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Tuesday, 23 August 2011

Fractional Reserve Banking

I have mentioned this in earlier posts. I haven't gone into detail because I only dimly understand it. The problem is not the complexity of the issue – although it isn't simple. The problem is believing that this is how banking works, how banks create money out of nothing. An additional difficulty is believing that the process works with the connivance of government. Only Victor Meldrew could do justice to this colossal scam, "I don't believe it!"

Below is a link to the first of a series of videos on YouTube: Money as Debt - Fractional Reserve Banking part 1 of 5

It is in cartoon format. When it's over you will see links to the other four parts. If and when you have understood all five parts you will be astonished – and depressed. Sorry!

When I have described in earlier posts the process by which depositors save money in banks (at x%) and banks lend the money (at y%) to entrepreneurs, who use it to produce stuff (ie wealth), I was oversimplifying. Would that I were not! That is how the system should work. Paper money should be "backed" by some commodity (traditionally gold or silver), which is valued for itself. In our world, paper currency is printed by the government and its value is simply the government's say-so. Economists call it fiat money – Latin subjunctive meaning, "Let it be!"

In an honest system, the rates of interest would depend on how much depositors save. If they are prepared to forgo present consumption themselves and save more, interest rates will be lower. If they spend instead of saving, rates will be higher. In our world, the government or the central bank decides the rate. They usually get it wrong. We are where we are because governments have kept rates too low. We have had low rates not because we were all saving so much but because the government wanted to create an artificial "boom", which makes us feel richer – for a time. This is cynical in the extreme. They want us to re-elect them. But it is unsustainable. Booms are always followed by "busts".

The Austrians teach us that although a boom feels good (for a while), booms are bad and the inevitable bust is the period when the economy is starting to cure itself. The Keynesians would like to "buck the market". It can't be done. They would have us believe that they can repeal the Law of Gravity.

Their solution is "stimulus": continued low interest rates and "quantitative easing". The "idea" is to cure the disease with more of what caused it. They claim that they can keep the boom going. Cloud Cuckoo Land!

Governments have an interest in our almost universal ignorance.

I have a headache!

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