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Fractional-Reserve Banking: From Goldsmiths To Hedge Funds To... Chaos

Tyler Durden's picture




 

From Chapter 15 of The Money Bubble, by James Turk and John Rubino:

Banking didn’t start out as a reckless, parasitical plaything of a moneyed and politically-connected aristocracy. In the beginning, in fact, bankers weren’t even bankers. They were jewelers and goldsmiths who had to maintain their inventory with vaults, guards etc., and offered storage services to others with valuables to protect. So the original banks were, in effect, very safe warehouses.

Eventually some goldsmiths noticed that the paper receipts they gave to their customers to evidence the valuables left in storage began to circulate as currency alongside their countries’ coins. A shopkeeper accepting these receipts in payment knew that he could go to the goldsmith to redeem them for gold and silver, and also recognized that a paper receipt was more convenient to use as currency than were pieces of metal. Gradually these receipts became a widely-accepted form of payment, circulating among buyers to sellers and saved like other forms of wealth.

The goldsmiths then noticed something else about their new paper-money invention: Only a tiny fraction of their clients asked for the return of their valuables in any given period, which led to a bright – but legally and morally-dubious – idea. Why not start issuing receipts in excess of the gold and silver on hand? The goldsmiths could spend this currency themselves or lend it to others – thus inventing the business/consumer loan. Henceforth the total gold and silver in the vault (the goldsmith’s reserves) would equal only a fraction of the receipts circulating as currency.

“Fractional reserve banking” was thus born of deception if not outright fraud, because for the receipts to retain their value the goldsmiths had to pretend that those paper claims to gold and silver were backed by an equal amount of metal and were therefore of equivalent value. They were not, of course, because a tangible asset is more valuable than a promise to pay a tangible asset, particularly when the latter outnumbers the former.

The goldsmiths, having evolved into more-or-less recognizable bankers, then realized that more deposits equaled more profits. So they began paying people for deposits of gold and silver rather than charging for their storage, thus inventing the interest-bearing account.

The resulting system had some inherent dangers, most obviously that it tempted bankers to lend out ever-greater multiples of deposits, increasing the odds that they would be unable to meet withdrawal requests and collapse. This happened frequently early-on, eventually leading governments to regulate the amount that a given bank could lend against its capital.

For a sense of how this works, imagine a bank with $100 in capital that is required to hold a reserve equal to 20 percent of its loans outstanding – which based on experience is usually more than enough to satisfy a typical day’s withdrawal requests. In our example, the bank can lend 4/5ths of its depositors’ money, or $80, while 1/5th, or $20, remains in reserve. Now here’s where it gets interesting: When our hypothetical bank makes a loan, the recipient deposits the proceeds in another bank, which can lend out 4/5ths of that deposit. The recipients of those loans make deposits in other banks, and so on, until a huge multiple of the original deposit base has been turned into circulating currency.

The result is an “elastic” money supply. When borrowers are optimistic and want to increase their borrowing, banks in a fractional reserve system can in the aggregate offer them immense amounts of new credit. So the money supply, instead of being determined by the amount of gold, silver or other bank capital in the system, can expand dramatically to accommodate an energetic society’s demands.

But it can also contract dramatically. If an economy that has greatly increased its money supply through bank lending suddenly takes a downturn or is unnerved by an unexpected crisis, borrowers will pay off their loans or default on them and banks won’t replace them, while depositors seek the return of their cash. These actions cause the money supply to collapse, potentially all the way back to the level of base money in the system. The result of this fluctuation in the supply of circulating currency is a recurring series of booms and busts that wipe out businesses, individuals, and banks and frequently send the general economy into recession or depression.

Fractional reserve banking was, in fact, a major cause of the Great Depression. To condense a long, complex story into a single paragraph, the extra currency that was printed by the belligerents during World War I (which ended in 1918) was recycled through the fractional reserve banking system and massively amplified via the process we’ve just described. This tsunami of new credit caused the Roaring Twenties boom in asset prices – especially global equities – that popped in 1929, destroying the pseudo-wealth created in the previous decade. The collateral supposedly guaranteeing bank loans evaporated and sentiment turned negative, sending the fractional reserve credit machinery into reverse and collapsing both the banking system and the real economy.

Today’s situation is much, much worse. To see how, click here.

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Fri, 05/23/2014 - 20:32 | 4790169 TeamDepends
TeamDepends's picture

But we have the FDIC today.

Fri, 05/23/2014 - 20:36 | 4790173 Dre4dwolf
Dre4dwolf's picture

Lets say you had 250,000 in the bank, and your bank among others failed.

By the time you get 250,000$ back from FDIC, after all these banks fail, do you think 250,000$ will be worth anything? . . . by the time you get it, it wont buy you bread, the people who had 20,000$ under the matress and spent it for gold/silver or something else are going to be on better footing than the guy who had 250k in the bank.

Fri, 05/23/2014 - 20:38 | 4790177 TeamDepends
TeamDepends's picture

Sarcasm.

Fri, 05/23/2014 - 20:54 | 4790196 Dre4dwolf
Dre4dwolf's picture

Its not sarcasm, these banks and governments are not going to sit there and fix the problem for your benefit, they are going to take advantage of the situation, just like they did in 2008, we will have bail-ins + bailouts for bankers, they will take your deposits, and promise you 50% of your money back over a year or two, at which point the economy is soo fucked, even if you had cash in the bank, it wouldn't do you much good.

FDIC is a confidence scam, its not a real solution, and in-fact only encourages banks to commit fraud (I say commit fraud, because what they do is NOT TAKE RISKS) the "risks" they take have nothing to do with gambling in the normal sense of the word, because the gambles they take are not on businesses (like lending money to a new business and hoping that it succeeds) its gambling on paper scams and garbage that no one understands because all the paper work is bifurcated, securitzed, chopped up, sent through a shredded duct taped back together and then digitized , sent to the trading floor and traded on as a derivative of something that no one even can keep track of for the simple fact that the paper work by definition on any common sense level is fraudulent.

 

FDIC only ENSURES that there will be a bank run in the future, by giving people a false sense of confidence leading to apathy and complacency (people don't withdraw their money from fraudulent banks, because they think they are protected) when in reality, they have never been more at risk.

Fri, 05/23/2014 - 21:00 | 4790208 Tinky
Tinky's picture

Wow. Even after he told you that he was being sarcastic (which shouldn't have been necessary in the first place), you continued to miss the point.

Quite a feat – in a sense.

Fri, 05/23/2014 - 21:01 | 4790212 Dre4dwolf
Dre4dwolf's picture

Wouldn't be the first time I glazzed over and continued a rant, probably wont be the last  . . .

Fri, 05/23/2014 - 21:09 | 4790232 Slave
Slave's picture

I love bankers. They help everybody reach their dreams. Specifically the American Dream!

Fri, 05/23/2014 - 21:31 | 4790284 SAT 800
SAT 800's picture

The reason they call it the "American Dream": is because you have to be asleep to believe it.----George Carlin. An excellent modern philosopher often mistaken for a comedian.

Fri, 05/23/2014 - 22:43 | 4790465 Tao 4 the Show
Tao 4 the Show's picture
Fractional-Reserve Banking: From Goldsmiths To Hedge Funds To... Profits from Thin Air
Sat, 05/24/2014 - 03:29 | 4790788 Theosebes Goodfellow
Theosebes Goodfellow's picture

Look, not to be the wet noodle here, but the sin of the banker isn't committed with fractional-reserve banking. The crime is something called "duration-mismatch". It's lending the money in demand deposits. for long loans. Kieth Weiner covers this quite well.

Adulteration of the currency is the other sin, but the writers of the post didn't bring that issue up. To a certain extent simply having bi-metalism can do it without even debasing your currency, (Gresham's Law).

Sat, 05/24/2014 - 09:16 | 4791038 Sean7k
Sean7k's picture

Fractional reserve banking encourages the borrowing of debt for the sole purpose of creating interest payments. When provided to government, the State can continue to borrow while only paying the interest. Thus, the debt is never retired, but carried on for generations- generations which never have representation nor opportunity to consent to this debt accumulation. 

This debt only being bound by the degree of faith the world places in it, could be potentially unlimited. Every dollar of debt requires the creation of a percentage of that dollar for interest, creating a constant need for more dollars. This only happens in a system that fails to pay down principle- FRACTIONAL RESERVE BANKING. 

Keith Weiner is a tool, but you should know that from his last name.

Fri, 05/23/2014 - 21:19 | 4790259 scatterbrains
scatterbrains's picture

Who loves you baby!   Rant on!!   You nailed it!  and hopefully helped ever more folks that are confused about what's going on understand a little clearer... great artical in my opinion by the way.

Sat, 05/24/2014 - 12:52 | 4791360 mojine
mojine's picture

Sarchasm
1. (n.) The abyss between the creator of witticisms and the intended recipient who does not find the humor in it.

Fri, 05/23/2014 - 21:00 | 4790209 Dre4dwolf
Dre4dwolf's picture

Ahh I see you were being sarcastic about FDIC, I gota lay off the keyboard, too much of an anti-banker mood today for me.

Fri, 05/23/2014 - 21:20 | 4790263 UselessEater
UselessEater's picture

You wrote a nice summary though, IMO; pity such a succinct overview will mean nothing to those around us we are trying to warn. I guess its true, that it has to actually happen to people before they get it; no wonder we all get so damn exasperated and hit the keyboard!!

Fri, 05/23/2014 - 22:05 | 4790379 TeamDepends
TeamDepends's picture

Not a problem, did not junk you.  We feel not just your rage, but THE  rage.  For instance, why didn't gold shoot up 2-5% today after the manipulation news broke?  Is the average dope who reads that headline thinking, "whew, good thing I didn't buy into that rigged market"?

Fri, 05/23/2014 - 23:19 | 4790526 mvsjcl
mvsjcl's picture

"...why didn't gold shoot up 2-5% today after the manipulation news broke?"

 

The question frames its own answer.

Fri, 05/23/2014 - 21:29 | 4790280 SAT 800
SAT 800's picture

And "Depends", too. LOL. I do understand your despairing sarcasm and sympathize with it, of course.

Sat, 05/24/2014 - 07:45 | 4790979 williambanzai7
williambanzai7's picture

Fri, 05/23/2014 - 20:40 | 4790179 LetThemEatRand
LetThemEatRand's picture

A guillotine makes fractional reserve bankers.

Fri, 05/23/2014 - 21:04 | 4790216 813kml
813kml's picture

A little too civilized, I'm thinking of something more medieval like a good drawing and quartering.  Maybe throw in a blood eagle for variety.

Fri, 05/23/2014 - 23:36 | 4790551 Greenskeeper_Carl
Greenskeeper_Carl's picture

I somehow don't see any of them managing not to scream during the blood eagle. No Valhalla for Jamie. (That shit looked pretty fucked up)

Sat, 05/24/2014 - 12:10 | 4791278 Kirk2NCC1701
Kirk2NCC1701's picture

They give themselves things like OBE (Order of the British Empire),

When they deserve a different OBE:  Order of the Blood Eagle.  We need a Ragnar Lothbrok to clean the swine palace.

Fri, 05/23/2014 - 21:09 | 4790229 Dre4dwolf
Dre4dwolf's picture

Just remember to dispose of the left-overs properly, you don't want the vermin to repopulate like starfish ;P

Fri, 05/23/2014 - 21:39 | 4790299 813kml
813kml's picture

I would say there is a 50/50 split of gentile/Jew bankers. So, for maximum effect...

The gentile gets it first, fed to the pigs, butcher the hog, serve as last meal to next Jew banker.  

Rinse, repeat.

Sat, 05/24/2014 - 06:46 | 4790835 Anasteus
Anasteus's picture

As regards the fractional mechanism, the author didn't mention one important thing making the article a bit hard to understand.

The 4/5th of the $100 deposit, that is $80, is not a loan taken from the $100 deposit, because the loan is not deducted from the original deposit. Instead, the deposit serves just as a base (or a limit) for calculating a brand new amount the applicant account can be credited. The key point is, both accounts (the original deposit and the one just credited) still have access to full amount of their money as if nothing happened; so we now have $180 for immediate use and the overall money supply is thus increased. If new loans were merely deducted from deposits there would be no fractional banking at all, just an existing money redistribution.

So, the crafty operation of crediting one account while 'forgetting' to deduct the amount from deposits is what makes banks create credit out of thin air.

Fri, 05/23/2014 - 20:41 | 4790183 Duc888
Duc888's picture

 

 

Nonsense, I see nothing wrong with pulling vapor money out of ones ass.  I only wish I could do it too.

Fri, 05/23/2014 - 20:46 | 4790188 Reaper
Reaper's picture

Today we have powerful witch in DC, who generates endless currency upon which she casts a spell making all who possess it never doubt its value.

Fri, 05/23/2014 - 20:49 | 4790189 Dr Benway
Dr Benway's picture

Lol the banks don't lend a proportion of deposited money. Deposits are created by lending, money pulled from thin air.

Fri, 05/23/2014 - 21:15 | 4790246 Yes_Questions
Yes_Questions's picture

 

 

and then there's that. 

Fri, 05/23/2014 - 20:51 | 4790192 Slave
Slave's picture

This article was a pretty good explanation for noobs. We need these once in a while.

Fri, 05/23/2014 - 20:53 | 4790194 allgoodmen
allgoodmen's picture

I like the term fictional reserve, somebody here came up with that. I almost never use the actual name. And what else do you call a system using a dollar backed by nothing? Worse than the Dow which once had a divisor of 30 and is now something like .000001

Fri, 05/23/2014 - 21:16 | 4790249 El Vaquero
El Vaquero's picture

Backed by nothing you say? No, it's worse than that. It's a coercive ponzi. It's backed by oil, as oil is priced in dollars. It's backed by force. The ways in which this is true are numerous, but if you want to see a domestic example, remember that "This note is legal tender for all debts, public and private" on it, and then look up what a writ of execution is. And it's backed by debt. I can guarantee that you know many people who will take your FRN because they owe debts to others, and if they don't pay them, there is the potential for the creditor to get a judgment and then a writ of execution. The fact that it either requires periodic partial collapse or sustained real exponential growth tells you of its ponzi nature.

Welcome to planet, motherfucker.

Fri, 05/23/2014 - 23:22 | 4790530 mvsjcl
mvsjcl's picture

Welcome to planet Motherfucker?

Sat, 05/24/2014 - 09:26 | 4791048 Sean7k
Sean7k's picture

Or read the Constitution and see that congress can make no bill of credit a legal tender. That a dollar is 371 1/4 grains of pure silver and gold a ratio thereof. That Congress is required to meet regularly and make sure the ratios of all monies are in balance. Then price a paper dollar, a silver dollar, a $5 dollar gold piece, a nickel-copper dollar and all their various weights. 

 

Fri, 05/23/2014 - 20:55 | 4790200 q99x2
q99x2's picture

Any nations still out there that haven't been taken over. Listen, it will behove you to arrest Loyd Blankfein the first chance you get. He will get you if you don't arrest him first.

If you do get him then we will come rejoicing bringing in the thieves. Bringing in the thieves bringing in the thieves, we will come rejoicing bringing in the thieves.

Fri, 05/23/2014 - 21:07 | 4790225 Mr. Pickles
Mr. Pickles's picture

Mostly accurate, but the 4/5 example is actually the bank keeping the $100 as reserve, while loaning out $400 in fraudulent paper. Inflation results, bubbles form and pop, then a run begins on the bank for $500. There's your depression, folks.

Fri, 05/23/2014 - 21:19 | 4790260 Dr Benway
Dr Benway's picture

No, it's actually worse than that. The bank creates the deposit by making the loan. So if the bank lends you $1000, it creates it in your account, no prior deposits of any kind necessary. You can withdraw $800 and buy propellerhats, the bank will still be within its 20% requirement.

Fri, 05/23/2014 - 21:29 | 4790277 potato
potato's picture

Yes. money multiplier is 1/(required reserve ratio) which is in this case 1/(1/5) = 5

The money supply increases by a factor of five in a 20% RRR regime

Fri, 05/23/2014 - 21:08 | 4790228 HeavyShadow
HeavyShadow's picture

an appearance of the 4th kind... what appears to be, but is not

Fri, 05/23/2014 - 21:17 | 4790230 RaceToTheBottom
RaceToTheBottom's picture

The engineering equivalent to Fractional Reserve Banking is building a toll bridge that works most of the time.  It saves a shitload of money and provides a shitload of profits to the owners of the toll bridge.

 

The only problem occurs when a traffic jam occurs and more cars are on the bridge than it can take and it falls into the river.

Fractional Reserve banking exactly the same thing:  It relies on probabilities and federal backups to stop the runs that would occur and increasse the profits of the banksters.

If an engineer built a toll bridge like that, he would lawsuited to death,; instead banksters get bonused to heaven...

 

Fri, 05/23/2014 - 21:49 | 4790329 JR
JR's picture

Since it was created in 1913 the Federal Reserve System has presided over the crashes of 1921 and 1929, the Great Depression of 1929-1939, recessions in the years 1953, 1957, 1969, 1975 and 1981, a stock market Black Monday in 1987, the bursting of the dot-com bubble in 2000,  the collapse of the sub-prime housing market in 2007, the 2008-economic meltdown…and ZIRP beginning in late 2008 - devaluing Americans’ savings while inflating the money supply hand over fist for Wall Street beginning with QE in early 2009.

The Fed has been, and is, a destructive force of gigantic proportions, attacking at the heart of America’s economy and leaving in its wake these past 100 years the destruction of the estates and lives of countless businessmen, farmers, depositors in the 1000s of failed small banks inthe 20s and 30s, indebted students, retirees, displaced home owners, young working people, and America’s standard of living in general.

America was a land of hope and opportunity, laying foundations in the early 20th century for consistent unequaled growth until a concentration of power in the hands of the big New York banks, the money trust, took ownership of the money supply in 1913 under the moniker, Federal Reserve System, destroying free enterprise competition in partnership with the government, with the sole power to create money out of nothing, bail out their bank failures and tax via inflation.

G. Edward Griffin explains the enormity of this gigantic scam, a scam that most people don't even know is a scam: “We're talking about a river of unearned wealth that is so wide you can't even think of crossing it, flowing perpetually into the banking cartel. A dead shot across the productive element of society. Money being taken from people who are working hard providing the material and the labor. They don't even know that this is being taken from them and it's in this huge river of wealth flowing into the banking cartel. It's a staggering thought.”

And where is this river flowing?

“They are spending it to acquire control over the power centers of society. The power centers are those groups and institutions through which individuals live and act and rely on for their information. They are literally buying up the world but not the real estate and the hardware, they're buying control over the organizations, the groups and institutions that control people…This process has gone on not only to a marked degree in America and in the other industrialized nations of the world, but it has gone on in the so-called third world or underdeveloped nations to such a degree that I would say the process is now complete. They own these countries… These countries have been purchased because the politicians in those countries are now totally addicted to this money.” …

“What I'm trying to say is that the name of the game out there is not wealth, it is power.”

Sat, 05/24/2014 - 00:17 | 4790614 Radical Marijuana
Radical Marijuana's picture

YES, JR!

That is well worth repeating:

“What I'm trying to say is that the name of the game out there is not wealth, it is power.”

The problem is that the source of that power is enforced frauds.

Backing up legalized lies with legalized violence NEVER makes those lies become true. Instead, the more successful the banksters become, the more insane the whole society is, because the more it is controlled by lies.

After at least a Century of the international banksters recapturing control over the American monetary system, the government of the USA has become more stark raving mad than we could actually comprehend, because its situation has devolved from debt slavery to debt insanity, which no longer has any mathematically possible way to be fixed within the established systems. There are no possible monetary "reforms" that could work ... Instead, we are being driven towards psychotic breakdowns, into some currently unimaginable phases of monetary "revolutions."

Sat, 05/24/2014 - 12:29 | 4791310 Kirk2NCC1701
Kirk2NCC1701's picture

As others have also pointed out, the variations on the FRB fraud have been around for millennia.

In fact, the New Testament documents this in the scene where Jesus has his only "meltdown" in a fit of Righteous Indignation*, when he overthrows the tables of the Money Changers.  They issued Temple Coins for Shekels, that were used to buy things in the Temple Store (doves, etc).  They paid the Temple Priests a percentage of the hefty profits.

I'd go so far as to claim that THIS was the real "unforgivable crime" that Jesus committed against the Priests, and what caused them to spring into action and why he "had to die".  Everything else was a smokescreen.  And don't forget that when the "Bible" was collated (into one volume, from a much larger collection of writings) at the Council of Nicaea, that the Roman Emperor Constantine sponsored the whole event of deciding what was "divinely inspired", what was not, and what was downright dangerous heresy.  Constantine wanted one national religion, whose leaders would mirror the hierarchy of the Roman military.  That would makes for very easy control of such a religion, by controlling or selecting its leadership.

 

* Most people confuse Rage with Righteous Indignation, and the MSM, public schools and HR people use only the former.  Rage is a purely emotional response, devoid of a rational component.  Righteous Indignation on the other hand, has a rational and moral basis of outrage -- that spills over into the emotional part also.  Big difference.

Fri, 05/23/2014 - 21:57 | 4790348 limacon
limacon's picture

Sigh . 

Fractional banking predates even money . 

See Celtic credit arrangements concerning cattle .

The Roman Empire copied all the good bits and the bad bits .

Gresham's Law struck , and the bad bits triumphed .

The Roman Banking System really worked the poor over to past penury .

Hence the early Christian and Islamic strictures against interest .

This is now about 1500  years on , and the same mistakes are repeated .

 

Greed and Stupidity are the hostlers of your penury and death by starvation .

See Ostrum systems how to avoid it .

Andre

 

Sat, 05/24/2014 - 00:31 | 4790629 Radical Marijuana
Radical Marijuana's picture

http://www.youtube.com/watch?v=CZIINXhGDcs

David Graeber, DEBT: The First 5,000 Years

The idea that "money" originally evolved from bartering is not completely correct, although it is wide-spread and seems to make common sense:

 http://www.youtube.com/watch?v=P49CuntfNGk

A Brief History of Money - By Deek Jackson

Anthropological studies show that social fiat currencies began with the dawn of time. For more details, see Charles Eisenstein & David Graeber, (video linked above) who say that "money" (as metal coins) was invented to finance war.

My definition is:

MONEY IS MEASUREMENT BACKED BY MURDER.

Fri, 05/23/2014 - 22:16 | 4790402 limacon
limacon's picture

Without Bankers nobody would be stupid enough to invest in Civilization .

Sat, 05/24/2014 - 00:07 | 4790596 Radical Marijuana
Radical Marijuana's picture

Ah!

The paradoxes of the specialization of labour!

The benefits tend to be off-set by some specializing in being dishonest, and backing that up with violence. Thus, the advantages of most people being productively specialized tend towards eventually being canceled out by a few who get into their own specialized feedback loops of deceits, backed by destruction, whereby the production of destruction controls production.

After any group in society starts to get away with fraud, then they automatically become more wealthy and powerful, and so, even more able to get away with fraud. The tragic trajectory of the banksters is degeneration from acting like the top carnivores in the human systems, towards becoming parasites that are like a cancer killing its host organism. THE PARADOX IS INTENSE THAT WHAT ORIGINALLY MAKES CIVILIZATION LATER IS WHAT BREAKS IT.

Fri, 05/23/2014 - 22:25 | 4790428 limacon
limacon's picture

Banker's Ruins .

When they just walk away .

Like Maya

Like Detroit 

Like Angkor

The City has become too onerous .

Not worth it .

Humans just walk away .

Andre

Fri, 05/23/2014 - 23:31 | 4790545 MrBoompi
MrBoompi's picture

One huge reason things are much worse today is because of derivatives. For example, just a small upward tick in interest rates would easily wipe out all capital in certain banks and worse, since I'm sure the Fed would secretly have to bail them out with trillions more newly printed dollars. And just like the mortgage derivative schemes, there are ways to place bets and cause the very disaster you can then make enormous profits from.

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