Putting a Splint on Banks
Full reserve banking is an alternative monetary system to fractional banking that requires banks to keep the full amount of any deposited currency at hand, ready for immediate withdrawal on demand. In comparison to fractional banking, where only a percentage of deposited cash is required as a reserve, the creation and growth of the money supply would be stunted as money deposited would now equate to the amount of money in circulation; the mechanism of money creation via banking entities and institutions would be eliminated and instead, the power to create money would fall entirely to the state. Even though the establishment of this form of monetary system is yet to be imposed in any country the practical theory behind it is well supported by the following reasons:
· The elimination of bank runs and fewer bank failures - in a period of economic downfall, customers withdraw their deposits due to the belief of financial insolvency, which in turn triggers further withdrawals as a bank faces the likelihood of default and bankruptcy. The reason behind bank runs is due to the lending behavior that occurs in fractional banking: When a bank makes a loan, it does not typically do so by giving them dollars worth of banknotes. Instead, it credits their bank account with money borrowed from a depositors account. At that moment, new money is created and the quantity of depositor’s money that is left is only the required reserve amount". With full reserve banking this panic would be eliminated and banking failures would be less of an occurrence.
· Booms and busts of a typical business cycle would be mitigated - These are largely due to inflation and deflation of fiat currency. Banks would be deprived of their current ability to print money and destroy it. When more money is supplied into the economy, the value of the dollar is depreciated; that is, making loans would not inflate our circulating medium and calling loans would not deflate it. This in turn would result to a more stable and predictable economy where full reserve banking is practiced and the power to create money is delivered to the state.
· The amount of debt in an economy would be substantially reduced - In fractional banking, money equals debt. Due to expansionary monetary policy, when new money is created and lent to customers, financial institutions require the principal to be paid back in full, on top of any added interest. However, in the process of money creation, only a principal amount of money is added into circulation - so where does the money to pay interest derive from? In full reserve banking debt would decrease as the mechanism of money creation and lending (which requires more than just the principal to be paid back) would diminish.
The Market Can Heal Any Wound
The Current system of fractional reserve banking is the greatest catalyst for economic growth since the introduction of uniformed currency. This system allows for the widespread availability of funds through a system of checks and balances. Fractional banking can be risky, do to bank runs, but this event can be mitigated by an institution known as the lender of last resort. In the United States we have the Federal Reserve, which allows banks to acquire cash flows to avert bank runs. In addition to the lender of last resort measure, national deposit insurance provides an extra layer of security. If fractional banking was such a risky endeavor then why are saving account interest rates so low? Does this not prove that the market is indicating that the fractional system is safe? Saving bonds from governments earn higher interest rates than a saving account; if we are to believe consumers are rational, cannot we reasonable assume that this system must not be a high risk venture. Fractional currency adds an important aspect to economies that is rarely mentioned, monetary velocity. The quick ability for money to move through economies with fractional banking systems is vital. This reduces the crowding out effect that can come with any large economic actor demanding funds. That is the key; fractional banking does not change the amount of capital in an economy, it changes the overturn rate. Fractional banking allows for financial institutions to preform large transaction without drastically effecting the economies monetary inputs.
· The power to create money always falls on the state, any other entity creating money is illegal. The government can control the monetary base, though, as the last recession showed us, they do not have the ability to control The M1, M2, and M3 accounts. (see chart at bottom)
· Money is debt, a necessary debt and cost a government must assume for the economic benefit of the people under their rule. The correlation between dollar value and quantity of dollars is a loose relation. When we regressive data since 2010, the relationship between the value of the U.S. dollar compared to other major currencies is effected by 0.0000879% (adjusted for residuals) for every million dollars added to the monetary supply. That change hardly warrants the destruction of the current banking system.
Fractional banking allows for banks, the institutions with the most adept understanding of debt demands, to control their supply. The government is not the best institution for understanding debt demands, so why should they be in charge of production of available debt? Fractional banking allows for the best institutions to make the decisions on how much debt should be produced, rather than giving that production from an economic entity that is well known for not being able to judge economic demands. The government should be left to account for negative externalities and regulating the “rules of the game,” they should not be a player. As I said in the beginning, fractional reserve banking is the greatest catalyst for economic growth since the introduction of uniformed currency.