JohnAl

Gold Equities Should Reward the Patient

The reason there are no 100% reserve demand deposit banks isn't because consumers don't want them, it's because the government guarantees fractional reserve demand deposits, making "free checking" profitable for banks. In turn, consumers will choose "free checking" instead of fee checking.

The question people need to ask about banking is why bankers aren't concerned about lending out checking account money, which depositors think of as their money, available on demand. Because if everybody went to the bank to remove their checking account money the banks would obviously fail. But they don't worry about failure because the government guarantees the deposits.

Many economists believe that it is this government intervention which is largely responsible for the 20th and now 21st century boom and bust cycle. The process goes like this.

Banks lend out a large portion of their demand deposit money, money they would never lend out in a free market system. This causes interest rates to be lower than they would be in a free market when this new government backed credit is added to true savings (the money that investors ARE willing to put on time deposit). This expansion of credit leads to credit bubbles, which recipients of the credit, like mortgage borrowers in the present crisis, use and thereby inflate the value of certain assets, like housing in the present crisis.

Eventually the credit bubble busts. In the present mortgage crisis the bust came when interest rates rose, and ARM rates based on interest rates went too high for the least qualified borrowers (those who wouldn't have received the loans in the first place but for the cheap credit caused at the start of the process.)

Of course, at the hub of all of the banking activity is the FED, acting like the Wizard of Oz, trying to engineer "just the right" rate of credit expansion. And that's the second big problem with the banking system - that it's essentially "centrally planned". And we know that central planning can and does fail. (Anybody remember the Soviet Union?)

Free market oriented people should question this whole process. I've come to believe that it's these government interventions that cause the boom and bust cycle. If we removed the government from the monetary system and allowed truly "free banking", we could avoid the pain of busts, because we wouldn't have false booms.

If you're interested in learning more about how government creates the boom and bust cycle start here:

mises.org/story/3128