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Testimony on fractional-reserve banking

Here is a link to video of Ron Paul's subcommittee hearing Thursday on fractional reserve banking. Below it is the text of my written statement.

Hearing June 28 2012 Fractional Reserve Banking

Statement of
Lawrence H. White
Professor of Economics, George Mason University
before the
House Subcommittee on Domestic Monetary Policy and Technology
United States House of Representatives
June 28, 2011

Chairman Paul and members of the subcommittee: Thank you for the opportunity to discuss the fractional-reserve character of modern banking, its positives and negatives, its relationship to financial instability, and to offer my thoughts on how to promote greater banking stability. I will begin by describing the historical origins of fractional-reserve banking (hereafter FRB), then move on to the effect of FRB on the money supply process, its connection to bank runs and financial instability, and finally the reforms needed to improve our banking system.

The origins of fractional reserve banking

A “bank” is a firm that both gathers funds by taking in “deposits” (or creating account balances) and makes loans with the funds gathered. A moneylender who draws only on his own wealth is not a banker, nor is a warehouseman who does not lend. A “deposit,” in ordinary modern usage, is a debt claim, an IOU issued by the banker and held by the “depositor,” which the banker is obliged to repay according to the terms of the contract. We can distinguish between a “time deposit,” which the banker is obliged to repay only at a specified date in the future, and a “demand deposit,” which gives the customer the legal right to repayment “on demand,” that is, whenever the customer chooses (on any day the bank is open).

Historically, deposit-taking grew out of the coin-changing and safekeeping businesses. Medieval Italian money-changers would (for a fee) swap coins from one city for those from another. Some traveling merchants, who brought in coins of one type, would chose to hold balances “on account” for the time being, preferring to receive coins of another type later when it was more convenient. The earliest deposit-takers in London were goldsmiths, artisans who made gold jewelry and candlesticks, who were also coin-changers. Like the Italian coin-changers, they provided safe-keeping in the vaults where they kept their own silver and gold.
A key to the development of fractional-reserve banking was that vault-keepers (money-changers and goldsmiths) began to provide payment services by deposit transfer. The earliest record of payment by deposit transfer is from Italy around 1200 AD. Before deposits became transferable, suppose Alphonso wanted to pay (say) 100 ounces of coined silver to Bartolomeo, both of them customers of the same vault-keeper. Al would go to the vault-keeper, have him weigh out the requisite amount of coins, and transport the coins to Bart, who would then have to transport the coins back to the vault-keeper to have them weighed again and placed back in the vault. There was great inconvenience, not to say risk, in transporting the coins across town and back. And there were fees to pay for weighing the coins. At the end of the day, Al’s account balance or claim on the vault-keeper would be down by 100 ounces (plus transaction fees), and Bart’s would be up by 100 ounces (minus transaction fees).

A less burdensome and safer way to accomplish such a payment was for Al and Bart to meet at the bank, and simply tell the banker to transfer 100 ounces on his books by writing Al’s account balance down and Bart’s up. No coins had to be weighed or moved, or even touched at all. Payment was now made not by handing over coins, but by handing over claims to coins.

Other methods for authorizing deposit transfer were often more convenient and soon displaced the three-party meeting in the banker’s office. For example, Al could sign a written authorization, what we now call a check. Today we have electronic funds transfer, but all of these methods accomplish the same end, which is to make a transfer funds from one account to another.

Some of the earliest deposit-taking was simple warehousing, in which the coins deposited were merely stored, and the exact same coins would be returned to the depositor on demand assuming all storage fees had been paid. (In legal parlance such a claim on the warehouseman is a “bailment” and not a debt.) In the early Middle Ages a customer who wanted this kind of storage would bring the coins to the vault in a sealed bag. The bag was not to be opened by the warehouseman. For each specific bag of coins that could be claimed by Al or Bart, those specific bag of coins were always in the vault. Supposing that the bags’ contents were recorded on the books (which they need not have been), we could say that for each ounce of coined silver claimed by depositors there was always an ounce of coined silver in the vault. This arrangement, which resembles the business today of renting safety deposit boxes, is sometimes described as “100 percent reserve banking,” although strictly speaking it isn’t banking at all, but simply warehousing.
As payment by deposit transfer became popular, goldsmiths and coin-changers found that they could offer a different kind of contract to customers who primarily wanted not storage but economical payment services. In a “fractional reserve” contract, the vault-keeper becomes a banker, able to lend out some of the funds deposited. In the early Middle Ages a customer who wanted this kind of account would bring loose coins to the vault. The coins could be mingled with other depositors’ coins, whereas in money warehousing there is no evident rationale for mingling. The customer would receive a redeemable claim, entitling him to get back equivalent coins on demand, but not to receive back the identical coins he brought in. The account is now a debt claim and not a bailment. Now the coins in the vault are a fraction of immediately demandable deposits. We can describe them as a reserve for meeting the redemption claims that will actually be made.

Later, beginning perhaps in the 1400s, banks began to issue deposit receipts that could be signed over, making them something like traveler’s checks today. For their customers’ convenience, they soon provided them in bearer form (no signing-over necessary) and round denominations. These we call banknotes, paper currency claims on banks that were payable to the bearer (whoever presented them), typically on demand. As currency, they could be transferable anonymously, and without bank involvement (unlike deposits transfers, which need to be recorded on the books). London goldsmiths were issuing banknotes in the mid-1600s. Banks also held fractional reserves against the total of their banknote liabilities.

When is a fractional reserve feasible?

For a unique or specific coin, which the customer wants to have back, it isn’t. A specific coin lent cannot be instantly recalled from the borrower who has spent it. But for coins that customers regard as interchangeable with other coins, it is. Likewise, you count on a coat check stand to keep your specific coat there all evening, and not to lend it out, because you don’t want back just any coat of the same size. Unlike coat-checkers, most depositors are willing to treat coins as interchangeable. Depositors do not insist on getting the very same coins back, so any equivalent coin in reserve will be satisfactory.

To avoid defaulting, or breaching the contractual obligation to repay, the bank obviously needs to keep enough coins in reserve. How can the bank count on having enough coins to meet all requests? It is a matter of practical calculation: the bank needs to know from experience the probability of any given amount of coins being demand on a given day. If it wants to be 99.99% safe, it needs to hold a reserve (or have ways of replenishing its reserves) sufficient to cover 99.99% of cases.

The economist Ludwig von Mises offered the following illustration. Consider a baker who issues 100 tokens, each stamped “good for one loaf of bread.” Leaving aside lost tokens, it is clear that the baker will need 100 loaves. All the tokens will be redeemed, because using them to get bread is their only use. By contrast, transferable claims to coin (bank deposits or banknotes) are useful even without being redeemed. Unlike bread tokens, which cannot be eaten with butter and jam, transferable bank accounts or banknotes can do the job of the coins in making payments. Once payment by deposit transfer and banknote becomes popular, the banker will reliably find that not all deposits notes or deposits are redeemed for coins on a given day, even if all are used to make payments. Thus a banker who issues $100 in demand deposits or notes will need less than $100 in coin to meet all the redemptions that will actually be demanded.

How much less than 100% the banker can hold, and still meet all the redemption demands that he does face, is a problem that the banker must solve by practical statistical calculation. There is no reason to think that a central authority can do the calculation better, and can improve matters by imposing an arbitrary percentage requirement. To provide the right incentive to hold enough reserves, it is important that the imprudent banker who miscalculates, holds too little in reserves, and fails to pay when obligated to pay, be subject to the ordinary legal penalties for breach of contract.

Advantages and disadvantages of fractional reserves

The advantage to the bank from keeping fractional reserves is clear: it earns interest on the lent-out funds. A few commentators have declared that FRB must be a fraud: the gain is all on the bank’s side, and no customer would agree to it if she realized what the bank was up to. But this claim assumes that there are no advantages to the bank’s customers. In fact there are clear advantages to the bank’s customers, at least under competition. To compete for customers, all experience shows, banks offering fractional-reserve accounts charge zero storage fees and even pay interest on deposits, up to point where the interest they pay falls short of the interest they earn only by just enough to cover the bank’s operating costs for safekeeping and payment services. In this way FRB creates a synergy between payments services (checkable deposits, banknotes) and intermediation (pooling savers’ funds for lending to selected borrowers). When the deposited funds that are not needed as reserves can be lent out, depositors enjoy lower (or zero) storage fees and interest on checking deposit balances.

By contrast to money warehousing, the savings of fractional-reserve banking do carry a disadvantage in the form of greater default risk. If the bank’s investments go sour, the depositor may not be repaid in full. The warehouse, by contrast, makes no investments. So the customer choosing between a bank account contract and a warehousing contract needs to consider: is the saving in storage fees and the interest paid on deposits high enough (relative to the increased risk of not being paid promptly)? Historically, in competitive systems where banks were free to diversify and capitalize themselves well, the answer was yes for most people. Thus well informed consumers who want economical payment services typically prefer a fractional-reserve bank to a warehouse. In sound banking systems historically, before deposit insurance, the risk of loss was a small fraction of one percent, while the interest was more than one percent, and the sum of interest and storage fee savings was even higher. Thus FRB can arise and survive without fraud.
The economist George Selgin has examined the record of the London goldsmith bankers, and debunked the myth that they pulled a fraudulent switcheroo, promising 100% reserves but holding less, at the beginning of the practice of FRB. Goldsmith bank accounts became enormously popular in the mid-1600s because they offered interest on demand deposits. The offer of interest is a clear signal that the contract is not a warehousing contract.

For payment by account transfer, FRB offers a more economic way of providing payment services. A money warehouse or 100% reserve institution could also offer payments by account transfer, but its services would be significantly more expensive. The other bank payment instrument, redeemable banknotes circulating in round denominations, simply cannot exist without fractional reserves. Banknotes are feasible for a fractional-reserve bank because the bank doesn’t need to assess storage fees to cover its costs. It can let the notes can circulate anonymously and at face value, unencumbered by fees, and cover its costs by interest income. An issuer of circulating 100% reserve notes would need to assess storage fees on someone, but would be unable to assess them on unknown note-holders. There are no known historical examples of circulating 100% reserve notes unemcumbered by storage fees.

Under a gold or silver standard, the introduction and public acceptance of fractionally backed demand deposits and banknotes means that the economy needs less gold or silver in its vaults to supply the quantity of money balances (commonly accepted media of exchange) that the public wants to hold. Thus money is supplied at a lower resource cost, that is, with less labor and capital devoted to mining or importing precious metals and fashioning them into coins or bars. Looking at the change in balance sheets from money warehouses to fractional reserve banks, the economy can now fund productive enterprises where before it only held metal. Gold can be exported, and productive machinery imported. This development in Scotland was praised by Adam Smith as a source of his country’s economic growth. As the economist Ludwig von Mises put it, “Fiduciary media [fractionally backed demand deposits and banknotes] … enrich both the person that issues them and the community that employs them."

Under a fiat money standard, as we have today with the Federal Reserve dollar, things are different. There are no mining or minting costs saved by holding fractional rather than 100% reserves in the form of fiat money. For commercial banks to hold 100% reserves in the form of fiat money issued by the federal government would, however, change drastically the function of the banks. Instead of funding productive enterprises, the banks would instead only fund the federal government. Fewer loanable funds would be available to the private economy, and more to the government. Private investment would be suppressed, and public spending enlarged.

The effect of FRB on the money supply process

With banks holding fractional reserves of Federal Reserve dollars (notes and deposit claims on the books of the Fed, whose sum is called “the monetary base”), when the Fed increases the quantity of Federal Reserve dollars by $1 billion, the banking system ordinarily creates a multiple amount of deposit dollars. The total stock of money held by the public (“M1”) increases, say by $2.3 billion. At the moment, however, we are in an anomalous situation. Banks are sitting on such vast quantities of excess reserves – paid to do so by the Federal Reserve as it pays a relative high interest rate on reserves – that the monetary base is larger than M1. Thus the US banking system today actually has more than 100% reserves against its demand deposits.

The problems of financial instability, bank runs, and crises

Perhaps the leading leading argument made in favor of government regulation of banks is the argument claiming that a fractional-reserve banking system is inherently fragile and so needs deposit insurance. The argument rests on three underlying propositions:
(a) An uninsured fractional-reserve banking system is inherently prone to runs and (due to “contagion”) panics. (A run means that many depositors seek to withdraw at the same time, out of fear of a reduced payoff if they wait. A panic means that many banks suffer runs at the same time.)
(b) Runs and panics have net harmful effects.
(c) Deposit insurance can reduce runs and panics below their laissez-faire level at a cost less than the benefit of doing so.

My research into banking history convinces me that (a) and (c) are actually false, and even proposition (b) requires some qualification.

A run is always possible against fractionally backed bank deposits that are unconditionally redeemable on demand. Against such deposits, a run can even, in theory, be self justifying: if a run forces the bank to conduct a hasty sale of illiquid assets, the bank may receive such a reduced value for its assets that it becomes insolvent (liabilities exceed assets), so that all depositors can no longer be paid in full. From this theoretical possibility, some economic theorists have jumped to the conclusion that fractional-reserve banks are in practice inherently run-prone. (The best known statement is a 1983 article by Douglas Diamond and Phillip Dybvig.) According to this view, a run can happen at any time, in any place, on any bank, triggered by nothing more than random fears or events that have no basis in the target bank’s solidity.
But are real-world deposit contracts so fragile? Historical evidence says no. Please consider: If real-world deposit contracts really were as fragile as the self-justifying-run theory supposes, it would be a mystery how they survived centuries of Darwinian banking competition before the first government deposit insurance schemes began. Wouldn’t a more robust arrangement have come to dominate the field?

The theory of runs that better fits the historical record is that runs occur, not randomly, but when depositors receive bad news indicating that their bank might be already (pre-run) insolvent. Receiving such news, depositors run because if assets are already be too small to pay all depositors back, the last in line get little or nothing. Unlike the self-justifying-run theory, the bad-news theory explains why runs typically occurred at onset of recessions (when bad news arrived about the banks’ borrowers declaring bankruptcy), and explains why countries that did not weaken their banks with legal restrictions (e.g. Scotland, Canada) very seldom experienced runs and almost never panics.

What makes a deposit contract run prone? Assume that depositors are rational. There must be a greater expected payoff to arriving sooner rather than later to redeem one’s deposit. This implies that the deposit is unconditionally redeemable on demand (and that the bank pays on a first-come-first-served basis), and that default is likely on last claim serviced. To make an account non-run-prone it suffices to modify either one of these two conditions. First, the deposit contract can make redemption conditional rather than unconditional. An important historical example was the “notice of withdrawal clause” that many savings banks and trust companies included in their deposit contracts. If withdrawals were too great for a bank to satisfy without suffering severe losses from hasty asset liquidation, the banker had the option to defer redemption for 60 or 90 days by requiring notice of intent to withdraw to be given that far in advance.

More importantly, banks made default unlikely by providing their depositors with credible assurances that the bank would maintain solvency, that is, assets sufficient to pay in full even the last in line, even under adverse circumstance. To provide credible assurance, banks before deposit insurance held much higher capital than they do today, in the neighborhood of 20%. They invested much more conservatively, so that they faced much less risk of large asset losses. They avoided loans with high default risk, high risk of loss from interest-rate movements, and loans that were illiquid (hard to resell). Banks that relied on demand deposits and banknotes did not make long-term fixed-rate housing loans, for example. They invested primarily in short-term, high-quality, liquid business IOUs, what were then called “bills of exchange” and is today called “commercial paper.” In some countries, banks had an additional backstop in the form of the right to call for more capital from their shareholders if otherwise depositors would go unpaid. Shareholders had extended liability, and in some systems unlimited liability, for the bank’s debts.

The historical record does of course indicate that runs and banking panics were a problem in United States during the pre-Fed or “National Banking” era (1863 1913), and also under the Fed’s watch during the early years of the Great Depression. But few other countries have had similar experiences. It is therefore clear that run-proneness and panics are not inherent to fractional-reserve banking. If we look for a pattern across countries, this is what we find: countries like Canada, Scotland, Sweden, and Switzerland, where the banking systems had no more than minimal restrictions on entry, note-issue, branching, and capitalization, had virtually no problem from runs and none from panics, in contrast to the more restricted and hence weaker banking systems of the United States and England.

The US banking system was made fragile by the federal and state ban on interstate branching, and even branching within many states. Branch banking limits reduced diversification of assets and deposit sources, indirectly limited capitalization, and hampered the effective allocation of reserves. Poorly diversified and poorly capitalized banks could not offer credible solvency assurances, which made them more vulnerable to “bad news” runs.

The US system was also made fragile by federal restrictions on banknote issue that prevented banks from meeting peak demands for currency. Because of those restrictions, seasonal demands for currency became scrambles for reserve money that occasionally escalated into panics.

Reforms to strengthen our banking system

The weakness in the US banking system today stems from a different set of government policies than the ban on branching (eroded in the 1980s and finally eliminated in 1995) and restriction on banknote issue (commercial banks stopped being allowed to issue any notes in the 1930s). Today the weakness is due not to restrictions, but to privileges. One indication of that is that the weakest banks today are not the smallest, but the largest banking companies.

Federal deposit insurance, since its birth in the 1930s, has meant that a comparatively risky bank (one with capital less adequate to cover potential losses on its asset portfolio) no longer faces a penalty in the market for retail deposits. Insured depositors have no incentive to shop around for a safe bank, so they no longer demand a higher interest rate to give it their deposits. Risk-taking is thereby effectively subsidized. Attempts to price deposit insurance according to risk, so as to recreate a penalty for holding on a risk bank portfolio, were mandated by the FDIC improvement act, but the attempt has failed. The FDIC insurance fund has been exhausted by bank failures, and now has a negative balance. Taxpayers are on the hook for the morally hazardous banking that the FDIC has fostered. Some way of rolling back and ultimately ending federal deposit insurance must be found.

The “too big to fail” doctrine compounds the problem. It gives even blanket protection even to a bank’s legally uninsured depositors and subordinated debt holders, removing their incentive to shop around for a prudently managed bank. “Too big to fail” treatment went from the exceptional event to the routine event during the last five years, as the Federal Reserve and the FDIC have deliberately declined to close several large insolvent banks. If no large bank is ever allowed to fail, then large depositors flock to the large banks that have the privilege of an implicit guarantee for all. On such a tilted playing field, an unnaturally large a share of deposits flows into the largest banks. We are already there. Some way of ending “too big to fail” must be found – quickly.


The evidence shows that a fractional-reserve banking system is not unstable when the banking system is free of hobbling legal restrictions and free of privileges. The US banking system in the 19th century was weakened by legal restrictions. In response to that weakness, rather than let the banking system become robust by repealing its restrictions, Congress in the 20th century patched over the problem by creating the Federal Reserve system (to act a “lender of last resort”) and federal deposit insurance. As a result, the US banking system in the 21st century is chronically weakened by government privileges (especially taxpayer-backed deposit insurance and taxpayer-backed “too big to fail” bailouts) that generate moral hazard. Banks take advantage of these guarantees by holding asset portfolios too full of default risk and interest-rate risk. They finance their portfolios with excess leverage (too much debt, not enough equity). Rather than trying to come up with another patch, Congress should seek to dismantle the restrictions and the privileges that have left the American people saddled with an unhealthy banking system.

  • Larry, how did you feel about testifying to an empty hearing room?

  • Paul Marks

    "(or creating account balances)".

    A lot could be said about that – but nothing more really NEEDS to be said.

    If a bank (of a group of banks – for some smoke and mirror games depend on their being more than one bank, they depend on a shell game of several banks) takes in one million Dollars of savings and then proceeds to lend out one hundred million Dollars it is fair to say the following…..

    "If your really need to ask what is wrong with that, you will not understand the answer".

    Sadly modern government intervention is designed to INCREASE, rather than reduce, the problem.

    Even in the 19th century government intervention (which, back then, was sometimes well intentioned – which it certainly has not been in modern times) missed the problem.

    It does no good to limit the issue of bank notes (as, for example, Sir Robert Peel's Act of 1844 does) if banks (as they do) have many other ways to do the same thing – i.e. lend out "money" that DOES NOT EXIST.

    As both Mises and Hayek said – the Currency School (the enemies of the Banking School) were "right about the problem, but wrong about the solution". The problem was the lending out of money that did not really exist (money that no one had ever really saved), but the solution (government regulations of various sorts) SIMPLY DID NOT WORK.

    Sadly modern interventions do not even try to limit the expansion of credit – on the contrary they are about expanding credit (the "cheap money" or "low interest rate" or "demand" fallacy).

    So Larry King is actually quite right – it would be better if government did nothing at all.

    Government intervention is (at best) ineffectual (as banks can, with ease, find ways round the rules) or (as in modern times) actively harmful – as it makes bank credit bubbles vastly BIGGER than would otherwise be the case.

    "But then you, Paul Marks, would allow bank credit bubbles".

    As I am certainly not more clever (indeed vastly less clever) than the bankers, they could find ways round any regulations I might create – so the only honest answer is "yes".

    "But what should government do when the credit bubble bursts?"


    Prices should be allowed to fall (as bank credit shinks back towards the monetary base) and wages should be allowed to fall also ("demand" fallacy to the contrary).

    And if banks go bankrupt (which they may or MAY NOT do) then they should be allowed to go bankrupt – and (yes) depositors should lose their money.

    It is to be hoped that the market place (i.e. human beings who wish to avoid such losses) will be better than government regulations at at least LIMITING the size of bank credit bubbles.

    The problem with present situation is that we (in the modern West) do not have a financial system with credit bubbles within it (the 19th century position) the credit bubble ("broad money" or whatever you want to call it) is now so big that it would more correct to say that the financial system (indeed "the economy" in general) IS a credit bubble.

    The size of the real economy (manufacturing, mining, farming and so on) is dwarfed by financial and other services – and this service economy is dominated (utterly dominated) by the credit bubble.

    To say that the present economic structure is "unsustainable" may be the biggest understatement of economic history.

  • Paul Marks

    Of course I meant "Larry White" not "Larry King" (I have just been thinking about an old interview of Jon Stewart by Mr King where Mr Stewart revealed his real political position) my apologies.

    I certainly did not mean to compare Larry White to Larry King – simply a matter of thinking about more than one matter at time.

    My apologies.

  • Rob R.

    "The economist Ludwig von Mises offered the following illustration. Consider a baker who issues 100 tokens, each stamped “good for one loaf of bread.” Leaving aside lost tokens, it is clear that the baker will need 100 loaves. All the tokens will be redeemed, because using them to get bread is their only use"

    I don't understand this example. I don't see any theoretical reason why one couldn't develop a fraction reserve system based upon bread. If the bread tokes started to be held because they were marketable and on a given day only some of the tokens were actually redeemed for bread then I don't see how this would differ from FRB based on any other commodity. Of course some of the attributes of bread (compared to other goods such as gold) make this unlikely to happen in practice.

  • Chuck Moulton

    I would have attended this hearing if I had realized it was scheduled.

    The testimonies of the other witnesses are also interesting.

    Hearing ("Fractional Reserve Banking and the Federal Reserve: The Economic Consequences of High-Powered Money"):

    Archived webcast:

    Dr. John Cochran testimony:

    Dr. Joseph Salerno testimony:

    Dr. Lawrence H. White testimony:

    All three advocate for free banking. Although Salerno supports 100% reserves, he seems to refrain from arguing for government imposed 100% reserves, but rather believe that people would choose 100% reserves in a free market. At least that's my reading of his testimony.

    I'd be interested in learning how the question and answer portion of the hearing went. Did anyone who attended the hearing or watched the webcast have any thoughts? (I haven't watched the webcast yet and won't have an opportunity to do so for a few days.)

    • Larry White

      Sorry I didn't give you a heads-up, Chuck. I announced it on Facebook, but I forgot that you were blacked out by my policy of not befriending current GMU students. Next time I'll announce here on

      • Chuck Moulton

        No problem. I was trying to express that I was surprised that I didn't see an announcement from Ron Paul's Congressional office through his Facebook, where I think I saw some past hearings promoted. But really it's my fault for not checking the hearings schedule more frequently.

        Announcing things like this in advance on is a wonderful idea!

  • Paul Marks

    Rob R.

    "I do not understand this example" – meaning Ludwig Von Mises' example of a hundred tokens each (supposedly) good for one loaf of bread, needing one hundred loaves of bread.

    As I said – if someone does not understand why lending out more money than has been saved (i.e. more "money" than actually EXISTS) is a bad idea, they will not understand an explination of why this is a bad idea.

    This is because any explination (such as the example that Mises gives) requires someone to grasp a basic point of logic (the same basic point of logic they failed to grasp in the first place) – and if they grasped that point of logic they would not need the example.

    It is similar to "A is A", if someone asks "why?" (and really does not know) then no explination will help.

    • George Selgin

      Rob, if someone "lends" anything, it follows that they no longer have the thing on hand–because it has gone to the person who borrowed it! Consequently it is the nature of intermediation that any lending by an intermediary leaves the intermediary with liabilities that exceed it's reserves. So what? The (supposedly) "Misesian" insistence that a bank must be lending "more than has been saved" if it's reserves fall short of its liabilities is proof, not of a superior command of logic, but of quite the opposite: a failure to come to grips with the most elementary principles of banking. That's "a basic point of logic."

      To the extent that calls for "sound money" are linked to arguments like yours against fractional reserves, the sound money movement can never expect to be taken seriously–and doesn't deserve to be taken seriously. Speaking as a proponent of greater monetary freedom, I think prospects for progress in that direction are hampered no less by the pseudoscience of 100-percent money types than they are by the efforts of the most relentless apologists for government intervention.

  • Paul Marks

    George Selgin.

    "Rob if someone lends something it follows they no longer have the thing"

    Quite correct.

    If I lend you my lawnmower I no longer have the lawnmower till when (and IF) you give it back

    Ditto with a one hundred Dollars – if I lend one hundred Dollars to you I no longer have the one hundred Dollars till when (and IF) you repay it.

    However, what if I never had a lawnmower?

    How can I "lend" you a lawnmower I do not have?

    Ditto with a hundred Dollars – I can not really "lend" you a hundred Dollars if I do not have a hundred Dollars.

    Sure I can say "just accept my written promise of a lawnmower – it is right over there in the shed" (and I can say the same thing with one hundred Dollars).

    However, if you open the door of the shed and find there is no lawnmower there because there NEVER WAS A LAWNMOWER IN THE SHED….

    Then I stand exposed as a FRAUD.

    A policeman is indeed an example of "government intervention".

    And I guess that you (George Selgin) would be on the side of a fraudster (or "con artist" if you prefer the term) rather than an evil government policeman.

    Would the same be true in the case of rapist or a murderer?

    Would that make you an "apologist" for rape and murder?

    How about if the policeman was NOT an employee of a government, if the cop was the employee of a anarchocapitalist enterprise?

    Would they be allowed to arrest bankers who claimed to "lend out" money that DOES NOT EXIST?

    Actually I personally believe that law enforcement is not always the best way to deal with fraudsters.

    The best way is sometimes just to expose them – so that no one does business with them in future.

    For example, if someone claims to have a billion Dollars to lend out….

    A simple request to SEE THE MONEY (the Federal Reserve notes) is enough.

    If a positive response to the request to "SHOW US THE MONEY" is not forthcomming it is obvious what sort of person one is dealing with.

    Still that is moral stuff – the sort of thing that Paul Kruman snears at ("moral theory of the economic cycle" with the word "moral" said with a deep snear and a little twisted smile).

    From an economic point of view lending out money that DOES NOT EXIST (i.e. engaging in smoke and mirror games – or, if you prefer, a shell game) has practical consequences.

    It produces first a "boom" then an inevitabel "bust".

    This has been known for centuries – and the skill for the fraudster it to get out (and to get out with real assets) before the bubble bursts.

    It is NOT an economically neutral process.

    An economy is not the same after the boom-bust as it would have been had no boom-bust event occured.

    Some people (normally the wealthy and politically connected) are better off than they otherwise would be.

    And some people (normally the poor and less politically connected) are worse off than they otherwise would have been.

    The economy as a whole?

    It is worse off than it would have been – had the boom-bust not happened.

    The gains of the people who win are SMALLER than the losses of the people who lose. An economy is not a zero sum game or a cake of a fixed size.

    And in the hopes of making the cake bigger (by a policy of "low interest rates" or "cheap money" via CREDIT EXPANSION i.e. by lending out money that DOES NOT EXIST) the policy actually maked the cake (the economy) SMALLER than it otherwise would have been.

    In the end if real saving is X number of Dollars (or sacks of salt – if that is what is money in that society) then lending can not be LARGER than X.

    That is the basic logic point – the point you endlessly (and I believe dishonestly) try to dodge.

    It can not be larger – not without terrible consequences.

    Again no "govenment intervention" is actually needed.

    No more than intervention is needed against people who want to rape or murder other people – as long as they decide to resist that temptation.

    All that one needs to ask is "SHOW ME THE MONEY".

    If someone says they have one hundred Dollars to lend then they should be able to SHOW THE ONE HUNDRED DOLLARS.

    Just as if they claim to have lawnmower to lend they should be able to SHOW THE LAWNMOWER.

    Mr Slater (of Slater/Walker) never (as far as I know) wore a mask or carried a gun in his life.

    This did not stop him robbing people (such as my father).

    Jim Slater did not rob people with a gun – he robbed them with a pen.

    Mr Slater pretended his enterprise had money it did not have.

    His own private "credit expansion".

    If only Mr Slater had called himself a "banker" and Slater-Walker a "bank".

    Then George Selgin would hail Jim Slater as a hero – and call any action against him a "government intervention".

    I thought that the first principle of "Free Banking" was that banks should be held to the same laws as any other business.

    If any other business claims to have money it does not have – then the people who make the claim go to jail for fraud.

    Why should bankers be different?

    After all the defence is easy.

    If they really do have the money – then they can SHOW US THE MONEY.

    Just as if I have a lawnmower I can SHOW YOU THE LAWNMOWER.

    Not a bit of paper (or a computer screen) with the word "lawnmower" written on it.

    If that is O.K. – then Jim Slater (and Bernie Madoff and…..) are all fine honest gentlemen.

    They were just engaged in "credit expansion", "crediting to the account" and so on.

    No bad consequences will come from their activities – which are fine and can go on for ever.

    • George Selgin

      "However, what if I never had a lawnmower?

      How can I "lend" you a lawnmower I do not have?

      Ditto with a hundred Dollars – I can not really "lend" you a hundred Dollars if I do not have a hundred Dollars."

      Paul, as Michael M. remarks, you don't get it. Banks are intermediaries; they lend what is first lent to them. And (unless they are fiat-money creating central banks), they must first "have" what they lend: otherwise, when the check returns, the banker can't pay! This is so rudimentary that I blush to have to explain it on this forum. But Paul, if you really believe that any banker can lend without first attracting funds from the public, why waste time here? Why not go and open and bank and put your "thin air" where your mouth is?

      And please make it a public company, so I can sell it short!

      • Rob R.


        Slightly off topic but I would welcome your views. Supporters of endogenous money theory make the claim that banks in today's banking system can indeed create money "out of thin air" and then find the reserves later. What they appear to mean is that banks can make loans based upon likely profitability and can then borrow the required funds at the interbank rate. The central bank will (if needed) create the reserves again apparently "out of thin air". In essence the claim is that banks will lend the maximum they are able to profitably give the current interbank rate and the CB will create the reserves needed. The CB would need to adjust the interbank rate if they wanted to control the level of lending.

        Are the endogenous money theorists correct in their description of this model ? If so, do you see this as just an artifact of a CB-controlled fiat money system and under free banking banks would always as you say above be "intermediaries; they lend what is first lent to them" ?

        • George Selgin

          Rob, sorry this is late…but, to answer your question, I think your position is indeed correct (though I would temper that "always" to a mere tendency). I wrote long ago on the topic, in an SEJ piece, "Commercial Bank's as Intermediaries."

          Generally speaking, I've never been impressed by the Post-Keynesian take on "endogenous" money, which confuses a truly demand determined nominal stock with an "infinitely interest elastic" one. The latter sort of "endogeneity" is, of course, to be realized only by an interest-rate pegging CB.

      • Mike Sproul

        "Banks are intermediaries; they lend what is first lent to them. And (unless they are fiat-money creating central banks), they must first "have" what they lend: otherwise, when the check returns, the banker can't pay! "

        That is incorrect. I bring the deed to my $100 house to my note-issuing bank. The banker prints up $70 of his notes and hands them to me in exchange for the deed. That bank might never have borrowed anything from anyone. When the check returns, it is either paid out of existing reserves, or else the banker has to sell the deed (or, more typically, his lien on the deed) to get enough money (or other stuff of value) to pay off the check.

        • Agreed.

          You bring the deed for your $100k house to a banker. The banker prints notes promising $70k (or a specified quantity of gold or any other standard of value) and hands these notes to you. I hand you another $30k from my pocket. You hand the deed to the banker.

          The banker holds the deed as collateral until I pay him another $70k which you may then claim from him. In the meantime, you hold the banker's notes in lieu of $70k, knowing that the banker holds the deed to the house and that you may reclaim its value (less my equity) if I ultimately fail to pay the $70k.

          If the banker's notes are negotiable, you need not hold them. Realizing that the notes represent the credible value of a house, George may accept them in trade just as you did. The notes are for all intents and purposes equivalent to $70k, because the holder of a note may claim so much of the value of a real, valuable asset, the house.

          By the time I pay the banker $70k, you don't hold his negotiable notes anymore. Someone else holds the notes, and someone else ultimately exchanges them for $70k as I pay the debt.

          Before someone exchanges one of the banker's note for dollars, the note is money as surely as a dollar is money. When someone exchanges a note for dollars at the bank, it ceases to be money. In this way, bankers continually create and destroy money in response to the demand for credit.

          For most of human history, money appeared this way faster than it disappeared. The volume of leveragable wealth continually grew, so the money supply continually grew.

          In the not too distant future, the human population will shrink globally, and money will disappear faster than it appears. Before the population shrinks, it ages rapidly. We see signs of this demographic transition now, but we discuss it remarkably little.

        • In a meaningful sense, the banker does lend what is lent to him, but what is lent to him is a house, not dollars.

  • MichaelM

    You're still missing how banking works Paul. A bank isn't lending anything it doesn't have when it maintains a fractional reserve, its lending a portion of its existing liabilities. What you really seem to be arguing against is the treatment of certain kinds of liabilities as loanable funds.

    Sounds a mite anti-freedom to me. Shouldn't people be allowed to treat whatever they want as money as long as the people they're contracting with agree?

  • Paul Marks

    Perhaps Michael really does not know – perhaps he thinks that when a banker talks of "capital" and "reserves" he is not (mostly) just blowing smoke.

    There is no pile of cash (with a notice on it saying "capital and reserves") somewhere that matches bank lending. But (as I say above) perhaps Michael (honestly and sincerely and with no corrupt intent) does not know that.

    However you, George Selgin, DO KNOW.

    Yet you write here that banks attract real savings from the public that match their loans.

    George Selgin – you know that is NOT TRUE.

    It is NOT the case that I (as banker) get the public to entrust me with one hundred lawn mowers so that I can lend out 90 (or even 100) lawn mowers.

    The vast majority of the "lawn mowers" that the banker lends out DO NOT EXIST.

    They are not entrusted to the banker by real savings – they DO NOT EXIST.

    Otherwise "broad money" (bank credit) could never be bigger than the monetary base – no creation of a credit bubble (a boom-bust) could occur.

    I repeat that Micheal may not know this (I am not claiming that he does).

    But you, George Selgin, do know all this – indeed you know it vastly better than I do.

    What you write here is not an honest mistake.

    It is deliberate dishonesty.

  • Paul Marks

    If "Free Banking" is to work it must be based on the truth (not upon lies).

    If a banker can attract one billion Dollars of real savings from people (including himself) prepared to entrust their savings to be invested by him (of course the words "deposit" and "depositors" should not be used as they are wildly misleading) then the banker has one billion Dollars to lend out.

    Not a Dollar more than this.

    And the people who entrusted the money to him (to be lent out) do not have the money any more – till when and IF the money is repaid by the borrowers.

  • Paul Marks

    The last few days have been a shock (a profound shock) to me.

    We have moved from a early 19th century Banking School position – that credit expansion is O.K. if it is "moderate" and in the hands of "responsble" people for the "needs of trade".

    This was the position that the early 19th century Currency School attacked – and they were right about the problem, but wrong about the solution (resticting the issue of bank notes does not solve the problem – as banks just find other ways to indulge in credit expansion, i.e. lending out "money" that no one really saved).

    Indeed it is possible that there IS NO SOLUTION – as bankers (being very clever indeed) will find ways to create a credit expansion (a boom-bust) regardless of the legal framework.

    And, I repeat, modern government intevention (at least that of the 20th century and 21 century) has been about making credit-money bubbles BIGGER not smaller – under the influence of the "cheap money", "low interest rate", "demand" fallacy.

    However, in recent days there has been a blatent denial that there is any such thing as credit expansion at all.

    On the contrary, we are told, bankers do not expand credit – not at all.

    Every Dollar of loans (we are told) is backed by a Dollar of "capital and reserves". A magic pile of cash that exists in a shed over there somewhere (but no one is allowed to see it – just now, come back later……).

    The debate between the Banking School and the Currency School was just that – a debate. A debate whether credit expansion (under certain conditions) was a good thing or not.

    A blatent statement that there is NO SUCH THING as credit expansion (no possible difference in size between, for example, M0 and M3) is not part of any debate.

    It is dishonesty.

    Blatent dishonesty.


    I repeat that I am shocked, profoundly shocked, by this turn of events.

    I did not expect it. And I do not know how to deal with it.

  • Paul Marks

    Mike Sproul made a point – I am sorry I did not see it till now.

    The point that if a bank is allowed to print notes and a person wants to sell his house for those notes, then no real savings need be involved.

    That is totally correct – and I have to admit that.

    If someone wants to sell their house for a some attractive bits of paper (I think Mike said 70) then that is THEIR CHOICE.

    As long as (of course) the bank does not call the notes "Dollars" (or whatnot) and does not claim that they "repesent gold" or some other thing the bank DOES NOT HAVE.

    By the way….

    If anyone really wants to sell their house (no Property Tax outstanding and structurally sound house) for 70 bits of paper with "Paul Marks" written on them – I am in the market.

    I can get those notes produced in a couple of minutes – and I will not even "print" them.

    I will hand write each note.

    You will have 70 originals.

    Actually I am NOT mocking this (at least not totally).

    The subjective theory of economic value indicates that if someone really values 70 pieces of paper with my name (or the name of a bank) written on them more than their house – then an exchange benefits both sides.

    I get a house – which I value more than the 70 bits of paper.

    And the the previous owner of the house gets 70 bits of paper – which they value more than the house.

    Both sides of the exchange benefit.

    And YES no real savings are involved.

    And no borrowing either.

    • When I exchange my house for promissory notes, I do not simply exchange it for attractive bits of paper. You might as well say that my deed to the house is only an attractive bit of paper and that I hold nothing more valuable than paper when I exchange gold for the deed.

  • Mike Sproul


    Actually, the same thing would be true if the 'dollars' issued by the bank were checking account dollars, rather than paper dollars. The physical form of a dollar is irrelevant. In that case I give the bank a lien on my $100 house, and the bank gives me 70 checking account dollars in exchange. If all of my checking account dollars are then presented to the bank, then the bank could either pay $70 out of its reserves, sell the lien for $70 and pay of the checking account dollars with that, or use the $70 lien to directly buy back the 70 checking account dollars that it issued.

  • Steve Horwitz


    I find the accusation of lying and dishonesty to be…. a shocking turn of events. If you think that those of us who are defending fractional reserve banking *and also agreeing that mixed with central banking it is a recipe for disaster* to be liars, please do two things: 1) tell us what we have to gain by lying and 2) consider whether you really want to be associated with liars like us.

  • Paul Marks

    Mike Sproul – remember what I wrote, the notes could NOT be called "Dollars".

    It would have to be clearly stated that the notes were NOT Dollars for the operation to be legit.

    The exchange would be 70 pieces of paper (with the name of the bank tastefully written upon them) for the house – that would be legit.

    Any claim that they were "Dollars" let alone "represented" some commodity – would not be legit.

    Steve Horwitz.

    You do not appear to have understood what I wrote – so I will repeat it.

    I did NOT mention your name.

    Also I did NOT say that people who supported "fractional reserve banking" were liars.

    There was a claim (by more than one person – but not you) that there is no such thing as credit expansion.

    That every Dollar of loans is "by every bank" backed up (Dollar for Dollar) by a Dollar of "capital and reserves". That there is a big pile of cash somewhere called "capital and reserves" that backs up "EVERY DOLLAR" of loans.

    If that was true there there would be no such thing as credit expansion.

    M3 (and other measures of bank credit) could never be bigger than the monetary base (clearly absurd) and so on.

    Credit bubbles and boom-bust events would not even be possible.

    You have NOT claimed this.

    Therefore I have NOT called you are liar.

    If you had claimed this (as others did) I would have called you a liar.

    Because you would have been telling lies.

    Someone who tells lies is a liar.

    Someone who does not tell lies is NOT liar.

    Understand now?

    • Mike Sproul

      Yes, dollars issued by bank of america would have to be called B of A dollars, and dollars issued by Chase would have to be called Chase dollars. B of A dollars appear on the liability side of B of A's balance sheet but not on Chase's balance sheet.

  • Paul Marks

    Actually I need to correct the above – because of the two people who made the (FALSE) claims one might not know they are false.

    MichealM may sincely and honestly belive that bank loans are 100% covered by a big pile of cash called "capital and reserves", i.e. that there is no such thing as credit expansion.

    This is wrong – but MichealM may not know it is wrong.

    However, GEORGE SELGIN does know it is wrong – and backed up the claim anyway.

    To back up a claim you KNOW not to be be true is to LIE.

  • Paul Marks

    I REPEAT (as I have done several times).

    This has nothing to do with a legitimate debate over fractional reserve banking – credit expansion (lending out "money" that was never really saved).

    Such as the debate between the Banking School and the Currency School in the early 19th century.

    Indeed this claim (the claim that 100% of loans are backed Dollar for Dollar by a big pile of cash called "capital and reserves") would make that debate VANISH.

    As there would be nothing to debate about – as there would be no such thing as credit expansion (no such thing as boom-busts).

    The claim was FALSE.

    Obviously FALSE.

    And it needs to be WITHDRAWN (and APOLOGISED for), before there can be any legitimate debate.

    Not just with me (I am not important – I am just a working Joe) – with ANYONE.

    It is simply not acceptable for a person to tell a LIE – and then just carry on as if nothing had happened.

    Especially if that person is a professional scholar.

  • Steve Horwitz

    Who said there is no such thing as credit expansion? I believe all of us would agree (contra the Banking School) that *central banks* can cause credit expansions via the injection of reserves. However, those of us who favor free banking would deny that such a system is capable of any sort of meaningful credit expansion (assuming by that one means "in excess of people's desired money holdings, as opposed to a warranted increase in the money supply to meet changes in that demand to hold). The problem, as we see it, is the central bank, not fractional reserves per se. That is where the disagreement is.

    I've written papers and books talking about the problems associated with inflation, and my work is consonant with that of Selgin and White, and I know that NONE of us would deny the possibility of credit expansion.

    So what exactly are you talking about?

  • Steve Horwitz

    And no one said that "capital and reserves" was a big pile of cash. Fractional reserve banks have assets to back their liabilities, only a fraction of those are in the form of cash. But the rest are indeed assets convertible to cash. And you still need to explain how systems like those in Canada and Scotland that had fractional reserves and no central bank managed to avoid large boom and bust cycles and financial panics.

  • Paul Marks

    No Mike Sproul – the word "Dollars" should not be used at all.

    That would simply confuse people – they might think that these notes they got from banks were legal tender for the payment of taxes.

    Rather that, properly speaking, works of art – which they accepted because they liked looking at them.

    That can happen – for example Russian Imperial Bonds and Imperial Chinese Railway Bonds traded (and still trade) long after anyone had hopes of them being paid (in the currency they were supposed to be paid in).

    They traded as WORKS OF ART – and if Bank of America (and J.P. Morgan Chase and….) had designs of sufficient quality their pieces of paper might also trade as WORKS OF ART (and even be exchanged for houses).

    But the word "Dollars" should NOT be used – as this would simply confuse the issue.

    Of course this should not be confused with the issue of PRIVATE CURRENCIES (private money).

    I totally oppose the action of Congress in the 1850s in banning the private minting of gold and silver coins – which was common in the West at the time.

    And if any bank wishes to issue notes claiming to have gold, silver (or any other) commodity – that should be up to buyers and sellers.

    For example if a bank issues one million notes each claiming to represent one ounce of copper (and the bank ACTUALLY HAS ONE MILLION OUCES OF COPPER) then I can not see why anyone should have a problem with that.

    When someone came to the bank with a note – one ounce of copper would be given to them, and the note would be DESTROYED.

    Thus the "two sides of the balance sheet" (as you put it) would avoid fraud.

    Alternatively, if the bank does not acutally have the copper, it should avoid the claim that the notes somehow represent ounces of copper. And the notes would be marketed as WORKS OF ART.

    In this case also, no fraud would have been committed.

    Steve Horwitz.

    The context of the discussion (on this AND OTHER) threads was plain.

    MichealM. claimed (repeatedly) that banks do NOT extend credit-money – that (on the contrary) every Dollar of bank loans is backed by a Dollar of "capital and reserves".

    An utterly absurd statement. As it would mean that bank credit ("broad money" the credit bubble – call it what you will) could never be bigger than the monetary base (i.e. that M3 and the other measues of bank credit could never be bigger than the monetary base – and that credit bubbles were impossible).

    But one I was prepared to let slide – on the grounds that I do not know the man and he might honestly and sincerly believe this nonsense.

    However, then George Selgin came in and BACKED UP MichealM.


    George Selgin knows the claim is NOT TRUE.

    He was not making a mistake – he was LYING.

    That is what is unacceptable.

    By the way….

    Strictly speaking this has got NOTHING TO DO with a debate on factional reserve banking.

    Socmeone can say "credit expansion is a good thing – if banks just loaned out real savings, interest rates would be too high and not enough money would be loaned out for the needs of trade".

    I would oppose that – but it is NOT a lie.

    It is a point of view.

    What is a LIE is to claim that there is no such thing as credit money expansion.

    That every Dollar of loans simply represents a Dollar of "capital and reserves" the banks have in their vaults.

    That is the lie.

    As I have said MANY times before….

    When a banker talks about "capital and reserves" they are often just blowing smoke.

    A simple way to check is to ask to SEE this "capital and reserves".

    I have no desire to steal this money – but have as many armed guards as you like, if you do not trust me.

    But I will not be shown this "100% backing" that MichealM (REPEATEDLY) claimed existed.


    Again I never asked George Selgin to BACK UP MichealM.

    He MADE A CHOICE to do that.

    A bad choice.

  • As in other comments I made previously, fractional reserve banking to be honest must produce perfectly clear contract titles:

    – 100% reserve banking notes and demand deposits are able to label it as commodity money.
    – Fractional reserve banking notes and demand deposits must be labeled as a “promise of payment”, this titles are not fungible with commodity money and must be exchanged in different accountable entities (as different currencies).

    The theoretical discussion of both being exchangeable at par or not is a different matter and we could leave it to the market. Personally I think, sooner or later a risk discount will be applied and if this is true, good money will drive bad money away.

  • Paul Marks

    Mike "promissory notes".

    Promising WHAT?

    Gold? Silver? Copper? WHAT ARE YOU PROMISING?

    And where are you going to get this stuff from?

    And how?

    The words "promissary notes" are not MAGIC words – any more than the words "capital and reserves" are MAGIC words.

    Either you have got the stuff or you have not.

    If you give a note saying "I have got an once of copper right now" or "I WILL HAVE an ounce of copper by the first of August 2012".

    You still either have to have the copper – or a real plan to get it.

    Using the WORDS "promissory notes" or the WORDS "capital and reserves" achieves NOTHING.

    Do not show me your WORDS (on a note) show me your ACTIONS.

    Show me the actual commodity – in your vault, in the full amount you promised.

    Otherwise your "promissory notes" are an empty promise.

    "But I could be promising Federal Reserve fiat money notes".

    Then SHOW ME those Federal Reserve fiat notes.

    At this time of day the world has had a enough of bankers and their "promises".

  • Paul Marks

    Martin Brock "what is lent to a banker is a house not Dollars".

    I see so I go along and "deposit" a house at the bank in my savings account.

    The word "deposit" is (of course) wildly misleading – as the money is to be lent out (NOT "deposited").

    But to talk of houses being deposited is to go into Crazy Town.

    Next stop California…

    Where people sue the banks – because they do not want to pay back the money they borrowed. I.E. because they are deadbeats who borrowed more money than they could afford – and now whine about it.

    And towns take the houses (but keep the deadbeats in them) by declaring "eminant domain".

    These Californians would LOVE stuff like "the houses are lent to the banks".

    Yes I know that banks lend out far more "money" than was ever really saved (I have said that myself – many times), but to talk of houses being lent to banks (and on and on) is really California language.

    They have got an excuse – between the sun and the drugs they do not have many brain cells left.

    But I will not accept such talk from non Californians.

    • You may deposit title to a house in a bank. A house is valuable to you only if you hold its title.

      • Paul Marks

        I apologise Martin.

        I was too dumb (and/or too paranoid)to understand that this is what you meant.

        Yes indeed the legal documents indicating ownership of a house may be kept (for safe keeping). Or at a safe deposit centre.

        Of course a safe deposit centre uses the word "deposit" in its literal sense – and quite rightly requires depositors to pay for depositing.

        It astonishes me that people think that a bank would PAY THEM for a (literal definition) deposit.

        If someone wants interest they must accept that the money will be LENT OUT (not "deposited" in the literal sense of the word).

        And "lent out" must involve RISK.

        All investment involves RISK.

        I could go into the non real savings aspect (which is on top of all this). And how the importance of real savings (in the system) has decline over time – and the bubble got bigger and bigger….

        But it is too depressing – and this is my birthday.

  • Paul Marks

    By the way Martin's other comment made a lot more sense (at least I think so).

    But it is hard to examine the comments correctly – because the comments that I see on my e.mail account do not seem to be here.

    I see a comment – and click on the link to read it and reply properly, but then the comment is not here.


    So I may be being unjust – as I am actually replying without seeing what I am replying to.

    So I end up replying to the line or two that I remember.

    I would like to see the full comments and to look at them as I write my replies.

  • Vinay Kolhatkar

    "For commercial banks to hold 100% reserves in the form of fiat money issued by the federal government would, however, change drastically the function of the banks. Instead of funding productive enterprises, the banks would instead only fund the federal government. Fewer loanable funds would be available to the private economy, and more to the government. Private investment would be suppressed, and public spending enlarged."

    This is not necessarily true. Banks could issue long-term cedrtificates of deposit that are listed on stock exchanges, and they would satisfy demand for liquidity at the same time not expose the bank to illiquidity.

    "If withdrawals were too great for a bank to satisfy without suffering severe losses from hasty asset liquidation, the banker had the option to defer redemption for 60 or 90 days by requiring notice of intent to withdraw to be given that far in advance."

    Then that is not FRB, as the deposit is not redeemable on demand.

    "More importantly, banks made default unlikely by providing their depositors with credible assurances that the bank would maintain solvency, that is, assets sufficient to pay in full even the last in line, even under adverse circumstance. To provide credible assurance, banks before deposit insurance held much higher capital than they do today, in the neighborhood of 20%."

    This is the real issue. In a free market, it would be impossible to function on ridiculous levels of reserves like 5%, and even more ludicrous levels of capital like less than 10%. No other form of business, not even other financial intermediaries like hedge funds or finance companies, let alone manufacturing companies, can get away with it.

    So yes, FRB is not inherently fradulent or destabilising, but current levels of low reserves & low capital do appear absolutely ridiculous and woudl not survive a real free market for a day. Why, the rating agencies would mark the debt of such banks as junk on day one in the absence of all government priviliges, insurance, subsidies & bailouts.