Fractional Reserve Banking in Pictures

"The few who understand the system, will either be so interested in its profits, or so dependent on its favors, that there will be no opposition from that class. The great body of people, mentally incapable of comprehending the tremendous advantages, will bear its burden without complaint."

- Lord Rothschild, European central banker

The below slides are meant to explain fractional reserve banking as simply as possible using pictures. The presentation itself can be found here, and a written description and documentation in "The Money Matrix - How the FED Works (PART 6/15)".

The below demonstration assumes a reserve requirement of 10%, which is the figure typically given by the banking industry and financial experts. However, in Part 2 I will demonstrate there there is effectively NO set reserve requirement though the banking system obviously carry some level of cash reserves. I alluded to this previously in "Off a Cliff with No Airbags: The FED Banking System Quivers in Fright".

click to enlarge

Disclosure: Like everyone else in the USA, I am still long the dollar.

Comments

[yellowhoard:]

I hope you win your race but I wouldn't be long the dollar.

Aug 07 07:59 AM

[Jake Towne:]

Well I still have a wallet and buy food in dollars... Gresham's Law, my friend....

On Aug 07 07:59 AM yellowhoard wrote:

> I hope you win your race but I wouldn't be long the dollar.

Aug 07 08:10 AM

[ron_paulite:]

very good presentation.
simple and easy to understand.
good luck to your race.

Aug 07 08:37 AM

[D. McHattie:]

You're being sarcastic in your long dollar comment, right? As in, you live in the US and pay for everything with USD so you have no choice but to be long the dollar.

But otherwise you would invest in anything but the dollar, right?

Aug 07 09:12 AM

[Moon Kil Woong:]

Umm this is hopelessly behind the times. Today banks need not adhere to reserve requirement. They have created money market accounts to skirt the rules, thereby not needing to put reserves down because they are not supposed backed by the government since they aren't suppose to be FDIC insured even though we can see with the bailouts they are backed by the government after all. Thus banks blissfully overleveraged themselves.

Then there is the loans which they dump to Fannie Mae and Freddie Mac so they can liberate their money and do it all over again as the Macs and Maes eat all the loss and charge it on the taxpayer. However, since the Macs and Maes play a vital role in loans now (no duh, who can compete with an operation run to intentionally loose money), it is business as usual.

In fact it has gotten so bad the Fed now has to buy out their loans in order to let them keep gorging themselves on mortgage losses (no one knows how much the fed loses because they clain being a private entity means they don't need to be audited).

Then there is Goldman Sacs that can create a velocity of money in the billions off of millions by playing patty cake with another brokerage (ummm I mean bank now) and trade thousands of times with each other every second (and hopefully execute your trade before it even hits the ticker tape). That way they can dominate the exchanges without even having enough assets on their books to meet the FDIC's VaR requirement with extra cash to pay $11 billion in bonuses.

Top it off with funky derivatives that are now about 10x the entire net worth of the US government and you get a better picture of why this depiction of how the money multiplier is no longer pertinent and why our economic foundations are being destablized.

You can also look at how the Fed, the auctioneer of US Treasury notes now has the ability to buy what he's auctioning off of loans from the government that needs money to loan top the Fed. If that doesn't tickle you pink I don't know what will.

Aug 07 09:31 AM

[Jake Towne:]

Dear D McHattie -
Glad you picked up on it. :)
If you check the rest of my articles, I bet you can guess what else I am long.

--
Jake Towne
2010 Candidate for US Congress, PA-15
TowneForCongress.com

"If there must be trouble, let it be in my day, that my child may have peace.” – Thomas Paine, “The American Crisis,” 1776


On Aug 07 09:12 AM D. McHattie wrote:

> You're being sarcastic in your long dollar comment, right? As in,
> you live in the US and pay for everything with USD so you have no
> choice but to be long the dollar.
>
> But otherwise you would invest in anything but the dollar, right?

Aug 07 09:32 AM

[Jake Towne:]

Dear Moon -
You wrote "Umm this is hopelessly behind the times" - yes about 15 years unfortunately. Your overall conclusion is correct, but not exactly the way you reached it. Stay tuned for Part 2.


On Aug 07 09:31 AM Moon Kil Woong wrote:

> Umm this is hopelessly behind the times. Today banks need not adhere
> to reserve requirement. They have created money market accounts to
> skirt the rules, thereby not needing to put reserves down because
> they are not supposed backed by the government since they aren't
> suppose to be FDIC insured even though we can see with the bailouts
> they are backed by the government after all. Thus banks blissfully
> overleveraged themselves.
>
> Then there is the loans which they dump to Fannie Mae and Freddie
> Mac so they can liberate their money and do it all over again as
> the Macs and Maes eat all the loss and charge it on the taxpayer.
> However, since the Macs and Maes play a vital role in loans now (no
> duh, who can compete with an operation run to intentionally loose
> money), it is business as usual.
>
> In fact it has gotten so bad the Fed now has to buy out their loans
> in order to let them keep gorging themselves on mortgage losses (no
> one knows how much the fed loses because they clain being a private
> entity means they don't need to be audited).
>
> Then there is Goldman Sacs that can create a velocity of money in
> the billions off of millions by playing patty cake with another brokerage
> (ummm I mean bank now) and trade thousands of times with each other
> every second (and hopefully execute your trade before it even hits
> the ticker tape). That way they can dominate the exchanges without
> even having enough assets on their books to meet the FDIC's VaR requirement
> with extra cash to pay $11 billion in bonuses.
>
> Top it off with funky derivatives that are now about 10x the entire
> net worth of the US government and you get a better picture of why
> this depiction of how the money multiplier is no longer pertinent
> and why our economic foundations are being destablized.
>
> You can also look at how the Fed, the auctioneer of US Treasury notes
> now has the ability to buy what he's auctioning off of loans from
> the government that needs money to loan top the Fed. If that doesn't
> tickle you pink I don't know what will.

Aug 07 11:14 PM

[Lucas:]

on slide 3 shouldn't the total money supply be $190? You have the $100 deposit ticket plus the new $90 dollar loan.

Aug 08 10:00 AM

[retired avi...:]

Fractional reserve banking is much older than the US dollar. It originated when goldsmiths, who were keepers of a communities valuables, noticed that typically very few owners would redeem their receipts for their gold at any given time. These receipts sometimes were in the form of transferable bearer bonds (simply paper money).

Over time the idea developed that the depositors could earn interest on their idle gold by loaning it out for worthy undertakings, and the goldsmith earn fees too. Over many years of watching most of the gold sitting idle in the vault all the time earning nothing, gradually the idea appealed to both goldsmiths (bankers) and depositors to earn more interest by issuing paper notes beyond the amount in the vaults. Thus was born fractional reserve banking. By putting your money in a bank rather than under your mattress, you are inherently agreeing to be a part of the fractional reserve system. You do have a choice. In the old days when bank runs sometimes wiped out depositors, people did eschew banks and stash their cash quite often. (If inflation is your worry in stashing cash, you can exchange your mattress money for some type of durable assets. As general inflation 'lifts most boats' over the very long term, your purchasing power can be maintained in the assets.)

The notion that banks first receive deposits and then loan out those funds is not really how it works (though it can be). That is the Econ 101 version. It is not well known outside the banking industry that private banks actually can create money out of thin air for borrowers. They do not need to 'transfer' funds from somewhere to a borrower (though they can if they choose). Since banks cannot create money for themselves, obviously, but only for a borrower, the system works pretty well. In creating new money, the bank books a loan receivable (asset) which is offset by the cash paid out to the borrower - a net wash on the books of the bank, except for future interest.

So your initial $100 deposit can instantly be sufficient reserve for that bank to create up to around $900 on behalf of a borrower (only). However, the $100 came from an account held at another bank in all probability, so that bank may have to pare back new lending to the degree its reserves had just shrunk.

The real limiting factor to this type of money growth is the number of willing borrowers. That is why the Fed is so focused on setting interest rates -- to influence the amount of new borrowing and the money supply, among other things.

Aug 08 01:09 PM

[Gregman2:]

See: www.pbs.org/wnet/ascen.../

Aug 08 01:30 PM

[Jade Bond:]

Good luck on your campaign. I hope it goes well. Like the article, too, no objections.

I hope you have something equally clear and easy to understand on the solution. Something that could be implemented without completely rebooting and turning economic activity on it's head. I don't want any Mad Max realities in my kids or my future.

There's gotta be a sensible solution. This is the best I've seen so far, but I think it needs some details flushed out: mises.org/story/2926

Aug 08 07:37 PM