[ExI] Fractional reserve banking (was Ron Paul's letter)

[Eric Messick]

Lee Corbin wrote:

>[...] Now this isn't all
>bad IMO, because an expanding economy needs more money,
>and this function could (and should have) replaced taxation.

>[...] The root
>cause of the problem is fractional reserve banking, which
>artificially creates wealth not backed by anything, where
>I walk down the street confident that I have $10,000
>and I pass someone else under the same illusion, when
>it turns out the bank has just lent my money to him.

The way things work now, the reserve fraction is a slider that the
government gets to control via regulations.  If it were slid all the
way to 1:1, banks could loan no money, and we would be in a situation
with a constant money supply.

IIRC, the slider was set differently for normal banks, versus the "big
five" investment banks.

That slider could be determined as a policy decision by each bank, and
advertised as a way to attract customers.  Higher reserves means your
money is safer.  Pressure from people wanting loans would work to keep
the reserve amount lower, and banks would balance the amount they make
from loans with the need to attract money to loan.

For this to work, banks would have to guarantee a reserve rate, and be
willing to be audited so depositors could be confident that the
reserve rate was met.

I've always wondered if an expanding economy really needs an expanding
money supply.  What if money could be divided into arbitrarily small
denominations?  As the ability to produce more goods expanded, we
would see deflation, indicating (quite correctly) that we can now more
easily produce things.

Different players in the market want to see prices change in different
directions.  Big borrowers like inflation, as they get to pay off
loans with inflated currency.  Likewise, big lenders should prefer
deflation.

Strangely, banks (big lenders) create inflation with fractional
reserve lending.  I think this may be related to the root of the
problem that Lee mentioned above.  They're seduced by free money, and
they know they can get away with it because the government will bail
them out.

$700,000,000,000 says they're right. :-(

-eric