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Does Fractional Reserve Banking Endanger the Economy? A Debate

Comments (33)
  1. Troy Stackhouse says:

    The root of the problem isn't fractional reserve lending. Counterintuitively, the problem can be pinned on the FDIC insurance that comes with every bank account (i.e. that thing that protects up to $250k of your funds if your bank goes insolvent). To illustrate why, ask yourself this: What is your bank doing with your money? Can you actually answer that? Neither can I, nor can most people, because unfortunately nobody cares anymore. The government, in its infinite quest to protect people from themselves (i.e. treat adults like they're children), took away the incentive for everyone to act as educated consumers.

    A long time ago, banks worked hard to build reputations based on trust, and having such a reputation was an existential concern for every bank. If they once again had to compete to gain your trust, because you knew you'd be out of luck if they lost your money, you wouldn't hesitate to put in the extra effort to find out which banks act responsibly vs. which ones take on extra risk to squeeze out the biggest profits for their executives (not you). The market would self-select those banks that behave in a way which most people would approve of them behaving with their money. If a bank wanted to do risky things, it would have to entice potential customers by rewarding them in some way for taking on the extra risk.

    In short, the free market would sort it all out. It's only when incentives are skewed by artificial policies (like government-provided insurance) that we have a problem, even when the intent is pure.

  2. agentx216 says:

    Hey @ReasonTV – where's the Dave Smtih opening?

    Is is ok when you support the debate on college rape but not when he's making fun of Cato?

  3. Maple Flavor says:

    we must allow fractional reserve banking yet i agree with Robert Murphy but none of this is relevant because of crypto currencies

  4. d4n4nable says:

    I was waiting for that. I'd be fine if either man designed our banking systems, but I tend to agree with Bob's position, at leas to some degree. FRB seems to have some effect of extending credit over actual savings.

  5. David Edward Garber says:

    The same money can't be in two different places at the same time. You can't loan out someone else's money at interest (without its owner's informed consent) while simultaneously keeping it in his/her account to withdraw or transfer at will. Keeping the same money in two (or more) places at the same time lasts only as long as there isn't a "run" on the bank, in which case the fraud is revealed, and the money that was temporarily in multiple places collapses back to only one place, leaving some people with their cash and others with nothing.

  6. d4n4nable says:

    I think the main point of contention between the two was sadly missed, even though George had to allude to it once. That is: FRB doesn't produce perpetual inflation, but it does create a "one-time" increase of outstanding credit (he admitted going from 100% to FRB would be inflationary once*). But that's Bob's point! And it doesn't need to be inflationary (in the ABCT-sense: credit creation above savings, causing interest rates to fall too low, causing simultaneous over-consumption *and over-investment) afterwards. The business cycle was already put in motion, and some investments will be unsustainable.

    After the credit contraction (that is the result without central bank intervention) occurs during the bust, we would expect it to grow once again. And so on and so on. Obviously that resulting business cycle will be much less severe than one with a central bank pumping in new money on top of that.

  7. ๖ۣۜ♥๖̶tacokitten๖̶ says:

    It only endangers the economy if it's not clear in the contract between the bank and customer that they are not guaranteed to actually have your money when you ask for it. If this is the case, and the bank is attempting to conceal the fact that they are spending your money and not guaranteeing you can take it back, the bank is committing fraud, which is stealing from you. Stealing is a violation of the NAP.
    That having been said, *There is nothing wrong at all with fractional reserve banking (or EVEN something like "no reserve banking") if it is clear in the contract. This gives every customer the understanding that they are taking a risk with placing their money in an account with this bank, since should it go bankrupt, they could lose their money. *
    Of course, it won't matter that we're having this debate soon enough, because soon the fiat currency system is going to completely fail and collapse, and become entirely replaced by decentralized cryptocurrencies.

  8. Francisco Rodriguez says:

    Where is the Dave Smith opening???? So he makes fun of the Cato Institute and you remove him…

  9. Drumsgoon says:

    Cool,Selgin has very good arguments.

  10. jerlstif says:

    At one point, George Selgin said that boom/bust cycles are cause by central banks (which I'm sure they do cause some and exacerbate others); but those cycles existed before central banking as well. Also, if a bank ran 100% reserves, how would it make money if it had no money to loan out? I suppose they'd have to charge depositors a storage fee?

  11. xt hydra says:

    you could have both models supported by 1 bank institution, 2 different chequing account ,2 different insurance on the money and 2 different monthly price for the account…it's very simple.

  12. Media Buster says:

    Here is the little secret. Banks do NOT loan depositors out. They CREATE NEW money out of THIN AIR when they "loan" money out.

  13. mineralt says:

    “There might be a slight fee every time you swipe your debit card”…BWAH HA HA HA….ever sold anything on eBay and given PayPal 5% of the transaction? That would be every transaction, 10x a day.

  14. Paul Kennedy says:

    I thought Selgin did a great job in this debate. Coming into this debate, my opinion was that the problem with fractional reserve banking is not the fractional reserve aspect itself but the duration mismatch involved with demand deposits. They can't truly be demand deposits unless the bank is merely providing a warehouse service, and any deposits which you wish to allow the bank to lend out should be deposited for a specific term (e.g. a year). But thinking of demand deposits as call loans — that is, loans with no specific term — makes quite a bit of sense. Most people are fine with depositing their money in the bank as a loan with no definite term in return for a cut of the interest that comes from the loans the bank makes, and it works quite well.

  15. Reason Speak says:

    Taking the coat analogy further, it seems in today’s financial system 1) banks lend out your coat for a fee to their benefit, 2) then deny you your coat back (if it’s worth over a certain amount), 3) report you (the coat owner) to the police as a criminal for requesting your property back, and finally 4) if the bank loses your coat, they just say “sorry” and have the taxpayer pay for the cost of a replacement for which you will never receive compensation.

  16. Singing Physics says:

    bob spent too long defining terms to really get his point across as clearly as he could have done

  17. Tor Lumnitor says:

    5:01 Bank notes? Like the thing in your hand that you just claimed was the "base money". It says right on it "Federal Reserve Note".

  18. Ricardo Afonso says:

    I have to say I came into this with a strong position for one of the sides…and this debate moved the needle quite a bit. Please more of these ..

  19. Erika Manning says:

    Kept cringing every time one of them said " a lot of economists think"

  20. Ahmed Adam says:

    Why are two Austrians debating. Surely keynesian would have been better debating with one of the chaps as both are Austrians

  21. Martyn Speck says:

    Selgin loses the first round by refuting the example of the movie. The example is presented as an illustration, not proof. Classic strawman.

  22. praisekek says:

    switzerlands votes at june 10th to end fractional banking completly. its probably not going to pass but lets see the debates in the media etc.

  23. Robert Miller says:

    A lot of the argumentation is complete nonsense. Which is to say, they are arguing things that are for the most part either theoretical or anachronistic, nether of which has anything to with what we have as modern banking.

    They talk about gold and "ban notes", and tickets, and we're supposed to think, oh well that sounds like it means something so it must be true. When was the last time you took out a loan and got a "bank note" or deposited money and got a "bank note"? For the most part, when you deposit money into a bank really all you have is a bank statement showing some amount recorded in your "account". And when you take out a loan, the bank transfers money from their reserves into your "account". So trying to argue in terms of "bank notes" and what not is specious because that's not who most banking (if any) is actually conducted.

    One fallacy is that commercial banks do not create money, only the treasury has the right to "print" money. If commercial banks were creating money that did not already exist, that would be counterfeit money and fraud as they are not permitted this power. Now, the Fed can play games that essentially creates money. The Fed can simply add to your account with them, effectively creating money. A commercial bank would be committing an illegal act in doing that. All a commercial bank can do is to "transfer" money from one accounting column to another. For example, transferring the (existing) money you deposit with them into their "reserves" and then potentially transferring from those (existing) reserves into the account of someone taking out a loan.

    But we also need to understand what is "money". People see, to think that gold is somehow different from money because thy talk about you can put your gold in the bank or you can put you money in the bank as if they are two different things. Principally that "money" is a "record" of some gold somewhere as if gold has some inherent value in and of itself that it essentially lends to "money" to give money it's value. This is specious nonsense. If you have a tone of gold are you really somehow better off? Yes you say? How exactly? You say because you can buy a lot of stuff with that gold. Well, exactly. It's not the gold that is of value to you in and of itself, but that for which you can exchange that gold for . So how is "money" any different? If you have a lot of it, can you not also exchange that for a lot of stuff? So really gold and "money" are exactly the same – their value is not in the thing itself but what it can be exchanged for . So to argue as if gold and money are somehow different is in reality specious.

    So the basic principle is this: anything that is used as "money" – it is the value of that for which it can be exchanged that gives "money" its value. It does not matter the item being used as "money" but only in that value of goods and services for which it can be exchanged. Now, it is true that some things have certain PROPERTIES that make then better or worse for use as "money". This is why people view gold the way they do – not because there is some inherent physical property of "money" obtained by 79 protons, it is that 79 protons have physical properties that make gold effective to use as "money".

    So when you deposit money in the bank what exactly are you then depositing? Firstly, you are depositing _exchange value_. You are depositing the exchange value you are owed. You are depositing exchange value that you do not currently need. What is also important to note is how you come to be in possession of that owed exchange value. At least in a free market economy, the way you come to be in possession of exchange value is to have created value for someone else in exchange for that exchange value. But rather than directly exchange goods and services which one of the exchange parties might not have that are wanted by the other, one will exchange a proxy for that value, aka "money". So rather than getting specific goods and services in exchange for the value you create, you get a proxy for that value (which is in turn the proxy value for something they created and exchanged) such that you can take that to someone who does have what you want to exchange for that.

    And we can see what is a "loan" in basic terms. They get this part wrong as well, but then so do most people. Once you have created value for someone else, you can lend your claim to exchange value to someone who has not yet created value for someone else. That is, that someone can borrow your claim to get an exchange for themselves before having created exchange value for that thing. Now, at some point, they will have to create value for someone else so that they can return to you your exchange value claim. This is a crucial economic tool. For example, if you want to produce and sell a product – this will create value for the recipients of those products and you will get exchange value in return. The problem is if you don't already have that exchange value, how can you exchange for the resources (like materials, labor, tools, etc.) that you will need to produce that product? You can borrow the exchange value that someone else has accumulated and then use a portion of that exchange value you get from the sale of the product to return that exchange value to whom you borrowed it from. And if the exchange value your get from the sale exceeds that which you owe, that is your profit or income. This is fundamentally how you grow wealth in an economy.

    But back to the point. So the reality is that in reserve banking, the bank holds a fraction of that exchange value to have the reserves to return the portion that may be demanded in the short term. The rest of the exchange value is then lent out for others to utilize that exchange value. Everything else they said, by whatever mechanism and what not is really nothing but a smoke screen or distraction from this basic fundamental principle.

    This is why I say that money is the greatest economic invention ever, but the worst invention for the discussion of the economy. Money gives us a portable tool, proxy in exchange, or "container", in which to store and manage and exchange our exchange value. But people try to discuss the economy as if money is its own inherent value thus distracting from what is actually economically important: exchange value.

  24. Fyterian TV says:

    Ohhh…they legit cut Dave Smith stand-up intro!?

  25. Liberty or Else says:

    How do we begin?
    Where is your starting point?
    The "commodity money" vs. the paper money needs to be re-thought.


    Paper is also a commodity.

    However, when fused together, known as – you have all the inconveniences of paper "money" vs precious metals – gone!

    And, the US Constitution defines real money as Gold and Silver Coin. It does not say how much. While seeking to purchase Gold Foil, I discovered, in the Fall of 2010, that a single Gram of pure gold was selling for $30 Per GRAM. [in FRNs, Federal Reserve Notes, aka USD]

    All perceived " inconveniences" disappear. Evaporate!

    And, it is then not able to be printed out of thin air. It dramatically rolls back.ALL pre-existing inflation.
    With Value that can not be overproduced, invoking inflation.. In fact, inflation is eliminated. by the elimination of USURY that can no be applied to a precious metal economy as witnessed in 1929, Which the Federal Reserve "fixed" that problem by stealing ALL private ownership of Real American Gold.

    MOST people now paying taxation to the IRS would also no longer be liable to pay any of the fruits of their labor to this hideous organization – Which does nothing to earn it.

    They fail the American people by becoming useless eaters.

    Predatory. Does anyone have ANY proof that the IRS "donates" what they TAKE and it is then deposited to the General Funds Account over at the Dept of Treasury?
    Please share, if you find any such proofs!

    How did the FED "FIX" this problem? They STOLE all Gold privately owned by the American people, using a seated US President, FDR who ordered all Gold to be handed over to Federal Reserve Member Banks.

    Interesting how they claim not to own any Gold today.
    My best guess is that it was all melted down and shipped overseas to the private vaults under the control of the Rothschild's Family..

    It is still ours, and they MUST return it.
    Making Restitution.
    It is the RIGHT thing to do,.
    If they rebel, then we send in our US Troops, and we TAKE it all back.

    BLAST those Vaults~!!!

  26. codediporpal says:

    Such a dumb question. When it comes to guarding against loan losses, it's the amount of investor capital in the bank than matters (assets – liabilities), not the amount of depositor funds held in reserve. "Libertarians" continue to display their profound ignorance about the very basics of banking.


    There is something wrong with the brain of people who support fractional reserve. Its magical thinking. A belief in some sort of alchemy. Also an inability to tell the difference between a resource and the tokens needed to buy the resource. Selgin may seem like a smart guy but there is something wrong with his wiring. It goes beyond a normal disagreement.


    So Selgin is saying "even the best regulated fractional reserve system will have problems" That means he is conceding the need for regulation. Which means he cannot squirm out of 100% backing on Randian non-initiation of force grounds. Which is what I used to see these people jumping from foot to foot with.

    Make no mistake about it. The "FREE BANKING" crowd are horrific charlatans. They are soft on regulation despite their excuse-making propaganda. The reality is they are fine with regulation. They only hate the one regulation which counts, and that is the reserve asset ratio for on-call demands for cash. The only regulation that they really object to in their black hearts.

  29. Parasuram Venkatesh says:

    How come Bob never brought up the point that Austrian economic theory is a priori – not subject to historical or empirical refutation? That would've been an easy parry to George's historical points

  30. D Tacherra says:

    Free Market system of banking? why not have fractional reserve and 100% reserves and see how the market performs.

  31. Yodaismycopilot says:

    I concede that a central bank printing money out of thin air would distort relative prices, but I fail to see how this has anything to do with fractional reserve banking.

  32. metalwright says:

    In Sowell's book "Black Rednecks, White Liberals" he attributes the rise of Scotland to a dramatic shift in their culture. Maybe banking played a role in facilitating, but…

  33. Richard Kerckhove says:

    I think George Selgin won this debate and think some of the hardcore Austrians need to open their minds a bit.

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