Why have fractional reserve banking?

Discussion in 'Economics & Trade' started by Kman, Feb 14, 2012.

  1. Kman

    Kman New Member

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    Can anyone explain to me why? If you had a 100% reserve ratio then all deposits would be covered and banks would be very stable, investments would then be procured from time deposits where people sign a contract explaining that for x time period they cannot withdraw their funds and they might lose said investment money.
     
  2. raymondo

    raymondo Banned

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    If you started that way , excellent . No problem .
    No risk , and I guess a boring world with a much reduced rate of growth or progress .
    But we are in the middle -- or near the end -- of a completely different system and no institution works in the way you suggest .
    If , absurdly , it was decided that everybody would switch tomorrow , the whole system would come tumbling down .
    The amount of money needed to make reserves equal borrowings is so great I cannot even sensibly guess the figure --- $ 250 000 trillion , perhaps .
    Our present system is fine -- with wise regulation and huge risk averse practises .
     
  3. Not Amused

    Not Amused New Member

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    The risk from fractional banking occurs during runs on the bank, or when a the percentage of borrowers that defaults exceeds the reserve.

    When times have been good (like the last 25 years during the "great moderation"), a lot of economists think they have everything figured out. The fraction for reserve erodes, and those reserves can be AAA rated mortgage funds. AAA mortage funds created from less than stellar mortgages by PhD's.

    Instead of the gold standard, we have been operating on the PhD standard.....

    I have found some PhD's to be educated well beyond their intelligence.
     
  4. dixon76710

    dixon76710 Well-Known Member

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    Because the banks would have to charge us to hold our money.
     
  5. Not Amused

    Not Amused New Member

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    Would you deposit money having to pay for the pleasure and knowing the bank could lose if for you?

    I'll stick with a lumpy mattress.
     
  6. headhawg7

    headhawg7 Well-Known Member

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    I would love to stick my dollars in a mattress....too bad through inflation and the ever expanding money supply that I have to invest or spend otherwise lose purchasing power. I guess it is nice to have bought gold when it was cheap otherwise all my purchasing power would be gone within next decade or so.

    Too bad the govt allows this fraud on people who are less fortunate, live on fixed incomes and grandmas who have saved their dollars all theirs lives.
     
  7. dixon76710

    dixon76710 Well-Known Member

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    With 100% reserve ratio there would be no risk of the bank losing your money, silly.
     
  8. Not Amused

    Not Amused New Member

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    Not my words - Kman's
     
  9. dixon76710

    dixon76710 Well-Known Member

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    Kmans words having NOTHING to do with YOUR words I quoted in my response, that you are now responding to.
     
  10. unrealist42

    unrealist42 New Member

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    There are plenty of hedge funds that operate that way, and a lot of investment pools, like mutual funds. They attract people willing to put up with the risk of losing their entire investment in return for possible large gains. Those who are more risk averse put their money in low risk money market funds which make only short term loans to low risk borrowers but even money market funds are subject to loss.

    Many banks operate money market funds for time deposits but that is periphery to their primary economic functions which are to keep depositors money safe and use that money to make judicious medium and long term loans.

    In a 100% reserve scenario banks could not lend deposits, ever, even with time deposits. What 100% reserve means is that the bank has 100% of its deposits on hand at all times.

    What you are proposing is that banks operate an investment fund on the side, which many already do, especially the "investment banks".

    The reality of fractional reserve banking is that it has been around for about 500 years and is what banking is all about. Since depositors do not ask for all their money every day the bank only needs to keep on hand enough for day to day business along with a cushion for bad loans and emergencies, a reserve.

    This leads to the classic dilemma of banking. In order to make money banks need to lend as much as possible. In order to survive emergencies they need to keep as large a reserve as possible. Historically, banks have been generally left to themselves to decide their reserve ratios.

    This has not always worked out very well in times of economic calamity since the banks did not keep adequate reserves. Since this required government intervention to preclude a complete economic collapse government regulators have stepped in and required banks to increase their reserve ratios. The problem is not fractional reserve banking per se, just its implementation.

    Fractional reserve banking allows savings to be recycled into the economy, giving it employment. In 100% reserve banking deposits are not employed, they do no work.
     
  11. Panzerkampfwagen

    Panzerkampfwagen New Member

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    Before FRB about 2 people owned all the weath, the King and the Bishop. Everyone else was lucky if they had enough to eat that night.
     
  12. IgnoranceisBliss

    IgnoranceisBliss Well-Known Member

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    In a 100% system how would people get capital for any kind of business or personal improvements? How would a company finance a new factory or roll out any new products? The reserve system is incredibly important in facilitating capital investments. Without it the economy would largely grind to a halt. I'm not even going to go into all the other components involved here like inflation and government spending.
     
  13. bacardi

    bacardi New Member

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    they already do!
     
  14. bacardi

    bacardi New Member

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    today the poor and the grandmas should be saving in silver rounds......do you know that a dime made of silver pre 1964 will still buy you a gallon of gasoline? It holds its value!
     
  15. venik

    venik New Member

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    From 1870 until 1913 we had little fractional reserve lending. During that period cars were invented, lightbulbs were invented, electricity became commonplace, airplanes were invented, the radio was invented, the microphone, record players, tanks, machine guns, grenades, the assembly line, etc

    It was the most innovative and healthy economy up until it's date. All this with a gold standard and no income tax.

    It's completely unverifiable, and very falsified, that you can borrow your way into prosperity.
     
  16. unrealist42

    unrealist42 New Member

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    We also had some very regular new gold strikes which resulted in massive injections of money into the economy which were regularly followed by economic catastrophes that would make 2008 comparatively insignificant. It became such a regular occurrence a new term was coined, "the business cycle".

    In fact most of the boom time growth was funded through fractional reserve lending and the crashes from when the borrowing was too much for the economy to sustain. Even so, it was the boom time lending that built the railroads and factories and telephone and electrical systems that allowed the economy to resume its growth when new gold was found and new money injected into the economy so new fractional reserve lending could fuel the introduction of even greater and newer things.

    It is an untidy prospect for your economy to be subject to the luck of prospectors. The economics have proven to be quite chaotic.
     
    sunnyside and (deleted member) like this.
  17. venik

    venik New Member

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    If gold is found and then entered into the economy, it doesn't matter as long as there is then printed as much money for each oz of gold as there was before.

    And while the gold standard of pre-1913 was not entirely 100% backed in gold, we did not have a fractional reserve lending system the reserve ratio was maintained nearly constant. The lack of reserves was simply to pay off the civil war.
     
  18. unrealist42

    unrealist42 New Member

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    Well, that is what the Treasury basically did during that period and it created the boom and bust economy. New money would flood into the economy creating a burst of inflation and then, as economic growth surpassed the supply of money the economy would slow, stagnate, and decline into deflation which would eventually coalesce in panics as borrowers began to default, and then default en-mass as the market sell off accelerated and led to margin call increases which further accelerated the decline. Savers would run to the banks to get their money out before the banks closed their doors.

    Back then there were no restrictions on banks lending to market speculators so banks lent, on margin, to basically anyone who wanted to gamble in the markets. The exposure of the entire economy to economic downturns was multiplied through the market catastrophes that were an inherent part of the cycle.

    The Treasury was regularly besieged by gold redemptions in times of economic panic and would usually borrow large quantities of gold from Wall Street financiers to meet these redemptions since Treasury reserves were often insufficient. The idea that the government gold reserves were always sufficient, or that reserve rations were constant is a deranged mythology. It may appear that the reserve ratio seems constant over the term but averages smooth over deviations, especially short term drastic ones, like the one the Treasury faced in 1913 that led to the formation of the Federal Reserve system.

    It was believed that a system of monetary and banking control could, if not entirely prevent, at least exert some control over the regular catastrophic economic downturns of the past. After the crash of 1929 it was seen that this was not enough so complementary controls were instituted. By 2000 these controls had been almost entirely removed.

    In 2008 the economy crashed in a scenario not far removed from the panics of the 1800s, or 1929.

    The time in between was one free of catastrophic failures, the economy had some ups and downs but nothing like the past, or the present. During that time fractional reserve was in full force.

    So, what seems to be the best path to an economy that can avoid the ups and downs of the past?
     
  19. venik

    venik New Member

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    Considering most gold in the economy was mined over the past 4000 years, I don't see any significant inflation resulting from increased supply of gold. Not to mention the 1890's-1910 we saw the biggest explosion in innovation in history, on a gold standard. Airplanes, cars, lightbulbs, electricity, radio, record players, skyscrapers, etc. **And** this period was known for it's deflation more than it's inflation. You're going to need more than subjective reasoning and "panics" to down-play that monetary policy.


    The federal reserve was created so that they **could** do fractional reserve lending. And it didn't stop the gold panic of 1929, either. In fact it merely put off the correction 10-15 years and made it one big correction.

    [​IMG]
    Note that when the FR was created, the currency was due for a deflation correction, but they were able to put it off. Until 1929, then marking the biggest correction in the history of the US.

    The difference between now and 1929 is that you cannot do a gold run on the bank, so instead of the currency deflating to meet the gold price the price of gold (and all commodities) is going to raise to meet the rest of the money supply. As was the case in 1929, Milk went from $.01 to $.15 while gold stayed at the same price. Thus every year it made more and more financial sense to redeem 30 oz of gold with $600 instead of buying 5 oz worth of goods with $600. So instead of wiping businesses off the face of the planet like we did in 1929, we thought hey maybe if we flip this thing upsidedown it won't happen. Instead of killing businesses we wiped out savings accounts and let our government get away with atrocious fiscal irresponsibility. Which was no doubt a cause of the unaccountability inherent in a fiat currency.

    I believe some sort of commodity standard, or labor standard, would work best.
     

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