I have heard some people rail against fractional-reserve banking (or, simply, “banking,” I know of no other kind) on occasion, but don’t understand their objections. They seem to think it’s some kind of evil conspiracy, or a way for bankers to coin money out of nothing, or something. But how could industrial capitalism be possible without it?
It’s just folk economics, having money listed in a customer’s account when it’s actually been loaned out to someone else just feels shady and weird to people who don’t know any better, so they conclude it must actually be a shady conspiracy that’s ripping them off.
Just a slightly updated variation on the old world’s contempt for charging interest on loans. Any economic activity that’s not physically tangible runs into these objections.
It’s called “full-reserve banking”. Its kind of a thing (your link mentions a few examples), but pretty uncommon. Basically they take depositor money and charge fees instead of loaning out cash to make a profit.
A few economist have tried to work out ways to make it work large scale, but they all either end up hypothetically abolishing fractional-reserve banks and then positing another institution which ends up being the same thing with another name, or end up assuming obviously silly things (like that someone that wants to buy a house can just make friends with a rich person and borrow the money from them.)
So I’d say you’re right. Large-scale capitalism doesn’t work unless there’s some sort of middle-man system that owes money to one group of people which it loans out to a second group of people.
I don’t have a problem with fractional reserve banking, but you could theoretically run an industrial capitalist economy without it. There are lenders out there who aren’t affiliated with savings institutions (payday lenders, etc.), and there are a number of ways to raise capital without borrowing from a lender (selling shares, etc.).
Sure, but I don’t think that would work very well on a large scale; you need investment banking for big biz.
Well, until the repeal of Glass-Steagall, investment banks weren’t either fractional or full-reserve banks, since they generally didn’t take deposits.
Where did they get their money?
Do you have any cites? I’d be curious to read the papers. For housing, a full-reserve system could just have the government intervene in the lending market (the way we currently do in the US), but then I supposed that doesn’t count as capitalism. Or, you could have a system where the vast majority of people are renters, rather than owners. None of these are systems I’d favor, but it seems like they should be functional at some scale.
Fees and trading stocks/derivatives/etc.
The problem with fractional reserve banking is what happens in the inevitable run/crash, and the attendant incentive problems that creates. The overall effect is that you get greater financial efficiency at the cost of stability, and this tends to privatize gains and socialize losses.
With full reserve banking, there’s no such thing as a run on a bank. If everyone shows up to take their money out, everyone gets their money.
Fundamentally, fractional reserve banking makes its money by paying less for short-term deposits than it earns for long-term loans. Which is great as long as the supply of the former meets the demand of the latter. When it doesn’t, you get a run on the banks. These days, runs are generally prevented by government insurance, which means that in good times, bankers make a bunch of money, and in bad times, the government takes a loss. Privatizing gains and socializing losses.
Once you establish the idea that the government will step in to protect banks from runs, you get moral hazard in banks (and in bank employees) who are encouraged to take larger risks. If they win, they get the money, and if they lose, the government takes the fall. See the recent global financial upset for an example.
Now, you can make a good argument that the added efficiency in the financial sector makes up for that, that we are all made better off by a system where credit is available, and the fact that the administrators of that credit make out like bandits is a small price to pay on a societal level. But it’s not a given.
You can head off some of these problems by limiting the risk Federally-insured banks engage in, and by making them pay adequate insurance premiums. You can’t eliminate Federal losses over the long run entirely, since there’s always the risk of some catastrophic shock which takes down the entire banking system. But we managed pretty well from the period between the end of WWII and the late sixties/early seventies.
I’ve been thinking about this a bit more, and (in my experience) there’s a large overlap between people who object to fractional banking and people who object to the concept of fiat currency. So, for those people, the objection could be that fractional banking looks a lot like printing fiat currency. And in one sense, fractional banking is printing fiat currency (although I think that’s a simplistic way of looking at it). So, that could be the source of the objection.
But why do they object to the concept of fiat currency? Fear of inflation, or does it go deeper?
You got me. Basically, their economic arguments tend to ignore the past 70 years or so of economic knowledge we’ve gained, and from what I can tell, there’s a philosophical objection to the notion that money is basically a concept rather than a physical object. Which, I guess puts us back Human Action’s analysis in post #2.
Or it could be a form of moralism.
BTW, if a U.S. dime were made of gold, it would be worth $91.41. A gold dollar coin would be something you’d have to handle with tweezers.
If a U.S. dime were made of silver, OTOH, it would be worth $1.42.
I’m assuming pure metals, of course; a dime would be worth somewhat less if alloyed with base metal, as it would need to be.
The idea behind gold-backed currency isn’t that the coins or paper money themselves are intrinsically made of a high value metal or product, but that the government requires a bank to give you a certain amount of gold whenever requested in whatever denomination when you want it.
It’s silly because, in open capitalism, we can all buy gold anytime we want with our fiat currency, even though the government isn’t mandating it and it’s not your local bank doing it. And it works just fine. There’s nothing wrong with fiat.
This is the most interesting reply so far, IMO. I’d like to see someone address it.