fractional reserve banking interest debt inflation

Savers, Lenders, and What Really Happens to Your Money
credit debit Greenspan reserve federal government

Can You 'Bank' on Your Bank?

This article appears here with the permission of its author. It also appears in arabnews.com

by Abdelmenem Jamil Addas

“Whomsoever controls the volume of money in any country is “absolute master” of all industry and commerce and when you realize that the entire system is very controlled, one way or another, by a few powerful men at the top, you will not have to be told how periods of inflation and depression originate”. — Late US President James Garfield (1831-1881).

Years later, the widely-known goldsmith and money-lender Mayer Rothschild, unintentionally confirmed President Garfield’s fear by proudly stating “Give me control of a nation’s money and I care not who makes the laws”. For the record, President Garfield was assassinated few weeks after he uttered the above words, and banking institutions ever since have been controlling the supply of the world’s paper money.

It all began few hundreds years ago, when people would deposit their gold saving with a presumably trusted “goldsmith” to safeguard against theft or loss. In return, the goldsmith would issue a deposit receipt for the gold. Those holders of receipts would then use the gold receipts as a medium of exchange to purchase various goods and services. As times went by, the goldsmith noticed that of all the people who deposited their gold holdings with him, only a small fraction, perhaps 5 percent, would come back to reclaim their gold from his warehouse. The remaining 95 percent continued to use his receipts as an accepted mode of payment. The goldsmith discovered a new, innovative and cheap means to increase his profits, by lending his standardized gold receipts at a predetermined interest rate to those people who were in need of money (borrowers) without depositing any gold in the warehouse; after all, those receipts would eventually become “as good as gold”. Borrowers were able to purchase various goods and services, thus, trade merchants were happy to see an increased economic activity; governments then were ecstatic to see this new financial innovation taking shape, and a few years later, governments would join in this wonderful cheap scheme, and one by one, they eventually established similar warehouses called “central banks”. This is the origin of “fractional reserve banking” as practiced today by all countries.

How does it operate in today’s environment? When people “deposit” their earned money in the bank, they are told by their friendly banker, they will get interest on their monies and can withdraw them at any time.

Same as above, the bank would have to keep say 5 percent as “reserves” with its respective central bank, and the balance, 95 percent, is lent out to a borrower(s). In turn, that borrower spends that money (the 95 percent) which again is deposited into another bank of the person who sold something to the borrower. And that second bank will keep 5 percent of that new deposit as reserves with the central bank, and lends 95 percent of that new deposit to a borrower(s) and this process will keep rolling along. Thanks to this scheme, the money supply is increased; economists who have any brains left in their head would call this “inflationary”. In brief, with a 5 percent required reserves, banks are able to “create” monies 20 times more than their clients’ deposits. In banking language, this is called “creating money out of thin air”. Is there a “free lunch”? The depositors sacrifice nothing, they receive interest (“Watch your money grow”) and they have peace of mind thinking all along that they can get their monies anytime.

The borrowers get to use their loans (whether for 1 week or 7 years is irrelevant) until the repayment date. This is known in finance as “the banks borrow short (for a short period of time) and lend long (for a long period of time), but as long as banks keep “creating money out of thin air”, everybody seems happy for the time being. Moreso, since the world has become more efficient and cares about the welfare of all human beings, someone had to take care of those savers who are against “interest payments.” No problem, here come the saviors, the banks fabricated various paper-schemes by way of sale-and-purchase of non-existent metals (stores of aluminum, copper etc.), with various labels such as “Amana”, “Murabaha”, “Musharakah”, with the same end-results as the goldsmith and fractional reserve bankers -- more interest payments and more debts....

One would ask, if a bank keeps 5 percent of his clients’ deposit with the central bank, and the balance 95 percent is lent out, what happens if few days later, a customer wants to withdraw 8 percent of his money? Well, that is easy for the bank, it borrows the extra 3 percent from another bank. This is called the “London Interbank Offered Rate”, after all, banks have successfully structured the most efficient and formidable “cartel” in the history of mankind.

Given the above-mentioned fractional reserve banking system, one must ask “so what are the consequences for my hard-earned money?” Since there are more borrowers who want capital and they get it in the form of “credit money” as a substitute, more credit money is being issued by the banking system than all savers have deposited in their accounts with their respective banks. Thus, there will always be too much money chasing too few goods and services, and ultimately, prices will increase at both the producers’ and consumers’ levels, and to top it all, the monies will gradually lose their purchasing power: Welcome to the world of inflation, recession, wealth redistribution, unemployment and increased poverty, a trademark of the 21st century’s civilization.

Of all monetary transactions, only 5 percent are cash, the balance 95 percent is with our friendly bankers. The factual meaning of deposit is “store with someone for safekeeping”, and the word “save” means to keep the “structure, form and content intact”. So, in reality, when people deposit their monies with their banks, since only a small fraction is kept as reserves while the balance is lent out, people are not truly depositing, but they are “lending” their monies to their friendly bankers. As for saving, it no longer exists anymore, it belongs to the old civilization of our ancestors.

It is a fact of life that if all borrowers were ever to repay all their debts to their friendly bankers, the world will not have any more money circulating on planet earth, bankers will have all the monies to themselves, “Vive les banques”. Another fact, if all depositors were to reclaim their monies from their banks, the latter will not be able to honor the original commitment to pay customers on demand.

As Alan Greenspan, years before he became Federal Reserve Board chairman, wrote in his famous article “Gold and Economic Freedom" (The Objectivist, July 1966), ".... that gold and economic freedom are inseparable...under the gold standard, a free banking system stands as the protector of an economy’s stability and balanced growth... in the absence of the gold standard, there is no way to protect savings from confiscation through inflation... Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard.”

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Abdelmenem Jamil Addas is a professor of financial markets at the College of Business Administration. He is based in Jeddah, Saudi Arabia.

Also see these:

Fred Foldvary on Monetary Geo-Economics
http://www.progress.org/archive/fold277.htm

The Lost Science of Money
http://www.progress.org/2003/revmoney.htm

Todd Altman on Reforming the Money System
http://www.progress.org/reform21.htm

Henry George and Monetary Reform
http://www.progress.org/cg/zarhg03.htm

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