Fractional Reserve Banking and America's Standard of Living
Most Americans today owe their standard of living to "fractional reserve banking." by James Luko
(centrist)
Sunday, August 21, 2011
“Fractional Reserve Banking” does NOT create money out of thin air! (contrary to popular misinformed belief.” The bank “borrows” at a cost (savings rate given to depositor) to lend depositors money- the bank does not keep the money loaned out- it makes only the spread between deposit interest and credit interest. So, “extra” funds are in essence being created- true- but they are ultimately collateralized by the demand deposit note- but this is irrelevant because the vast majority of depositors will not demand redemption of their deposits at the same time.
Here is the inverse of the fractional reserve debate- if banks must keep a “full reserve” and not able to lend out against deposits- then, how do investors and consumers borrow money ?? What standard of living we would have if you couldn’t obtain a mortgage or a car loan or finance your children’s college education. From whom would you borrow then ? There would be no money to borrow and your lifestyle and entire economic system would implode- and deflate to the point of whatever cash was in the system or savings only. So, if you could not save cash to buy a house- you would never own a home. Or it might take many years to save up to buy a home- you might be retired before you could ever enjoy home ownership.
Secondly, without fractional reserve banking- this implosion of available money (cash plus credit) would create enormous DEFLATION leading to almost total collapse in the economy- bringing us to rudimentary lifestyles like Iraq and Afghanistan (and many African nations- In fact, this author has lived in a war zone for 15 years and could see first hand- an economy without credit- a cash only economy brings a very rudimentary lifestyle).
In addition, as a depositor- I will receive no income on my savings- no interest bearing account since the bank is not using my money to make money. Not only would I not make interest on my deposit, I would have to pay the bank to service my account and store my money- so I would be “losing” money on my deposit instead of making money under a fractional reserve system.
We know full well that some inflation “may” be created by fractional reserve banking (if the extra money being created is greater in proportion to increasing economic volume), but that has proven, over time, to be more stable, less dangerous and facilitates much greater lifestyles overall then living from cash only.
Does the Austrian school answer from where would I be able to obtain a mortgage or credit to start or maintain a business? Credit would be severely limited to a few wealthy individuals as investors (creating a terrible oligarchy- as exists in Russia) but 95% of people and business would have no access to credit- as most people would have no savings as they struggle to pay cash for everything- healthcare, two cars, the house, etc. therefore, only those who were paid much above what they needed to live off of could enjoy a middle class lifestyle.
Conditions described here already exists, in most of Africa, Afghanistan, Iraq, Russia, Eastern Europe, Philippines, etc. so one can visit those countries and see the lifestyle of the majority of those people. I think, when faced with that reality, most people would be begging to return to a fractional reserve banking system.
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"So, 'extra' funds are in essence being created- true- but they are ultimately collateralized by the demand deposit note- but this is irrelevant because the vast majority of depositors will not demand redemption of their deposits at the same time."
First of all, money that is created using collateral without the permission of the collateral's owner is theft, regardless of whether it is recognized as such by the government.
Second, if the creation of new money is irrelevant because the vast majority of depositors will not demand redemption of their deposits at the same time, then please define the term "run on the bank". Also, please explain how a bank could ever be in default if not for the possibility of universal demand for deposits held.
how do investors and consumers borrow money ??
The original meaning of the word "capitalism" was a system whereby capital is accumulated by selling a good or service, earning a profit, and then reinvesting all or most of the profit back into the business, thus increasing the business's capital. The consumer's parallel to old-style capitalism is savings. The way to buy a house or a car is to save for it.
Without easy credit, prices have to come down to a level that people can afford to buy. Does that mean that all prices decrease (not deflate...the author is misusing that word) to zero? Not at all. Just because the author imagines an extreme nightmare scenario doesn't mean that his extremism is true. The end of easy credit does not mean that the economy comes to a halt. It merely means that prices cannot rise in anticipation of easy credit, thus forcing people to borrow in order to buy a major item. Thus, if prices are too high (as they always are because of inflation), they must come down in order to meet available demand. If demand can only buy houses when prices come down, then they will come down to the point where people can afford to buy them. This does not mean, however, that prices will reduce to zero. That's the author's false reading of the situation.
Easy credit makes it impossible to save to buy a large item, because the market automatically calculates the ability to borrow into the pricing. Remove that automatic borrowing, and the cost comes down to levels where people can afford to save to buy it without going deep into debt.
There was a time, before the era of easy credit, when one could afford to build a house and pay for it within a year or two. That is no longer true because of easy credit. Today, a 30 year mortgage is the minimum for most people, and it involves giving up at least 25% to 30% of their total income in order to cover the monthly payment, in addition to saving a 15-20% down payment...and that's if their credit is good! People with mediocre credit today have virtually no chance of buying a house.
Secondly, without fractional reserve banking- this implosion of available money (cash plus credit) would create enormous DEFLATION leading to almost total collapse in the economy- bringing us to rudimentary lifestyles like Iraq and Afghanistan (and many African nations- In fact, this author has lived in a war zone for 15 years and could see first hand- an economy without credit- a cash only economy brings a very rudimentary lifestyle).
Oh my word what a lie! Afghanistan and Iraq lie in economic ruins because of massive inflation, not deflation! War zones are created by inflationary governments and central banks, not deflationary governments and central banks! The Afghanistan afghani, for example, is one of the most highly inflated currencies on the planet, with a current inflation rate of over 25%! The Iraqi dinar has been so heavily inflated over the years that this year the central bank took steps to remove three zeroes from the currency. That means the value of the dinar, over time, had plummeted to 1/1000th of its original value!
We know full well that some inflation “may” be created by fractional reserve banking...
No, the word "may" is incorrect. It should be replaced with "will always". See the Producer Price Index chart at Mises.org. It shows just how much of a distortion of the truth the author has uttered here.
Does the Austrian school answer from where would I be able to obtain a mortgage or credit to start or maintain a business?
Yes. When your income and savings aren't being inflated away, you are able to do something you cannot do under an inflationary system. You can actually save to buy. Only under an inflationary system does it become virtually impossible to save enough money in order to start a business. See the works of O. Henry from the 19th century for some ideas on the subject.
Credit would be severely limited to a few wealthy individuals as investors (creating a terrible oligarchy- as exists in Russia) but 95% of people and business would have no access to credit- as most people would have no savings as they struggle to pay cash for everything- healthcare, two cars, the house, etc. therefore, only those who were paid much above what they needed to live off of could enjoy a middle class lifestyle.
This struggle only happens in times of inflation, as the Russian Revolution case proves. See the Wikipedia article on the subject of the Russian Revolution for some cursory details. "...the government, in order to finance the war, had been printing off millions of rouble notes, and by 1917 inflation had sent prices up to four times what they had been in 1914."
You are confused, as are other status quo proponets, about who actually creates value in an economic system.
The financial system, including all banks and bank like firms, create extremely little value in the economy. All real value is created by those who create a product or a service that others are willing to give up value for.
The banks simply and deceptively take the deposits of its customers that have resulted from value created and transfer the same deposits to others who wish to attempt to create value or purchase something that has already been produced.
They also accept the counterfeit value that the government issues as real value and profit off that by passing it off as something of actual substance. The "value" that fiat currency gets, comes only from monopoly and already produced value.
In a free economy, what banks do {hand your money to your neighbor} would probably only warrant a half of a percent or so. its hard to say with certainty since our banking system is an absolute monopoly, but what percent would you pay someone who takes your money and hands it to someone else? Would you give yourself, the person who created the value, a half of a percent and give the broker banker who created none of that value five or ten percent, as is done in our present system?
This would place interest rates in the general economy not much higher than what you receive now when you walk into a bank with a deposit.
There would be less currency, if the fed was also subject to market competition. Prices and interest would both be lower.
Posted By: jamesluko
Date: August 25, 2011 02:56:05 AM
[SIZE=2]First of all, money that is created using collateral without the permission of the collateral's owner is theft, regardless of whether it is recognized as such by the government.
Walt, that is not true, when depositors sign their savings agreement- they give their express permission for their monies to be loaned out (as most account agreements have, or should have, an article which upon you agree to abide by state and federal laws which regulate the use of your money by the bank. In return you receive interest- meaning- you make money on your deposit- I would assume then Walt that if you’ve used a bank account before- and you believe what you say here- then in that case- can you attest that you have returned the “interest” you earned on your bank accounts now or in the past ? If you kept the interest that you earned on your bank accounts- then you are guilty of receiving stolen funds right ?
You say this is “theft” “regardless of whether it is recognized as such by the government”? Of course it is NOT theft if it is not violating existing laws, as such that you may “wish” to “label” it as theft- just as you might say government tax collection is theft- then sure- you can say anything- let’s say its theft- but according to the law it’s not.
In addition, the very fact that “reserve requirements” are set by the Federal Reserve- a legal institution, would indicate to you it is legal for banks to loan out their deposits- and or/ transmission of the collateral as credit- as this practice has NOT been overturned by the Supreme Court- our highest law of the land.
In addition Walt, NO one says that you can’t keep cash or gold under your mattress if you prefer that to your bank, there is NO law which requires you to use a bank. So, if you don’t want your bank to commit “theft” against you, don’t deposit your money there- pretty simple isn’t it? I mean, the bank CAN”T STEAL from you unless you voluntarily deposited your money there right? From where did you assume the bank was paying the interest on your savings, checking and CD accounts? The explanations I’m reading in response to my article is the response logic of out of reality straw-men- what if scenarios which are not complete in their line of thinking. A little more intellectual prose would be appropriate.
“Second, if the creation of new money is irrelevant because the vast majority of depositors will not demand redemption of their deposits at the same time, then please define the term "run on the bank". Also, please explain how a bank could ever be in default if not for the possibility of universal demand for deposits held.”
Obviously, using fractional reserve banking is risky if “too many” depositors demand all their funds immediately, thereby exposing the banks system of running from a “fractional reserve” of their deposits- hence the name- fractional reserve banking. Of course this is a risk, but that is why one of the major functions of the Federal Reserve is to plug such a gap with liquidity- and why depositors have the FDIC to protect their deposits. This is self-explanatory- need I explain this here ???
“The original meaning of the word "capitalism" was a system whereby capital is accumulated by selling a good or service, earning a profit, and then reinvesting all or most of the profit back into the business, thus increasing the business's capital. The consumer's parallel to old-style capitalism is savings. The way to buy a house or a car is to save for it.”
Before the credit era, turn of the century, few Americans could afford a car, let alone a home. Walt, buying a home in two or three years from the savings from your income? Well, if you are talking about American’s who built their own log cabins, maybe yes, but it’s clear that until easy credit and low down payments were made available to the post WWII baby boomers, home ownership remained low. Before easy credit and low down payments- buying homes with your savings or building your log cabin resulted in only 32-46% of Americans owning their own homes from 1900-1920. After, easy credit, mortgages and low down payments- home ownership boomed- by 1950- home ownership was up to 55%, by 1960 it was 62%, by 1990 it was 64% and today- it’s over 67% (75% for White Americans). So, your facts are totally wrong regarding what Americans could afford before the turn of the century- easy credit era, and era of mortgages- wherein ONLY mortgages could be made available because of fractional reserve banking.
“original” meaning of capitalism ? Haven’t seen an “original” definition, in fact, there isn’t ONE concise universal definition. The word itself is “usually” defined as the means of production being in the hands of private owners, whereby profits, salaries and rent are made. Profits (surplus capital) would be re-invested in a business to increase production or expand overall. Along with the general definitions of capitalism is: “capital accumulation” which does NOT mean just saving your profits or salary- it also means (in the context of free enterprise, “accumulating” capital by taping investors- or banks and collecting enough money to create businesses which can operate on “economies of scale.” In this way, a “big” factory can take advantage of high productivity by means of investing in machines or trained workers and technology. When a big factory can attain high productivity- then products can be sold cheaply to consumers- thereby increasing their standard of living- while still making profits. Saving your profits or salary does not a capitalist economy make (in the real world), Walt- we would be in the stone age and stuck with cottage industries- toiling as a family in a dark dank hut sewing shoes together if we followed your ideas and definitions. Walt, your models of economic analysis “seems” very Marxian indeed.
Without credit a cash economy as I’ve witnessed for many years in the Balkans would absolutely be a disaster. Lack of expansion, or, inflation of money supply- commensurate with growth in economic activity (either volume or more economic actors- i.e growing population) could, but not, result in a continued deflation until businesses went bankrupt- this is plain logic. It’s not a scare scenario it’s YOUR scenario. Prices would be ever increasingly be bid down as money supply remained static, but more economic actors entered the market place. Eventually, the price bid would be below costs- and hence, no profit and then bankruptcy. Money supply growth (inflation) MUST accompany increased economic activity or growing numbers of economic actors in any given market. Is this explanation too complex to understand ?
.
Walt, you say: “oh my word what a lie” I guess on this forum I would try to be a bit more diplomatic instead of saying that I’m “lying” it would be a lie if I write or say it knowing or intending something as true when I knew it was NOT true. But I would state to you here that I believe what I’m writing, so I wouldn’t classify it as a lie. Maybe you might say that my economic explanations are not true, as in ‘economically incorrect’- and/or in the context of economics, but to state that I’m lying seems out of place in such a forum don’t you think ?
The economies of Afghanistan, Iraq, Sudan, Somalia, etc. collapsed and never were developed due to shortage or non-existent credit facilities. There is massive price inflation due to a lack of accepted currency, as well as shortages of goods- but not because of a classic inflation due to massive amounts of currency. The economies of those countries operate on cash and therefore- a deflation of economic volume and activity has brought those economies to subsistence levels.
PRICE Inflation, NOT due to production or market shortages, is not “assured” by merely increasing money supply- IF, the increase (in money supply) is commensurate (correlating closely) to the growth in economic activity- volume, or added actors in the market place, INFLATION in prices does not result. Price inflation is NOT only or ALWAYS due to an increase in money supply. So, I continue to support the use of the word “may” when speaking in context of fractional reserve banking causing “price” inflation. Money supply- or money inflation of course WILL occur with fractional reserve banking- but if the Federal Reserve tracks the economy close enough- the banking reserve requirements set by the Feds would negate price inflation. Perhaps in the back and forth here, we haven’t been always clear to specify inflation of money supply or inflation of prices. Inflation in prices does NOT erode your standard of living if there is a correlating increase in salaries.
Does the Austrian school answer from where would I be able to obtain a mortgage or credit to start or maintain a business?
“Yes. When your income and savings aren't being inflated away, you are able to do something you cannot do under an inflationary system. You can actually save to buy. Only under an inflationary system does it become virtually impossible to save enough money in order to start a business. See the works of O. Henry from the 19th century for some ideas on the subject.”
Posted By: jamesluko
Date: August 25, 2011 02:58:02 AM
NOT TRUE Walt, under fractional reserve banking which you label as the “inflationary system”, home ownership boomed- wide and deep. From 1900-1920 U.S. home ownership was between 32-46%, but after the “inflationary system” that you so deride, home ownership zoomed to 55% in 1950, 62% in 1960, 64% in 1990 and 67% today (75% for white familes) (So, the stats disprove your assumptions and assertions. Clearly, the standard of living for Americans, across the board, has soared and proof is in the pudding, the Federal Reserve, fiat currency and fractional reserve banking has given an unprecedented amount of people the highest standard of living in history.
Gede, About creating value in an economy, let’s make a difference between basic economy theory and real life. Our economy is complex with many elements that break economic theory and rules, so let’s try to remember that. I don’t think the banks take deposits “deceptively” this is not a John Birch conspiracy in my opinion.
