reason why houses should be burgled at the same time. There *are* reasons for bank runs.

    No actuarial table can be created for a bank run. That’s why insuring against it (as FDIC does) is just fraud. Recent events demonstrate this.

  5. I agree to a large extent with Jock and Paul.

    However, Jock pulls up short. It is all well and good saying we need to move banks to free banking,BUT, and this is a but bigger than all the Front Bench combined, how is this to be done?

  6. Roger, I see no way of moving to free banking politically. I think it will happen given time because of crises.

  7. Current: “It isn’t the same thing. There is no reason why houses should be burgled at the same time. There *are* reasons for bank runs.”

    There is nothing to say that there won’t be a large spate of burglaries though. An even more real danger is a number of natural disasters in a short space of time. In both businesses, the company is taking on a large number of risks based on a prediction that they won’t all materialise at once.

    “No actuarial table can be created for a bank run.”

    True, but an actuarial table only allows predictions, it doesn’t provide any guarantees.

    “That’s why insuring against it (as FDIC does) is just fraud. Recent events demonstrate this.”

    I wouldn’t say it’s fraud, but it is incredibly stupid. The main problem with the FDIC in the US and the FSCS in the UK is that they are government bodies. That gives depositors too much confidence; if they didn’t think the insurance carried a government guarantee, they’d be more aware of the possibility of losing money and take more care with it.

    The other problem with deposit insurance, especially a state scheme which isn’t based on market risk assessment practices, is that it encourages risky behaviour by allowing banks to take more risks, safe in the knowledge that they are being externalised.

    The state shouldn’t be in the business of offering insurance and that is the real problem with FRB as we have it at the minute. If failing banks were going into administration and depositors were lining up as creditors and facing losses, I would expect a lot more prudence in future. National Savings, safety deposit boxes and custodian banks would start to look a lot more attractive.

  8. However, Jock pulls up short. It is all well and good saying we need to move banks to free banking,BUT, and this is a but bigger than all the Front Bench combined, how is this to be done?

    Indeed. A knotty one. I think your policy is getting there. I also think recreating a global “common” reserve currency – which could be gold or could be the SDR idea China and Soros are pushing, albeit with tweaks, would allow us to say “you can use whatever you want for money (which of course a lot of humanity does anyway), just float it against the reserve currency”.

    But I also think “free money” is inevitable with the globalization of communications. Already we see alternative currencies in online “worlds” such as Second Life and World of Warcraft. Airmiles, Nectar and ClubCard type products are effectively the basis for corporate private money. There are barter and exchange networks sprining up all over the net that allow businesses to monetize spare capacity, unused stock, and even exchanges where these barter networks can exchange with other barter networks through a common “currency”. Even though cash still accounts for 56% of all transactions between consumers and businesses in the UK and a third of the value of all high street spending, new payment mechanisms will make a dent in this and could easily be used for multi-currency transactions.

    Long standing systems such as the WIR Bank in Switzerland show that “closed” currency networks work more efficiently as people tend to spend the money more quickly within the network.

    I’ll be presenting a business plan on Tuesday to potential investors that has three strands –

    • changing mortgages from loans to partnerships where the investment is not specifically in the underlying property but in the income (effectively rental yield) of the asset (and could take on existing disressed assets placed in the asset protection scheme in return for a steady and index linked yield to the existing lender)

    • a business to business mutual credit network (50% of Oxfordshire’s 25,000 SMEs spend more than 50% of their supplier budget with other Oxfordshire businesses) that could also incorporate customers in a county wide loyalty card

    • and a corporate scrip that could be used to link the Oxfordshire network with trading networks in developing countries – much more efficiently than the Grameen Bank mechanism (which can work out as 80% APR because of charges on the tiny loans).

    In many ways it would help if this crisis got even deeper, eroding even more confidence in national currencies while we watch more borrowers get into distress and businesses founder with a lack of sound money in the system.

    For money is only really a token of trust – if people lose trust in (or access to) the state created stuff imagination can take over. And I’m with David Friedman in thinking that “anonymous e-cash” could be just around the corner.

    Of course states are scared shitless about all of this. Taxation becomes ever more difficult as authorities have to find the trading mechanisms and then value them before they can even get to the point of evaluating tax liabilities – like “tax havens” right under their noses!

    As a mutualist, I believe that we can achieve change by building up alternative institutions that people learn work efficiently, before breaking down the state managed existing ones. In the US in the Great Depression more than a thousand types of corporate, local authority, and trading networks scrips prung into life to aleviate the pressures of the national currency in turmoil – some suggest that the New Deal was effectively created as a means to force these into oblivion, claiming they were “unconstitutional”, the Danes forces JAK bank out of business having first outlawed their complementary currency.

  9. the Federal Reserve admitted that new money is created through fractional reserve lending in its publication: Modern Money Mechanics

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