Fractional-Reserve Banking: An Analysis from an Ethical and Economic Standpoint - Part 1: Introduction and History

(This is part 1 of a 8 part series on Fractional-Reserve Banking)

Fractional-Reserve Banking: An Analysis from an Ethnical and Economic Perspective

Our current system of banking, a centralized system of money production and control, is one of mystery and will be discussed for this essay. This system of money creation and its implications will be analyzed for their ethical dexterity and economic effects. The modern system of banking, where a Central Bank controls the entire money supply of a country, must be understood and explored since money is the lifeblood of any economy. However, our monetary system is not well-understood and met with confusion and ignorance rather than curiosity and knowledge. The fractional-reserve system will be the focus of this paper as I examine its history, process, legality, economic and ethical rational and criticisms, and also present a discussion on possible alternatives.

History

The beginnings of fractional-reserve banking go as far back as 8th century China1
(Rothbard 91) but the emergence of standardized practices did not exist till around the seventeenth century. While the practice was not the same everywhere the basic story follows this pattern: Gold and silver coin were the prevailing currency at this time and people would carry their coins around with them and keep their stores somewhere in their home. Goldsmiths would keep their extra gold in vaults at their shops and customers would ask to keep their extra currency in there as well for safe keeping. The Goldsmiths would charge a fine for the service and in return for the deposit of gold would issue deposit receipts to the customers for the amount of gold placed in the vault (typically one note per ounce of gold). As more people began using these “money warehouses” the more people began having deposit receipts. As a result, it was found that by just exchanging deposit receipts for goods and services, instead of the actual gold, transactions could be made easier in the marketplace. The exchange of notes proved much more convenient instead of having to carry around gold, or transfer large amounts of precious metals.

The Goldsmiths realized this trend and decided to take advantage of the situation. Since very few customers actually took their gold out of the vaults and instead used the deposit notes as a medium of exchange, the Goldsmiths were able to issue more notes than actual deposits as loans with interest. Thus the Goldsmiths moved from 100% reserves to fractional-reserves since they could not redeem all the notes from the gold reserves. They justified these actions by calling the extra notes an IOU liability that they would pay back to the depositors’ accounts. However, these money warehouses (becoming the equivalent of modern banks now that they lent out depositors money) still recognized depositors’ right to redeem their gold on demand. It is not hard to see as Murray Rothbard put it, “But the legal claims issued by the bank must then be fraudulent, since the bank could not possibly meet them all” (ibid 99). These practices continued and soon became legalized banking practices and are the base to the modern system that exists here in America and around the world.

Here in America our Central Bank, the Federal Reserve, controls monetary policy and the supply of money in the economy. The Federal Reserve (commonly known as the Fed) conducts monetary policy through tools such as open-market operations and the required reserve ratio. The Federal Reserve controls the operations of commercial banks by changing this reserve ratio, thereby affecting the amount of credit, or new money, that can be created. This process of making new money, of how money is created out of thin air, will be detailed in this next section.
First off, it is important to understand why a Federal Reserve is needed in a fractional-reserve system. Since banks cannot possibly redeem all deposits at the same time (the phenomenon know as a “bank run”) the system is inherently unstable. Recognizing such instability, bankers pushed for, and got, the Federal Government to establish a central bank to act as “lender of last resort”. The purpose of the central bank is one of providing liquidity to banks during times where the banks would have otherwise become insolvent and declared bankruptcy. Having such a power allows banks to continue fractional-reserve practices without the worry of going out of business.

$77 Billion - The true cost of the Drug War

More and more people are starting to question the so called "War on Drugs" and its true costs to society. In this above video, a Harvard (yes 'the' Harvard) professor of economics argues that around $77 billion could be saved if Marijuana was legalized. This issue has been a hot topic recently with videos like Ron Paul discussing Marijuana on Larry King. My question is: If Prohibition did not work in the 1920s with alcohol, how do we expect prohibition to work today with drugs?

This is a very interesting topic to myself because I use to scoff at arguments that drugs should be legalized. "How can we legalize hard drugs?" I would ask, "There has to be a limit to what people are allowed to take shouldn't there?". But then one has to ask, with prescription drugs now the fourth leading cause of death in america, is the system really working?

You can look at the issue a few different ways. One way is to say that by legalizing drugs would add enormous revenue to the government by way of taxes on the drugs, and by the amount of funds not spent on fighting drug cartels. Another way is to argue about the benefits drugs like marijuana have in treating pain especially in cancer patients, and how it lacks the dangerous side-effects of most prescription drugs. But I think the most important way to look at the issue is it is a matter of personal choice.

By creating a law the government is simply saying all the obvious side effects of drug abuse (loss of job, broken family relations, deteriorating health, addiction, extreme money cost, death...) are not enough for people. Instead the State has to pile on fines and jail time to add to such costs. But instead of all cost being put squarely on the individual who decides to take drugs, all of society has to pay for one persons choice through the funding of the "War of Drugs". But its ludicrous. If a person thinks they can avoid all the inherent costs already associated with taking drugs, what is a fine or jail time to them? If they think they can avoid the inherent costs, then they most assuredly think they can avoid any state induced costs. Why do I have to pay for a choice someone has already decided to take regardless of a law? I shouldn't because the State has no right to force someone not to make that choice.

By taking drugs, that person has made the choice to accept the costs inherent with drug use, and that is their choice to make. It is obvious that a 'law' does not keep someone from not making such a choice or we wouldn't spend billions fighting drug use. Whenever the State tries to tell people they cannot do something, they usually do exactly that. We should have learned our lesson with the failed policy of alcohol Prohibition (at least that was Constitutionally amended unlike the current drug prohibition). People will not stop taking drugs because of a law, just like people will not stop speeding or stealing because its against the law. The only way to effectively combat such aberrant behavior is through education and letting people make choices on their own. Sometimes letting someone fail is the only way they can learn. The freedom to fail is how we can only truly succeed.

"Freedom Watch", amazing libertarian show

Sorry for the long delay (guy needs a break)

Well it looks like Fox News (aka Faux News) is actually beginning to do some things right. First with bringing on Glenn Beck, which you can see at 5pm, and his common sense apporach to politics. But this show takes the cake. Not on tv but on Foxnews.com/strategyroom, "Freedom Watch" is basically a Libertarian roundtable for an entire hour. Judge Napolitano hosts the show and regular guests include: Ron Paul, Peter Schiff, Lew Rockwell, Tracy Burns (I could do without her), Cody Willard, and so on... Basically every person I have been following the past several months and they finally have an outlet to speak without being called "crazy" or "doom and gloom". Please check out the show and support it--hopefully it will garner enough support to get on the air. It's on the website every Wednesday at 2PM

(This is just part 1 - follow the link and you can find the other parts on Youtube)

Youtube link

What If? -- Ron Paul Speech

Great Video made about Ron Paul's "What If?" speech. This will be famous one day.

here's the link to the actual speech

Book Review: The Revolution: A Manifesto by Ron Paul

"If we want to live in a free society, we need to break free from these artificial limitations on free debate and start asking serious questions once again. . . These ideas cannot be allowed to die, buried beneath the mind-numbing chorus of empty slogans and inanities that constitute official political discourse in America.

This is why I wrote this book"

A call to Liberty, and a return to reason are the main themes of this Manifesto. Texas congressman and 2008 presidential candidate, Ron Paul, writes the story of American politics today and how the founding principles of liberty have all but been forgotten. The book is more than just a campaign manifesto... it's the manifesto for Liberty and Truth. Before I drool anymore on it, I'll go into some of the key points Dr. Paul addresses.

Foreign Policy:

Dr. Paul goes into the Constitutionality of our foreign policy, the enormous cost of our military-industrial complex, and the whole theory of "blow-back" and its ties into the 9-11 attacks. He provides ample history without getting dry and points out how if we cut just half of our military budget it would provide $500 billion in funds.

The Constitution:

The most important document in American history, the Constitution is the groundwork for liberty and we have all but disregarded it. Dr. Paul discusses the blatant lack of respect our politicians have for this document and how it is ruining our country.

Economic Freedom:

Perhaps the most important subject for our current situation, this chapter outlines how having a free-market economy--as opposed to our heavily regulated, government intervened economy--would greatly improve our standard of living and how we would never have had a financial collapse such as in 2008. He also addresses the issues of Social Security and Healthcare, and how we should deal with these pressing issues.

Civil Liberties and Personal Freedom:

"Our Constitution was written to restrain government, not the people" It seems more and more that we answer to the government, and it refuses to answer to us. Personal freedom is indivisable and every person is "entitled" to nothing, except what we earn ourselves--and no person (especially the government) has no right to take from what we earn by force. If we refuse freedom in exchange for government control we will never get it back. This is not a political issue, it truly is a human issue.

Ron Paul is the reason I became awake to the struggle for Liberty confronting us today. This book will serve as a guide for generations to come as truth on how government and society should act. I highly recommend this book to anyone interested in the proper role of government and the Freedom Movement. Furthermore join the Campaign for Liberty by following the link of the right to support the growing movement. Long live Freedom!