The Key To Understanding The FED: The Dangers of Fractional-Reserve Banking

Posted: May 31, 2012 in Epistemology, Metaphysics, Politics
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(Note from author: I have recently been convinced that fractional-reserve banking, though it’s a bad idea, should not be outlawed.  The government should not outlaw bad ideas unless fraud or another for a violating rights is involved.)


In order to understand the Federal Reserve (FED), you need to understand credit expansion and the banking systems, which is full reserve and fractional reserve banking.  In order to understand the banking systems, you need to understand the nature of wealth and money, and their differences.

Money does not equate to wealth, or put slightly differently, money is not wealth .  If money was wealth, then why does printing money not increase the total amount of wealth in our society?  Sure, money can be traded for items that satisfy our needs or wants of utility, but as is, the paper is not useful — it’s only potentially useful.  What money represents — e.g., things that satisfy our needs and wants of utility — is useful, which is money’s source of value.

Money is simply a tool of exchange and a means of saving — i.e., the postponement of consumption.   Wealth is the goods you have at your disposal, which will satisfy your needs or wants of utility — i.e., wealth is your standard of living.  The wealthier you are the more you have at your disposal.

The implications behind the meaning of money — as a tool of exchange and a means of saving — are that to possess money you must have produced something of value and passed on your disposal of it to someone else in exchange for an IOU on society — the trade isn’t complete until you trade that IOU for something you need or want.  In essence, you’re bartering and exchanging what you produced for something you haven’t produced — money is simply the median or the “middle-man.”  Money has value but it doesn’t represent a static standard of wealth.

Think of the errors that one might conclude if one equates wealth to money consistently to that end:

1.  Wealth can be produced by reproducing money

2.  Wealth is only as static as the amount of money that exists, which leads some to assume wealth is static

3.  Since wealth is static, then it’s only fair to redistribute it evenly (a common argument)

4.  Profit is exploitation and wealthy people must have exploited the poor (another common argument)

5.  The exchange of money means one benefits at another’s expense

6.  Exporting is good because it brings in money, and therefore, wealth (another common argument)

7.  Importing is bad because it sends money out, and therefore, it drains our wealth (another common argument)

8.  Money just sitting on a table does not multiply; therefore, lending money cannot multiply wealth; therefore, lending money at interest is charging for something money has no ability to produce — more money; therefore, money should be lent at no interest, otherwise it’s exploitation (not an uncommon argument)

People in our society also tend to equate the dollar value of an item as its worth — another error.  Let’s say an item produced was originally $8 per unit.  Now let’s say that half of the items were destroyed — the unit may now be closer to $16.  Instead, let’s say that the money supply reduces by half — the item may now be closer to $4.  In the first case the item’s value relative to demand went up, and in the second case the value stayed the same relative to demand, but the price went down — the value of money fluctuated.  (We are assuming of course that the effects of inflation were instantaneous).

There are many reasons for the value of money to fluctuate.  For example, we could create more money, it can be destroyed, people’s interest in it could change, more things are produced, fewer things are produced, and probably more variables have a play (like foreign currency) than what I have listed.  (A speculator’s sole purpose is to predict these fluctuations and act on those predictions).  People’s desire is hard to predict, which means desire would be hard to predict for any kind of currency whatever; therefore, let’s limit the scope of our study to the aspects that cause fluctuations that can be predicted — like production and the creation of money.

Let’s first analyze what different effects that fluctuating currencies has on wealth.  Gold is a great place to begin our study because, compared to fiat money, gold has a relatively static quantity.  We’ll then shift our focus to fiat money because it contains a lot of the same principles as gold, but in addition to those, fiat money can rapidly multiply.

Given our study, the only real means for gold’s value to fluctuate is a change in the production of goods.  If production increases, then deflation takes hold, which means the value of gold goes up (relative to goods) because you can buy more with the same amount of gold.  If goods and production are destroyed, then inflation takes hold, which means the value of gold goes down (relative to goods) because you are able to buy less than before.

What happens to the treatment of gold as its value decreases? People tend to exchange more of it for goods because a certain amount of gold does not go as far as it used to; therefore, people pay more to receive the same about of goods.  The less gold is worth, the more people prefer goods over gold.  One can anticipate a threshold for the use of money — i.e., men in society have to reach a certain level of production, which isn’t much, to warrant the use of money over barter.

Who are the winners and losers if the devaluation of gold occurs?  The wealth in savings decreases along with gold — savers lose.  The total amount of goods decreases, and therefore, so does the standard of living  — everyone loses.  Because the standard of living decreases, people are less able to store their money in banks — the banks lose.  Does anyone win in this case?  I don’t think so; I can’t think of anyone who benefits.  Maybe those who take out loans benefit by paying back the loan with less valuable money than they borrowed, but that’s isolating a particular situation of the borrowers whole life; his standard of living will decrease with everyone else’s.  Even if someone ends up better off than before, they would be even better off if devaluation did not occur.

What happens to the treatment of gold as its value increases?  People tend to exchange less of it for goods because a certain amount of gold goes farther than it used to; therefore, people can buy the same things with less gold leaving them with change in their pocket.  The more gold is worth, the more people prefer gold over goods.

Who are the winners and losers if the value of gold increases?  The wealth in savings increases along with gold — savers win.  The total amount of goods increases, and therefore, so does the standard of living — everyone wins.   People are able to save more money and borrowers pay back loans with more valuable money — the banks win.  (Sure, borrowers need to work harder to pay back the loan, but that’s no different than paying interest).  Some people will lose, but only on their own efforts and risk to capital.

To sum up, a gold currency will tend to guide self-interest people towards production and savings making everyone a winner.

Shifting our attention towards fiat money; it has all the fluctuations of gold (as mentioned above) except in addition to those fluctuations, its value can fluctuate easily by reproducing or destroying it.  Since the destroyer of fiat money is the sole loser, however, we can assume no one is that self destructive; therefore, we can limit our focus solely on situations covering the production of fiat currency.  In order to isolate the effects of printing money, we need to consider a scenario with static production, meaning the same products are produced every year.

To begin, as one spends freshly printed money, he removes from society the product of their labor without reciprocating.  This causes more money to exist than what goods have been produced; therefore, the more money you print and spend, the lower its value will become due to inflation.

Inflation is not instantaneous because it takes awhile for its effects to propagate.  The information only propagates as the money exchanges hands.  For example, one can print a pile of money in their basement, but until they spend it the effects will be contained in his basement. Why is this?  Because the printer of money hasn’t made a claim on society by spending that money; it’s not until he removes goods from society without producing goods that society finally begins to realizes there are less goods than before (relative to money).  T he first recipient of freshly printed money may not know the money he’s receiving is printed, but after several exchanges people will adjust their prices when more demand for goods (relative to money) increases.  On the other side of the exchange, the first user of freshly printed money extracts its full value before inflation, but as the exchanges continue, the value extracted decreases as inflation increases.

Who are the winners and losers when money is printed?  The printer of money obviously benefits by being able to consume goods without producing them; however, this causes a strain on everyone who does produce equal to or more than they consume because the printer of money consumes what they have produced — everyone else loses.  The individuals who save money lose wealth in their savings as the value of their money is redistributed into the new total of money — they lose.   Those who take out loans benefit more than savers in the short run because the money they use to pay off the loan is worth less than the money they borrowed; however, in the long run their standard of living decreases with everyone else’s.   There is a point where the standard of living suffers so much that one is unable to pay off a loan and buy sustenance — i.e., their life is no longer self-sustaining. These borrowers go bankrupt, thus consuming the goods of society (spending the loaned money) without producing (not paying off the loan) — they join a similar status as printers on money.  So those who benefit the most are the printers of money and the borrowers of money  (for the short term) — neither of which produced anything for the privilege of spending money– while everyone else suffers.

We now know the different causes of fluctuations in the value of money that can be controlled, which means we discovered enough context to continue onto the banking process; and after that, the Federal Reserve.

Given a static value for currency, let’s see what purposes or value a bank provides.  If men had the ability to keep all their money on their person, then the necessity of banks goes down.  If men could secure their money better than banks, then the value in using a bank goes down.  Since men have trouble keeping all of their money on them securely, banks have value.  This is why men uses banks; for security and ease of use.

The first banks that were used kept money in a vault, and they never lent any of that money out; that type of system is called full reserve banking where 100% of the deposits are kept in their reserves (AKA their vault).  Banks were able to stay in business because they earned money for securing its members’ money — people would pay the banks to secure their money.  The banks would also lend out money that they owned at interest.  At times, they even acted as middlemen between one of their depositors and a borrower and earned some sort of commission on that money.  Full reserve banking does not cause the value of money to fluctuate because it doesn’t reproduce money nor does banking in and of itself produce enough goods to change the value of money — it just secures the principle of property rights ensuring property owners keep their property.

A second system of banking is called fractional reserve banking, and, as the name sounds, the bank is able keep less than 100% of their deposits in reserve, which means the banks can lend out depositors’ money at interest without their knowledge.  The depositors no longer have to pay banks to secure their money because the cost is paid by the interest earned on the lent money; in fact the bank earns so much money that they pay the members for storing their money in their bank.  This banking system causes the value of money to fluctuate, so this warrants further analysis.

The essential difference between the two systems that causes the value of money to fluctuate under fractional reserve banking, but not under full reserve banking, is that for full reserve banking the lender losses access to their money when a loan is created.  For fractional reserve banking, however, loans are made without any lender losing access to their money .  It is important to understand this difference and its full implication because without doing so would mean increasing your risk of making bad evaluations in your conclusions based on this information — like people often do after they equate money to wealth.  First let’s further understand the difference before we get into its implications.

For full reserve banking, when a loan is made the lender sees the money leave his account along with a place holder (or an IOU) for that money; the person taking out the loan has the money along with a negative place holder.  Each place holder and money, or lack of money, counter balances each other — i.e., money with a negative place holder, and lack of money with a place holder cancel each other out.

For fractional reserve banking, however, the bank sees the lack of money along with a place holder, while the person borrowing the money sees the money along with a negative place holder — seems equivalent to full reserve, doesn’t it?  Well, not quite.  Where does the bank get the money to lend?  Is that their money?  It can be, but more than likely that money comes from a depositor.  (It doesn’t matter if the bank uses $100 from one depositor or 10,000 pennies from 10,000 depositors — the essentials are the same regardless of the break down).  What place holders or money transfers do the depositors see?  The answer is none — they see 100% of their money in their account.  Is this a problem?  You bet it is — it’s the root contradiction which causes secondary and tertiary effects down the road.

A contradiction follows the formula of something that is and is not at the same time in the same respect.  Well in the fractional reserve bank’s example, the depositor’s money is his (as displayed in his account) and is not his (as displayed in someone else’s account) at the same time (from the initiation of the loan until it’s paid off) in the same respect (as seen in an account) — the very definition of a contradiction.  It is inessential that the banks have not named one depositor they’re taking from when they take from the pool of money in their vault  — that money came from somewhere and doesn’t eliminate the contradiction.  It is inessential that the lender puts collateral up against the loan to counteract the risk of default — it doesn’t eliminate the contradiction.

The contradiction is the single piece of essential information because contradictions cannot exist and every attempt to bring a contradiction into existence has resulted in some sort of annihilation.  For example, think of the results of carrying out polices based on equating money to wealth — e.g., you seek to print more money, you wage war to confiscate money, you eliminate trade as people attempt to sell their products and boycott yours and vice versa, etc.  It eventually results in the annihilation of whatever value you were trying to create — i.e., money and societies lose their value.  In the case of fractional reserve banking, as we will discover, the results are the same — i.e., the retardation of wealth at best and destruction of wealth at worst.

(This particular contradiction within fractional reserve banking is also a violation of property rights, where property is necessarily singular ownership — i.e., one thing one owner.  For fractional reserve banking, multiple owners exist for a single thing — i.e., depositors and borrowers own the same dollar.  Of all the economic reasons I’ll go over in explaining the perils of fractional reserve banking, it is the argument for securing property rights that should be sufficient to a free society, that has any interest in remaining free, in ceasing the act on moral grounds and making it illegal).

In full reserve banking, the amount of claims (potential claims) on society are never greater than (and are actually equal to) the amount produced — i.e., the producer lends his claim on society in exchange for interest, which is paid by the borrower.  In fractional reserve banking, however, you have greater claims on society than what has been produced because you have producers who do not lend their claim on society, and you still have borrowers who acquire a claim; this creates a lag effect, where claims on society increases faster than what is produced.  Where did the increase in claims come from?

So how did the banks succeed in creating a contradiction if they cannot exist?  How is it that the depositor’s money is and is not his at the same time in the same respect?  I’ll I’ve you a hint, a contradiction cannot exist.  When you think you’re facing a contradiction, check your premises; you’ll find that one of them is wrong.

Our essential premises are that the depositor still has access to his money and that the money supply did not multiply.  We know that bank runs can occur, which leads one to suspect the former.  We also know that the depositor can use his money (under normal conditions), which leads me to suspect the later.  The truth is that both premises are false under different contexts, and both are never true at the same time.  The double contradiction only serves to further conceal the contradiction — it allows most to accept the lie that both premises are true, which is only half of the truth when in fact both are never true at the same time.  The reason that two contradictions seem to exist is because the respects (remember “…in the same respect”) change subtly making it hard to track.  In one respect, the money is owned on paper, and in another respect the money is owned physically.  On paper the money supply multiplies and physically it does not .  So when the money is owned in one respect, let’s say physically, then the money supply premise is true, while all depositors having access to their money is false.  If money is owned in the other respect — on paper — then all depositors having access is true, while the non expansion of the money supply is false.  (I suggest rereading the arguments surrounding the different respects of ownership until it sinks in).

A fair number of people see that both premises are false under different conditions, but fail to understand the implications or severity in accepting the contradiction.  They obviously understand from history that bank runs are bad, but think they can be avoided and see no negative repercussions for expanding the money supply.  We understand, from our discussions of inflation, why expanding the money supply is bad.

Who are the winners and losers under fractional reserve banking?  Savers find that the money they saved loses value over time more than the interest they earn on that money — they lose.  More consumers than producers exist at any one time   — everyone loses as the standard of living suffers.  Bankers are able to earn a ton of money from interest on money they didn’t own — they win, but only for the short term because their standard of living suffers more than it would have if the money supply didn’t expand.  (It’s would be difficult for bankers to understand this because they can potentially make 45 cents on the physical dollar every year).  The borrowers win in the short run by paying off the loan with less valuable money, but like the bankers, their standard of living suffers in the long run for the same reasons as bankers.  There is a point where the standard of living suffers so much that one is unable to buy sustenance and pay off their loan — their life is no longer self-sustaining.  Unlike full reserve banking, however, where the lender would lose his money along with the person he lent money to, no depositor “loses” theirs under fractional reserve banking.

A limit exists for how much banks can lend out, under fractional reserve banking, and still function.  If they keep 100% in reserves, then it’s no longer fractional reserve.  If they lend out all of their reserves, then they default on any withdrawals, which results in a bank run.  What number, between 0% and 100%, allows a bank to function and allows depositors to have access?  It really depends on how much people need money.  The ability for people to save increases as the standard of living increases; and vice versa as the standard of living decreases.  In addition, when people borrow money, they use unconsumed goods — i.e., what would become savings — to pay off the principle and the interest.   There is a point, therefore, like there is in the use of money, where the standard of living needs to reach a certain point before fractional reserve banking can exist because people need to save money in order for fractional reserve banking to function and people need to earn enough to save.

Let’s assume that we reached the limit of credit expansion, what happens when we reduce the amount of credit by paying off loans?  Deflation occurs.  Is this a good thing?  We discussed earlier that deflation is good, but in this case, it is good only under a certain context.  The savers benefit because the value of their money increases — they win.  The standard of living increases as more goods are consumed when people start to pay off loans — everyone wins.  The borrowers suffer because they need to pay back the loans with more valuable money than they borrowed — they lose, but they would pay interest anyway.

Deflation is bad under fractional reserve banking, however, if it occurs rapidly.  For example, the faster deflation occurs the harder it will be for borrowers to pay off the loan and buy sustenance, which increases their likelihood of bankruptcy.  Borrowers lose the ability to pay off the loan because they now need to work several times harder (up to 10 times) to pay off loans — they lose.  The more borrowers that go bankrupt, the less money the banks will have to pay depositors their interest.  The less the banks have to pay depositors, then the more likely they will go bankrupt — they lose.  If a bank manages to avoid bankruptcy, they will still be unable to return to full reserve banking; that equates to lost value.  The bigger the gap between what the banks have in reserves and what the depositors have in their accounts, then the more value is lost — savers lose.  The more value that is lost, then the more the standard of living suffers — everyone loses — e.g., the market crash of 1929.  The trend of fractional reserve banking is to resist returning to full reserve for that exact reason — everyone loses.

So at the limit of fractional reserve banking — meaning the reserves are at their lowest and the expansion of the money supply is impossible — is it better than full reserve banking?  Under full reserve banking production matches or surpasses claims to consume, the standard of living matches advances in production, and property rights are protected.  Under fractional reserve banking at its limit, production lags behind claims to consume (remember there are more claims to consume than what people produce due the fractional reserve banking contradiction), the standard of living matches advances in production, and property rights are violated.  All being equal, if my evaluation is correct, a full reserve banking society would improve their standard of living at a similar rate to that of a fractional reserve banking society; however, there would be a period of time, for the fractional reserve banking society, when the standard of living would lag behind until the limit of expanding money is reached.  The icing on the cake (sarcasm), however, is that everyone’s property in banks are constantly at risk because they are relying on others not to make a physical claim on their money.  As our standard of living continues to drop, how much longer to you suppose people can live without making that physical claim?

We talked about the nature of money, the ways in which it can fluctuate, different systems of banking, and the implications of each; now we have a great base of knowledge to discuss the FED.  Every fact you read about the FED is true, but not the evaluations.  For example, they do control the money supply by setting the interest rate for loans, but that is not in the long term interest of anyone, and only serves the short term interests of very few people.  They don’t print money and loan it out, they simply loan money in the form of electrons, and fill their reserves with printed money that the US Treasury Department printed — essentially the same thing as loaning printed money.  They actively strive to cause inflation, between 3% and 5% every year, which continually increases the limit   of fractional reserve banking; thus, avoiding the system’s natural limit.  The FED is able to loan money even if there are no depositors to back it up.  Depositors become an old fashioned notion when the production of every dollar carrying person is backing up the freshly printed bills.  This leads us to our next question: is fractional reserve banking better than full reserve banking if the natural limit placed on fractional reserve banking is removed?  The question reduces to, is steady inflation better than steady deflation?  You have the information; you be the judge.  I suggest starting with the lagging of production behind consumption that we discussed in fractional reserve banking, which would necessarily continue and become greater.  Is that good?  Do you think there is a possibility where the increases in claims to consume would surpass the advances in production?  And finally, do you benefit?

The FED is convinced that their actions are in the best interest of the country, and therefore, in your best interest — that is their evaluation.  What is yours?

  1. dbhalling says:

    This article is pretty good, but contains a misunderstanding of fractional reserve banking. I believe this error occurs because the author assumes (has lived their live under) legal tender laws. I have written a couple of posts on this issue, but will briefly explain the points of the posts below.

    Did Midas Mulligan Run a Fractional Reserve Bank

    Understanding the Coming Financial Collapse: Central Banking, Fraction Reserve Banking, and Legal Tender Laws

    The error in this article has been repeated by many Austrian economists and confuses legal tender laws, fractional reserve banking and central banks.

    Fractional Reserve Banks are not a government creation, they are part of the free market.
    Central Banks are a government creation and not part of the free market.
    Legal Tender laws are a government creation and not part of the free market.

    Fraction Reserve Banking is a process of collateralizing non-liquid assets. It is no different than creating bank notes for gold or issuing bonds by a company and similar to issued stock certificates. Logically, if you are against fractional reserve banking you have to be against the issuance of bonds. Meaning you have to interfere in the free market – people’s right to contract.

    Legal Tender laws define what is considered money. The US did not have any legal tender laws until the 1860s (Note they were originally ruled unconstitutional) . Legal tender laws are necessary for government counterfeiting to work. Otherwise people would refuse to deal in a currency that could be manipulated.

    Central Banking is a system for government control of the money supply and cannot work without legal tender laws.

    Eliminating legal tender laws is the key to stopping the government from counterfeiting money – which shifts wealth from productive people to politically connected people.

    • m082844 says:

      I don’t think I made an error here, but I will research your links for clarification.

      At first glance, I’m not making the error you assume I make. I am not assuming legal tender laws when considering fractional reserve banking (FRB). FRB existed long before legal tender laws.

      My problem with FRB is that it’s a contradiction with property rights via fraud qua contradiction. The government interferes, and should interfere, when fraud or actions contradict property rights.

      Not every contract can rigtfully be made just because it can be imagined; such as a contract to enslave yourself. Rights are not transferable against their nature via contracts, which is how I see FRB at the moment — an attempt to transfer a right against its nature. For slavery, one cannot transfer their soverenty no matter how hard one tries. For property, it cannot be split it two with each part containing 100% ownership.

    • m082844 says:

      I read your links. You make some interesting points. I agree that eliminating legal tender laws will result in people leaving the dollar. Legal tender laws does make it possible for the FED to expand the money supply, but so does fractional reserve banking (FRB) due to the “sophisticated” method the FED uses to expand the money supply. If FRB was outlawed like any other fraud, then it would be impossible for the FED to expand the money supply without breaking the law.

      Have you ever considered that FRB might be a type of fraud? If it is a fraud then the nature of this particular fraud must be elegant for so many people to look at FRB head on and call it legitimate — and it is elegant. Not everything within a contract is legitimate even if two people agree to signing a contract because a fraud would make the foundation for forming a contract illegitimate. For example, selling the same object twice to two different entities as happened in the Fountainhead is a classic example of people signing an illegitimate contract. Another classic example is saying something that is when it can’t be (such as a forgery). Both of these frauds exist within FRB.

      I see that your argument for securitizing other assets in the form of bank notes is appealing, but there are some issues with that line of thinking that I’m not sure are recoverable. In reading Francisco’s money speech, one gains a strong understanding of the root and nature of money. One learns, if not known already, that money is a tool of exchange. One accepts money for their hard work trusting to be able to exchange it for another’s hard work. FRB contradicts this principle at the very first attempt to implement FRB. The bank issues a note to securitize the hard work of others. Had the bank received the bank note by producing themselves, then it would not contradict, which happens sometimes, but isn’t isolated to FRB. The contradiction arises, however, from the fact that the bank sometimes hand the notes over after having drafted them, which is isolated to FRB. Had the note been made to be equivalent to whatever is securitized (e.g., each note being equal to a percentage of a house that was mortgaged) then FRB might have a leg to stand on (maybe not, I haven’t considered it fully). As it is, however, notes are marked as equivalent to gold. This process eliminates the closed loop that exists is the proper activity of exchanging money by introducing a source of money without bottom. The evidence for this is that this process creates more bank notes, that are said to equal gold, than the amount of gold that exists. The first hint of the fraud.

      The fraud of FRB is two fold: it is said that it does not create money, and that two people don’t own the same money. Both of these statements contradict reality when FRB is applied. What makes this fraud elegant is that the contradictions don’t exist in the same respect, so depending on which respect your considering, there doesn’t appear to be a contradiction. This makes it difficult to shift ones focus from a respect that creates consistency to a respect that creates inconsistency.

      The different respects, within the context that notes are said to be equal to gold, are the notes or the gold. When considering notes, the expansion of money is created because more notes exist than does gold. When considering gold, more than one person owns the same object because more notes exist than does gold. However, when considering notes, no more than one person owns the same note. And when considering gold, the expansion of gold is not created. Which is the proper perspective? This is a trick question because every perspective needs to be consistent.

      The expansion of money and more than one person owning the same object violate property rights. The former by means of counterfeiting and should be made illegal for the same reason forgery is illegal. The latter by means of breaching the nature of property rights and should be outlawed for the same reason double selling is outlawed.

      • dbhalling says:

        Money is not a fixed thing and will expand with the size of the economy, unless arbitrarily limited by government rules. Many things have functioned as money including stocks, bonds, digital entries (see bitcoin). Just because the supply of silver and gold is fixed (stable) does not mean that money will not expand. The ability to securitize assets is key to an advanced economy. If you cannot mortgage your land, you will have underinvestment in irrigation or tractors. If you cannot sell stocks and bonds or obtain loans in your company the economy will severely under invest in new technologies. Expanding our level of technology is the only way to increase real per capita income. A FRB system is just a method of securitizing assets like farms, cars, business, future work. Each loan in a FRB expands the money supply, but no faster than the economy grows (it is securitizing assets). If the banks give out too many loans, over expand the money supply, then they will not be paid back and the money supply will shrink. Since all loans have to be paid back or defaulted, the expansion of money by banks is always balanced by the contraction of the money supply when the loans are repaid.

        Despite saying that you are not intermingling the concepts of FRB with a central bank, you continue to do so as evidenced by this statement “but so does fractional reserve banking (FRB) due to the “sophisticated” method the FED uses to expand the money supply.” FRBs do not require a central bank and are a free market creation. These banks are providing the service of securitizing illiquid assets, just like an investment bank issues stocks and bonds on a company. They receive payment in the form of interest for this service.

        You make the statement “As it is, however, notes are marked as equivalent to gold.” I have never seen a US note marked in an equivalent of gold (silver certificates disappeared at least by the 1950s). Even if it were this does not mean that banks are committing fraud by issuing more notes than they have gold on hand, unless they have contractually stated that they will do so, the statement is a measure value not a statement of having the gold on hand. A bank note is not a contract to hold the gold in an account, if you want that you can put your gold in a safety deposit box or start a 100% reserve ration bank. I would agree that banks should disclose that they are FRBs. However, eliminating FRBs would be an economic disaster and as I pointed out logically would mean you should not be able to issued bonds or stocks.

        A FRB does not result in “The expansion of money and more than one person owning the same object violate property rights” unless you are confusing a loan with two people owning the same property. If you take out a mortgage on the house, the bank has rights in your house. Property right are not a single thing, they are a bundle of different rights (actions) associated with a physical item. If I rent a house, I have rights in that house, but so does the owner and if the owner has a mortgage so does the bank and if there is an easement on the land then so does the easement holder. Austrian economists often fail to understand what property rights are and confuse property rights with the object and with possession. For more information see

  2. m082844 says:

    Again, I’m not limiting FRB with central banking. I referenced the FED in response to your paper covering legal tender, fractional reserve banking, and central banking because you bring up a way to end the FED by eliminating legal tender laws. I am listing one specific case of FRB within a more general case to demonstrate that the FED also relies on FRB to expand the money supply.

    I don’t think mortgages or any loan making, while using collateral, is limited to FRB, isn’t it possible under full reserve? Full reserve doesn’t limit anything in this regard.

    I know notes are no longer marked as equivalent to gold. I was using a fictional example to assist in articulating a point. Today they are marked as equivalent to a dollar, and that fact doesn’t really matter. The principle is the same: there are more dollars on the books than that exist. I’m using my fictitious example to highlight a non-central bank example, which uses gold.

    You make some interesting point, but none of them address and resolve the two contradictions I highlighted. I’m afraid no number of articulate arguments are useful until they address and resolve these contradictions.

    Ideas leading to the prevention of FRB legally isn’t any more arbitrary than ideas leading to legally preventing double selling, forgery or any kind of fraud. I’m sure double selling, forgery, or any other fraud would be a “free market creation” if those activities where not made illegal.

    I’m looking into your link on property and ownership.

    • m082844 says:

      I’ve read your paper on property rights. Applying this to my statement that multiple people own the same thing, I can now clarify what I meant implicitly. I understand that multiple people can seeming own different aspects of the same thing without contradiction because the respects differ. What I’m saying is that multiple people own the same aspects of the same thing, given FRB.

      When more notes exist than gold, for example, more than one hundred percent of the gold is claimed for as evidenced by the possibility of bank runs. It doesn’t matter if your account says you have X amount of money in it. When a bank run occurs, then you come to realize more than 100% cannot be claimed of a single object in the same respect.

    • dbhalling says:

      Actually, the FED can use open market operations to create money much more efficiently, like it is doing now. It is buying, with money created out of thin air (actually electrons in a computer), mortgage backed securities and Treasuries. This is true counterfeiting.

      FRB is not fraud – unless you believe issuing bonds are a fraud and it is not theft and it is not creating something out of nothing. It is a part of any free market. If I give you a certificate for so much gold you deposited with me that is collateralizing the gold. There is no logical reason why I should not be able to give you a certificate that is a portion of your land or your land and farm implements or etc. You are suggesting that it is okay to outlaw a transaction that is neither fraud or theft – that is not a free market.

      Yes, 100% reserve ratio bank FRB does limit the ability to get a loan, because only gold, for example, can be collateralize – I doubt you are suggesting we all carry around gold coins for all our transaction.

      Loved you post on gun rights in the Gulch

  3. m082844 says:

    I’m glad you liked my gun rights post in the gulch. I’ve been enjoying your papers. It’s nice to meet like minded people, who agree on the basics and can discuss details rationally.

    I’m not intimately familiar with how bonds work, so I can’t say if I associate them with FRB.

    I do agree, and I have no issue with lending money in exchange for interest; or securing money in exchange for a fee. This by itself does not create the two contradictions. I also don’t have a problem borrowing money by putting things up as collateral (like a mortgage). None of these activities are indicative of FRB.

    The issue I take is lending part of a reserve, which creates more money on the books than does exist. Where is my error with regards to FRB? Does this not create more money on the books than does exist? Does this not create an environment where bank runs are possible? And because of this, does it not create the two contradictions I highlighted, or did I make an error?

  4. dbhalling says:

    Great blog. I focus on Intellectual property issues and issues involving inventions (inNOvation)

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