Origin And Danger Of Fractional-Reserve Banking

If there is any one thing in particular that threatens the collapse of our banking system and financial structures worldwide, it is the practice of fractional-reserve banking. The subject is rarely mentioned in the financial press. When it is mentioned, a clear explanation is usually not available. 

From History Of Gold As Money …

The warehouse proprietors (‘bankers’) decided they needed to find a way to increase their profits. Earning fees from their depository and safekeeping services wasn’t enough. Since most of the gold remained in storage and most transactions involved exchange or transfer of paper receipts for the gold on deposit, they decided to issue ‘loans’ of the gold/money to others and charge interest. The cumulative amounts of gold loaned out could not exceed the amount of gold held in storage. And, hopefully, not too many depositors would ask to redeem their physical gold at the same time. 

It seemed to be a workable system. But apparently the ‘bankers’ were not content. They soon started issuing more loans/receipts for gold which did not exist. Of course they saw no need to inform anyone of their actions and the receipts still stated that they were redeemable in fixed amounts of gold. And when someone wanted to take possession of their gold on a physical basis they could still do so. Up to a point.

Fractional-reserve accounting by warehouses/banks was the original starting point for the credit expansion that now engulfs our world economy.

Here is an example of how this works today…

Your brother-in-law pays you thirty thousand dollars he borrowed three years ago. You decide to put the money in a time deposit (one year CD, etc.) at your bank. At the end of the day when your banker balances his books he finds that deposits at the bank exceed the funds which are currently loaned out/invested by an amount in excess of the ten percent US Federal Reserve requirement. And since that surplus amount is now available for new loans and additional investments, your bank’s loan committee and investment department are busily engaged in efforts to allocate those funds on a – hopefully – profitable basis. After due consideration, it loans twelve thousand dollars to Jane, who wants to buy a car and fifteen thousand dollars to a local entrepreneur.

Joan pays the twelve thousand dollars to Mr. Jones who is selling the car to her (private transaction). Jane drives away in her new car and Mr. Jones deposits the money in his bank which subsequently loans out ten thousand eight hundred dollars to a local dentist who is expanding his practice.

The local entrepreneur deposits the fifteen thousand dollars in his business account which is at the same bank that loaned him the money. Voila! The same bank which made the two loans now has fifteen thousand dollars in ‘new’ deposits of which it can lend out or invest another thirteen thousand five dollars. Which it promptly does.

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Gary Tanashian 1 week ago Contributor's comment

I like the explanation of how fractional reserve banking can almost magically grow its lending possibilities. A one-way Ponzi, ultimately, with a hazy end date.