Fractional Reserve Banking

There is, as we know, a varied group of people who think that fractional reserve banking is for the very Devil.

It\’s a minority view, to be sure, but they do seem to be very intense about it. Various people screaming about how the banks get the profits from hte creation of credit for example, how we should nationalise this so as to benefit as the wider society.

All has been dealt with hundreds of years ago of course, Adam Smith devotes many of his interminable pages (yes, it\’s a very good book, WoN, but not exactly an easy read to the modern eye) to pointing out why fractional reserve banking is such a good idea.

Still, for this freakish sub sect there is good news.

So, for these folks: good news! We don\’t have fractional reserve banking anymore.

In statistics-speak, since last November, the monetary base has exceeded M1, which means, more or less, that bank reserves (plus surplus vault cash) exceed liquid deposits.

And now that we don\’t have fractional reserve banking everything is just fine, isn\’t it?

11 thoughts on “Fractional Reserve Banking”

  1. This is the US and it’s only M1. The banks are holding cash to cover future losses. They are dead banks walking.

  2. It’s a system that cannot go for significant periods of time without crises. Moreover (and this is my own thesis) it becomes increasingly fragile with the advance of interconnectedness.

    Adam Smith was a very decent economist. But NO economists prior to 1850 or so had the enormous advantage of the understanding conveyed by the “discovery” of the subjective nature of value and the subsequent teasing-out of marginal utility theory (especially by Menger, whose theoretical work was continued by the Austrian School: Bohm and Mises).

  3. Fractional Reserve banking is not the very Devil. The very Devil is that there are not the checks and balances in place to stop banks manufacturing money and understating the true value of the risks they have taken on.

    The greater Ponzi scheme than Madoff ever achieved by far is the indiscriminate securitization of debt repackaged and relabelled with unrealistic (and fraudulent) risk ratings. That has created the financial pass-the-parcel that has blown up Wall Street and the City of London and everywhere.

  4. Read Mr Barman, he knows what he is talking about, as does Brit in Aussie.

    Then read Ludvig Von Mises and F.A.Hayek.

    Tim is barking up the wrong tree here. Although banks in the US now have full reserves they have no reason to keep those reserves. Nothing in law compels them to tell the truth about checking accounts to their customers. They remain defended by the central bank who will bail them out when they screw up. And their customers remain defended by the FDIC who will bail them out when they screw up. So, nothing has really changed, everything remains horribly broken. All that has happened is that temporarily the reserve fraction has become 1.

  5. Current (and Brit):

    My thought on the matter is certainly an outgrowth of the Austrian perspective but is somewhat in extension. The fact is that I can’t prove the validity of my hypothesis (nor can I see any method for its disproof other than experience). I have actually been pondering the matter for roughly 25 years.

    The starting point (for me) lay in comments made by Mises (and Rothbard) having to do with the re-establishment of a sound monetary system, i.e., a return to a gold standard of the classical form (as opposed to the gold-exchange variety of the standard).

    My problem with all such suggestions (and they’ve been echoed by many others) is that such reconstructions do nothing to prevent the very same scenario from occurring at some time in the future. Whether Mises or any other, I could see not even a glimmering of recognition that the gold standard itself was merely a “way-station” on the road to the present and that, by going back to a system that had served in the past but that had obviously elicited government interference in its operation, we should not be merely “setting ourselves up” for reiteration when adherence to the standard had again proved troublesome to political authority.

    My current (and for the past 15 years or so) belief is that relative economic and financial stability(and by this I do not invoke any idea of equilibrium or stasis) cannot be achieved by any means whatever short of a unitary monetary authority (and which would carry with it all of the shortcomings of socialism, most especially of the absence of monetary calculation). But, in my estimation, this is precisely the road on which we shall find ourselves sooner or later, as various major sovereignties seek to “cooperate” in the achievement of “stability.” Whether this
    path would bring to fruition Hayek’s “Road to Serfdom” or not is not my point; in that direction lie conditions far worse than known to serfs of the past.

    The only alternative to the preceding scenario that I see as consistent with human liberty and increasing human welfare is one in which there would exist no monetary “authority” capable of interfering with the various and changing valuations attached by acting humans to the means of their satisfaction and attainment of the
    multiplicity of their ends.

    The regime (and the ONLY one capable of success in any more than the shortest of terms between crises) would be one in which ALL of whatever served as the monetary commodity (and which I would presume to be the same, nearly universally-accepted GOLD) would be in the physical possession of individuals and private entities (with the only exception being necessary “strategic,”–defense-related– reserves. This would entail the necessity of the repeal of all “legal tender” laws endowing any other than the prevailing monetary commodity (gold) with legal standing and, further, bar all government entities from establishing or “fixing” any prices, wage rates, or profits. Government would be authorized to produce its own exchange media (paper, metallic tokens, even bonds, perhaps)) in whatever quantities it
    wished, with due notice and authorization in advance of each quantity. This money would be a mandatory medium for the compensation of all government officials and employees and for all transactions between government and its agencies, on the one hand, and vendors and contractors on the other. And, last (but not least), government would be unable to require payment of all due it, whether taxes, duties, fees, licenses, etc. in any other form than its own money. (These last would burden government itself with the problems of keeping the purchasing power of its money at an acceptable level with respect to the “open-market” money).

    You can mull that over for a few years, anyway.

  6. Current:

    No, I haven’t. But I saw something in reference to it just a few days ago at–something that made me think he might have been thinking along lines similar.

    Also, not long ago, I saw something suggesting Hulsmann might also.

    It’s almost impossible to believe that Mises believed a simple “re-do” could possibly be enough to establish greater monetary integrity than in the past. He was quite familiar with the tendency, among “determined” men, to treat constitutions and previous laws restricting government interference as annoyances to be gotten around one way or another.

    I’m convinced that there needs to be as great a separation as possible between government and control of money. Even the one I suggest is ultimately breachable for the guys with the guns but at least it might put more obstacles in their path. FDR certainly knew what he was doing when he conficated gold in 1933.

  7. Money is the means of exchange. At the end of the day money and credit are only information. The ability for banks to charge interest on money they pretend to have (ignoring the fraction they reserve) is just a case of “information creation”.

    Money/Credit needs to be universally recognisable to work. We don’t really require middle men (banks) to conjure information into existence in this age. At the end of the day we humans can come up with a non-socialist privatised (down to individual / legal person level). All we need is credit rating and a few other checks and balances – avoid inflation – fractional reserve banking can be inflationary as well as simply printing money.

    The boom bust of fractional reserve banking need not be.

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