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GOLD MONEY VERSUS FRACTIONAL RESERVE BANKING

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For 100% reserve paper money to be honest, it has to say something like:

This note is redeemable for 1 gram of gold, payable upon demand

For fractional reserve paper money to be honest, it would have to say something like:

This note is redeemable for some unpredictable fraction of 1 gram of gold, payable if this is your lucky day

Most of us, I'm sure would refuse to accept the fractional kind. The law currently requires merchants to accept the fractional kind, so the natural response is to spend them and horde the good kind. Thus, bad money drives out good (Gresham's law)

In the absence of coercive laws, I suspect fractional reserve banking would die from lack of popularity.

It reminds me of Gault in the valley: "What money? You're penniless, Miss Taggart."

I would have no problem accepting fractional money in my business, and as per my previous posts, I see nothing wrong with it.

But I don't think an honest fractional banking note will say what you say it will on it. Instead I imagine it will say something like "This note is redeemable for 1 gram of gold, payable within 30 days." so if a bank does end up in trouble, it has time to seek emergency financing from investers, or a bridging loan if it is a temporary problem.

Fractional banking is simply the recognition of the fact that wealth doesn't sit there being used 24/7, it is only called upon part of the time, so the banks set the percentages that there is enough in reserve to cover the percentage of the time that the owners call upon it, and the rest is lent out to ensure the most efficient use of resources.

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OK, it could say redeemable within 30 days. But whatever it said, it would be apparent that it was not as easily redeemable as 100% reserve paper. Assuming that both types were in circulation, I would feel nervous holding the fractional stuff because I would always be wondering if the rest of the world was going to stop accepting it and I would be left holding a lot of worthless paper. I’m certain that most people prefer hard currency and won’t accept anything else unless they are coerced, which is why there are legal tender laws.

So what I’m getting at, is that you might be happy to accept fractional money, but if not enough other people are, then you won’t be able to spend it and you’ll get hungry.

My guess is that when bizarre things happen to an economy, such as we see today (I’m getting off the subject a little here), everyone wants to feel confident that they can convert their paper to gold in a hurry. Since the 70’s, I’ve been expecting a colossal crash and I’m going to lose everything unless I can convert it to gold. And if everyone wants to redeem their paper for gold at the same time, and there isn’t enough gold to go around, well… we know the rest.

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I offer that those who have a concern on the subject of gold, money and other items dealing with banking should read two of Richard Salsman's bulletins titled, "Gold and Liberty" and "The Collapse of Deposit Insurance -- and the Case for Abolition."

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My thanks for the links and references to publications about gold and fractional reserve. I have read all that were easily accessible and will do what I can to obtain more. However, my primary interest is the moral issue. If anyone can point me to an article on that I appreciate it. This may have been discussed earlier in this thread, and if so, I apologize for missing it, I’m a newcomer. Here it is in my own words.

Let’s say I have 100 grams of gold in my safe at home, and I make 100 paper notes with the promise: “This note is redeemable for 1 gram of gold at the bank of Tony Ibbott”. Then I spend them all. I buy a bicycle from one friend, a sack of potatoes from another, loan a few to my cousin, and so on, and I sleep well at night knowing that I’m honest.

A week later, no one has come to claim their gold, so I make one more paper note and buy a painting.

Now I’m lying awake at night because I know that I got something for nothing. The gold in my safe was all owned or borrowed by others. I know that I could say that I am putting my investment to work, but I can’t avoid the fact that I have created money out of thin air. Even if I inform everyone that I’m practicing fractional reserve banking, and nobody cares, it doesn’t change the facts. I still spent something I didn’t have. I took money out of an inkwell. I can only conclude that fractional reserve, to any degree, is dishonest. Am I missing something?

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My thanks for the links and references to publications about gold and fractional reserve. I have read all that were easily accessible and will do what I can to obtain more. However, my primary interest is the moral issue. If anyone can point me to an article on that I appreciate it. This may have been discussed earlier in this thread, and if so, I apologize for missing it, I’m a newcomer. Here it is in my own words.

Let’s say I have 100 grams of gold in my safe at home, and I make 100 paper notes with the promise: “This note is redeemable for 1 gram of gold at the bank of Tony Ibbott”. Then I spend them all. I buy a bicycle from one friend, a sack of potatoes from another, loan a few to my cousin, and so on, and I sleep well at night knowing that I’m honest.

A week later, no one has come to claim their gold, so I make one more paper note and buy a painting.

Now I’m lying awake at night because I know that I got something for nothing. The gold in my safe was all owned or borrowed by others. I know that I could say that I am putting my investment to work, but I can’t avoid the fact that I have created money out of thin air. Even if I inform everyone that I’m practicing fractional reserve banking, and nobody cares, it doesn’t change the facts. I still spent something I didn’t have. I took money out of an inkwell. I can only conclude that fractional reserve, to any degree, is dishonest. Am I missing something?

I may not have this right either, but the way I understood how the honourable fractional reserve system worked was this; you lend the bank, via deposit, 10 oz gold. So do many others. The bank keeps a certain percentage in reserve in case the depositor needs it again. The bank informs the depositor that it pays him interest for the use of his money to lend to others at a higher rate to make up for the higher risk of loans to individuals. At no stage is more money in circulation than should be. You give up your right to the money for an agreed period for a price in the form of interest.

If the bank lends out money it doesn't have a right to, that then is the road to inflation - more cash chasing a given amount of goods.

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A week later, no one has come to claim their gold, so I make one more paper note and buy a painting.

Now I’m lying awake at night because I know that I got something for nothing. The gold in my safe was all owned or borrowed by others. I know that I could say that I am putting my investment to work, but I can’t avoid the fact that I have created money out of thin air. Even if I inform everyone that I’m practicing fractional reserve banking, and nobody cares, it doesn’t change the facts. I still spent something I didn’t have. I took money out of an inkwell. I can only conclude that fractional reserve, to any degree, is dishonest. Am I missing something?

I do not have the time this morning to give a proper explanation to your request, but I will point out one problem with your example. Banks lend money (which is what gold is, a form of money) to people that they estimate to return it with interest from their future productivity. Your example highlighted above is not really a form of direct productivity but instead an example of consumption or a destroying of wealthy. With that stated even if you did borrow the money to obtain the picture the bank expects you to return the wealth from your future productivity or in other words wealth creation. And if banks lend money to producers for an expected return of interest and some profits which means the creation of more wealth, then they would pay a gold miner to produce mine more gold to carry their fractional reserves.

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I’m pretty sure that I have described the essence of fractional reserve banking. Here is a quote from the PASSPORT CAPITOL article referred to earlier. My thanks to rtg24.

“Fractional reserve banking was inherently inflationary because it caused the number of gold receipts circulating in the

economy to increase. Consider this scenario. A bank is capitalized with a customer depositing 100 ounces of gold and in return issues the customer 100 gold receipts. At this point 100 gold receipts are circulating in the economy chasing whatever goods and services that economy produces. Now, the bank issues 20 gold receipts to someone as a loan. There are still only 100 ounces of gold in the vault, but there are now 120 gold receipts circulating in the economy.”

. . .

Because banks issued more receipts than they had gold in their vaults, at any given time banks had only a fraction of the gold needed to honor their liabilities.”

The example I created of my own bank was an attempt to reduce fractional reserve banking to its essentials. That is, I have 100 grams of gold in my safe, yet I have issued 101 receipts.

A real bank of course, does other things such as loaning money and charging interest, paying dividends on savings, and so on. But I think the essence is the same: it issues more receipts than it has gold in the vault. Worse than that, it is my understanding that because paper money can no longer be redeemed for gold, banks don’t even have gold in the vault anymore. They simply have dollars listed in the ledger books, and every time someone borrows from one bank and deposits it in another, the receiving bank multiplies it many times by loaning out many times more money. So, I’m still of the opinion that the whole scheme is dishonest. I’ve been searching to see if any Objectivist economists agree, but I haven’t found anything specific yet.

It is also my understanding that this, combined with the massive amounts of fiat money printed by the Fed, is why the entire economy is now based on debt instead of savings, why my parents bought their first house for $17,000, and that house today is probably selling for $500,000, and why a massive collapse is inevitable.

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Tony, I recommend that you do a lot more reading within the whole field of economics and specifically gold, banking, interest and other items. I have already mentioned a simple place to start, but would also add that you read the man that I consider to be the best economist of all time Jean-Baptiste Say. Until then I would add that there is nothing intrinsically nor morally wrong with factional reserve banking and that the problems you mention happen in a statist economy not a capitalist one.

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I am familiar with the works of JB Say and hold him in high regard. I’ve also read many others. There are some really impressive men among them. But honesty must be judged by my own mind. I cannot simply take anyone else’s word for it.

Interestingly, I think I’m seeing a trend. For the last several centuries, fractional reserve has been promoted as a beneficial innovation, but recently I’m starting to see negative articles more frequently, and by many different authors. I am not the only one questioning its legitimacy.

Here is a thought. In a simple society such as Gault’s Gulch, where as near as I can tell, all trading is done by gold coins only and no paper money, fractional reserve is not possible; the gold can only be in one pocket at a time. It is only the advent of paper receipts in lieu of precious metal that makes it possible for multiple borrowers to unknowingly lay claim to the same gold at the same time. That in itself raises my suspicions.

But to continue. I can observe that printing more notes causes inflation, and I have seen from my own experience that inflation erodes savings, so when I consider opening a bank and practicing fractional reserve, I know that even though I am enabling some people to make use of money that did not previously exist, I am simultaneously reducing the buying power of all the other players.

I could achieve the same result by going around town, dipping my hand into the pocket of each other person, withdrawing a dollar bill and lighting it with a match.

Thus, my opinion is that fractional reserve is (1) loaning out something I don’t have, and (2) destroying a small amount of wealth of each of the other players.

I will continue studying all sources in an effort to find any argument that might alter my conclusion.

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Tony, all you keep doing is stating the same thing although through different examples which I still disagree with. Your first post did not convince me and none of the others have either nor will they for reasons I have already given in this thread and other areas on this forum. And if your best attempt at persuading us is that "others" have questioned fractional bankings legitamacy, then you do not know Objectivist very well.

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I’m pretty sure that I have described the essence of fractional reserve banking. Here is a quote from the PASSPORT CAPITOL article referred to earlier. My thanks to rtg24.

“Fractional reserve banking was inherently inflationary because it caused the number of gold receipts circulating in the

economy to increase. Consider this scenario. A bank is capitalized with a customer depositing 100 ounces of gold and in return issues the customer 100 gold receipts. At this point 100 gold receipts are circulating in the economy chasing whatever goods and services that economy produces. Now, the bank issues 20 gold receipts to someone as a loan. There are still only 100 ounces of gold in the vault, but there are now 120 gold receipts circulating in the economy.”

. . .

Because banks issued more receipts than they had gold in their vaults, at any given time banks had only a fraction of the gold needed to honor their liabilities.”

What you describe has existed. Paper money has been printed without an intrinsic basis. However, a proper fractional reserve would rest on your agreement to give up the use of your money so that others could use it. Your payment is in the form of interest. The receipts for your gold would have terms that prevented you from spending them for the duration of the loan to the bank. It is a term deposit. Your receipts are not in the market chasing goods, until the bank has collected the loan from the other party it lent your money to. At that time, the other party no longer has the money in the market, so no inflation takes hold.

Unfortunately such discipline doesn't always take place, and the gold being held has too many receipts outstanding. That happened in 1968 and led to the abandonment of gold as a standard. After all, paper is easier to print than gold.

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[...] . . . . . But, I do not agree with you at all about how trade fits into economics or that trade requires arithmetic. The process that economists are more concerned with is how a person and thus the market selects one economic good over another. [...]
[...]

Trade requires arithmetic. When you purchase a product you may, for example, say that you want to buy a quantity of fifteen items at a price of ten dollars each, and [using arithmetic] that comes to a total of, fifteen dollars. Next time you buy something, or review your credit account statement, tell me that you haven't used arithmetic.

[...]

Error. The total of fifteen times ten equals one hundred fifty [not the fifteen written above].

The next time the Federal Reserve audits the Fed's U.S. gold reserves, the citizens of the U.S.A. should watch them like a hawk reinforced by the ATF, FBI, U.S. Marshals, CIA, the Supreme Court to issue arrest warrants, and element's of all the several States' National Guard units.

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