Fractional reserve banking, quick question.

tomstickland

I'm gearing up to do a load of reading on this.
Just see if what I remember from last time makes any sense....

Start with a world empty of money. The bank creats a load and lends it out. They demand that it is paid back with interest. They have to create more money to cover the interest. This itself will have to be paid back with interest.

So we already have a mathematically unsustainable system.

jim83

Aye.

Money is created as debt, but this only represents the principal of loans - interest is charged on top of this. But the money to be used to pay the interest has not been created. This leads to there being more more debt than there is money in circulation. Bankruptcies are inherently built into the system.

There's a good film floating around on Google Video called Zeitgeist Addendum which explains this very well (it then goes on to some conspiracy theory stuff which can be taken with a pinch of salt - but the start is good).

tomstickland

I've got a list of things to read and watch. Moneymasters is one.

PasturesNew

If you see money as debt, I think it says there that the maximum you can turn £1 into is £100k.

Bit rusty on it now though.

I'm (slowly) collecting all this stuff together for myself in one place, so I can dig it all out easily.

jim83

Incidentally, this is exactly the reason why banking bailouts are destined to fail.

Governments printing more money simply increases the amount of debt in the system and exacerbates the problem. The only way to keep it going is to keep printing, but eventually we will reach a point where the money becomes completely valuless and the system breaks down again.

It also negates the position that many are taking that this will be a deflationary recession - yes, assets are being sold rapidly in a desperate attempt to deleverage, but more money needs to be created in order for the existing debts to be destroyed. I think the deflation we are seeing at the moment is simply a temporary situation before the newly created money filters its way down into general circulation.

amcluesent

>I think the deflation we are seeing at the moment is simply a temporary situation<

Gold is going to $2000 both because of fiat currencies and as something for when the civil war kicks off. It's no wonder HMG has gone all out to disarm citizens, and the EU has trained and resourced it's own para-military 'police' to flood into any country where the people get above themselves.

Clown must be itching to invoke his Enabling Act and use the Civil Contingency powers.

lethal0r

this is the kind of thing i've been wanting to understand for ages, i'll have a look at that zeitgeist vid!

a question from me

is this why everything, in general, always goes up in price slowly over time?

caveatvenditor

Don't forget bank spend their earnings (Rent, dividends, wages etc) into the economy as non-interest bearing money.

Provided the money borrowed from banks is used to create value in the economy then the system is entirely sustainable. The problem comes (as we are seeing now) when money is spent on non-productive investments. i.e. selling houses to each other at ever increasing prices.

The debt based system is fine and sustainable provided is used correctly.

tomstickland

My original question wasn't really a fractional reserve question I suppose.

True fractional reserve banking means that a bank only needs to keep a fraction of its lending in reserves.

When this newly lent money is deposited somewhere else then the next bank can lend a proportion of the deposited money.

So £1 of original money creates a lot more new money, the amount being based on the rules for the reserve fraction.
Hence why some describe it as a "pyramid ponzi scheme".

http://en.wikipedia.org/wiki/Fractional_reserve#Money_creation

One thing that's intriguing me is that 100% lending would, on first thoughts, be entirely logical.
Money would then be pushed along a chain until it gets to the final borrower. Meanwhile it would have created an unquanitifiable and potentionally massive amount of commercial money.
ie: if a chain of 10 people pass a £1 coin along a line then only £1 really exists but on paper there'd be £10 of commerical money created.

With the fractional method, say the fraction was 20% then the first person would create 80p and lend that, the next would create 64p and lend that etc until the 10th person received 0.8^10 pounds.

Back to 0% reserves....
Imagine the 10 people, each time create a line in a different order, each time the first person is given a £1 coin and each time passing it along the lending line.
£100 of commercial money would have been created, each person having lent £10 but having no reserves. Further more they've only actually got one real borrower each.

In order to unravel it all then the money would have move back along the lines.
Now imagine that one of the random people is requested to pay back £5 of their borrowing. They'd have to go to all those that they'd lent to asking for their money back and the whole lot would have to untangle. Practically speaking it's very unlikely that it could be unravelled just like that. They could go to their one true borrower and get £1 back. So they'd be £4 short.

With a higher fraction they'd have some level of reserves, the amount depending on where they'd been in each of the 10 lending lines. The idea being that somone hopes that the reserves that they have are large enough to cover any demands for payment.

All a lot of fun.

slipthru

Also check out the money masters for a good explanation on the debt based system.

amcluesent

There's talk the in papers of reverting to a Bretton Woods style of financing, where the currencies are pegged to the gold standard.