![[personal profile]](https://www.dreamwidth.org/img/silk/identity/user.png){kind=small}
Fractional reserve banking is the system used in the U.S. and practically every other country. It is the foundation of the modern banking system, and the cornerstone of finance.
It is also a massive money and power grab by banks, in cooperation with national governments (anytime you hear the phrase "public-private partnership", it's a reason to be nervous), which funnels all real property to bank owners.
Basically, it is a law which allows banks to loan out more money than they have. The "reserve requirement" is what percentage of the deposits that the bank must keep in actual assets. Our reserve requirement is somewhere in the neighborhood of 20%, so we'll use 20% in the following examples. For illustration purposes, I'm using an economy with only one bank, called The Bank. It works exactly the same way if there is more than one.
Person A deposits $100 in The Bank. The Bank is required to keep 20% in reserve.
Person B gets a loan for $80, which he deposits in The Bank.
Person C gets a loan for $64, which he deposits in The Bank.
Person D gets a loan for $51, which he deposits in The Bank.
Person E gets a loan for $41, which he deposits in The Bank.
Person F gets a loan for $33, which he deposits in The bank.
Person G gets a loan for $26, which he deposits in The Bank.
And so on down until person V gets a loan for $1 and deposits it in The Bank, and eventually someone gets a 1-cent loan.
The Bank now has $100 in its vaults. It also owes people $400 in the form of demand deposits (checking accounts). Persons A-V are owed a total of $396; the last $4 are what we get if we keep loaning 80% down to $0.01. We'll always hit an amount with the ratio of (initial cash deposit) * (1 / reserve requirement).
The additional $300 has been created out of thin air. This is where inflation comes from -- whereas before there was only $100, there is now $400. Inflation benefits the people who get the newly created money first at the expense of those who get it last -- in this case, Persons A-V get to spend their money at prices that assume $100 in the economy, but everyone getting paid by them will be eventually spending their money at (higher) prices that assume $400 in the economy. Prices don't rise instantly -- it takes time. Inflation benefits those who have money early at the expense of those who have money late. The Bank, of course, has the money earliest of all, since they created it out of thin air.
But it gets worse -- much worse. Next, we'll combine fractional reserve banking with lending at interest -- which is, of course, the primary reason to have fractional reserve banking at all (if you can't charge interest, why loan the money out at all?) The Bank now has $100, and owes $400. But what about all those people who got loans from The Bank? Well, let's assume these loans were standard home mortgage loans. In general, you get to pay back about 2.5 times as much as you borrowed, once principal and all the compounding interest is considered. So these people owe the bank $1200. So the bank has now turned $100 in real money into $400 owed to other people -- and $1200 owed to it. See why banking is so profitable?
Now, in real life, we don't just have The Bank. We have many banks, so everyone who gets money out of a bank does not necessarily give it right back as a deposit to be loaned out again. But the effect is the same. If instead of "The Bank", we use "the banking system", the $100 still goes in and comes back out as $400 owed to people and $1200 owed to banks. This makes no manifest difference.
You'd think that from all this, the banks would be pretty darned happy with the business they're in. But apparently they weren't happy enough -- after all, you can never have too much money and power (and I say this only half-jokingly, as I admittedly have a touch of megalomania myself). So, back in 1913, at Jeckyll Island, GA, a number of banks created the Federal Reserve System in partnership with the United States Federal Government. The Federal Reserve System sounds like a government agency, but it's not -- it's a privately held corporation owned and operated by its stockholders... which are the banks. This said, it would be useless without its ties to the government -- it is in a sense the ultimate "public-private partnership". The Federal Reserve System's purpose is to function as a bank for banks -- it will take deposits for banks, and make loans to banks. Deposits in the Federal Reserve System count as reserves, not as credit, so it is a "safe" place for banks to put their reserves. In addition, it can participate in fractional reserve banking. Most importantly, though, it controls the money supply -- the Federal Reserve alone is allowed to purchase money (Federal Reserve Notes) from the U.S. Mint. It purchases it at a spectacular discount ($100 bills cost about $0.70).
Now, the first effect is that "a bank for banks" multiplies the effect of fractional reserve banking. When The Bank gets that $100 deposit, and has to put the $20 in reserve before loaning out the rest, it puts it in its account at the Federal Reserve. Which now has $20, which it can loan out to banks... where it counts as reserves allowing the banks to loan out even more money.
But this isn't really the problem. Let's go back to the numbers. The Bank has $100, owes $400, and is owed $1200. How are people going to pay back the $1200 that they owe? Well, the economy is quite productive, and wealth is actually created by capitalism on a very regular basis. The wealth comes in the form of declining prices and increased productivity. But capitalism creates wealth, it doesn't create money -- because only the Federal Reserve is allowed to create money. So if you want money, you have to go to The Bank...
The Federal Reserve System has actually created a system by which there is more money owed to the banks than exists in the economy. That is, taken as a whole, the nation is hopelessly in debt to the banks -- because the banks, using the combination of interest-bearing loans and fractional reserve banking, have created more debt owed to them than debt owed from them. Since we are no longer on a gold or silver standard (which serves as a check to all this, as it limits how much reserves can actually be held to the amount of specie in existence), and money is created only by the Federal Reserve (part of the banking system), the only way we can pay them back is to borrow more from them. And when we borrow more, once again, they create more debt owed to them than debt owed from them. There's no way to dig out of the hole -- any attempt to repay the loans just digs you in deeper.
The national debt is $6.382 trillion dollars. There is less than half a trillion dollars of cash in circulation. It's quite a business model these banks have.
For more details on this written by an actual economist, rather than by me, refer to The Mystery of Banking by Murray Rothbard.
It is also a massive money and power grab by banks, in cooperation with national governments (anytime you hear the phrase "public-private partnership", it's a reason to be nervous), which funnels all real property to bank owners.
Basically, it is a law which allows banks to loan out more money than they have. The "reserve requirement" is what percentage of the deposits that the bank must keep in actual assets. Our reserve requirement is somewhere in the neighborhood of 20%, so we'll use 20% in the following examples. For illustration purposes, I'm using an economy with only one bank, called The Bank. It works exactly the same way if there is more than one.
Person A deposits $100 in The Bank. The Bank is required to keep 20% in reserve.
Person B gets a loan for $80, which he deposits in The Bank.
Person C gets a loan for $64, which he deposits in The Bank.
Person D gets a loan for $51, which he deposits in The Bank.
Person E gets a loan for $41, which he deposits in The Bank.
Person F gets a loan for $33, which he deposits in The bank.
Person G gets a loan for $26, which he deposits in The Bank.
And so on down until person V gets a loan for $1 and deposits it in The Bank, and eventually someone gets a 1-cent loan.
The Bank now has $100 in its vaults. It also owes people $400 in the form of demand deposits (checking accounts). Persons A-V are owed a total of $396; the last $4 are what we get if we keep loaning 80% down to $0.01. We'll always hit an amount with the ratio of (initial cash deposit) * (1 / reserve requirement).
The additional $300 has been created out of thin air. This is where inflation comes from -- whereas before there was only $100, there is now $400. Inflation benefits the people who get the newly created money first at the expense of those who get it last -- in this case, Persons A-V get to spend their money at prices that assume $100 in the economy, but everyone getting paid by them will be eventually spending their money at (higher) prices that assume $400 in the economy. Prices don't rise instantly -- it takes time. Inflation benefits those who have money early at the expense of those who have money late. The Bank, of course, has the money earliest of all, since they created it out of thin air.
But it gets worse -- much worse. Next, we'll combine fractional reserve banking with lending at interest -- which is, of course, the primary reason to have fractional reserve banking at all (if you can't charge interest, why loan the money out at all?) The Bank now has $100, and owes $400. But what about all those people who got loans from The Bank? Well, let's assume these loans were standard home mortgage loans. In general, you get to pay back about 2.5 times as much as you borrowed, once principal and all the compounding interest is considered. So these people owe the bank $1200. So the bank has now turned $100 in real money into $400 owed to other people -- and $1200 owed to it. See why banking is so profitable?
Now, in real life, we don't just have The Bank. We have many banks, so everyone who gets money out of a bank does not necessarily give it right back as a deposit to be loaned out again. But the effect is the same. If instead of "The Bank", we use "the banking system", the $100 still goes in and comes back out as $400 owed to people and $1200 owed to banks. This makes no manifest difference.
You'd think that from all this, the banks would be pretty darned happy with the business they're in. But apparently they weren't happy enough -- after all, you can never have too much money and power (and I say this only half-jokingly, as I admittedly have a touch of megalomania myself). So, back in 1913, at Jeckyll Island, GA, a number of banks created the Federal Reserve System in partnership with the United States Federal Government. The Federal Reserve System sounds like a government agency, but it's not -- it's a privately held corporation owned and operated by its stockholders... which are the banks. This said, it would be useless without its ties to the government -- it is in a sense the ultimate "public-private partnership". The Federal Reserve System's purpose is to function as a bank for banks -- it will take deposits for banks, and make loans to banks. Deposits in the Federal Reserve System count as reserves, not as credit, so it is a "safe" place for banks to put their reserves. In addition, it can participate in fractional reserve banking. Most importantly, though, it controls the money supply -- the Federal Reserve alone is allowed to purchase money (Federal Reserve Notes) from the U.S. Mint. It purchases it at a spectacular discount ($100 bills cost about $0.70).
Now, the first effect is that "a bank for banks" multiplies the effect of fractional reserve banking. When The Bank gets that $100 deposit, and has to put the $20 in reserve before loaning out the rest, it puts it in its account at the Federal Reserve. Which now has $20, which it can loan out to banks... where it counts as reserves allowing the banks to loan out even more money.
But this isn't really the problem. Let's go back to the numbers. The Bank has $100, owes $400, and is owed $1200. How are people going to pay back the $1200 that they owe? Well, the economy is quite productive, and wealth is actually created by capitalism on a very regular basis. The wealth comes in the form of declining prices and increased productivity. But capitalism creates wealth, it doesn't create money -- because only the Federal Reserve is allowed to create money. So if you want money, you have to go to The Bank...
The Federal Reserve System has actually created a system by which there is more money owed to the banks than exists in the economy. That is, taken as a whole, the nation is hopelessly in debt to the banks -- because the banks, using the combination of interest-bearing loans and fractional reserve banking, have created more debt owed to them than debt owed from them. Since we are no longer on a gold or silver standard (which serves as a check to all this, as it limits how much reserves can actually be held to the amount of specie in existence), and money is created only by the Federal Reserve (part of the banking system), the only way we can pay them back is to borrow more from them. And when we borrow more, once again, they create more debt owed to them than debt owed from them. There's no way to dig out of the hole -- any attempt to repay the loans just digs you in deeper.
The national debt is $6.382 trillion dollars. There is less than half a trillion dollars of cash in circulation. It's quite a business model these banks have.
For more details on this written by an actual economist, rather than by me, refer to The Mystery of Banking by Murray Rothbard.
