Finance and Stuff

Thoughts on finance and other stuff by Johan Lindén

Q&A:s The Monetary System & Fractional Banking

criticism fractional banking monetary systemA look into the arguments against our current monetary system, and the criticism surrounding fractional reserve banking with fiat money.

There are thousands of opinions and experts that claims that our monetary system, a fractional reserve banking system backed by fiat money, is doomed to fail. The idea got even more popularized by the criticized but also praised documentary Zeitgeist. There is also a lot of critical, often gold-related, websites such as www.gold-eagle.com and lewrockwell.com who make these claims.

Here follows a summation of some arguments used to criticize our current monetary system:

Our monetary system is totally based on fiat (faith) money without any real value or promise. What many people, especially from the younger generation, do not know is that there was a time where people could exchange their money for gold. Today they are guaranteed to exchange their money for exactly nothing in the end.

All things will at some time in history return to its intrinsic value. That means that paper money will at some point be worth only the paper it is written on.

Debt grows exponentially, while the economies’ of states grows like s-shaped curves. That must lead to a debt that will sooner or later being too big to being paid back. All economies depending on this monetary system will therefore eventually crash.

Although the claims above seem very logical, a few arguments arise that are not so often answered by the people who are making those claims:

  1. You are not forced to take credit. So you are never forced to pay any exponentially growing interest to some evil bank. How bad can it be to let people freely do business with their own chosen terms?

  2. Most creditors are likely to be included in our economies. The economies that we are told will be destroyed be the exponentially growing interest in the long-run. So the only thing that can really happen to our economy is that money goes from the people making bad business to the people who are doing smart business. Kind of like how the system has worked since the beginning of time.

  3. Even if we had a gold standard we could and would still have exponentially growing debt. If you lend someone ten ounces of gold you would still want to have eleven ounces back. So that argument is not specifically related to our current monetary system, but to all free economy systems.

  4. If the fractional banking system of today is so bad, how come most countries, that are economically and politically stable, have had their monetary system intact since War World II?

  5.  The fact that debt is growing exponentially may sound alarming, but exponentially only means that it grows by a certain factor every year. If debt increases by 2% every year it is growing exponentially, but it is growing at a fairly low rate. It will take 35 years for that debt to double. The growth of debt is met by economic output, such as services, natural resources and production of goods which is constantly being added to the economy. So an exponentially growing debt will be met as long as people work. Increasing debt also means inflation or that the value of money/debt decreases. With an increasing population and economic growth there should be no problem with an increasing amount of money or debt as long as it increasing in harmony with other economic outputs such as houses, cars, or plates with food. In the long-run there will be a problem to produce an ever-increasing stream of those products, but that is an ecological problem and not a problem of the monetary system.

Please feel free to come with other questions or if you are one of those questioning the current monetary system try to answer one or more of the questions above.

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11 Comments

  1. 1. The argument of that there´s no necessity of anyone taking any credit or using any debt based money, honestly makes no real appeal to me.

    2. Since society is based upon the fact that people once has made the choice of limiting the competion, and only compete under certain given social rules, one must also understand that there´s sooner rather than later no way left for society, except acceptance of betrial and treason among people or easing the limits of society, so to speak.

    3. As well as the declaration of human rights put it, humanity will not for sure develop out of competition and most certainly not make a never ending social progress by excuting exponential growth on a limited planet. Limitless consumtion in a limited system, is somewhat contradictive.

    4. Since the creation of this system in the mid twenties and it´s implementation in 1931, the total amount of debt has continually risen uptil todays date while sometimes overvalued markets took their tribute by collapsing the value of assets. This time that´s not the case, it´s now time for the systemic collapse due to the rate of debtgrowth in relation to how the real economy must contract while the financial side of the economy expands ton any given total amount of debt.

    5. Exponentially means for instance also that at a rate of seven percent a certain amount will double in just ten years, so maintining a deficit does not necessarily mean the cheaper way out.

  2. John, You pose some good questions above for opponents of fractional reserve. I’ll take them in turn. Numbers correspond to your numbers.

    1. The claim that “You are not forced to take credit” is not true in the sense that where a private sector entity wants to buy some asset or other, and doesn’t have the cash to hand, it absolutely must borrow or “take credit”.

    The alternative of course is for the entity to save up money, and then buy the relevant asset. But the latter option can lead to inefficiencies: e.g. if a business spots a very profitable or useful means of employing resources, it benefits us all if it goes ahead straight away and borrows the money needed to get the project going.

    Ergo the argument that “you are not forced to take credit” is a weak argument.

    2. I agree with your “No 2” point. At least I agree that many of the opponents of fractional reserve over-do the alleged damaging effects of debt.

    I’m not an official spokesman for Positive Money, but I think most PM supporters would agree that there will always be lending and borrowing. Plus there will always be foolish borrowers, and the latter should be allowed to go bust.

    3. Agreed. In other words I don’t entirely agree with Positive Money here. Put another way, given full reserve, people and businesses would still want to borrow and lend, and it COULD BE that the total amount of debt would not be GREATLY changed by the switch to full reserve.

    The main weaknesses in fractional reserve seem to me to be thus.

    First, it promotes instability. That is commercial banks expand privately created money in booms, then come the bust, everyone deleverages, i.e. this form of money contracts.

    Second, the private banking system can lend and create money even where those it lends to do not get a commercial return on money borrowed. This is because producing such money costs essentially nothing. This phenomenon reduces interest rates to below the free market or optimum level, which in turn means there is more borrowing or debt than is optimum.

  3. Thomas

    The interest rate system is a very severe problem, exponential growth can never ever work in the long run, every exponential growth starts very slowly and goes off like a rocket after some time. In nature, cancer grows exponentially. And the interest rate system problem can not be avoided by just not going into exponentially growing debt. That would be the point of view of people who do not differ between a microeconomic and a macroeconomic point of view. Because, if total debt of society is not growing exponentially, money gets withdrawn from real economy (in other words, it gets hoarded) and that means more and more unemployment.

    http://www.webinformation.at/material/debtmoney.pdf

  4. The root of the problem is dept. Dept is against the nature. In nature no dept exist.

    Bake the bread during spring, then harvest the crop for it in summer?

    Build the house first, then create the bricks for it later?

    This is the one side of the problem.

    The fraudulent behavior of the banks is the another and bigger problem…

    You know, if you pay for something, you will have less money and the other side will have more money. This is not the case in banks.

    If you borrow money from a bank, you sell your house or car (or anything the loan is backed by) to bank and you buy it back for a higher price by paying off the loan. (If you can pay, they will take the backing.)

    Banks do not pay with their own money, the money you borrow, just appear on your account and no one else’s account balance will be decreased, because it’s only a number in a computer system. They create money and give it to you. This is counterfeiting and they can do it legally.

    If you pay off the loan, your money WILL appear on the bank’s account.
    So if you borrowed $50 and you paid back $60, it’s $60 revenue for the bank and not $10 as many people think, since $50 is not an expense for the bank – they created it.

    Dept creates slavery, you need to work hard to pay off the loan and stupid people still not realize they will end up worse than without borrowing money.

    If there are too much dept, people will be unable to pay off the loan and become insolvent.

    If people become insolvent, they don’t want to buy.

    If people don’t want to buy, factories can not sell their goods.

    If factories can’t sell their goods, they will stop production.

    Without production, the factories won’t have revenue.

    Without revenue, factories will be closed.

    If factories close, they need to fire all workers.

    If workers are fired, they won’t get income, so they can not pay. This makes more people insolvent.

    And this will have a cascading effect, as the factory’s suppliers can’t sell their goods too.

    And the entire economy comes to a halt.

    And at the end, banks will have entire cities of foreclosed houses and a huge portfolio of sold off companies, and they will be the absolute winners.

    And the third problem is yes, the humankind will extinct soon… After we cut out the last tree, we will realize that we can not eat the money!

  5. Johan Lindén

    RALPH, thanks for your thoughts. I still do not think that you need to take on credit or debt. Let us say that these X and Y wants to do some business. They could either pay with other means of payment such as gold, stocks, or options. The latter happens quite often. They could also make there own internal debt agreement. X make payments to Y with 25% of their earnings until the debt is cleared or such. No central bank is involved in their private affair in the above example.

  6. Johan Lindén

    CARL, I really do not see any arguments in your rebuttal about the points I wrote or you are not making your arguments clear enough for me to understand. About: “Limitless consumtion in a limited system, is somewhat contradictive.” I think I answered that clearly in the last sentence I wrote: “… that is an ecological problem and not a problem of the monetary system.”

  7. Johan Lindén

    THOMAS, does not look like you read my article. I clearly address those so called problems you mention.

  8. Johan Lindén

    CALMARIUS,
    “The root of the problem is dept. Dept is against the nature. In nature no dept exist. Bake the bread during spring, then harvest the crop for it in summer? Build the house first, then create the bricks for it later?”

    Coming from a broad scientific background with academic studies in anthropology and evolutionary biology I must say those arguments are very weak. We are Homo Sapiens, known to have many traits that make us very different from other living species. We have many traits that have made us more fit to survive than other species. So just because you do not see it in nature does not mean it is wrong.

    “So if you borrowed $50 and you paid back $60, it’s $60 revenue for the bank and not $10 as many people think, since $50 is not an expense for the bank – they created it.”

    Your point being? What has revenue anything to do with this? They are not earning $60 if that is what you think.

    For the rest of what you are writing, read point 1, 2, 3, 4, and 5 in my article above and you will have an answer to that too.

  9. Yeah, my previous comment was a bit dumb.

    After a bit of thinking I realized that fractional banking and fiat money works.

    But the only thing that annoys me, that it allows bankers and the government to create money and spend it without working and earn it, essentially robbing purchasing power from everyone that owns the currency.

    When gold is used as currency this money creation is not possible, at least someone need to work to mine that gold.

    • “After a bit of thinking I realized that fractional banking and fiat money works”

      one thing to realize here is that a free banking fractional reserve system does not hand out fiat notes.

      “But the only thing that annoys me, that it allows bankers and the government to create money and spend it without working and earn it, essentially robbing purchasing power from everyone that owns the currency.”

      Wrong. Free banking fractional reserve requires reserves on demand for a given note. The creation of notes work around supply and demand, reserve ratios, and the competition between rival banks.

      “When gold is used as currency this money creation is not possible, at least someone need to work to mine that gold.”

      Banks are not warehouses for your gold, well they can be, but that is not the majority of their business. History shows that free banking fractional reserves outperformed any gold standard bank… as a matter of fact, there has never been a free market gold standard bank before, by that I mean a bank that is a gold standard that is owned privately and not by government and relatively low regulation

      • Johan Lindén

        Hi Isaac and thanks for commenting!

        Unfortunately you do not seem to make your point clear. First of all, what is a “free banking fractional reserve”? The banking system we have now is not free in any way.

        Also, first you say “free banking fractional reserves outperformed any gold standard bank” and then you say “there has never been a free market gold standard bank before”. Very confusing.

        And thirdly “bank that is a gold standard”. How can a bank BE a gold standard?

        I think you need to rethink if you have any points or rephrase your sentences.

        I wish you a good day!

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