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Guest Post: The Problem With Fractional Reserve Banking

Tyler Durden's picture



John Tamny and the Problem with Fractional Reserve Banking





To understand precisely how fractional reserve banking can be seen as fraudulent, just consider if I were to sell my car to two different drivers where both are under the impression that they had full use of the vehicle at any given time.  Because both can’t have access to the car at the same time, the crime of contractual fraud was committed.  In the case of fractional reserve banking, if depositors were to agree that their money was to be used for additional lending, there would be no issue.  But usually depositors don’t fully realize that their funds are not really there in whole.  In a recent study commissioned by The Cobden Center, it was found that 74% of U.K. residents polled believed they were the legal owners of their banking deposits.  And while 61% answered that they wouldn’t mind if their money was used for additional lending, 67% responded that they wanted convenient access to what they saw as their money.  Whether or not one regards fractional reserve banking as a clear case of fraud, it seems that a good portion of the public is wrongly informed on the mechanics of modern day banking.

Besides standing on shaky ethical grounds, what is problematic with fractional reserve banking in practice?  As the Austrian Business Cycle Theory stipulates, credit expansion distorts relative prices and economic calculation to the point where entrepreneurs see long term investment projects as profitable.  The inter-temporal coordination between consumption and production is thrown off by fiduciary media entering the economy which lowers interest rates below the level that would normally exist under natural conditions.  The cheap money causes investment to funnel into high order capital goods while fewer resources are used in the production of consumer goods.  But because consumers themselves haven’t changed their spending patterns so that the pool of real resources isn’t drained as quickly, precious capital ends up being consumed as the eyes of business are blinded by the illusion of low-cost money.  As this truth comes to light, long term investment projects must be abandoned and liquidated.  The large number of “for sale” signs which still dot the yards of the areas most affected by the housing bubble in the U.S. are demonstrative of the harmful effects an inflation-induced boom. And just as money printing by the central bank pushes down interest rates in order to facilitate a boom, unbacked credit expansion has the same effect.

To see how credit, or what is also called fiduciary media, expansion can and does become pyramided through fractional reserve lending, it helps to consult Murray Rothbard’s textbook on banking “The Mystery of Banking.”  To show in detail how exactly banks within a hypothetical competitive banking system with a 20% required reserve rate governed over by the Federal Reserve create fiduciary media and expand credit, Rothbard writes:

To make it simple, suppose we assume that the Fed buys a bond for $1,000 from Jones & Co., and Jones & Co. deposits the bond in Bank A, Citibank. The first step that occurs we have already seen (Figure 10.9) but will be shown again in Figure 11.1. Demand deposits, and therefore the money supply, increase by $1,000, held by Jones & Co., and Citibank’s reserves also go up by $1,000.


With a 20% reserve requirement, the multiplier then becomes 5:1 where Citibank could in theory create as much as $4,000 out of thin air to lend out while still keeping $1,000 on hand as required.   But Citibank can’t just recklessly extend credit by the multiplier of 5:1 immediately, thereby creating a demand deposit of $4,000 for the borrower.  Doing so would risk the newly created money coming into the possession of a rival bank that would demand payment which could obviously not be redeemed.  $4,000 would be called for redemption while Citibank only has $1,000 in possession.  Rothbard notes this and explains further that Citibank will likely “expand much more moderately and cautiously.”  If Citibank were to expand credit by 80% or $800 and create a demand deposit in the form of a loan to Macy’s, the store may in turn purchases furniture from Smith Furniture Co. Smith Furniture Co. then deposits the $800 in its account with Chembank.  Chembank then calls upon Citibank for the $800 which Citibank pays through its reserves of $1,000 provided initially by the Fed’s purchase of a bond from Jones & Co.  Rothbard’s next figure shows how the money supply initially expanded with Citibank’s creating of an $800 loan:

The money supply went from $1,000 to $1,800; an 80% increase.  But as Rothbard notes in regards to Citibank

its increase of the money supply is back to the original $1,000, but now another bank, Bank B, is exactly in the same position as Citibank had been before, except that its new reserves are $800 instead of $1,000. Right now, Bank A has increased the money supply by the original reserve increase of $1,000, but Bank B, ChemBank, has also increased the money supply by an extra $800.

The following figure shows the final result:

The Federal Reserve may have only injected $1,000 into the economy at first but now the money supply stands at $1,800 with $800 being created out of thin air.

With the extra $800, Chembank can now make a loan of $640, or 80%, to another borrower, Joe’s Diner, who could then proceed to purchase goods from a supplier, Robbins Appliance Co., who has an account with Bank C otherwise known as the Bank of Great Neck.  Again, a deposit was created out of thin air that has the backing of the reserves acquired from the previous transactions with Citibank.  The balance ledgers of Chembank and Bank of Great Neck at the end of transaction are presented below:

As the Bank of Great Neck clears the transaction and receives its money from Chembank, Chembank is left with $160 in reserves which is enough to satisfy its 20% reserve requirement.  Throughout this whole affair it becomes clear just how fractional reserve banking works in practice.  As Rothbard writes:

…the process of bank credit expansion has a ripple effect outward from the initial bank. Each outward ripple is less intense. For each succeeding bank increases the money supply by a lower amount (in our example, Bank A increases demand deposits by $1,000, Bank B by $800, and Bank C by $640), each bank increases its loan by a lower amount (Bank A by $800, Bank B by $640), and the increased reserves get distributed to other banks, but in lesser degree (Bank A by $200, Bank B by $160).

 The next step will be for Bank C to expand by 80 percent of its new reserves, which will be $512. And so on from bank to bank, in ever decreasing ripple effects.

Demand deposits end up being ratcheted up in a way where the multiplier, if taken to its full theoretical extent, works its magic as the money supply can go from just $1,000 to $5,000.  Accounting wise, it is obvious exactly how banks extend credit not backed by reserves.  Admittedly this scenario can be a bit difficult to follow so I will present just one more example from economist Robert P. Murphy that will make clear that banks really do have the legal ability to create money out of thin air.  In this scenario which is comparable to Rothbard’s example above, Billy finds $1,000 stuffed away in his attic which he then proceeds to deposit in his account at Bank A.  Bank A, seeing a profit opportunity in Billy’s idle funds, proceeds to make a $9,000 loan to Sally which would still keep the bank within an imposed 10% reserve requirement.  Bank A’s balance sheet is as follows:

Again, Bank A still has $1,000 in physical currency to back its $10,000 in liabilities; thus adhering to the 10% reserve requirement.  But should Sally use her new loan to purchase goods she needs for her business, Bank A would eventually be called on by another bank to redeem the $9,000 which it clearly does not posses.  While Bank A would be foolish to make such a hefty loan, it would still be within the legal confines of the 10% reserve requirement.  So by adhering to the reserve requirement, banks really can create money out of thin air simply by adjusting their ledgers in a way to extend credit.

The problem with all of these examples is that they assume that the original depositors will not drawdown their accounts which would put banks that lend out more than they have on reserve under pressure to remain solvent.  If a bank experiences a large withdraw of funds, the money supply will end up contracting since it can’t extend credit like before as it loses reserves to meet its requirement.  The same happens, as Rothbard shows, when borrowers repay their loans.  Take for example the Rothbard Bank that has $50,000 of deposits but makes an $80,000 loan to Smith.  When Smith eventually repays his loan with interest, the $80,000 that was recorded as a liability and asset is then erased.  Because fractional reserve banks end up making money off of inflationary lending to many different patrons, one borrower repaying his loan doesn’t present too great of a risk.  This doesn’t dispute the fact that fractional reserve lending leaves banks as, in Rothbard’s words, “sitting ducks” because while credit can expand, it can also contract.  Just take a look at the following chart.

If fractional reserve banking doesn’t create money out of thin air, how then exactly did M1 grow by negative percentages?  Where did the money disappear to then if it wasn’t created solely by the magic of adjusting the bank ledger to represent a newly created credit?  If, as Tamny alleges, the money supply doesn’t expand via the money multiplier, how did it then contract?

Tamny ends up confusing the money multiplier of fractional reserve banks creating money out of nothing with the Keynesian multiplier which holds that government spending creates extra income “if it changes hands enough times.”  While it’s true that money changing hands does not lead to an increase in the money supply, attempting to cash in on lending long with funds you don’t really have does.  As long as a majority of the customers leave their deposits intact and don’t withdraw them too quickly, the pyramid scheme can continue ad infinitum if only in theory.  Milton Friedman, who knew something about banking and monetary policy, made the distinction in Capitalism and Freedom between the non-effect of the Keynesian multiplier with the fact that banks can take in a dollar deposit and

add fifteen or twenty cents to its cash; the rest it will lend out through another window. The borrower may in turn rede-posit it, in this or another bank, and the process is repeated. The result is that for every dollar of cash owned by banks, they owe several dollars of deposits. The total stock of money — cash plus deposits — for a given amount of cash is therefore higher the larger the fraction of its money the public is willing to hold as deposits.

Despite his shortcomings in recognizing the utterly destructive nature of central banking, Friedman understood that fractional reserve banking does create money out of thin air and puts the whole system at risk if depositors begin withdrawing their funds en masse.

Tamny proceeds to claim that fractional reserve banking runs counter to capitalism.  He claims that if banks were mere storehouses that charged depositors a fee, then they wouldn’t be banks.  This is basically correct.  But then he goes on to say because individuals want to be paid for storing their monies, these warehouses don’t exist and hence fractional reserve banking becomes the norm.  What Tamny gives is a false choice; one or the other.  In reality, just as people pay storage unit owners to safeguard their possessions, some may pay for warehousing of their money as history has shown.  If some individuals in turn wish to be paid interest for their deposits, they may sign over their funds for a specific period of time and interest for the bank to lend it out at a higher rate.  Capitalism doesn’t rely upon fractional reserve lending; a government and financial sector addicted to cheap money do.

In the end, Tamny thankfully realizes that the backstop provided by the Federal Reserve and government deposit insurance provides the perfect mix of incentives for banks to engage in risky lending.  Abolishing both would be a great first step in achieving sounder money and a healthier banking system.  It is unfortunate that he doesn’t hold the same to be true of fractional reserve banking.  As Ludwig von Mises, whom Tamny quotes frequently in his work, wrote:

It would be a mistake to assume that the modern organization of exchange is bound to continue to exist. It carries within itself the germ of its own destruction; the development of fiduciary media must necessarily lead to its breakdown.… It will be a task for the future to erect safeguards against the inflationary misuse of the monetary system by the government and against the extension of the circulation of fiduciary media by the banks.

In ancient times, the penalty imposed on bankers for lending out money held strictly as demand deposits would vary from being forced onto a diet of bread and water to public beheading.  Though these punishments were extreme, they show just how unethical fractional reserve banking used to be seen as.  Tamny’s mischaracterization of fractional reserve banking may not be unethical but it certainly begs for his re


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Fri, 08/03/2012 - 12:49 | Link to Comment SilverTree
SilverTree's picture


Fri, 08/03/2012 - 14:19 | Link to Comment Silver Bug
Silver Bug's picture

Eventually people want their money back.

Fri, 08/03/2012 - 14:36 | Link to Comment Aziz
Aziz's picture

"Fictional Reserve Banking"

Fri, 08/03/2012 - 15:50 | Link to Comment Bay of Pigs
Bay of Pigs's picture

What, no long winded diatribe against the author from LetThemEatRand?

I figured that was a given.

Fri, 08/03/2012 - 20:02 | Link to Comment BigJim
BigJim's picture

She doesn't like to comment unless she can get in early and derail the whole thread.

Sat, 08/04/2012 - 11:28 | Link to Comment Pinto Currency
Pinto Currency's picture


US Coinage Act of 1792:


Penalty on debasing coins


Fractional reserve inflation, central bank inflation and QE - all for profit and gain - may be cool now, but it wasn't cool in 1792.

Fri, 08/03/2012 - 12:50 | Link to Comment Shizzmoney
Shizzmoney's picture

I didn't even need to read this whole thing.

ZH: "The Problem with Fractonal Reserve banking"

Me: "Everything".

Fri, 08/03/2012 - 13:03 | Link to Comment EL INDIO
EL INDIO's picture

Exactly what I think.


It’s just all wrong.

Fri, 08/03/2012 - 14:31 | Link to Comment francis_sawyer
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Another invention from the chosen ones to separate you from your wealth without lifting a finger...

Fri, 08/03/2012 - 15:26 | Link to Comment Citxmech
Citxmech's picture

Fractional Reserve Banking is "borderline" fraudulent?


Sat, 08/04/2012 - 08:17 | Link to Comment SWRichmond
SWRichmond's picture

"So what exactly is ethically wrong with fractional reserve banking?"

It's fraud.

Sat, 08/04/2012 - 00:51 | Link to Comment DaveyJones
DaveyJones's picture

You mean people take advantage of others? over money?

Fri, 08/03/2012 - 13:05 | Link to Comment SheepRevolution
SheepRevolution's picture

The problem: We The Sheeple can't do it, only the banksters can. Well... technically we can, but we go to prison for it.

Fri, 08/03/2012 - 14:26 | Link to Comment TaxSlave
TaxSlave's picture

It's called a Ponzi scheme if you do it.  (But of course it's Free Market Capitalism when the shysters do it.)

Fri, 08/03/2012 - 12:55 | Link to Comment t_kAyk
Fri, 08/03/2012 - 14:34 | Link to Comment marathonman
marathonman's picture


Money as Debt 2: Promises Unleashed

The Money Masters


Secrets of the Federal Reserve by Eustace Mullins

Web of Debt by Ellen Brown


The Case Against the Fed by Murray Rothbard

End the Fed by Ron Paul

Those are just the ones I've personally read.  I'm sure there are many more.  I haven't even hit the heavy weights like Mises or Hayek.

Sat, 08/04/2012 - 04:42 | Link to Comment awakening
awakening's picture

I liked this one the best, nice and easy to follow that even a n00b to eCONomics can see the theft happening before me:

Fri, 08/03/2012 - 12:53 | Link to Comment slaughterer
slaughterer's picture

This rally shoud continue for another two or three market days until we see new highs of the year. 

DAX has about another 6-8% upside.

S&P at least another 5%

Sat, 08/04/2012 - 11:34 | Link to Comment FiatFobia
FiatFobia's picture

Yep, squeezing out the shorts.    Everybody in the pool!!   Then they drain it.

Fri, 08/03/2012 - 12:57 | Link to Comment ebworthen
ebworthen's picture

The FED is the enabler of fractional reserve banking, allowing "banks" such as the J.P. Morgue to use depositer money to gamble in the rehypothecation casino and murky ocean of London.

Worse, the depositor's money is "backed" by the FDIC.

The FED is "backed" by the taxpayer.

How can it not be fraudulent to back bank gambling with taxpayer money via a non-trasparent FED that supplies cash to banks with no strings attached, and no rule of law?

Fri, 08/03/2012 - 14:35 | Link to Comment marathonman
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'How can it not be fraudulent?'  Because it was allowed by Congress 99 years ago.

Fri, 08/03/2012 - 13:01 | Link to Comment TheSilverJournal
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Money is not created out of thin air through fractional reserve banking. The money that banks lend out actually exists.

Fractional Reserve Banking is not the problem, the problem is:


The fraud is that depositors are told they have demand deposits, or deposit that they are able to demand at any time, when in reality they have time deposits, or deposits that can only be withdrawn under certain conditions. Furthermore, depositors aren't warned about the risk of never being able to withdraw their deposits in the case that the loans that the bank makes with their money goes bad, and if the FDIC runs out of funds (the FDIC has a very small percentage of available funds relative to the total amount of deposits it insures).

It is important to realize that banks don't create money out thin air. The answer is more simple, which is that depositors think they have money at the bank which isn't really there.

Fri, 08/03/2012 - 13:09 | Link to Comment hedgeless_horseman
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...while the ECB's reserve requirement was HALVED from 2% to 1%..."to support bank lending and liquidity in the euro area money market."

How many of you, Europeans or otherwise, actually understand what a 1% reserve requirement means?  It means not one single bank can remain competitive without the back-stopping of the Central Bank.  Period.  It means that there are no longer really any private banks. 

Fri, 08/03/2012 - 13:09 | Link to Comment SheepRevolution
SheepRevolution's picture

We understand what a 0,000000001% reserve requirement means, but 1%?! Rather vulgar if you ask me.

Fri, 08/03/2012 - 13:19 | Link to Comment TheSilverJournal
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I'd like for one person to tell me what money is created out of thin air?

The fact is there's no money created out of thin air through fractional reserve banking. The money doesn't exist. The fraud is that the system gets depositors to believe that money exists that really doesn't.

Fri, 08/03/2012 - 13:47 | Link to Comment MachoMan
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well...  how is it that the money supply increases if not for creating money?  You're trying to separate the printer from the distributors...  it's all one system...  a centrally planned one at that...

Fri, 08/03/2012 - 13:57 | Link to Comment TheSilverJournal
TheSilverJournal's picture

Yes, it is all one system but the ONLY place currency is created is at the Federal Reserve. This is not to say that fractional reserve banking doesn't created a money multiplier effect due to fraud, but there is certainly no currency being created out of thin air.

It would be just fine by me to have fractional reserve banking if there wasn't fraud involved in the business plan, which is certainly possible. In order to take the fraud out, the depositor would have to be aware that they may not be able to withdraw their money whenever they please, and the depositor must also be made aware that if the bank's loans go sour and the insurance on their deposits doesn't pull through, then they may be at risk of losing their deposits entirely.

Fri, 08/03/2012 - 17:25 | Link to Comment MachoMan
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Let's put it another way, do you believe that fractional reserve lending has any effect on the FED to create money?  Or, alternatively, do you believe that requests from troubled member banks in need of funding (due to fractional reserve lending), to captured officials, have any effect on increases in the money supply?  Similarly, what about requests from foreign central banks?

You're acting as though the money printer acts in a vacuum...  sorry...  that's not how it works...  not only do you have to take into account the whole economic system when discussing the creation of money, but you have to take into account the whole political and regulatory systems as well... 

Fri, 08/03/2012 - 20:57 | Link to Comment TheSilverJournal
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Fractional Reserve Banking was in play long before the Federal reserved existed.

Fri, 08/03/2012 - 22:08 | Link to Comment The Navigator
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True, but when those fraudsters were caught they were soon hanging from a tree and it was 'just' punishment.

Fri, 08/03/2012 - 19:01 | Link to Comment valkyrie99
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About 98% of the money supply is creted by private banks in the US, as well as all other nations who are part of the global banking system.  The money is created through the process described above - 1 bank creates money with little real backing for a loan, the person receiving the loan can only use it to pay for something and the person paid can only deposit it in their bank account - where it is used as the reserves for creating more money even though it wasn't 'real' backed money in the first place.

This is creating money; 98% of our money. You can say that if it were all paid back it would dissapear, but it won't be - if it was it would be increadibly deflationary (98% of our money supply would dissapear). The system only continues by constantly growing the overall amount of debt which increases the money in circulation so everyone doesn't default.

This is why the Fed has little control over the economy even when it 'prints' only creates the hot money that is the basis for bank reserves, how many times the banks leverage that money is what impacts the money supply. The Fed's funtion is as a backstop to the inherant instability of fractional reserve banking, not to create all our currency.

IMHO This is important to distinguish because bank-created fiat is the worst monetary system that has ever existed.  Gold, bi-metalism, cattle, cowrie shells, and even government created fiat have all shown more long term stability then fiat created by private banks for private purposes.

Sat, 08/04/2012 - 07:38 | Link to Comment Withdrawn Sanction
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At least 2 ways:

(1) When the Fed conducts and open mkt purchase of bonds from a primary dealer (bank), it marks up the reserves acct of that bank by amount of the purchase.  The reserves are thus "conjured" into existence if it does not correspondingly liquidate a different asset (gold, other securities, etc.) to "pay" the bank.

(2) The bank, now w/excess reserves, can lend that amount to a new borrower.  The 1st borrower signs a promissory note, for a car say, and the proceeds of the new loan are deposited into the car dealer's account, increasing the deposits at the car dealer's bank.  That bank can now lend a fraction of those new deposits to another borrower.  (Here's where you need to keep your eye on the ball...).  The next borrower signs a promissory note and upon doing so the bank credits the account of the loan proceeds recipient (say, the flat screen TV store).  Notice:  it is the act of new debt creation that creates the next deposit in the chain.  IOW, the money supply will not expand (out of thin air or otherwise) unless someone is willing to go into debt, and someone is willing to loan the money for that new debt.

The money multiplier (or credit multiplier would be more accurate) is under normal circumstances a far more powerful mechanism for conjuring money than federal reserve money creation.  And that's its Achilles heal.  Since 2009, the M1 money multiplier has not been working (i.e., it's been below 1.0), which means it is not expanding the money supply, but actually contracting it.  The reason is a "pick em" (a) borrowers who are either unwilling or unable to borrow (the bankers' excuse); or (b) lenders who are unwilling or unable to borrow (the  borrowers' excuse).  I believe it's a bit of both because this is what happens when a society reaches debt saturation:  no one--neither borrower nor lender--wants any more debt.  Debt saturation is also whay BB will fail in his efforts to revive the economy w/EZ money.  He can create all the money in the world, but in the end, if people wont spend or lend, then the system shrinks as existing debts repay or are defaulted on.

 Dont feel bad if you dont see or understand the credit multiplier process in detail.  The economics profession did not even acknowledge or accept the workings of this mechanism until about the 1940s or so.  

Sat, 08/04/2012 - 09:49 | Link to Comment TheSilverJournal
TheSilverJournal's picture

1) The Federal Reserve is not a bank and is not a necessary part of fractional reserve banking.

2) No money is created through fractional reserve banking. Depositor's money is lent out, while the depositor still believes their money is accessible at any time (this is not creating money, it is just fraud by telling the depositor that they can get at their money any time they please.) This is the mechanism through which you're saying money is created. It is not created. It is just not there. But the depositor is lead to believe it's there. Fraud, not money creation.

Sat, 08/04/2012 - 09:54 | Link to Comment engineertheeconomy
engineertheeconomy's picture


Sat, 08/04/2012 - 10:32 | Link to Comment TheSilverJournal
TheSilverJournal's picture

Nice one word name calling response. Look in the mirror at who the real troll is.

Sat, 08/04/2012 - 10:39 | Link to Comment engineertheeconomy
engineertheeconomy's picture

Funny, I don't see you in my mirror...

Sat, 08/04/2012 - 11:25 | Link to Comment Uncle Remus
Uncle Remus's picture

You're still pissed you didn't get the Sham-Wow gig aren't you?

Sat, 08/04/2012 - 13:00 | Link to Comment TheSilverJournal
TheSilverJournal's picture

All I can do is point out that most of depositor's money isn't there. I repeat, most of depostor's money doesn't exist. It has never been created, it simply isn't there, and doesn't exist. Fraud.

If you want to say that something that's doesn't exist has been created, well, I can't argue with nonsense.

Sun, 08/05/2012 - 12:56 | Link to Comment Uncle Remus
Uncle Remus's picture

No argument on the fraud. Discussions on fractional reserve banking is a like trying to appreciate the intangibles of the Grand Canyon with only a photograph and the perspective from which said photograph was taken.

Interesting too, in light of current events, that in the early 90's there was a rash of German Nationals that fell to their death in the Grand Canyon. Hmmm.

Fri, 08/03/2012 - 13:32 | Link to Comment acetinker
acetinker's picture

Most respectfully, I submit that your statement that "banks do not create money out of thin air" is partly true, but incomplete.  To my understanding, it is the borrower who creates money by way of his/her signature on a loan document, aka promissory note.  The banker is simply the authorized agent which enables the borrower to "leverage" his/her future labor.


Of course, the borrower is obligated to pay this money back from the proceeds of his/her future labor- plus interest.  A question then arises: Where does the money to pay the interest come from since it was never created in the first place?  That my friend is the "germ of its own destruction" of which Rothbard spake.

Fri, 08/03/2012 - 13:46 | Link to Comment TheSilverJournal
TheSilverJournal's picture

The borrower doesn't create the money. The borrower actually receives the money from the bank. Nothing is created out of thin air during this process.

The area of discussion is around the reserves and demand deposits. Depositors think they can withdraw there deposits at any time, when in fact they can't. It's this fraud, or deception, that many on this thread here are calling "creating money out of thin air." Where did the deposits go?...They were lent out and likely redeposited by someone else who also believes the money can be withdrawn at any time. See...nothing is created, but the fraud is clear.

Even gold and silver have an exponential aspects, although it is clearly a finite resource whereas digital / paper currency can be infinite (gold is mined and added to existing stock at about 1.5% / year).


Fri, 08/03/2012 - 13:58 | Link to Comment acetinker
acetinker's picture

I think we're looking at opposite ends of the same mule here ;) If you mean physical FRN's, then of course you are correct.  Only a fraction (there's that word again!) of our "currency" exists as physical notes.

So, the "value" of all deposits is entirely notional and based someone else's promise to pay.  It could simply vaporize at any moment, but it hasn't.  The only reason I can see for this is that most people simply don't know how our system of money and credit works.  When awareness of the utter fraud that is "Modern Money Mechanics" reaches critical mass, it's game over.

Thanks for the reply, BTW!

Fri, 08/03/2012 - 14:51 | Link to Comment TheSilverJournal
TheSilverJournal's picture

'Twas a good discussion!

It would also be game over if the bond bubble bursts, Spain defualts, inflation takes off (oil, gold, silver, or food soars), the petrodollar seizes to exist, China or Japan dumps their US Treasuries, asset prices implode again, bank runs start, or, doubtfully, if the Fed raises interest rates. I'm sure i missed some, but we'll have to wait and see which "black swan" does the world fiat monetary ponzi scheme in.

Fri, 08/03/2012 - 14:02 | Link to Comment ZerOhead
ZerOhead's picture

It has to come from the creation of yet more debt.

Once the new debt creation ponzi stops the music stops. This is why Bernanke always begs congress not to cut the deficit.

Fri, 08/03/2012 - 15:32 | Link to Comment TheSilverJournal
TheSilverJournal's picture

Also, sometimes loans go bad and simply don't get paid back. Falling asset prices creates a huge incentive not to pay off the loan on that asset, which is why propping up housing is so important to the banking system starts. Once ultra low rates drive up asset prices, not only do those rates need to be kept low though more money printing in order to keep pumping malinvestments into the inflated asset class, but the rate of money creation must also be continually increased in order to keep the malinvestments from becoming exposed. It's like a high that wares off eventually and the next dose must be even larger in order to stay high. And the next dose even higher. And the dose after that even higher. My guess is the next dose from the Fed kills the addict by driving up inflation and bursting the bond bubble.

As a side note, on a true gold standard, it would come from digging more gold out of the ground.

Fri, 08/03/2012 - 13:01 | Link to Comment billsykes
billsykes's picture

Its graft. there has always been someone or the goal or a group of people to get something for nothing. I believe its in the DNA.

If you said to someone on the street I am going to give you pieces of paper that I make from old rags to you in exchange for your house, they would think you are nuts and a scammer.


Fri, 08/03/2012 - 13:25 | Link to Comment Azwethinkweiz
Azwethinkweiz's picture

...and fcuk PayPal. Those bastards placed a hold on my account, froze my funds for 180+ days and meanwhile are able to extend credit based on those funds. Together, eBay and PayPal have fcuked more people in the ass than the dude with the large shlong on my favorite porn series, "Monsters of Cock."

Fri, 08/03/2012 - 13:37 | Link to Comment Obadiah
Obadiah's picture

oh snap my favorites always involve big tities

Fri, 08/03/2012 - 13:46 | Link to Comment HANKREARDON

But he has a really really neat beard and I can pause live television!

Fri, 08/03/2012 - 13:48 | Link to Comment bank guy in Brussels
bank guy in Brussels's picture

It's excess credit and leverage that is the problem, not fractional reserve banking

Fractional reserve banking WORKED SUPERBLY for several decades in the US and Europe, as long as leverage was kept within 10 or 12 to 1 ... not 30 to 1 and 50 or 60 to 1 like now after 'de-regulation', the end of Glass-Steagall and similar idiocies

Indeed, excess credit destroys the system ... but there's no need to become luddites and throw out the productive baby with the dirty bath water ... we are over-reacting with the fanaticism about fractional reserve banking ... at low leverage, fractional reserve banking is little more than a vehicle for money velocity

There were many more severe panics under the gold standard than since it was dropped ... because they still had the same problem of excess credit and leverage ... and the consequences were much worse with needing gold coins for liquidity (not solvency) issues

There is no need for a 'bank run' in a fiat system with low leverage ... if we had kept within 12-to-1 leverage in the Western world, plus kept the strict barrier between ordinary banking and investment casino 'banking' - in other words, the Glass-Steagall type separations ... we would still be okay today.

Nothing wrong with gold, but we need to go back to the 1950s type of financial system, where deposit-accepting bankers did not make much money and were heavily circumscribed in what they could do

They violated the leverage rule in the 1920s and got a Great Depression. They violated the leverage rule since the 1980s and now we have the Greater Depression.

It's not hard, really

Fri, 08/03/2012 - 15:50 | Link to Comment MoneyMagician
MoneyMagician's picture

Heh, but the problem why are those rules violated in the first place? It's operated by man, that's why. It's the old scheme of human behavior, if I can break the rule little bit more, what's the harm. With Full Reserve Banking law, any embezzling of money would be against the law, not just bending a rule. Full Reserve Banking wouldn't operate much more differently than a Fractional Reserve Banking system, but it would be much more transparent if the protocol is followed by honestly, versus today's public of ignorance  in regards to their savings, and desposits. It would safe guard hard savings from being looted legally in legal embezzlement, without contractual permission. You can say excess credit is the problem, but that's the nature of frational reserve banking in the first place, that's why it exists in the first place to create excess credit.

Fri, 08/03/2012 - 15:56 | Link to Comment MoneyMagician
MoneyMagician's picture

Let's not forget when politicians control the banking sector either directly, or indirectly, they have the very human vanity of trying to inflate the economy for political purposes. Full Reserve Banking law would separate the politicians from the banking sector much more because full reserve banking is would be more decentralized, and systemic risk more contained versus a fractional reserve system like the Federal Reserve, or have convoluted banking laws like separation of investment banks, and ordinary banks, which didn't work in China to prevent the housing bubble. It removes the need of central planners manipulating, and exploiting the banking system, which such law is mostly guarded, if not all, guard by simple law, not central planners who manipulate interest rates, reserves, etc.

Fri, 08/03/2012 - 17:49 | Link to Comment acetinker
acetinker's picture

Interesting thoughts in an interesting thread.  I think fractional lending is a workable system IF 1) The participants are rational and, 2) The participants have integrity.  Hmmmm, wonder what went wrong there?

Seriously though, as a younger man I pondered the relative prosperity of the West with other parts of the world which are by any estimation shitholes of squalor.  I determined that a large factor in that equation is -wait for it- fractional reserve lending!

Would we have been able to exploit the vast resources needed to build huge cities, travel to the moon, or develop the technologies that enable me to reply to you here without leverage?  I dunno, but probably not.

Anyway, the experiment seems to have found its own fatal flaw, that being unlimited expansion within a finite system.  It was baked right in the cake from the get-go.  Was it Confucius who said "May you live in interesting times"?  That cheeky bastard! ;)

Fri, 08/03/2012 - 20:38 | Link to Comment Bazza McKenzie
Bazza McKenzie's picture

In summary, FRB worked, until it didn't.

Fri, 08/03/2012 - 21:26 | Link to Comment Gromit
Gromit's picture

Working for five hundred years of world domination so far so good cobber.

Enjoy a technicolor yawn and go shake hands with the unemployed!

(continued on page 94)

Sat, 08/04/2012 - 17:50 | Link to Comment falak pema
falak pema's picture

frb and compound interest imposed on borrowers smells of a spiral of geometric entropy dissemination mechanism, fatal flaw in society  that is nourished on human impulse of rentier greed expressed through the monetary pipeline of power concentration; its a classical case of an elite using regulatory capture to ensure its perennial power, not based on RISK taking but on parasitical pimping. The risk takers are the entrepreneurs on whose backs the financiers make money and control power using them as stepping stones for their own success, by manipulating the asset risk markets artificially. 


In our current system the financial institutions are protected from risk penalty by their TBTF status of controlling oligarchs. 

Sat, 08/04/2012 - 10:56 | Link to Comment FiatFobia
FiatFobia's picture





Amsel (Amschel) Bauer Mayer Rothschild, 1838:





Fri, 08/03/2012 - 13:50 | Link to Comment BalanceOrBust
BalanceOrBust's picture

Forget about fractional reserve banking.

What happened to the fractional silver deposit investigation?

Fri, 08/03/2012 - 14:11 | Link to Comment coltek
coltek's picture

I'm just really glad that I have no friggin' money.....


....I have a Silver Eagle that may just buy me my last meal when the lights go out - But what the fuck, you have a terrible edge when you don't care.



Fri, 08/03/2012 - 13:51 | Link to Comment ljag
ljag's picture

If you cash out of your brokerage account, it takes roughly one month to actually get your money (assuming, of course, your account had more than 50k when you cashed in your chips). Think about that! A fukking month!

Fri, 08/03/2012 - 15:15 | Link to Comment falak pema
falak pema's picture

While the financial pundits start to discuss the symptoms of the disease, some more prescient observes discuss the root causes, as presented by yours truly here in his posts : The decline of Pax Americana.

Analyst Presents A Terrifying Vision: THE DECLINE OF THE WEST - Business Insider

Shades of Edward Gibbon's Decline and Fall of the Roman Empire!

We are in tipping times as I have often voiced in my posts on western decadent chimes : for whom the bell tolls, is a title of things to come, that is not irrelevant to my ears in describing the state of the world... 

But i stay an optimist; its my personal intuition of history's footprint in these telling times. 


Fri, 08/03/2012 - 21:28 | Link to Comment Gromit
Gromit's picture

As long as 11 aircraft carrier groups dominate the seas your fears are premature.....

Fri, 08/03/2012 - 15:34 | Link to Comment Fix It Again Timmy
Fix It Again Timmy's picture

The Credit River Decision - Money Is Created Out of Thin Air as admitted by a banker...


Fri, 08/03/2012 - 15:40 | Link to Comment MrBoompi
MrBoompi's picture

I don't know why you would call the nature of central banking destructive.  It obviously works exactly like it was designed.

Fri, 08/03/2012 - 15:44 | Link to Comment eddiebe
eddiebe's picture

And that is why the founding fathers of the then great United States demanded a gold and silver link to money.

Fri, 08/03/2012 - 16:19 | Link to Comment Blue Dog
Blue Dog's picture

Really? The bank has $5000 so they lend me $50,000 for a mortgage. Where does that money come from if not from thin air? Literally it comes from the Fed where they can borrow as much as they want at rates that approach 0.

Fri, 08/03/2012 - 17:14 | Link to Comment dootyfree
dootyfree's picture

The 1000 bond would be deposited at the Feds account at the treasury not Citibank.  Wrong from beginning.

The money multiplier is a myth.  Banks are never constrained by reserves, and can lend whenever they want.  They settle reserve ratios on a standard day of week after loans are made.  The BIS has written an excellent paper on this.  READ.


Fri, 08/03/2012 - 20:36 | Link to Comment Bazza McKenzie
Bazza McKenzie's picture

If bank lending is unconstrained then the money multiplier can presumably become infinite.  Thanks for clearing that up.

Fri, 08/03/2012 - 20:08 | Link to Comment OneTinSoldier66
OneTinSoldier66's picture

I don't know that FRB is the real problem. I do know the 'unit of account' currently being used is though.


If Physical Gold were being used as money and the unit of account, and some Physical Gold was loaned out, at least it could not be said that loan(gold) was just created out of thin air.

Fri, 08/03/2012 - 20:19 | Link to Comment Coldfire
Coldfire's picture

Theft on a cosmic scale. Perfectly consistent with the universal deceit of our age. Keep truthing on, Tylers.

Fri, 08/03/2012 - 20:26 | Link to Comment taeonu
taeonu's picture


Mr. Black now takes the $90,000 Miss White paid him for his house and deposits it into his checking account at the town bank. The bank adds the $90,000 to it's reserve balance at its Federal Reserve bank and advances 90 percent of this sum, or $81,000 to Mrs. Green, who wants to buy a house from Mr. Gray. Over 30 years, Mrs Green owes the bank $81,000 in principle plus $98,541 in interest, or $179,541; and the bank has become the effective owner of another house until the loan is paid off.

Mr Grey then deposits Mrs. Green's money into his checking account. The process continues until the bank has "lent" $900,000, on which it collects $900,000 in principal and $985,410 in interest, for a total of $1,885,410. The bank has thus created $900,000 out of thin air and has acquired effective ownership of a string of houses, at least temporarily, all from an initial $100,000 deposit; and it is owed $985,410 in interest on this loan. The $900,000 principle is extinguished by an entry on the credit side of the ledger when the loans are paid off; but the other half of this conjured $2 million - the interest - remains solidy in the coffers of the bank, and if any of the borrowers should default on their loans, the bank becomes the owner of the mortgaged property.

Instead of houses, let's try it with the $100 million in Treasury bills bought by the Fed in a single day in the National Geographic example, using $100 million in book-entry money created out of thin air. At a reserve requirement of 10 percent, $100 million can generate $900 million in loans. If the interest rate on these loans is 5 percent, the $900 million will return $45 million the first year in interest to the banks that wrote the loans. At compound interest, then, a $100 million "investment" in money created out of thin air is doubled in about two years!"

Web of Debt
Chapter 17 - Page 166
by Ellen Brown

Sat, 08/04/2012 - 11:45 | Link to Comment CustomersMan
CustomersMan's picture



We need to do a write-up on N. Dakota's State Bank, how it came about, who lost and who one.


At least this is an alternative to the present banking criminal set-up.


P.S. Do you really think Bernie Madoff is in prison? I just read an interesting article about how the Chinese use "body-doubles" to serve out sentences for important people.


They said they can always find poor people to serve out sentences, undergo plastic surgury in needed, all for a fee.


In view of this I think "It's NOT Bernie" behind bars.

Sun, 09/02/2012 - 14:15 | Link to Comment Peter Pan
Peter Pan's picture

Fractional reserve banking is very accommodative on the way up as loans are made. But when liquidation of assets which have lost value are sold and the losses impair the loan value, then we see fractional reserve banking in all its twisted glory as it destroys everything in its path.
