Punchinello’s Chronicles

July 30, 2009

Fractional Reserve Banking – Theory vs Truth

Filed under: Surely a Jest? — Punchinello @ 3:20 am
Tags: , , ,

Let’s all keep in mind that banks only make money from interest on loans. Investment banks have another rip-off scheme, making money on derivatives. That’s not what I want to talk about though. Instead, I had a chance to again hear about the unbelievable and outright robbery going on in our banking system. It’s been going on for as long as banks have existed, but with the accompaniment of the Federal Reserve (the Fed), it’s why we’re in the situation we’re in today.

Banks are told by the Fed that they must keep a certain percentage of their deposits in the vault, on reserve. That number can go up or down, and currently stands at about 3%, to simplify things. But let’s say I’m wrong, and let’s say the banks have to keep 10% of their deposits in the vault. That’s $100 for every $1,000.

The remaining $900, in this example, is money those banks can lend out. They use it to make loans…and interest.

Here’s what I learned today. Way back when the Fed was created (1917), it was meant to be a way to help build the economy. After all, if ALL the money people deposited stayed in the vault, there wouldn’t be any money for loans. And loans, for the most part, are good. At least they are when they’re for real things, borrowed by real people, who really can pay back the loans.

Suppose John plants a few acres of land with corn. At harvest time, he brings in lots of bushels of corn. That’s real corn. John did real work, digging real dirt, and planting real seeds. He farmed the land for the summer, spending real time. When it came to harvest, he really did sweat and exert muscle power to get those bushels of actual corn.

John goes to Mary, and offers to sell the corn for $1,000 in money. Where does that money come from?

Mary goes to the US Treasury and says she needs $1,000 in Federal Reserve notes. Those are legal contracts indicating that “somehow” the United States will replace each dollar note with “something.” Let’s say Mary offers 1 oz. of gold in exchange for the $1,000. Presumably, she could get back her gold.

Mary gives John the $1,000, which is as good as gold. If John wanted to, he could go to the US Treasury and exchange the paper for gold. Fat chance! Not any more. But that’s not important right now.

What we now have is $1,000 in notes. They’re given to John, and he gives Mary the corn. She uses it for whatever. John takes the $1,000 and puts it in the bank. Fractional reserve deposits mean that the bank only has to keep $100 in the vault. They can now make loans with $900.

Okay. The original theory means that real corn and real work created a real product. That real product was symbolized by $1,000 in paper money. But that paper money was “backed” by actual product. It could have been gold, or it can be the Gross Domestic Product (GDP). In the latter case, John’s real work and real corn is “creating” the $1,000.

We use paper money as a convenience. It’s easier to handle than actual gold. It’s also easier for John and Mary to handle when they go to the store and buy paint or a hammer.

Originally, the bank was allowed to lend out $900. But that meant that the entire $1,000 actually represented something real. By lending out the money, hoping John wouldn’t suddenly want back his entire deposit, other people could start farms or stores.

10% is 10%, right? That’s what the bankers decided. And who would know?

The reality is utterly astounding!

Instead of FIRST getting $1,000 as a deposit, THEN lending out $900, the banks decided that the entire $1,000 was “really the same as” 10% of what they “likely would have later.”

Suddenly, the entire $1,000 became the fraction. The reserve. The 10%.

That meant the bank “felt” it could lend out $9,000! That’s NINE THOUSAND dollars! Why? Because “really,” the bank had $1,000 on hand (in the vault), and that’s the ten percent the Fed required.

Nobody ever asked about any of this. Why? Because economics is too hard to think about! And, it’s not taught in grade school.

The fundamental lie or problem with all this is that it complete disassociates REAL product from actual money! In the original theory, the corn John harvested was $1,000 worth of actual product. The bank kept 10% of that REAL product in the vault, and lent out the other, remaining 90%. But when you total it all up, it all came back to REAL corn!

This new “scheme” that’s been going of for at least a hundred years (actually, a whole lot longer), means there’s $9,000 of NOTHING in the bank!

Where does the bank get the NOTHING that gets turned into $9,000? Why…from the Federal Reserve banking system!

The Fed writes a check to the US Treasury, which then prints $9,000. The bank adds those pieces of worthless paper, disassociated with any kind of make-believe reality, to the $1,000 REAL dollars and, wah-lah! $10,000! Out of thin air!

Where does the Fed get the money to write the check? The answer is they don’t have to have money. Their check is as good as money, which is why the Treasury then prints the money, the Federal Reserve Notes that “act as if” they’re actual money. In other words, the Fed has a bottomless checkbook. It never runs out of money because it isn’t actual money in the first place. It’s just a smile and a promise of nothing.

You borrow $9,000 to buy a motorbike. You’ll be paying back that loan forever, with interest! The bank pockets the interest. What happens if you pay back the loan?

You’ve actually paid back $9,000 of NOTHING. And how does the bank make any kind of interest or money on NOTHING? They don’t! So they really, really don’t want you to pay back that loan! And that, my friends, is what’s known as “consumer spending.”

When you bought a bike or car, you actually could expect to pay the loan back in a few years. So the banks gave us revolving credit cards. That way, you don’t have to go through a loan application, and you can borrow money to buy a hamburger. When you pay back the minimum payments, you’re only paying back part of the interest.

Ergo, ShaZAM!…you have a never-ending loan! The bank gets never-ending interest, and there’s ZERO money anywhere!

The absolutely mind-numbing truth of all this is that it’s not only legal, it’s why we have trillions of dollars in bailout money, loans to banks, and new worthless money from the Fed. All because bankers decided that instead of keeping 10% of what really exists, why not say that what actually exists is only 10% of………….something?

What’s that something? Nobody knows. It’s a total mystery!

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1 Comment »

  1. Pretty cool post. I just came by your blog and wanted to say that I have really enjoyed browsing your posts.

    Any way I’ll be subscribing to your feed and I hope you post again soon!

    Comment by nick — August 16, 2009 @ 9:45 pm | Reply


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