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Author Topic: Fractional Reserve Lending IS NOT bad - its unavoidable  (Read 12621 times)
theonewhowaskazu
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May 11, 2014, 03:41:51 AM
 #1

Lots of the time on here I see people complaining about the existence of FRB while at the same time preaching the free market and real money. I think its important to understand what the so called "real money" is, and why FRB is not only unavoidable but the only way for an economy to succeed assuming a free market. In short, in the current system, money is backed by debt issued by a central authority and there's a theoretically unlimited supply of it. In what many people here seem to think is a "real" system, money is backed by something in limited supply, and not debt, and is decentralized. In reality, in order for an economy to truly be stable, there must both be a decentralized limited supply of money AND it must be backed (at least somewhat) by debt.

Scenario: Money in a limited supply without debt.

First, money is in a limited supply, so people hoard it, as its going up. Then, something happens, and some big holders stop holding it. This is usually triggered by a period of huge expenditures, such as war, a bubble in another commodity, or when a great new invention is created that everyone wants. People decide that owning that new product, or spending on war, is preferable and will produce a greater return over the economy in general than hoarding actual currency. This means that contractors/producers of the new product either start hoarding the new product, or they run out of supply. This drives the price of the product up, reducing the economy-wide deflationary effect. What follows is an economic boom where everybody is spending their currency, and since nobody has any real reason to hoard it now that its decreasing in price anyway, it money velocity increases and eventually the currency goes to 0 and is forgotten, unless some people hoard it again, beginning the cycle anew. Result: Hugely unstable boom-bust economy. Eventually, one of these people that buys up the currency decides to lend it out, leading to the ideal "debt/limited supply" hybrid economy.

Now for the debt-only backed system.

In the debt backed system, all money is backed by debt meaning that the entire money supply is ultimately owed to a central issuer (there could never be multiple issuers under this system, because each issuer would be afraid that the other would print more money - to clarify, each currency can only have one central issuer, although there can be multiple different currencies, each of which has their own issuer). The central issuer, since its lending out the entire money supply, collects what is effectively rent on the entire money supply. This system can have one of two possible outcomes: Either hyperinflation to zero, or the accumulation of almost all goods and services by the issuers of the currency. The reason is this: The money must be paid to the issuer with interest. So, either the issuer spends that interest, putting it back into the economy, which gives him some hard good or service, moving that good/service into his own hands from the hands of the masses; or, the issuer hoards that interest, forcing defaults, moving the collateral to the hands of the issuer, again taking it from the masses; or, the issuer issues more debt to those already in debt so they can pay back the interest, constantly increasing the money supply, leading to hyperinflation.

Finally, for the hybrid system:

There is a currency of limited supply which people are spending on products. Some holder(s) of a larger amount of this currency lend currency out to individuals, to collect interest. This creates a fractional reserve banking phenomenon, as those holder(s) realize that they can profit from a spread between the interest they pay smaller holders or holders requiring more liquidity, and the interest they collect themselves. Unless the currency is already too centralized (in which the interest causes almost all the currency to be collected by one individual who then deflates it to magnify its worth, and then engages in what is effectively a debt-only backed system) there will be multiple of such lenders. These lenders will be motivated to lend for collateral worth less and less more than the underlying currency. This will cause a period of slight inflation, but it can never inflate too much, because each lender has a limited supply to lend. If the effective reserve ratio ever becomes too low (i.e, there's too many "layers" on the fractional reserve pyramid), then money will be easy to come by, and some individual will hoard it, which will cause others to default, which will move the property used as collateral into the hands of the original lenders, causing, once again, one person to have property and another to have the money, causing the system to repeat once again. Since, of course, the collateral on the loans last issued would be valued the most vs. the currency, and the currency would deflate during the period of defaults, the lenders would lose money each time this occurs, rewarding reasonable reserve requirements. As such, through normal free market "selection of the fittest", the best lenders survive while the rest fail/give up, meaning that the currency stabilizes over time. Of course there will always be some fluctuation in the value of the currency. But hopefully you can see that the currency can never deflate more than the excess collateral %, and can never inflate to the point where a new group of banker(s) can afford to buy up a significant portion of the money supply. This probably has some correlation to the Gini Coefficient, but I'm not going to calculate it because that is too hard Smiley

Tl;Dr: Debt-backed system doesn't work. Limited supply system doesn't work unless there's also a lot of lending going on. Currency (and whole economy for that matter) will be most stable when there's a wide distribution of wealth among both non-bankers and bankers. The bigger the difference between the wealth of bankers, and the wealth of non-bankers (taking into account both currency and assets used as collateral), the more potential the currency has to inflate.

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LAMarcellus
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May 11, 2014, 05:22:43 AM
 #2

Wrong.
Fractional reserve lending is fraud.
Prices transmit information in a free market.
"Some holder(s) of a larger amount of this currency lend currency out to individuals, to collect interest. This creates a fractional reserve banking phenomenon"
lending money at interest is not fractional reserve banking.
You have your definitions mixed up.  Huh

The only way to deal with an unfree world is to become so absolutely free that your very existence is an act of rebellion. – Albert Camus
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May 11, 2014, 05:53:30 AM
 #3

vote with your bitcoins
if a company holds your bitcoins is engaging in fractoinal reserve
you can choose not to deposit your coins with them
if they cant cover their bitcoin withdrawls (in a bank run) there is a chance they will go under.

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maurya78
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May 11, 2014, 07:23:35 AM
 #4

Fractional reserve banking is akin to counterfeiting money, creating what shouldn't be there
It's a Ponzi scheme ultimately

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May 11, 2014, 07:34:42 AM
 #5

Wrong.
Fractional reserve lending is fraud.
How is it fraud? Care to elaborate?
Ozziecoin
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May 11, 2014, 10:30:21 AM
 #6

FRB is FRAUD.

FRB explained: http://ozziecoin.com/index.php/fractional-reserve-banking-explained

Non-technical coin. Use OZC to intro coins to everyday aussies: http://ozziecoin.com
greenlion
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May 11, 2014, 10:53:20 AM
 #7

It's fraud because you're lending out money that you're also making available for withdrawl simultaineously. If too many people exercise their rights to deposits the whole system falls apart, That's exactly like a Ponzi.
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May 11, 2014, 10:54:01 AM
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It's fraud because you're lending out money that you're also making available for withdrawl simultaineously. If too many people exercise their rights to deposits the whole system falls apart, That's exactly like a Ponzi.

Amen bro. Not to mention ordinary workers' savings are diluted to sweet nothing.

Non-technical coin. Use OZC to intro coins to everyday aussies: http://ozziecoin.com
twiifm
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May 11, 2014, 03:38:07 PM
 #9

It's fraud because you're lending out money that you're also making available for withdrawl simultaineously. If too many people exercise their rights to deposits the whole system falls apart, That's exactly like a Ponzi.

Is insurance fraud too?
greenlion
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May 11, 2014, 03:43:53 PM
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It's fraud because you're lending out money that you're also making available for withdrawl simultaineously. If too many people exercise their rights to deposits the whole system falls apart, That's exactly like a Ponzi.

Is insurance fraud too?

No, because insurance payouts involve meeting the criteria of the policy, and there is nothing to stop insurance companies from borrowing money to meet unexpected obligations, much like for example any other company responding to a sharp unexpected increase in costs. In the case of regular banking, all deposits are liabilities that the depositors are entitled to collect at any time.

It's not necessarily fraud for a business to find itself in a situation where it can't meet all its liabilities. But banking is actually designed from the ground up such that they intentionally can't meet the liabilities they've explicitly accepted.
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May 11, 2014, 03:56:48 PM
 #11

It's fraud because you're lending out money that you're also making available for withdrawl simultaineously. If too many people exercise their rights to deposits the whole system falls apart, That's exactly like a Ponzi.

Is insurance fraud too?

No, because insurance payouts involve meeting the criteria of the policy, and there is nothing to stop insurance companies from borrowing money to meet unexpected obligations, much like for example any other company responding to a sharp unexpected increase in costs. In the case of regular banking, all deposits are liabilities that the depositors are entitled to collect at any time.

It's not necessarily fraud for a business to find itself in a situation where it can't meet all its liabilities. But banking is actually designed from the ground up such that they intentionally can't meet the liabilities they've explicitly accepted.

Say what?  If a bank takes in your deposit and loans out 900% of that as FRB.  The loan is an asset-no?  BTW this is not how it works.  But I'm trying to use YOUR logic.

How is it you think banks are designed not to meet liabilities if their assets exceed liabilities due to being able to create new money
theonewhowaskazu
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May 11, 2014, 04:22:50 PM
 #12

Wrong.
Fractional reserve lending is fraud.
Prices transmit information in a free market.
"Some holder(s) of a larger amount of this currency lend currency out to individuals, to collect interest. This creates a fractional reserve banking phenomenon"
lending money at interest is not fractional reserve banking.
You have your definitions mixed up.  Huh

Sorry, I skipped over a bit here. When large holders are lending, they will release that they can accept deposits from others, and lend that money as well, for the same reasons basically any investment fund exists. Eventually, most people will become aligned with one or more of these funds and stick their savings in there to get interest. Then some smart merchant will realize that he may as well accept money in these accounts as payment in place of cash, because there's no reason not to (he would have stuck it in there anyway) and because accepting the money in these accounts as payment increases the money supply bidding for his products, increasing his sales/profits.

Where there's low-risk lending there will eventually be a fractional reserve system.

theonewhowaskazu
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May 11, 2014, 04:35:42 PM
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It's fraud because you're lending out money that you're also making available for withdrawl simultaineously. If too many people exercise their rights to deposits the whole system falls apart, That's exactly like a Ponzi.

not really. What you're doing is, you're lending out money, while simultaneously allowing the transfer of the deposited balance(s) between depositors. In order for fractional reserve to be fractional reserve, the only requirement is that deposits are used as currency in their own right - the bank need not guarantee liquidity.

EDIT: Even if they are offering liquidity though, that doesn't make them a scam. By that logic every form of maturity transformation should be illegal.

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May 11, 2014, 05:44:43 PM
 #14

it's fraud and it's bad.

Consider this:

You store $100 at the bank

the bank uses that $100 as a security to grand a $1000 loan to someone else. So the bank magically makes $900 and gambles with your money.

The bank now also expects the $1000 'back' (while it was never their possession in the first place) and on top of that they also charge interest on it.

So they actually make money on money that never existed in the first place. That's pretty much counterfeiting.
twiifm
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May 11, 2014, 06:03:15 PM
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it's fraud and it's bad.

Consider this:

You store $100 at the bank

the bank uses that $100 as a security to grand a $1000 loan to someone else. So the bank magically makes $900 and gambles with your money.

The bank now also expects the $1000 'back' (while it was never their possession in the first place) and on top of that they also charge interest on it.

So they actually make money on money that never existed in the first place. That's pretty much counterfeiting.

Umm.  Thats not how modern banks work though.

Besides if they don't do this then how do people get loans?
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May 11, 2014, 06:19:14 PM
Last edit: May 11, 2014, 06:30:34 PM by DeathAndTaxes
 #16

Quote
Besides if they don't do this then how do people get loans?

Loans are possible without fractional reserve banking.  It just isn't done with depositor funds.  It involves a lender and a lendee.   If your friend needs $5K to buy a car so he can commute to work and you have $5K cash, you could lend it to him, and he repays you over time.  That is an example of lending without fractional reserve banking.  

Borrowing, lending and interest far predates fractional reserve banking.  AFAIK the earliest recorded example of FRB by design was in the late 1600s.  Prior to that banking was a bailor-bailee arrangement, it was a place for merchants to store coinage that was more secure than what they had available themselves and they usually paid fee for the security.  If the bank couldn't pay out everything it took in, then it probably was going to end with someone being hanged.
greenlion
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May 11, 2014, 06:53:48 PM
 #17

Say what?  If a bank takes in your deposit and loans out 900% of that as FRB.  The loan is an asset-no?  BTW this is not how it works.  But I'm trying to use YOUR logic.

How is it you think banks are designed not to meet liabilities if their assets exceed liabilities due to being able to create new money


Replace the word "liability" with "obligation" or whatever general English word you want to use, and the argument still holds up. Your rhetorical spasms here sound good dramatically but the entire point you're trying to make is a sloppy equivocation on the definition of money, then you're acting like it's outrageous that somebody else produces an argument that doesn't accept your at best controversial baked-in assumptions.
theonewhowaskazu
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May 11, 2014, 07:02:47 PM
 #18

it's fraud and it's bad.

Consider this:

You store $100 at the bank

the bank uses that $100 as a security to grand a $1000 loan to someone else. So the bank magically makes $900 and gambles with your money.

The bank now also expects the $1000 'back' (while it was never their possession in the first place) and on top of that they also charge interest on it.

So they actually make money on money that never existed in the first place. That's pretty much counterfeiting.

Umm.  Thats not how modern banks work though.

Besides if they don't do this then how do people get loans?

Actually that is how it works (although he got the numbers wrong, since the bank would now have $1100 liabilities and $100 liquid assets, that wouldn't have a high enough reserve ratio, you would only be able to lend out $900 when you got a $100 deposit).

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May 11, 2014, 07:15:03 PM
 #19

FRB without regulation -- recipe for disaster.  Works just fine with regulation, though.  100% of the world's economy runs on fiat and FRB.
Well, 100% minus Bitcoin banks like NeoBee Undecided
Robert Paulson
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May 11, 2014, 09:03:01 PM
 #20

The advantage is increased availability of money for investment, leading to higher productivity and growth. The disadvantage is increased risk of failure. So far it has been a net positive, but the story is not over yet.

who said i agree for the bank to take my money and invest it.
not only did the bank invest my money i don't get anything in return for the risk.
if ill want to invest my money ill invest it myself, the bank has no right investing my money while still claiming its in my account.
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