Fractional Reserve System?

I found this interesting site about the fractional reserve system at:

http://www.mind-trek.com/reports/tl17a.htm

Is this how the banking system really works and is the average Joe really getting screwed by it?:confused:

For those of you who do not want to read the article, it basically states that banks can loan out more money than they actually have deposited. They then can collect the interests on these loans and then loan out many times the money they make from from the interest on these loans.

This effect “snowballs” where the banks are making ungodly amounts of money while causing inflation that makes the american public’s money worth less and less every day.

IANAE but AFAIK banks indeed lend out money they have deposited, and in fact, more than that. They can lend out even more if the people they lend it out to pay it to someone who puts it in a bank, but I can’t remember this. Ask an economist

This is generally accepted as normal by people who know something about it. Whether the % is too high in America, or if it ruins the economy, I have no idea.

I do note the site linked to looks rather kooky. For instance random capitalisation and confusion (if congress sold your county to someone they’re not breaking the law). I might have missed it, but it didn’t seem to explain HOW this ruined the economy (sorry if I missed that bit)

I’m not an economist, but my attenae went up with the Lincoln quote right at the beginning. According to Snopes Lincoln never said it or wrote it:

Snopes doesn’t refer to the Wilson quotation, but I notice that the webpage doesn’t give a citation for that one, either, so I’m dubious.

It is well enough that the people of the nation do not understand our banking and monetary system for, if they did, I believe that there would be a revolution before tomorrow morning.
Henry Ford Sr

I consider people ranting against the Fed in the same category as creationists and flat earthers.

As Henry Ford Sr. states, the banking system is probably like sauasage making and political compromising. The reserve system might appear strange but it can be a very effective economic spur and brake. As

If the required reserve was 100%, economic growth would slow to a crawl. It would be like being on the gold standard. Economic growth would be limited to the growth of the amount of currency in circulation.
I believe a more efficient use of the reserve requirement by the Fed rather than changes in Fed Funds and Discount Rate would result in less bumpy economic growth. In this I share the belief of (God help me) John Kenneth Galbraith.

I’ve now browsed a bit on the other pages linked to the website in the OP. It seems to be a haven for the de-taxers and “sovereign citizen” folks. I don’t know much about economics and banking, but I’m very familar with the de-taxers and sovereign cits. Their legal “theories” are complete gibberish, so I wouldn’t put any faith in anything on those webpages.

Fractional Reserve Banking is, in contrast to that article’s claims, dramatically more efficient than pure reserve banking. Fractional Reserve Banking allows the banks to loan out money, increasing the money supply and thus the strength of the economy, and paying interest on the accounts of those who have deposits. The only person who “loses” in this proposition is the recipient of the loan who has to pay back interest, and I think we can tell by people’s willingness to take out loans that they consider it a fair trade to pay interest in order to recieve an influx of cash.

I am not a conspiracy theorist or anything but the system does seem to stink to high heaven. If more money needs to be introduced into the economy, it seems it would benefit the people more if the government did it by “printing”(i know most money circulating is not currency but money registered into accounts) more money and spending it into the economy to pay for government services instead of borrowing money from bankers and having to pay interest to them.

I admit I am not an economists, it just seems like common sense if I am understanding the system correctly.

Please someone explain the benefits of our current system to the one I just proposed.

As I read more of the article, I think the confusion comes down to the issue of the money supply. The write of the article seems to think that increasing the money supply is a bad thing, that it will instantly devalue all other money in circulation. This is not so. Fractional Reserve Banking doesn’t create money out of thin air, it simply allows the much more efficient distribution of the money that exists, keeping a larger percentage of it in circulation. Intelligent management of the economy, which is the job of the Federal Reserve, can keep inflation in check while still reaping the economic benefits of an increased money supply. I should note that banks have a vested interest in keeping inflation as LOW as possible, since inflation devalues debts that are owed to them.

Oh, and for the record, IANAEconomist.

Jodocus: Creating money that does not exist causes inflation, in which money in circulation becomes less valuable because there is more of it around. Prices rise, and loans, when repaid, do not cover the costs of making the initial loan. Inflation wipes out people’s savings, and is generally a very bad thing for an economy. Keeping inflation as low as possible, while avoiding the opposite problem of DEflation, is one of the important jobs of the Federal Reserve.

Aleron: So aren’t banks “creating out of thin air” more money by loaning out money they don’t have? This new money circulates as checks and wire transfers thus reducing the value of money overall.

I don’t mean to be argumentative with you, I am just trying to understand the concept :slight_smile:

So, Jodocus, you didn’t like the replies you received twenty-four hours ago when you posted the same thread? :wink:

Ah, me. There is a guy here in north San Diego County who leases time on one of the local access stations to rant and rave on this same subject. It’s always fun to listen to when I run across him while channel surfing. The link you gave was pretty much material of the same ilk.

If the following simplified explanation ticks off someone in the banking business, forgive me.

Banks can not lend out more money than they have in deposits. Period. Banks are regulated and are required to keep approximately 10% of their total deposits in reserve. There is actually a two-tiered level of required reserves but this is a decent approximation. In any case, the reserve level is not zero. This means that on a bank’s balance sheet we see initially, oh say, $10,000 dollars in total deposits. These are liabilities from the bank’s perspective since they, in effect, owe that money to the depositors. The required reserve of 10% limits the amount of money loaned, which appears on the asset side of their balance sheet, to no more than $9,000.

Everything’s cool, right. But in our simple example here there is only one bank in town. The $9,000 the bank loaned out has now been re-deposited by the young couple financing their remodel in their checking account for expenses. The bank now has $19,000 dollars in deposits. The required reserve of 10% means they can now have $17,100 out in loans. They already have $9,000 out in loans but clearly have $8,100 in excess deposits now available for lending. The bank manager finds a suitable customer to whom to lend the money and does so. And the borrower, of course, promptly deposits her loan in her account and the bank now has $27,100 in total deposits. The required reserve of 10%…

Can you see where this is going? This is a decreasing geometrical progression of sums. If the bank continues the cycle* ad infinitum* the total deposits on hand at the bank will be $100,000. It does not go increase indefinitely. The banks do not have carte blanche to create unlimited amounts of money. The increase of money in circulation is referred to as the money multiplier. The multiplier is equal to 1/(1-R), where R equals the required reserve.

Looking at the math you can see that an ‘R’ of zero leads to bad news. Banks would, in that case, be free to add to the money supply to any extent their boldness allowed. In the early, unregulated days of banking referred to by the conspiracy folks I wouldn’t be surprised that there was tremendous abuse. Of course today even with a required reserve there is no guarantee that banks won’t make bad decisions. But it is a far cry from the situation often described by the Econo-luddites.

So are banks creating more money, even though it is limited by the reserve requirements?

If not, then how does new money get introduced into the economy. I admit I am having some difficulty grasping these concepts.

Thanks for your patience

Banks are not creating money, they are increasing the money supply. They simply increase the percentage of the available money that is circulating in the economy at any given time.

Thanks guys for your input. I think I understand the system better now!

No worries, Jodocus. It’s no problem for as much as I can help.

To answer, yep, the banks are increasing the money supply when they lend out money. As we’ve seen (God, I sound like a prof) the total amount of increase is limited. Bear in mind, however, the money supply is decreased whenever a borrower pays back any portion of his or her loan.

Say the couple of the previous example decides to not do their remodel. They write a check to the bank for $9,000 to pay off their loan. The bank takes off $9,000 in deposits from the couple’s checking account to cover the draft and cancel the loan. The bank’s total deposits have been decreased by $9,000. Just as the money supply was increased when the couple drew the loan it was decreased when the couple paid the loan off. I realize I’m ignoring interest in this example. In reference to the link cited in the OP it’s not really germane.

The money supply goes up or down with the relative abundance of money to be borrowed. Banks are not required to lend to their full ability. If they’re feeling nervous they might hold back loans that might have been made in a more optimistic economic picture. The greater our bank’s net reserves are the smaller the money supply. It’s not so much a matter of ‘new’ money being introduced to the economy as a matter of the amount of ‘grease’ in the economic machine.

Most of us are engaged in our own form of Fractional Reserve Banking.

When we buy a house, say we put 20% of our own funds toward the purchase and borrow the rest. What are we using to guarantee own paper promise? The asset itself, which we would not own if we had not borrowed the money.

Out of thin air, someone with $20,000 ends up with an asset worth $100,000.

And credit cards no down payment is needed. So that system is a fractional reserve system, except the reserve percentage is zero.

I understand the initial reaction, but doesn’t that approach amount to saying the government should give us free money in exchange for votes? That’s a recipe for instant economic disaster, since the power of the government to print money in that scenario is not tied to market forces. Drastic increase in the money supply triggers hyper inflation, everyone’s savings decrease in value, etc.

By contrast, the bank’s power to lend money is subject to market demands, with at least two actors making economic decisions: the bank, and the potential borrower.

The bank has to decide if the borrower is a good risk and what interest rate to charge. If times are good, the bank may be willing to take a greater risk, but if times are tight, the bank may refuse riskier loans, or charge a higher rate of interest.

Then, the borrower has to decide if the terms the bank is offering are worth it. The borrower may agree, or may say the terms aren’t worth it, not take out the loan, and defer the project/purchase until the borrower has saved more money, become a better credit risk, etc.

So, yes, if the bank makes the loan it has increaesd the money supply, but its power to do so is constrained by market forces, rather than being driven by political considerations. That imposes an economic discipline to the increase in the money supply.

Again, IANAE, so I stand to be corrected.

Yes, banks issue loans in excess of the deposits they have on hand. This is how banking, and the whole concept of a money supply works, honest. This is the case even when a gold standard is in place.

What I am about to share is essentially an ad hominem atack, I suppose, but it still seems worthwhile to consider who, exactly, the people making these arguments are, and what their general world view is like.

Much of the material in the link posted dovetails with information given in None Dare Call It Conspiracy and other ultra-right wing writings of the 1960s and 70s. Basically, it sounds like one of the more psedointellectual rants of the John Birch Society.

The arguments are also highly reminiscent of the writings of Fr. Coughlin, a fun-loving Catholic radio evangelist of the 1930s who spent a good deal of time worrying about the Federal Reserve and its role in the worldwide Zionist conspiracy. A number of his close associates went to jail in World War II for their efforts in support of Germany. Eventually the Roman Catholic Church awarded Coughlin with it equivalent of the hat trick: he was defrocked, excommunicated and interdicted. Not only was he not allowed to practice as a priest and thrown out of the Church, he was not supposed to even walk into a church again.

A few years back there was actually a bogus institution called The Fractional Reserve Bank issuing checking accounts. They were worthless, except in the minds of the people running the bank and their few supporters. Timothy McVeigh attempted to pay a bill with a Fractional Reserve Bank check.

Some of these same issues were discussed recently in a thread about a proposal to let Nevada issue its own money.

I’ve seen some good responses so far but I would like to add that the loaning out of money by banks is not the means by which the Federal Reserve manipulates the money supply. Instead this is done through open market operations, the buying and selling of assets such as foriegn currency or bonds. When the Fed buys bonds it prints out the money necessary to purchase it and that money is added to the money supply. When the Fed sells assets it takes the money that it gets and takes it out of circulation, thus decreasing the money supply.