Fractional Reserve Banking versus Ayn Rand's Ethics

[softwareNerd]

Is it inflationary, though?

Only if one believes the typical interpretation of the Quantity Theory of Money. Back in the real world, I don't see a good reason to think that it would be inflationary if one does not have fiat money. Under a gold-standard, FRB-style credit is the "monetization" of some other non-gold asset. Most often this is an existing asset, as concrete as gold, though sometimes it is an asset that will be created in the future.

[C.W.]

The problem with a discussion like this is the ambiguities. There are several different “gold standards”, for example. (And, when you say “inflation” do you mean prices going up or expansion of the money supply, as sNerd does.)

The gold standard most often seen in history is the “gold exchange standard” in which a note or credit instrument can be exchanged for gold at the issuing bank or a bank that is willing to accept it (in addition to gold currency and perhaps another metal for coinage). In this approach, the actual amount of gold held in banking institutions tends to be higher than the issued currency and demand deposits. Certain banks would be practicing fractional banking, with backup from other banks, as mentioned by another poster.

One to one currency to gold ratios are rare, especially when you get to periods with checking and credit instruments.

Also important to remember is that the demand for credit is not a constant but varies with changes in technology as it is applied and changes in business practices, e.g., improvements in management. Interest rate changes attract more capital and savings. Fractional banking by individual institutions can smooth out these variations.

I have seen people suggesting that the fractions that a bank would practice ranging from 90% to 500% of deposits. I think that the actual percentage would be much less, say less than 50%, maybe even 30%. (If anyone has a reference to historical practices, I would like to see them.) Bankers are conservative. The amount loaned would be greater than their capital, reserves, and deposited savings accounts. If it were double those amounts, the bank would be in a very precarious position.

If a bank did not practice fractional banking, it would have to look elsewhere for revenue and profits. In most cases it would have to charge deposit fees to store and account for the money placed with it in demand deposits. The competition in the market place with banks that practice fractional banking would cause the bank to clearly say that the reason it is charging fees is because it is “safer” since it isn’t practicing fractional banking, throwing into focus what other banks are doing (who would be advertising their feeless accounts, and why). The consumer is then offered the clear choice between paying fees with no risk and not paying fees with some risk (or maybe lots). Bank management practices are thrown into light and consumers, if they are wise, make informed decisions. I think that when considering a free market it is an error to make an argument based upon the ignorance of any actor.

[MichaelFilo]

Does the fake money given out in fractional reserve banking reflect objective reality? I only ask because one of Rand's criticisms in Atlas Shrugged is that the government money had no value.

The other issue with fractional reserve banking is that on top of it's creation of money out of thin air, it also stipulates an interest on the non-backed money lent out. When interest is payed, supposedly real money is being payed for money made out of thin air. When the principal is payed back, the original loan money is destroyed, at least to that bank.

Now, it obviously is a worthless system for every bank, because, after all, it exists on a premise that more money is owed than created, because any creation of money has a cost in interest. If every bank did so, we'd be in endless turmoil trying to catch up with our debts. Indebtedness, as you all know, is an easy leap into slavery to tyranny, but that is what the system itself creates, by it's nature.

The other issue, of course, is that if one bank did lend using fractional reserves, and another kept a 100% reserve, it is not hard to imagine what would happen. Both banks are created, bank one using fracional reserves, and bank two using "honest money." We will assume the gold standard, because fiat currency is also not based in reality. Bank one and bank two start off with 1000 dollars in deposit, with each bank having an understanding from its lenders that all moneys may be borrowed out. Bank one can loan out, using a 10:1 reserve system, 10,000 dollars in bank notes while the second bank can only lend out 1,000 in bank notes. Now, imagine both are in a similiar market and both collect 10% interest on a loans each month. Bank one would rake in 1,000 to the second banks 100. Is it hard to imagine, then, how a system that allows fractional reserve banking, with it's fake money, is favorable to any banker? As such, the free market will tend towards it. Given that, the law must, as it does with any fraud, outlaw the practice. If it does not then the free market will tend to profitable legalized fraud, as the free market is not a moral or intellectual agent, and we will again be faced with a system where the large source of money is indebtedness. A cycle where our medium of trade is controlled by bankers, and with governments and people and businesses indebted to the bankers.

[softwareNerd]

Your objections to fractional reserve have been answered earlier in the topic.

[Dynamite]

Although it doesn't make it right, the current system's way of doing things is so entrenched that it will be difficult to change, even though its practices are well known to some people.

At the end of your video you mentioned what the solution should be, but what would it take to make it a reality, really?

Good video, very informative.

Edited August 15, 2010 by Dynamite