Evan's Easy Economics: #23 The Obvious Evils of Fractional Reserve Banking

Fractional Reserve Banking: It's Obviously Evil

Some of you might be thinking “Hey, this isn't so bad! In fact, it's a good idea!”, others may be thinking “What the heck?! There's no way this can be legal!!” Others may even be thinking “Who cares, I want to go play some football!”

Well, to the latter, this sort of thinking is exactly the reason why fractional reserve banking is possible – people just don't care. To the former, I can only hope that this section will show exactly why fractional reserve banking is evil, and show just how bad things have gotten. To those in the middle – darn tootin'!

With fractional reserve banking, the banks were allowed to take people's money – gold and silver – and then create up to ten times the number of receipts for the gold, and turn around and give the phony money to someone else.

“Why is this evil and immoral? More people have money, and more people have access to money! Plus, people are getting paid money to keep their metals in a bank... sounds pretty nice!”, the first group is thinking.

Well, if the argument that fractional reserve banking is synonymous with counterfeiting and lying doesn't win you over, maybe we need to remember our second rule of good money: the less of any commodity (in this case, money) there is, the more it's worth. Reversing this, the more of a commodity there is, the less it's worth.

So if a bank can just print out more dollars than there really are, then every other dollar in existence becomes worth less. That means that creating any amount of money is the exact same thing as theft: the person creating the money is stealing the value of every other person's money. That means that, if a bank lends out 90% of the money you put into the bank, and thus creates 10 times the amount of money, every other person's bills of credit become worth less without them even knowing it. This means that, for some “strange” reason, the watermelon that you bought last year for $3.00 cost $3.25 this year, and will probably cost $3.50 next year.

The watermelon isn't actually worth more - the value of your money is going down.

In addition to this practice being nothing more than a drain on the value of your money, we'll also see yet another problem. If there were to be a bank run, there would be no possible way that the banks could even hope to redeem all the money that the customers deserve. If one dollar is turned into 100, and everyone goes to get their money, then the majority would not be able to receive their money. Fractional reserve banking is also theft because the bank is able to collect interest on $9 worth of money, when it actually only has one dollar.

Another interesting result of this policy involves the idea of collateral. When people take a loan out from the bank, both parties are required to put up collateral. Usually the debtor will put up his house or his fancy car, whereas the bank will put up a lot of money. What’s important to realize, though, is that the bank isn’t actually putting up any collateral: the money it’s putting up as collateral doesn’t really exist. For example, if the bank promises a million dollars in collateral it is only risking $100,000 – the other $900,000 were created through fractional reserve banking out of thin air!

The bank is actually able to steal the wealth of everyone's money in the economy through inflation, and it's able to collect interest on money it doesn’t even have, and it's able to lend the money out before the newly created money has lost any wealth (we’ll talk about this later), and it's able to put up money that doesn't exist as collateral on contracts when the other party has to put up real wealth, and it's able to get away with it!

Imagine if another sector of the economy was able to do this – if a farmer produced only 1 pound of carrots but then promised 1 pound of carrots to ten people, he would be thrown in jail! In fact whenever someone else does do this, they do go to jail – the crime is called counterfeiting.

For some reason fractional reserve banking is accepted. This literally means that in our society it's acceptable for one group of people to counterfeit, but illegal for others. Why should the mobster making fake money be thrown in jail if some bankster is just doing the same thing with the government's approval?

The final argument against fractional reserve banking is that it leads to the boom bust cycle.