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Post details: Fractional Reserve Lending

Fractional Reserve Lending

Henry Ford once observed: "It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning." Fractional reserve lending, which is at the heart of our banking system, is indeed one of the most subtle scams in the whole entire Universe.

On the surface, lending is a fairly straightforward business. Suppose you have an extra $10000, while a good friend of yours has a brilliant business plan. You have idling money in your mattress, your friend has a profitable idea, so you naturally help him out and bankroll his enterprise. The value of your previous hard work will be put to good use, and for this friendly service you get rewarded with interest.

The trouble is that sometimes there is no good friend around to utilize people's dormant capital and that led to formation of the banking system. Banks look after your extra cash and, while you have no immediate need for it, loan it to people who have, and are willing to pay a little fee for the privilege. Banks essentially function as a matchmaker, which is a valuable service for which they take a cut in the form of an interest spread.

However, most laymen think that when a bank lends money, it comes from some depositor's account; that the value of the loan is fully backed by someone's hard work. That is not true. Banks may lend up to 10 times of what they are collecting. So if you deposit say $100, not only can your bank lend out that amount, but it can continue lending up to roughly $1000. It makes 10 loans with your capital. Thus when you take a loan, the bank does not just transfer someone else's money to you, in most cases it simply creates it by an accounting trick. Of course, the banks won't share the interest coming from those extra loans with you. You get your little interest on the first loan, while the remaining nine generate interest solely for the banksters' pockets, despite the obvious fact that you are the one who provided the capital to begin with.

This lovely habit harks back to the Middle Ages when goldsmiths issuing gold certificates for stored bullion realized that on the average only about 10% of physical gold was claimed back at any given time. Cunningly, they started issuing more deposits than they had gold for and today's banks just happily continue this tradition. In plain terms, this is nothing else than sanctioned counterfeiting, which is why our current monetary system would better be named Fractional Reserve Pretending.

That brings us to the crucial question: As the amount of goods and services in the whole economy expands, and the money supply needs to expand with it (to prevent deflation), who should have the right to implement it? Should bankers be allowed to rake in obscene profits just by creating money out of thin air and then lending it to us at interest? This is something that should be subject of a serious political debate. I am not an economist, but in my ideal world such sovereign prerogative should benefit the whole nation, not just its financiers.

I would say the banks should implement the full reserve lending and cede ALL money creation to a fully public central bank. This would allow interest collected from the expanded money supply during economic boom to go back to the Treasury and, by extension, to the people. You could build bridges and hospitals with this interest, you could fund research in new technologies and energy resources, you could use it for federal emergency assistance. That would provide much better social service than luxurious private yachts of Goldman Sachs alumni.

Transferring the money creation solely to a central bank would also simplify the current feed back mechanism. If any given commercial bank had more entrepreneurs with brilliant ideas than people with capital, and the bank would think the ideas were worth it, they could then ask the central bank to create the extra money and lend it to them at interest. Again, the bank's core source of income should be the interest rate spread (the difference between the rate at which they borrow from the central bank and lend to the entrepreneur). In good times the central bank would raise the interest rate to discourage runaway lending, in bad times they would lower it. Banks would be less willing to go on a reckless lending binge, if most of the profits from a further credit expansion went into the public Treasury.

There is no apparent reason why bankers should be the richest people on Earth. After all, they are just matchmakers. They do not produce anything of value. They do not create revolutionary inventions, or miracle drugs, they don't write engrossing bestsellers. When you drive down a small town's main street, the shiniest building on the block will invariably be a local bank. Why should that be? That building should belong to an architectural studio, to an engineering firm or a software development company. Again, it should belong to people who produce and create.

Bankers certainly deserve good salaries for their service, but the easy windfalls coming from usurping the right to create money should not be theirs. They effectively come from raping our currency. If banking was redefined to serve our communities, as it was originally intended, it would have beneficial effects on careers decisions, too - more smart people would be considering productive careers in engineering, technology, sciences, manufacturing, farming or arts, rather than dreaming about get-rich-quick schemes conjured up by the Wall Street.

The true importance of this issue can be gleaned from the words of Mayer Amschel Rothschild, the founder of the well known international banking dynasty: "Let me issue and control a nation's money and I care not who writes the laws". In the 21st century, it is outright outlandish to let bankers still get away with this game. We should return the control of our currency to the people of the land to whom it rightfully belongs. Separating the commercial and investment banking and placing severe restrictions on what the banks can do with our money would be a good start.


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