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Mix-Ansicht- Tlaga on Fractional Reserve Banking - CRASH_GURU, 20.01.2004, 07:54
Tlaga on Fractional Reserve Banking
-->WRONG THEORY CAN KILL OUR HOPE
Copyright 2004 J. N. Tlaga
The promised Part 2 of Questions and Answers related to"How To Defang All The Banks Once For All" is being presented one question at a time to allow for faster editing of my book. The additional benefit of this approach is that column size editorials are more reader friendly.
Question V:
Why do you pay so much attention to this obscure issue of the fractional reserve banking as if the fate of the whole world depended on it?
Answer V:
Because the fate of the whole world may in fact depend on our understanding of this"obscure issue".
The myth that fractional reserve banking creates credit money out of thin air, and that repayment of that credit makes the created money disappear into thin air, supplies...
very powerful alibi for central banks racketeering, and
the best sophistry weapon to sabotage the only practical scenario for returning to honest money.
I focused on this issue because I perceived Harald Haas' doctoral dissertation not as a traction for my ideas but as a clever attempt to undermine my ideas.
THE ALTERNATIVE FUTURE - A Call for Overnight Revolution - is the key proposal that makes a return to honest money feasible.
Without this proposal, restoring silver and gold to their monetary role would still be only a golden dream.
When I read THE CASE FOR GOLD - A Minority Report of the US Gold Commission - by Ron Paul and Lewis Lehrman (published by CATO Institute in 1982), I asked myself a simple question:
"What was it that made it a minority rather than a majority report?"
And my answer was:"Lack of viable transition".
This is how the minority report envisions our return to the honest money system:
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First, the present Federal Reserve notes would be retired and replaced by notes redeemable in gold or silver or some other commodity. Such notes would be similar to travelers checks now in use which are, at the present time, redeemable only in paper notes. Like travelers checks, such notes would not be legal tender and no one would be forced to accept them in payment. And since they would be promises to pay, any institution that issued them and then failed to redeem them as promised would be subject to both civil and criminal prosecution, unlike the Federal Reserve, which is subject to neither.
As for the present circulating Federal Reserve notes, they could be made redeemable for gold once a"dollar" is defined as a weight of gold. Anyone who wishes to redeem them could simply do so by exchanging them for gold coins at his bank.
It is important to note that should we institute a gold standard before the Federal Reserve System is ended, that system must function along classical gold standard lines. As Friedman and Schwartz pointed out, it was the failure of the Federal Reserve to abide by the classical gold standard rules that caused the panic of 1929 and the subsequent depression.
In chapters two and three, we demonstrated the disruptive effects fractional reserve banking has caused in the United States. Since we still suffer with that system, it is imperative that a fundamental reform of it be made. That reform is simply that all promises to pay on demand whether made in the form of notes or deposits, be backed 100 percent by whatever is promised, be it silver, gold, or watermelons. If there is any failure to carry 100 percent reserves or to make delivery when demanded, such persons or institutions would be subject to severe penalties. The fractional reserve system has created the business cycle, and if that is to be eliminated, its cause must be also.
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And these are the points I wrote on my book marker after I read this impractical proposal:
The Fed, its debt, and the entire gangster system built over the eighty years of its existence must be cut off and thrown into a dumpster of history with one swing of an axe. No transitional legitimacy of any kind!
The economy must take off the next morning on honest money basis, with undiminished money supply, as a free self-executing system without"severe penalties" of any kind and without further interference from the government.
Find the way!
THE ALTERNATIVE FUTURE is the final outcome of my search for"the way".
My insistence on eradicating the false interpretation of the role of the fractional reserve banking is motivated by very practical consideration:
If the misguided Austrian imperative -- to use government's police power to enforce 100 percent reserve banking -- would be carried out, the immense amount of credit would disappear instantly, the economy would be paralyzed, and the honest money system would take the blame. Here is why:
Fractional Reserve banking makes demand deposits available for lending when depositors themselves would never consider lending them.
Austrians have no problem with time deposits. When Joe and Jane buy a six-month certificate of deposit, they give the bank the use of their money for six months in exchange for interest.
But when Joe and Jane put their spending money into checking account because they know they will need it in a few days, the Austrians think the banks create new money out of thin air if they use such time deposits for lending.
There may be a hundred million of such demand deposits adding up to hundreds of billions of dollars. Because statistically only a fraction of these deposits may be withdrawn without counterbalancing new deposits in a particular bank, it is safe to keep such fraction for withdrawals and to lend the rest. Such practice does not, repeat, does not amount to creating new money out of thin air. Bank merely lends out currently not required part of Joe's and Jane's demand deposit to a third party, say by buying commercial paper of some enterprise.
If the Austrians would enforce their postulate of 100 percent reserve banking, all these hundreds of billions of dollars in demand deposits, now being used to finance multitude of business transactions, would all of the sudden be withdrawn from the economy and placed under the mattress so to speak.
The term"money multiplier", often used to describe the effect of fractional reserve banking, is rather ill chosen because it implies that a pile of new money is created out of thin air, when in reality all the loans, one by one, are made possible by the same money changing hands again and again.
When we have, say, 250 million dollars a year economy, we don't need 250 million dollars money supply to keep it going. Just 1 million will do, if it will change hands 250 times a year, once every business day.
If the same 1 million dollars would change hands four times every business day, it could support a 1,000 million dollars economy.
The number of times money changes hands is called velocity of money. Fractional reserve banking merely accelerates velocity of money. It does not increase the volume of money stock. Only central bank can increase the volume of money stock (by printing or by computer entry). This is what we keep telling to the Austrian gentlemen, but they keep insisting that fractional reserve banking creates new money out of thin air.
In summary, the reason I took immediate exception to Dr Haas' view, and I made it clear that I do not propose to abolish fractional reserve banking, was that any such abolishing would effectively sabotage the whole return to honest money, People who may continue this mantra -- that abolishing fractional reserve banking is a prerequisite for returning to honest money -- should know they are doing a fundamental disservice to the cause of honest money.
This editorial should not be interpreted in opposition to the Austrian School of economics as such, nor in opposition to the authors of THE CASE FOR GOLD. Correcting their misinterpretation of the fractional reserve banking will affect neither one of them negatively in any way. Austrian School of economics and the authors of THE CASE FOR GOLD should and will remain our best hope.
18 January 2004
J. N. Tlaga
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