After at least 2 years of intensive study, I am changing my opinion
on Fractional Reserve Banking.
The writing on this page has been rewritten today -- 12/12/09. It will be found to contradict much of what I had written previously. I plan to change everything I have previously written to match what is written here. That does not mean I guarantee everything written here is true -- I can only offer what my thoughts tell me after a considerable amount of study of real life and the most logical information I could find.
An explanation is in order as to why I am changing my position. Where do my ideas come from? I am not formally trained as an economist. Everything I learned about money and banking is based on (A) one college course in Economics at Newark College Of Engineering in 1955, (B) what I picked up over about 50 years in casually reading Forbes Magazine Weekly and The Wall Street Journal Daily for 13 years from 1973 to 1986, and (C) serious independent study of Money and Banking from about 2005 to 2009. What I have written here is my more-or-less up-to-date opinions on how our money and banking systems work. If there is a conflict between what is written here and what I have written previously -- what is here is to be considered correct -- as far as I know. In any event, follow Buddha's dictum -- Believe nothing, no matter where you read it, or who said it, no matter if I have said it, unless it agrees with your own reason and your own common sense. / Buddha.
Virtually nothing that is written about money can be accepted as the absolute truth. Even the Constitution can't be believed -- what follows, in blue, at (A) & (B) in the next sentence -- is from the Constitution -- but is no longer followed. Certainly, (A) Congress does not create money and regulate the value thereof and certainly (B) the President does not sign monetary treaties with foreign countries with the advice and consent of Congress. The best we can do is observe what seems to be happening and do our best to suss out the underlying rules according to our own good sense. Even Congress does not declare War any longer -- it hasn't since 1942 and we have had any number of Wars since then.
In my opinion, The Federal Reserve lies regularly. Take the little test at << http://www.primeronmoney.com/arewebeingliedto.html >>
In my humble opinion, the seven links found at the following link will be just about, but not quite, the equivalent of a college education in Banking for a student who reads and absorbs the essence of these laws.
http://www.primeronmoney.com/bankinglaws.html -- Laws, rules and regulations regarding money and banking (7 links)
Fractional Reserve Banking --
when paper money was falsely backed by gold -- is an antiquated system
that has evolved into a Sovereign-created paper money that is absolutely reliable and completely backed by by the laws and wealth of our nation.
Fractional Reserve Banking was a banking system in which a fraction of the sum of (a) a private bank's invested capital and (b) the deposits of gold by the private bank's customers at the bank had to be kept on hand at the bank, in gold, to (a) meet routine expenditures of the bank and (b) to return deposits to the depositors when the depositors wanted their gold deposits back. In that sense, when a private bank loaned paper money to a borrower, it guaranteed, falsely, that that paper money was backed by whatever amount of gold was written or printed on the money. That guarantee was a sham -- the bank never had more that a fraction of the gold on hand. See <<http://www.primeronmoney.com/chapters/chapter3.html>>. We still have private banks but they now deal only in official, sanctioned, lawful money, backed for all purposes by U.S. Government law.
Bear in mind that many (most? all?) people think the reserves are somehow
still needed by the bank to back loans that the bank makes. That is a
simple fallacy. Banks do not back loans -- they never have since
questionable gold backed paper money was stopped.
When a bank gives a customer a loan now -- it gives the customer cash or a check based on the customer having enough collateral in the form of assets or income to pay the loan back in accordance with the terms of the loan contract. The cash is also, by a legal tender law, guaranteed to be legal by an official government action and every citizen is compelled by that law to accept that money in payment of all debts. Remember --- (1) BANKS NO LONGER BACK LOANS. THE MONEY THAT A BANK NOW GIVES WHEN MAKING A LOAN IS GUARANTEED TO BE GOOD BECAUSE IT IS MONEY THAT WAS LEGALLY MADE BY LAW UNDER THE CONSTITUTION.
Also bear in mind that many (most?) people think "Reserves" have something to do with loans made by the bank. THEY DON'T. The money for loans is created for the borrower based on the fact that the bank is acting as an agent of the government, acting to exercise the government's sovereign right to create whatever money it needs to run the money supply in accordance with its Constitutional mandate to coin money and regulate the value thereof. Remember -- (2) RESERVES HAVE NOTHING TO DO WITH LOANS SINCE WE WENT OFF THE GOLD STANDARD. Isn't it kind of dumb to think we somehow have Paper Money Reserves for Paper money like we once had Gold reserves for Paper money?
The money used NOW for bank loans does not originate with the bank: it was NOT the bank's money before it was created for the loan. The fact that the borrower pays interest on that money and apparently the bank keeps that interest does not alter the fact that the bank has none of its money in the loan. I have never seen the paperwork that spells out the responsibilities of (a) the government, (b) the Fed. and (c) the bank as to what happens to the interest paid by the borrower -- but I assume the bank keeps that interest even though it did not lend its money to the borrower. It seems logical to assume that the bank keeps the interest -- because in the event of a default by the borrower we know that the bank (not the Government and not the Fed.) forecloses, exercising the bank's right to the interest due on the loan contract. We also understand that when I made interest payments on a mortgage in the past -- those payments (capital and interest) went to the bank and was kept by the bank. The capital part of those payments had been made previously, in full, to the seller of the house.
It would be more correct to say we are now using a Sovereign Money Banking System wherein all money in the system is created by the government (or its agents -- now, the Fed. and its banks).
The Sovereign Money Banking System is actually simple -- but it is so counter-intuitive that it is very difficult to understand. It certainly does not seem possible that (a) the bank can lend money that it never had and (b) the banks have an endless amount of money to draw from that it can lend or spend into the economy. The fact that the private bank keeps all the interest seems at first glance to be somehow excessive, and perhaps it is, but the bank seems to be the entity responsible to the Fed. and to the Government that the loan is paid back by the borrower. The bank is responsible for making sure that the borrower is responsible and the borrower's plan to use the money is legitimate and sensible. Neither the Fed nor the Government seems to bear a loss if a borrower does not pay back a loan -- simply because the borrower has no contractual obligation to the Fed. or the Government. It is possible that I am wrong on this and the bank has a contract or agreement with the Fed or the Government that the bank will share all profit and loss on loans the bank makes on money created for a loan it makes. I have never heard or read of such a contract or agreement so I think I am justified in believing no such contract or agreement exists (I have read through most of the law at http://www.primeronmoney.com/bankinglaws.html -- Laws, rules and regulations regarding money and banking -- 7 links)
Most of the following material is based on A Primer On Money a 141
page book by Wright Patman - a Democratic member of the United States
House of Representatives from Texas. Patman was also Chairman of the
Banking Committee of the House of Representatives.